Yesterday, TD Economics Group issued a special report entitled: “The Economic Impact of HST Reform”. TD economists Derek Burleton and Diana Petramala said in the report that overall prices in Ontario are expected to increase by 1.5 percentage points within the first year, but within three years about half of the increase is expected to be offset by businesses passing on the savings from input tax credits, leading to a permanent increase of 0.9 percentage points.

In a September 18, 2009 special report, the same TD Economics Group concluded that lower prices resulting from passing forward the cost savings for business should lead to a permanent price increase of 0.7 percentage points. A trivial difference between these two reports, but a difference nevertheless that was not explained.

By the way, the Premier of Ontario, Dalton McGuinty, used the September 2009 TD Economics report, especially the part predicting a 0.8% to 0.9% drop in the “pre-ticket prices on the purchases of goods and services” in Ontario to support his contention that sales tax harmonization with the federal government (resulting in the Harmonized Sales Tax or HST for provincial consumers) would be beneficial for Ontario. McGuinty did not highlight that TD Economics expected a permanent increase in consumer prices in Ontario.

But there are other problems with the analysis presented by the TD economists.

Every economics undergraduate is taught about the incidence of taxes. That is, when a tax rate is increased, particularly a sales tax, consumers do not necessarily absorb or pay the entire increase. Part of the increase in the tax rate may be absorbed by producers in the form of lower prices, thus reducing their profitability. The split between consumers and producers – the incidence of the tax – depends on the “shapes” (price elasticities) of the demand and supply curves. Thus, setting aside what companies do in response to lower costs because of the new input tax credits for the former provincial sales tax in Ontario, it is unlikely that consumer prices in Ontario will increase 1.5 percentage points. But any price savings for consumers translates into lower profits for companies selling their products and services in Ontario.

Dalton McGuinty, relying on a study by Jack Mintz, also claimed that the move to the HST together with other tax reforms in the province would result in a significant number of new jobs in the province over the next 10 years. I have discussed in a previous blog why Mintz’s economics are sloppy. Moreover, it will be almost impossible to test the accuracy of Mintz’s predictions in 10 years’ time. Too many other changes will have taken place to isolate the impacts of tax reform.

However, the simple tax incidence model should have made it clear to McGuinty, or at least his advisers, that the HST part of the tax reform package by itself might result in some modest job losses. Politicians are prone to pick and choose from among all available economic analysis, and economists also are prone to ignore certain outcomes that weaken their general, and biased, positions.

The TD economists assumed that competition would force companies to pass on most of the cost savings from the input tax credits to consumers. This assumption implies that companies selling goods and services that are now subject to the provincial part of the HST would absorb most of the increase in the sales tax rate (from 5% to 13%). Consequently, the impact on consumer prices would be much smaller, perhaps consumer prices might even decline. And the negative impact on profits would be even greater. The TD economists seem to have ignored this possibility given their assumption about competition. Hey, economists are not generally known for being consistent.

Furthermore, there is no assurance that competition will drive down prices in Ontario. This assumption can be categorized as a leap of faith by the TD economists. Indeed, there appears to be a limited degree of competition in several of the sectors that are now subject to the provincial component of the HST. It is unlikely that much, if any, of the cost savings will be passed on to consumers.

So what will be the net impact of the HST on consumer prices in Ontario? No one knows with any degree of accuracy. This will not stop some economists from trying to estimate the impact at some future point in time. Of course, their findings will be far from conclusive.

The opinions expressed in this blog are personal and do not reflect the views of either Global Brief or the Glendon School of Public and International Affairs.