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It is a decision that still casts a long shadow over Ottawa's books.

Cutting the goods and services tax by two percentage points starting in 2006 makes almost everything the government has done since seem, well, like small potatoes. That includes the entirety of last week's 433-page budget.

Every percentage point of GST is now worth just shy of $7-billion a year, according to a recent calculation by the Parliamentary Budget Officer. Two points cost Ottawa a staggering $14-billion.

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For a sense of scale, reversing the GST rollback would virtually wipe out next year's projected federal deficit of $18.7-billion.

Indeed, the sum dwarfs all the signature items trumpeted in Finance Minister Jim Flaherty's latest budget. Think of the $5-billion a year that's being invested in Canada's crumbling urban infrastructure, the $500-million a year cost of Ottawa's vaunted jobs grant program or the $140-million a year for extending the tax break for embattled manufacturers who invest in machinery and equipment.

Needless to say, not having $14-billion also delays what the Conservatives now insist is job No. 1 – erasing the deficit by 2015.

Maybe you don't buy the argument that deficit reduction is a worthy goal. So imagine, then, what the federal government might do with $14-billion the next time you're filing your taxes or waiting to see an orthopedic surgeon.

It isn't just the opportunity cost of $14-billion. Tax policy is arguably the most important lever a government possesses. Taxes send important signals about what individuals and companies do with their money, affecting how resources are spread throughout Canada's $1.5-trillion economy.

The economic literature is overwhelming on the relative merits of various taxes – consumption taxes versus personal or corporate income tax. The GST is a clear winner.

Start with the assumption that no one likes paying taxes. Taxes of all kinds discourage people from working because individuals keep less of what they earn. What governments should strive for is finding the least economically damaging means of raising the revenue they need.

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The benefit of consumption taxes over income taxes is that they are less likely to distort where and when people spend. Consumption taxes, such as the GST, essentially treat current and future consumption the same. Income taxes, on the other hand, penalize future consumption over current consumption and discourage saving.

Consumption taxes aren't perfect. They're regressive, meaning they hit the poor disproportionately hard. Unlike income taxes, which are scaled up as you earn more, everyone pays the same GST rate. Ottawa offsets this by giving a credit to low-wage earners.

Back in the early 1990s, another Conservative government – Brian Mulroney's – concluded that on balance a national value-added tax on most goods and services was the way to go. Stephen Harper's Conservatives unwound a big piece of that policy when they lowered the GST rate, first to six per cent in 2006 and then to five per cent in 2008.

Politically, it was a success. The party secured its majority.

Economically, it was a mistake that may never be reversed.

The government apparently saw the move as an expedient way to burnish its credentials as a tax-slashing government. Perhaps, the government also thought (mistakenly as it turns out) that cutting the GST would provide the impetus to make government smaller by starving the beast of revenue. Both the deficit and the government have grown hugely since 2006.

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The GST rollback was a gift to retailers, many of whom exploited it as a way to raise profit margins. The benefits that flow to consumers disproportionately go to the wealthy, who spend more.

Governing is about choices. Ottawa opted for GST cut over lower income taxes, which would have had the added benefit of encouraging people to save for retirement – now identified as a major problem in Canada. The decision also shifted the relative tax burden to an inefficient tax over a efficient one.

Perhaps most distressingly, the GST cut deprived Ottawa of a cushion to weather the next economic crisis that may come its way – a commodities bear market, a housing collapse or a stall in the U.S. recovery.

Canada went into the global recession in relatively good shape.

Just imagine where it might be now with another $14-billion in the war chest.

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About the Author
National Business Correspondent

Barrie McKenna is correspondent and columnist in The Globe and Mail's Ottawa bureau. From 1997 until 2010, he covered Washington from The Globe's bureau in the U.S. capital. During his U.S. posting, he traveled widely, filing stories from more than 30 states. Mr. McKenna has also been a frequent visitor to Japan and South Korea on reporting assignments. More


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