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

print this article

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 nonresident’s 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.


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.

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 constitutional.)

Second, the opposition parties in Canada’s Parliament lined up to denounce the proposed new tax and used it as a wedge issue to undermine the ruling Progressive Conservative Party’s popularity in public opinion polls. (The opposition parties, of course, at all times failed to highlight that the GST would be replacing the antiquated but hidden FST that drove up the price of Canadian exports, making them less competitive in the international marketplace and prejudicing Canadian manufacturers.)

While the ruling Progressive Conservatives had a majority in Canada’s House of Commons, allowing them to pass the new GST legislation through the House, the opposition Liberal Party of Canada had the majority in the Senate, creating the potential for them to block the legislation from becoming law.

The result? Then-Prime Minister Brian Mulroney had to employ little-used provisions in the Canadian Constitution to appoint additional members to the Senate, thereby achieving the majority necessary to pass this needed tax reform.

For once, tax policy trumped politics!

But not for long.

In the 1993 federal election, the Liberal Party under Jean Chretien campaigned on a promise to replace the now-vilified and hated GST. (It was affectionately known as the “Gouge and Screw Tax,” among other more colorful names!)

The Liberals won that election by a landslide, leaving the Progressive Conservative Party with only two remaining seats in the House of Commons. It would take more than 15 years before a reformed Conservative Party of Canada would be elected with a majority government.

Road to “Harmonization”

While 1991 saw certain provinces occupying themselves with suing the federal government over the GST, others continued their negotiations with a view to “harmonizing” their PST with the new federal tax.

Notably, in February 1991—one month after the GST came into effect—Saskatchewan announced that it would harmonize in 1992. Again, politics intervened, and Grant Devine’s Progressive Conservative government fell to the provincial New Democratic Party in October 1991, and Saskatchewan’s planned harmonization was canceled. (To this day, it remains one of only three remaining PST provinces that have yet to harmonize.)

Québec, being Québec, took a separate and distinct route toward harmonization.

In August 1990, Québec and the federal government signed an agreement whereby Québec would administer the new federal GST within its provincial borders.

Concurrently, Québec began a gradual process of converting its own PST over to a VAT—but of course in stages and of course not identical to the federal VAT, as that would have been too simple. By 1995, the Québec Sales Tax (or QST) was almost identical to the federal GST, save for certain key exceptions, such as financial services being zero-rated as opposed to exempt supplies, and the inability of large corporations to fully recover the QST they paid on certain business inputs.

Meanwhile the newly elected Liberal Party of Canada had that pesky 1993 election promise of replacing the GST upon which they had to make good (and yet still needed the tax revenues to clean up Canadian debt). In keeping with political tradition, Chretien (who was now prime minister) appointed his internal party leadership rival Paul Martin as his finance minister (keep friends close and enemies closer, don’t you know!) and saddled him with fulfilling their party’s campaign promise.

Public hearings were held, experts consulted, industry groups canvassed, and, in the end, the House of Commons’ Standing Committee on Finance recommended replacing the GST with “a nationally integrated, multistage value-added tax on consumption.” In other words, exactly what the Progressive Conservative Party had sought back in 1987 when it began negotiations with the provinces with a view to introducing a single national VAT. However, that would require the cooperation of the provinces—so Martin stood in the House of Commons and apologized to Canadians for the Liberals’ promise to replace the GST. (Besides, the next federal election was still at least two more years away.)

Then in the fall of 1996, a breakthrough: The federal government convinced three of the four Atlantic Canadian provinces to “harmonize”—to eliminate their provincial sales and use taxes and replace it with a single rate “harmonized sales tax”—and HST in Canada was born.

The new system required each province—Newfoundland and Labrador, Nova Scotia, and New Brunswick—to adopt the same tax rate: fifteen percent (seven percent being for the federal government and eight percent for the province). The new HST would be centrally administered by Revenue Canada (now the Canada Revenue Agency). Businesses wouldn’t need to track the two components separately. Instead, a revenue-sharing formula was agreed upon among the provinces and the federal government based on economic and statistical data. As the HST was federal legislation, the tax had the added advantage for the three provinces that businesses in other provinces would be required to collect and remit HST on sales they made to customers in the new HST “participating provinces.”

Making it even more palatable for these three provinces to harmonize were two additional facts. First, all three provinces’ PST rates at the time were higher than the eight percent provincial component of the new HST, so the politicians in these provinces were able to sell “harmonization” as being a tax cut, regardless of the broader tax base of the GST/HST compared with PST. Second, the federal government promised to pay each province $1 billion over four years to offset any loss of sales tax revenues by the province.

All went quiet on the harmonization front for another decade as we waited for another financial crisis.

If low oil prices and the financial crisis facing Alberta continues, it seems inevitable that the province will join the federal HST system.

October 2008 — Ontario Shrugs!

The mis-selling of mortgages led to the “asset-backed” commercial paper crisis of the summer of 2008, and finally the crash of Wall Street and the seizing up of Bay Street in Canada in October 2008.

Ontario’s premier, Dalton McGuinty, and his department of finance were ready, as no one likes to let a good financial crisis go to waste. With equity markets frozen and Ontario’s automobile sector in crisis, the provincial government knew that if there was ever a time they could introduce a tax policy like sales-tax harmonization on the basis that it would help the province’s struggling manufacturing sector, now was the time. But part of the key was that it couldn’t be the government’s idea.

Working with the Ontario Chamber of Commerce and other supportive industry groups, this collection of industry players published a report in January 2009 entitled “A Made In Ontario Sales Tax Solution.” When asked about it, McGuinty did not dismiss the report on the basis that his government had no interest in sales tax reform, but instead he floated the political trial balloon by responding, “I just think we need to give a rethink in a number of areas that we’ve rejected in the past.”

Two weeks later, in early February 2009, he said, “The Ontario Chamber of Commerce has put forward a position that says you absolutely must harmonize the GST and the PST. … That’s a tough thing to do politically, and we take a revenue hit. All previous governments have shied away from that. We need to give that a very serious look, for example.”

Lo and behold, when Ontario tabled its March 2009 budget, it announced that effective April 1, 2010, it was eliminating its PST and harmonizing with the federal GST. It also helped that the federal government promised to pay Ontario $4.3 billion to assist in the transition.

Ontario also used its political clout to extract changes from the federal government that the three Atlantic provinces had not.

First, Ontario insisted that it be able to set its own provincial HST rate.

So they sought out former Premier William (Bill) Vander Zalm, who, although he was forced to resign from office, was charismatic in the way that—well, for American readers—Donald J. Trump is charismatic.

Second, to eliminate the risk of McGuinty being tarnished as the premier who taxed children’s clothing or feminine hygiene products, the federal government allowed the province to provide exemption from the provincial component of the HST on products whose aggregate value totaled five percent or less of the tax base.

In 1997, the federal government had insisted on a single HST rate and a single tax base. While these changes would make administration of the “new” HST more complex and would make the revenue-sharing formula a multipage formula of mathematical and statistical hieroglyphics, the federal government relented, as if Ontario—the most populous province in the country—was willing to harmonize, others may soon follow.

McGuinty and the Ontario Provincial Liberal Party achieved a feat nothing short of miraculous politically. They managed to implement HST in Ontario without reducing the tax rate (PST was eight percent, as was the provincial component of the HST), regardless of the fact that the HST tax base was broader. More significantly, in the next provincial election, they managed to get re-elected! They managed the change by using the October 2008 financial crisis to their advantage. Further, they ensured they had the support of industry and stakeholders like the major automobile workers’ unions. Finally, they made it appear as if it was not the government imposing change, but rather the government adopting one brought forward by the Ontario Chamber of Commerce.

It also likely helped that the Liberals were not the right-wing political party in the province. Had the provincial Progressive Conservative Party (PC)attempted to introduce harmonization, it’s likely both the Liberals and New Democratic parties would have used it as a political wedge issue, accusing the PCs of again doing favors for big business.

July 2009 — British Columbia Rebels!

If Ontario provided a textbook example of how to implement tax policy, British Columbia (BC) provided a textbook example of how not do it.

In July 2009, four months after Ontario had announced it was harmonizing, newly re-elected British Columbia Premier Gordon Campbell and his finance minister held a press conference announcing BC would be following suit.

Unfortunately, the announcement appeared to catch everyone, including the business community, off-guard and therefore ill-prepared to defend the government’s decision.

While the provincial opposition party—the New Democrats (NDP)—knew they couldn’t come out directly against the tax (knowing that if they did, they could be branded as antibusiness in the time of an economic downturn), they knew they could use it as a political wedge.

So they sought out former Premier William (Bill) Vander Zalm, who, although he was forced to resign from office, was charismatic in the way that—well, for American readers—Donald J. Trump is charismatic.

Similar to Trump, unfortunately, the BC government initially did not take him seriously.

Vander Zalm, with the backing and support of backroom political operatives, used a little-used provincial referendum law to ferment the largest and most successful tax protest in the province’s history. The campaign resulted in the resignation of Campbell as premier. Then, with his successor, Christie Clarke, seeking to put a 100-foot pole between her and the tax, a provincewide mail-in referendum took place, during which the government promised to cut the HST by two percent if voters agreed to retain the tax (the largest proposed tax cut in the province’s history).

It was all for naught. On August 26, 2011, fifty-six percent of those who voted in the referendum rejected the HST. On April 1, 2013, British Columbia “de-harmonized” and reverted back to PST.

Other Provinces

In fairness to British Columbia Premier Gordon Campbell, he did attempt to put good tax policy before politics. In addition, there were rumors that Manitoba was likely to announce shortly after British Columbia that it intended to harmonize, but then provincial Progressive Conservative Premier Gary Doer was appointed by the prime minister as Canada’s new ambassador to the United States, and in the ensuing leadership race to replace him, no candidate was willing to publicly support such a significant change in provincial taxation.

Subsequent to Ontario’s successful harmonization, the Canadian federal government has renegotiated its sales-tax agreements with the three 1997 HST Atlantic Canadian provinces to allow them to set their own rates and exemptions like Ontario.

Further, effective April 1, 2013, Canada’s smallest province, Prince Edward Island, joined the family of HST “participating provinces.”

Even Québec renegotiated its HST agreement with the federal government in which it more closely “harmonized” with the federal HST—with financial services becoming “exempt supplies” for QST purposes and restrictions on large corporations’ ability to recover QST on certain business inputs being eliminated over time, as with the other HST provinces. That being said, as Québec must always have some distinction, GST and QST continue to be administered by Revenu Québec and not by the Canada Revenue Agency.

The Future

It’s now 2016, and it has been a century since Canada introduced its first multistage sales tax.

Today, a line can be drawn down the middle of the country at the Manitoba/Ontario border. To the east, there is a single but multirate, centrally administered (save for Québec) national value-added tax known as the HST. To the west, there remains the federal GST, with three provinces—Manitoba, Saskatchewan, and British Columbia—each still imposing its own separate provincial sales and use tax.

And it only took 100 years!

The remaining four provinces will eventually harmonize with the federal GST/HST system. It just will take the right financial crisis, the right political party to be in power, and the right groundwork and education to be laid in advance by industry and labor groups in the province. After all, sales and use taxes like PST are not only expensive to administer, but they increase the cost of manufacturing goods and selling services, thereby making each province’s exports less competitive on international markets.

Alberta is currently suffering from a significant economic downturn due to the price of oil, and the province is forecasting record deficits. Further, the left-wing political party—the New Democrats—are currently in power in the province, which would normally mean the stars are aligning for good tax policy to trump politics. Unfortunately, they promised in the last provincial election that they would not introduce a sales tax. (Although I do note that HST is technically a federal tax, and Albertans are fooling themselves when they say they don’t have a sales tax—they pay the federal GST!)

If low oil prices and the financial crisis facing Alberta continue, it seems inevitable that the province will join the federal HST system. If Alberta joins, the likelihood of the other western provinces—particularly Saskatchewan and Manitoba—harmonizing will certainly increase.

U.S. Sales Tax Reform

All this then leads to the question: What about the United States?

As an outsider, it is hardly my place to comment on the intricacies and complexities of the web that is the U.S. state and local tax system.

From a competitive perspective, as a citizen of the United States’ largest trading partner, I’m pleased Canada has chosen a value-added tax system that eliminates virtually all of the embedded sales-tax costs on business inputs, making our exports more competitive.

But in terms of U.S. sales-tax reform, I will only offer this observation: Canada’s population is ten percent the size of the United States’ population. Our economy is about ten percent the size of the United States’ economy. It took Canada 100 years to reform its sales-tax system, and therefore, that should be about ten percent the time it will take for sales-tax reform in the United States. We took a century. So for the United States, it should only take a millennium!

Portrait of David RobertsonDavid Robertson is a partner at EY Law LLP in Canada.

Leave a Reply

Your email address will not be published. Required fields are marked *

XHTML: You can use these tags <a href="" title=""> <abbr title=""> <acronym title=""> <b> <blockquote cite=""> <cite> <code> <del datetime=""> <em> <i> <q cite=""> <s> <strike> <strong>