There is a parallel between the student protests in 2012 leading to cancellation of Quebec’s tuition fee increases and the referendum a year earlier that put a stop to sales tax reform in British Columbia. No one likes paying higher taxes or fees. But, viewed objectively, former Quebec Premier Jean Charest had a good case – as did former B.C. Premier Gordon Campbell.¹

Charest defended his proposed university tuition fee increases in terms of both efficiency and equity. The efficiency case: Quebec imposes high tax rates, has a large public debt and is running deficits that, in the medium term, are untenable. Other provinces have demonstrated that higher student fees do not discourage student enrolment (Quebec enrolment is below the Canadian average despite very low fees). The equity case: Students are overwhelmingly from families with above-average incomes, and their degrees will enable them in turn to earn above-average incomes. Hence, for reasons of both efficiency and equity students should bear a larger share of the university costs they generate.

Rather than rebut Charest’s case, the students successfully changed the debate into “questions of principle.” Can a government, thanks to its commanding a majority in a legislature, legitimately legislate whatever level of taxes – or fees – it dictates? If a significant number of people object strongly to a tax or fee, should a government be required to seek additional democratic legitimacy, say by submitting the proposal to a referendum? Students answered no to the first question and yes to the second. I disagree. My answers are yes to the first question and no to the second.

The same questions can be asked in relation to B.C.’s debate over its harmonized sales tax, in which ex-Premier Bill Vander Zalm led a successful referendum campaign that culminated in the government rescinding the HST. For the first time, Canadians decided a major tax policy in a referendum, as opposed to in a general election in which voters weigh a government’s tax decisions against other considerations. While this was the first tax referendum in Canadian history, it may not be the last.

At first sight, Quebec student leaders and Vander Zalm do not have much in common. The student leaders take inspiration from the Occupy movement and French socialist traditions of tuition-free universities; Vander Zalm is a populist in the American Tea Party tradition. There are differences between the campaigns. The students generated sufficient civil disobedience to precipitate an early general election, and the winning party, the Parti Québécois, rescinded the fee increase. While a large minority supported the students, opinion polls suggested the majority did not. B.C. has referendum legislation on the books, and Vander Zalm’s campaign successfully exploited it. What the two events have in common is that both successfully challenged the legitimacy of a major revenue-raising decision enacted by a duly elected government.

For those east of the Rockies, the B.C. HST referendum is probably, at best, a vaguely remembered incident (just as Quebec’s tumultuous 2012 student protests are west of the Rockies). I start with a chronology of events, written with at least a semblance of neutrality. Following that, I put forward two conclusions. The first is obvious: there is little understanding among British Columbians – and probably Canadians in general – of the desirability of value-added taxation as the basis for consumption taxes. Second, this incident provides reason to fear the loss of legitimacy of parliamentary supremacy in matters of taxation.

A chronology

In the spring of 2009, British Columbians voted in a provincial general election. Tax policy was a major issue. In 2008, the governing Liberals had introduced a carbon tax with scheduled rate increases in future years. It was the first significant venture in this direction by any North American jurisdiction. In one of its less principled decisions, the NDP, official opposition in Victoria, promised that if elected it would repeal the tax. The Liberals won.

With the election over, Ottawa offered an inducement of $1.6 billion to B.C. (a similar incentive had been offered to Ontario) to transform its provincial sales tax (PST) into a broad-based value-added tax, the HST, that Ottawa would administer jointly with the federal goods and services tax (GST). From the opening scene in the summer of 2009, when then-Premier Campbell and then-Finance Minister Colin Hansen announced its conception, to the summer of 2011, when the curtain fell on its corpse, the HST consumed much of the political energy of British Columbians.

In the wake of a general election in which the governing Liberals had dismissed casual questions about sales tax reform, and with no public consultation, the B.C. cabinet accepted the federal offer. As in most provinces, the recession had induced a budget deficit and the prospect of a $1.6 billion windfall had obvious appeal. In retrospect, agreeing to the federal offer before conducting a major public engagement on the case for broadly based value-added taxation was a fatal mistake. However, as Premier, Campbell viewed his role as that of a senior executive pursuing strategic opportunities and initiatives, not as a mediator leading from behind. The B.C. HST came into effect in July 2010.

Political opposition to the HST quickly emerged, led by Vander Zalm but with extensive NDP support. The NDP made an unsubstantiated case that the impact of the HST would be regressive, but they did not propose low-income tax credits more generous than the ones the Liberals were proposing. The basis of their engagement with Vander Zalm was that the enemy of my enemy is my friend. B.C. shares with other western provinces and western American states a tradition of direct democracy enabling referendums on legislation and petitions to recall elected representatives. The “Fight HST” coalition collected enough signatures to oblige the government, under existing legislation, either to refer the HST to the legislature for review or to conduct a referendum. In September 2010, the government chose to conduct a binding referendum on repeal of the HST and return to the PST-GST.

Other interest groups entered the fray. Larger businesses formed the Smart Tax Alliance and undertook a well-funded pro-HST campaign. The impact of their campaign was probably counterproductive. It fed populist mistrust: if big business favoured the HST, the tax must be bad for the average family. Representing small business, the Canadian Federation of Independent Business (CFIB) hovered on the sidelines, unable to decide whether to intervene for or against the reform. The HST lowered tax compliance costs for federation members, a longstanding CFIB demand. On the other hand, the HST broadened the tax base to most services including restaurant meals, and restaurant owners adamantly insisted on preserving their historical sales tax exemption. The left-leaning Canadian Centre for Policy Alternatives articulated better than most the case for value added as the basis for sales taxation, but criticized the government for insufficiently offsetting regressive implications for low-income cohorts.

Academic and professional economists within the province assumed the role of chorus in classical Greek theatre. They argued that sales taxes should be levied on value added and on both goods and services, and that the PST was an inefficient accumulation of ad hoc exemptions and excessively taxed goods and ignored the evolution of the economy toward services.² As in Greek drama, the chorus offered sage advice, but passions were high and the impact of economic lectures was negligible.

The political opposition maintained – without evidence – that the government had deceived the electorate during the 2009 election by concealing its intention to impose the HST. In November 2010, the chief protagonist in the drama, Premier Campbell, resigned. At this point, the government finally appreciated the furies it had unleashed. Among its initial responses was the commissioning of a provincewide survey of public attitudes toward the HST. Superficially, the debate was over the pros and cons of sales tax reform; more fundamentally, the debate had become an extension of the 2009 provincial campaign. The results of the survey are shown in table 1; the following points are worth highlighting:

• At the time of Campbell’s resignation, a very large majority (74 per cent of respondents – table 1, statement 1) objected to his governing style, as exemplified by the HST decision.
• A very large majority (70 per cent – statement 2) also agreed with the small government antitax ideology effectively promoted by Vander Zalm.
• A similarly large majority (68 per cent – statement 3) accepted the argument, made most forcefully by spokespeople for the NDP, that the HST worsened the lot of low-income families.
• A majority (56 per cent – statement 4) believed that the HST favoured business over consumers and thereby rendered income distribution more unequal.
• Only a minority believed the government’s case that redesigning the PST would make it a “better tax for the economy” (37 per cent – statement 5), that the HST would improve the productivity of the provincial economy (34 per cent – statement 6), or that reverting to the GST and PST would hinder British Columbia’s ability to compete (32 per cent – statement 7).
• A bare majority (50 per cent – statement 8) accepted the argument that the HST reform reduced compliance costs for firms.

From implementation of the HST in July 2010 to Campbell’s resignation four months later, opposition to the HST remained above 75 per cent (see figure 1). By late December, opposition fell to roughly 60 per cent, the level at which it remained until early May 2011.

Having persuaded Campbell to abandon the fight, HST opponents shifted their emphasis: the HST was a surreptitious tax increase with regressive incidence. It allegedly worsened overall income distribution by lowering the sales tax levied on major exporting firms.

In an attempt to inject credible neutral information into the debate, the government struck an independent panel (I served as a panel member).³ The panel’s report was released in early May 2011.

The panel confirmed opponents’ claims that the HST was not only a tax reform but also a tax increase. In its first year, the HST, net of offsets, collected nearly 10 per cent more revenue than would have been collected under the PST. Prior to implementation, the 2010 budget had claimed that, with allowance for personal income tax offsets, transition to the HST “is expected to be roughly fiscally neutral.” In a separate passage, the budget had allowed that “in future years, harmonization is expected to result in increased revenues … because the HST is a more stable and robust revenue source than the PST.”

On the other hand, the panel refuted the claim that the tax reform was regressive. Allowing for personal income tax offsets, family cohorts with income under $10,000 were slightly ahead; cohorts in the $10,000–$20,000 interval were unaffected; and cohorts at higher income levels paid more, with the percentage increase rising with income. Under the PST “pass through” assumptions incorporated in the panel’s modelling, the HST had indeed generated a shift in tax incidence from business to domestic consumers, but given that business largely passed through any taxes paid under the PST, the shift was modest. Finally, the panel predicted that the HST would lead to higher investment and a modest increase in overall economic productivity in the coming decade.

Following release of the panel’s report, the provincial cabinet conducted a series of electronic town hall meetings across the province to hear opinions and publicize the case for the HST. In response to its opponents, the government promised in late May 2011 to lower the provincial portion of the HST in stages from 7 per cent to 5 per cent, and to offset lost revenue by an increase in the provincial corporate income tax rate.⁴

These belated initiatives lowered opposition to the HST by a further 11 points between March and late May 2011. In a poll conducted in late May, HST supporters and opponents were virtually tied (see figure 1). But saving the HST was not a high priority for the new Premier, Christy Clark, and HST opponents rallied. A poll in early June showed a five-point rise in opposition to 54 per cent among decided voters. Referendum voting took place, by mail-in ballot, from late June to early August. The referendum result was identical to the result in the early June poll: 54.7 per cent in favour of repealing the HST, 45.3 per cent against.

The limited legitimacy of broadly based value-added taxation

In governments headed by left-of-centre and right-of-centre parties, government finance officials across Canada and Europe overwhelmingly agree that value added (the difference in value of goods and services sold and inputs purchased by a firm) is the appropriate basis for levying consumption taxes, and that consumption taxes should be a major source of government tax revenue. Most British Columbians – and probably most Canadians – disagree.

Not only is value added the appropriate basis; in principle, all firms should be liable to value-added taxation, whether they produce goods or services. Were the restaurant lobby to argue, for example, that all workers in the sector should be exempt from personal income tax and restaurant owners should be exempt from corporate income tax, public opposition would be intense. On the other hand, probably most British Columbians consider it defensible to exempt value added in the restaurant sector from sales taxes.

Income and consumption are the two largest tax bases from which Canadian provincial and federal governments generate revenue. Whatever the disagreements over details of personal and corporate income tax, the Canadian public accepts the legitimacy of governments using personal and corporate income as a base from which to raise general revenue. In provinces west of the Ottawa River, and in the United States, no comparable support exists for using value added across goods and services as the basis for levying consumption taxes. Two decades after introduction of the GST, widespread opposition toward the federal government persists for its reform of sales tax on the basis of value added. Such opposition is even stronger at the provincial level, and not only in British Columbia. Even though the Ontario Liberal government secured reelection in the fall of 2011, most observers cited the introduction of the Ontario HST as a reason for reduced Liberal support.⁵

This continuing opposition to broad-based value-added taxes offers a powerful temptation to political parties and interest groups to oppose sales tax reform. Small-tax conservatives oppose reform on the general principle that overall taxing effort should be lower. Left-wing critics oppose value-added taxation because, without targeted tax offsets, it may be regressive, and because they favour traditional retail sales taxes as a second-best means of taxing corporate income. As Stephen Gordon has argued, financing generous European welfare states requires the imposition of broad-based value-added taxes at rates higher than the current rates in Canada.⁶ It is time for Canadian political parties wanting to preserve a relatively generous set of social programs to conduct an “adult conversation” on tax policy and abandon their visceral opposition to broad-based value-added taxes.

The unintended consequences of deciding tax policy via referendum

An independent panel report on the pros and cons of the HST should have been published two years earlier, before the government accepted Ottawa’s Faustian deal. Had the government engaged the public on the subject of sales tax reform prior to accepting the federal offer of $1.6 billion, the passions surrounding the anti-HST campaign might have been contained. Nevertheless, I am far from certain that the overall result would have been different. If legislation exists to enable referendums on tax policy, the temptation to organize an antitax referendum is ever-present. It is not overly cynical to fear that, having tasted blood, well-organized opponents of any particular tax will in the future resort to a referendum campaign. Whether or not such campaigns succeed, they are a massive diversion of political energy from other more useful tasks.

Supporters of democratic innovations have been reluctant to acknowledge these unintended consequences of separating taxation from spending decisions. Doug McArthur is a prominent public intellectual in B.C. and an apologist for the use of referendums to decide tax policy. Here, in summary, is his case that the provincial institutions of petition and referendum proved their worth:

The legislation resulted in legitimate, intelligent and much needed debate. The opponents of the HST understood the issues, communicated effectively and honestly by the standards of political campaigns, and voters responded rationally. The legislation helped to force a recalcitrant government into a review that was legitimate and indeed healthy.

It is widely off the mark to blame either the process or the opponents for the faults of a government that proved incapable of managing the issue. Indeed the process and the outcome speaks to the health and vibrancy of BC politics and its institutions, and not to its dysfunction as alleged by some … has proven to be a legitimate and effective part of the BC policy process that could well be emulated by others.⁷

It is hard to disagree with McArthur’s conclusion that the government “proved incapable of managing the issue” and that opponents of the HST “communicated effectively.” Maybe opponents “communicated … honestly by the standards of political campaigns,” but the qualification should not be ignored.

Howard Jarvis “communicated effectively” when, in 1978, he stumped California on behalf of an initiative to constrain the growth of municipal property taxes.⁸ Maybe he also “communicated honestly by the standards of political campaigns.” The unintended consequence of his Proposition 13, however, has been to provide a precedent for many subsequent referendums on tax policy, which have cumulatively stymied the ability of the state government to finance core services adequately. Viewing the dire status of California state finances, Canadians should not be celebrating the victory of Vander Zalm and his followers. Similarly, they should entertain doubts about setting university tuition fees via street demonstrations.

The worst form of government?

In 1945, British voters rejected the Victorian-era vision of Winston Churchill, the triumphant war hero who had saved his country from Nazi conquest. Instead, they opted for the Fabian socialism of the far less charismatic Clement Attlee. Churchill accepted defeat with reasonable grace, and delivered one of the more famous quips about democracy: that it is “the worst form of government except all those other forms that have been tried from time to time.”⁹ By democracy, Churchill meant representative parliamentary democracy as he knew it.

While far from perfect, parliamentary democracy in which a cabinet can exercise broad discretion with respect to spending and taxation is probably the best form of government in high-income countries with elaborate social programs requiring a correspondingly elaborate taxing effort. General elections are the appropriate mechanism for citizens to pass judgement on their leaders’ performance and select among teams of potential rulers. If, in a general election, voters opt for a conservative government favouring smaller government and lower taxes, fair enough. If, on the other hand, they elect a left-of-centre government that favours more generous social programs and higher taxes, that too is a legitimate public judgement. By contrast, what transpired in British Columbia over the last two years was a lurch toward the “worst form of government.”

Notes

¹ For a prescient introduction to the B.C. HST debate, see Reg Whitaker’s column “The Audacity of Nope,” Inroads, Winter/Spring 2011, pp. 13–16.

² Jock Finlayson, executive director of the Business Council of British Columbia, and Kevin Milligan, UBC economist, organized an open letter signed by 100 economists. See Jock Finlayson and Kevin Milligan, “Ninety-One Economists Rally Behind the HST: An Open Letter from Economists to the Citizens of BC,” July 4, 2011, at faculty.arts.ubc.ca/kmilligan/economists-for-hst/#letter

³HST or PST/GST? It’s Your Decision: The Independent Panel’s Report (Victoria: British Columbia HST Information Office, 2011).

⁴ These amendments came very late in the drama. Much earlier, Jon Kesselman (“Income Tax Death Good News for HST?”, Vancouver Sun, November 24, 2010) had made similar recommendations, which in turn were endorsed in a Vancouver Sun editorial and promoted by unsuccessful Liberal leadership contender Kevin Falcon. Falcon subsequently replaced Colin Hansen as B.C. finance minister.

⁵ In a December 2009 poll, Ipsos-Reid reported that 82 per cent of B.C. residents and 74 per cent of Ontario residents opposed their respective government’s proposals to harmonize federal and provincial consumption taxes. See Ipsos-Reid, “Majority of British Columbians (82%) and Ontarians (74%) United in Opposition of Harmonized Sales Tax,” December, 5, 2009, at www.ipsos-na.com/news-polls/pressrelease.aspx?id=4624

⁶ Stephen Gordon, “It’s Time for an Adult Discussion About HST/GST,” Toronto Globe and Mail, September 16, 2011 (www.theglobeandmail.com/report-on-business/economy/economy-lab/stephen-gordon/its-time-for-an-adult-discussion-about-hstgst/article2168428). Gordon appeals to the left to enter into “an adult conversation” on the need for levying a sizable fraction of government revenues via consumption taxes, and the corollary that value added is the appropriate basis in the design of such taxes. The regressive implications of value-added taxation must be discussed in the context of lower compliance costs for sales taxes relative to the compliance costs associated with corporate income taxes and progressive personal income taxes.

⁷ Doug McArthur, “The British Columbia HST Debacle,” Policy Options, November 2011, p.32.

⁸ See “Proposition 13: War by Initiative: A Case Study in Unintended Consequences,” Special Report: Democracy in California, The Economist, April 23, 2011, pp. 8–10.

⁹ Hansard (UK), November 11, 1947.

Photo courtesy Tony Sprackett