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Pro-HST Economist Defends His BC Business Council Study

Kesselman says Clark's 'fix' cuts too deep, fires back at Schreck critique in Tyee.

By Jonathan Rhys Kesselman 30 May 2011 |

Jonathan Rhys Kesselman is a Canada Research Chair in Public Finance and professor with the School of Public Policy, Simon Fraser University; he is currently conducting research with the Institute of Fiscal Studies, London.

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Professor Jon Kesselman: A one per cent cut is enough. Photo: SFU.

In his recent Tyee column, David Schreck launched a scathing critique of my study of the HST's impact on B.C. consumers. He asserts that my estimating methodology was flawed and that the data I employed was inadequate to the task. Based on his own computations, Schreck claims that my results could easily have resulted from random variation rather than measuring the HST's true impact. However, as I shall demonstrate here, his critique is rife with fundamental errors of analysis and interpretation. Additionally, Schreck offers no alternative methodology for gauging the HST's consumer impact. Astonishingly, he suggests that "community activists who can see what the HST is costing families" are a more accurate gauge of the HST's impact than objective analysis using the best available data.

To provide a basis for understanding my objection to Schreck's critique, I begin by summarizing the key methods and findings of my study, which will be published in a revised form in the June issue of Canadian Public Policy. By comparing movements in the consumer price index (CPI) for B.C. with those for the other western provinces in the period preceding and following the HST switch, I compute the net impact on B.C. consumers. This estimate includes both the direct impact of the HST's broadened coverage and the offset by any pass-through of the business tax savings to consumers. The issue of whether, and to what extent, businesses have passed through their savings in the form of lower (or less rapidly increasing) prices is critical to assessing B.C.'s HST reform. My study is the first to undertake this assessment in an objective, systematic manner using well-established methods of program impact evaluation.

As expected, in the month of the reform (July 2010), consumer prices rose for B.C. but only by one per cent relative to the comparator provinces (Alberta, Manitoba, and Saskatchewan). In the following five months, B.C.'s CPI relative to the comparator provinces declined by 0.6 per cent, which gives a net impact for B.C.'s HST of 0.6 per cent (rounding the sum of the two figures). When I extended the post-HST period for additional months into 2011 (not in my original study), this result proves stable and falls even further to a net impact of 0.5 per cent. These figures imply a net burden on consumers as a result of the switch from B.C.'s old sales tax plus GST to the new HST of just one dollar for every $165 to $200 they were paying before the reform.

My further analysis revealed that this estimate was consistent with B.C. businesses having passed through all of their tax savings associated with their goods and services sold to B.C. consumers. And as expected from the economics of the HST, B.C. businesses had not passed through to B.C. consumers their tax savings associated with their sale of goods and services outside the province. Those retained business tax savings created both the net cost of the HST to consumers and the incentive for firms to expand their investment and employment in B.C. Especially significant is that many of these gains will arise in regions of high unemployment, where they will create many well-paying jobs in export-oriented resource industries over future years. Other gains for workers and wages will arise in urban areas in the high-tech and knowledge sectors as well as motion picture production.

Taking on Schreck's criticisms

Schreck begins his critique by asserting that "Kesselman's study is incorrect for two reasons." He cites an article on the "difference-in-differences" method, a standard method for evaluating program impacts and used in my study, that finds possible issues of unreliability. What Schreck fails to note -- a point explicit in the article he cited -- is that this problem can be resolved by collapsing the data into "pre-change" and "post-change" periods, rather than using all of the individual observations in each of those intervals. My research method did precisely that, and thus avoided the deficiency alleged by Schreck. I compared a post-HST period (July through December of 2010, which in more recent estimates I have extended through April of 2011) with the pre-HST period of June 2010. My results are also stable using a longer pre-HST observation period.

Schreck goes on to undertake computations of price changes that he claims are comparable to mine using CPI data for B.C. and the other western provinces for the 30 years from 1981 to the current date. He finds a lot of volatility in the figures (shown in his graph), which he interprets to imply that my estimate for the period surrounding the HST in 2010 must be unreliable. However, the period that he selected includes episodes of much higher inflation than the relevant period for assessing the HST impact (rates approaching 13 per cent in 1981, six per cent in 1991, and five per cent in 2003). With such high inflation rates also comes a lot more price volatility than B.C. and its neighbouring provinces have experienced over the past year. Schreck's inappropriate comparison invalidates his inference that my 0.5 to 0.6 per cent estimate must be unreliable.

Schreck next argues that "the CPI data (Kesselman) used may be inadequate for the purposes for which he used it." He cites a Statistics Canada publication's warning about possible reliability problems in using the CPI data for single month-to-month changes or narrow product categories. However, my analysis used a long series of months (seven in my original analysis, now extended to 11) and the broadest aggregate of consumer goods and services (excluding only energy to improve cross-province comparability), thus heeding the StatsCan warning and avoiding the hazards that Schreck cites.

Further support for the validity of my estimated impact for B.C. stems from a comparable study for Ontario by Professor Michael Smart, a leading public finance economist at the University of Toronto. Employing the same methodology as I have used and taking Quebec as the best comparator for Ontario, Smart arrives at a similar 0.6 per cent estimate for the HST's consumer impact in that province. Still other economic studies such as one undertaken for a cut in France's VAT rate similarly find fast and high pass-through of business tax savings to consumers for goods and services in competitive markets.

HST does away with hidden taxes

Schreck states that no survey exists to support my claim that most economists favour value-added taxes (or VATs) like the HST. In fact, support for VATs relative to more distorting types of sales taxes is almost universal among economists specializing in taxation. Concrete evidence of this is the fact that more than 140 countries around the world (including the social democracies of Europe) have long ago moved to VATs from various forms of sales taxes that burdened businesses and hindered the economy. Closer to home, economic analysts at both the B.C. and Ontario branches of the Canadian Centre for Policy Alternatives have joined more conservative analysts in finding that the HST is superior to B.C.'s old sales tax in terms of its efficiency for the overall economy. These analysts do differ in their views about the distributional impacts of the HST, but my study offered evidence that the B.C. portion of the HST is less regressive than the B.C. tax it replaced.

My disagreement with Schreck may appear to be one of mere methodological import, but that is not the case. Having well-grounded estimates of the consumer impact of B.C.'s HST, and the extent of pass-through to consumers of the business tax savings, is essential to public debate over the new tax. Most people never realized how much they were bearing of the old B.C. sales tax embedded in the prices of goods and services. Nearly as much tax was hidden in product prices as the amount of tax consumers paid so visibly at the cash register. My estimates demonstrate that the HST's relief of these tax burdens on business has flowed through to the benefit of consumers. And even if we have not observed many outright price cuts post-HST, less noticed is the lower inflation rate that the statistics show B.C. consumers have enjoyed relative to the other western provinces.

A two per cent cut in HST rate is too much

Because a broadly based HST is more conducive to economic growth than the previous sales tax, it will increase revenues for needed public services and create more well-paying jobs across the province. In the run-up to the HST referendum, the government is committing to cut the rate by two per cent. I believe that such a cut, while perhaps popular, might constrain revenues even if partially offset by corporate tax hikes. My estimates show that a one point cut would fully offset the HST's consumer impact (one per cent times the 55 per cent of consumption taxed by the HST equals 0.55 per cent, in line with my estimate of the price impact). That would leave all consumers as well off as under the old tax and low and moderate income households significantly better off because of the HST credits. Any larger cut in the HST rate can only be justified by the need to secure public support to retain the tax and avoid a return to an economically damaging sales tax.  [Tyee]

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