Canadian sales tax reform: how the U.S. neighbor to the north transitioned from a multistage sales tax to an almost fully harmonized single VAT - in just one century.

• Author: Robertson, David Douglas
• Position: Value added tax

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The problem with good tax policy is that politics always gets in the way.

And for the United States--a country whose sales tax system (at least from a nonresidents perspective) cries out for reform--your neighbor to the north and our experience may offer a cautionary tale of inspiration.

After all, it has only taken us a century to transition from a multistage sales tax to an (almost!) fully harmonized single national value-added tax.

Background

It all started as a "temporary" measure--as all new tax measures do.

In 1920, the Canadian federal government introduced a multistage one percent federal sales tax to pay for the Great War. It was multistaged in that it applied to all transactions other than retail sales. After all, if it applied to retail sales, consumers (i.e., voters) would know they were paying it, and the tax would remind them of the politician who introduced it each time they found themselves standing before a cash register.

The cascading effect of this one percent sales tax certainly raised federal tax revenues, but as a "simplification" measure in 1924, the federal government replaced this "temporary" multistage tax with a single six percent tax that applied to sales by manufacturers. The federal manufacturer's sales tax (FST) was born.

What then ensued was sixty years of recommended reforms by various expert panels, specialized House of Commons committees, and Royal Commissions--most notably, the recommendation of applying the FST at the wholesale as opposed to the manufacturing level so as to broaden the tax base and cease discriminating against domestic manufacturers. Like substantially all such recommendations, none were followed to any great measure by any politician. Experts make reasoned recommendations; politicians seek re-election.

During this sixty-year period, however, the provinces also ventured into the sales tax game.

Notably, the first province to do so was Alberta back in the 1930s with the election of the right-wing Social Credit Party. A retail sales and use tax that applied only to goods, the tax proved so unpopular that voter backlash forced the Alberta government to withdraw it after less than a year. To this day, Alberta remains the only province without any form of provincial sales tax of general application.

All other provinces, however, faced financial need and managed to successfully introduce their own sales and use taxes (PST, as they are commonly known) with catchy names like "Education and Health Tax" or "Social Service Tax Act." After all, it's important to remind voters what those tax dollars are going toward!

Then, in the early 1980s, something fortuitous happened, at least from a tax policy perspective:

The Canadian federal government was digging itself so badly into debt, tax reform started to take precedence over politics.

In 1983, the Federal Sales Tax Review Committee recommended that Canada replace its now very antiquated FST with (1) a national retail sales tax, (2) a federal retail sales tax, or (3) a federal value-added tax (VAT). A year later, in 1984, after consulting with the provinces, the private sector, and other interested parties, the federal government announced it was considering introducing a VAT.

In June 1987--at about the time the international bond rating agencies and economic publications were openly musing as to whether Canada was headed for bankruptcy--the minister of finance published the Goods and Services Tax White Paper.

It proposed replacing the federal FST and the provincial PSTs with a single, national VAT. Negotiations with the provinces ensued, but by early 1989, it became clear a deal with all the provinces was not going to happen. So on April 24, 1989, the minister of finance announced that the federal government would independently introduce its own federal VAT--or goods and services tax (GST)--on January 1, 1991.

The politics of introducing the GST was exactly as one would have expected.

First, certain provinces--each of whom the federal government had been negotiating with for more than two years about introducing a combined federal/provincial VAT--responded by suing the federal government, alleging that the new GST would be a flagrant, unconstitutional intrusion on the provinces' taxing powers. (In June 1992--eighteen months after the GST's introduction--the Supreme Court of Canada ruled the GST was...