35
econometric analysis, they find that the impact of HST reform on M&E investment is
positive and statistically significant.
The inefficiency resulting from the PST on capital goods has been illustrated in a
study by Baylor and Beausejour (2004) based on a dynamic computable general
equilibrium model of the Canadian economy. The study found that the marginal cost of a
dollar of revenue raised by provincial governments24 through sales taxes on capital is
$2.30, compared to $1.40 for corporate income taxes and $1.13 for consumption taxes
like the GST/HST.
A case can thus be made that equal cuts to the different components of the METR
do not in fact have the same impact on investment and that cuts to the PST have a greater
incremental effect than cuts to the corporate income tax. This is because the cuts to the
PST reduce the cost of capital goods to firms, directly impacting the price of capital
goods. This induces investment by making it more profitable through lowering costs.
Cuts to corporate income taxes increase after-tax profits, but have no effect on the price
of capital goods. There is also no guarantee that any ex post increase in after-tax profits
will be invested. An additional reason to reduce the METR through removal of the PST
rather than by corporate income tax (CIT) cuts is that the current CIT rates ensure at least
some of resource sector economic rents arising from higher commodity prices flow to
governments as corporate taxes.
It should also be noted that the PST affects short-lived assets such as information
and communications technology investment goods much more than long-lived assets
such as structures since the former turn over, and hence are taxed, more frequently than
the latter. ICT investment is particularly important for productivity growth.
The federal government has long recognized the problems associated with the
PST on capital goods, particularly in Ontario and British Columbia as these provinces are
responsible for the lion’s share of the 5 percentage point national gap between the METR
with and without the PST.
The federal government would like to see the PST harmonized with the GST, as
happened with the establishment of the Harmonized Sales Tax in Newfoundland, Nova
Scotia, and New Brunswick. One of the key reason for such a policy is removal of the
PST from capital goods. Because of its input tax credit, the GST does not constitute a tax
on capital goods like the PST. But provinces are reluctant to drop the PST on capital
goods. For such a measure to be revenue neutral, provincial governments would have to
increase taxes on consumer goods, a politically unpopular move.
A possible resolution to this situation lies in the federal government providing
financial assistance to the PST provinces to harmonize their PST with the GST. Such
assistance was offered to the three Atlantic provinces in the early 1990s to encourage
24 The marginal cost of a dollar of revenue is the cost of raising an additional dollar of revenue, which
includes the direct cost (the dollar of revenue actually raised) plus any additional welfare costs resulting
from the change in the tax structure.