Does the construction industry suffer false consciousness?

According to research carried out by Professor Jack Mintz of University of Calgary, the construction industry stood to gain enormously from Ontario's adoption of the Harmonized Sales Tax (HST):

 In 2009, the business tax  structure was heavily biased against investments in construction (42.2%) and services... By 2018, however, Ontario’s business tax structure will be not only internationally competitive but also more neutral and fair across industries. The highest-taxed industry in 2018 will be construction, at 20.9%, but this will not be significantly more than manufacturing (18.2%) or transportation and storage (16.3%). 

Most of this reduction in the effective marginal tax rate on construction-industry investments is, Jack Mintz argues, due to the introduction of the HST.

So why did the Canadian Home Builders Association and its provincial counterparts oppose introduction of the HST?

The figures calculated by Jack Mintz and quoted above consider only the cost of investment in new machinery and equipment. Under the old provincial sales tax regime, construction companies had to pay tax on their equipment. With the HST, construction companies can claim an input tax credit for machinery and equipment purchases, so the tax paid on machinery and equipment falls.

On the other hand, old-style provincial sales taxes did not tax houses - there was no PST on the cost of a new house. Under the HST, purchases of new homes are taxable, although in Ontario a sales tax rebate of up to $24,000 means that only purchasers of homes over $400,000 will see an increase in net taxes paid. However, the experience in the Atlantic provinces, where a harmonized sales tax has been in place for some time, suggests that such rebates will tend to be eroded over time.

According to the Canadian Home Builders Association:

With respect to its effect on housing, the experience with harmonization to date [2008] is not encouraging – the housing sector bears much greater provincial sales taxes in the harmonized provinces than was the case prior to harmonization.

Now it could be that the construction industry suffers from false consciousness, that is, it is not aware of what is in its own best interests.

Or it could be that the ultimate effects of any tax change depends upon many different factors: the ability of firms to shift taxes to consumers or employees, administrative costs, the ease of tax evasion, the psychology of consumers.

In the case of the HST, Jack Mintz's widely cited analysis focussed primarily on the cost of new machinery and equipment, but largely ignored the impact of the imposition of HST on previously untaxed goods such as housing.

Perhaps Jack Mintz is right: what matters is the cost of machinery and equipment. Perhaps the CHBA is right: the HST will lead to an increase in tax evasion. The point is: you can't believe everything you read about taxes on business.

Comments

[Robert McClelland]

The figures calculated by Jack Mintz and quoted above consider only the cost of investment in new machinery and equipment.

And here's how we know Mintz is full of it. Most construction requires very little investment in new machinery and equipment. Residential construction requires almost none.

Seriously, why does anyone still listen to this propagandist.

[Stephen Gordon]

Okay, so we have a study that says that existing policy severely penalizes investment in M&E, and your counter-argument is that the construction sector doesn't invest much in M&E?

[Kevin milligan]

RM: are you serious? Pounding nails with your bare fist, hauling 2x4's from the lumber yard on your shoulder, and digging a hole with your fingernails may sound like fun and efficient to you, but I think otherwise.

[Patrick]

What does Mintz mean by "new machinery and equipment"? Does it include materiels (2x4s, cement, nails, drywall)? If it does, I'd say his claim passes the sniff test. If the construction industry can now claim an input tax credit on all the materiel they buy, it's going to be a huge benefit to them. If they use it.

One question I have is: are builders - especially small contractors - sufficiently well organized to keep all their receipts and fill out the paperwork to claim the tax credits? In many cases I'm sure the receipt for the box of nails goes into the pile of empty Tim Horton coffee cups on the passenger side floor of the pick-up.

[Robert McClelland]

Okay, so we have a study that says that existing policy severely penalizes investment in M&E, and your counter-argument is that the construction sector doesn't invest much in M&E?

I don't see your point, Stephen. Is this post not about the construction sector.

RM: are you serious? Pounding nails with your bare fist, hauling 2x4's from the lumber yard on your shoulder, and digging a hole with your fingernails may sound like fun and efficient to you, but I think otherwise.

Employees are required to supply most tools and they don't benefit from what Mintz is talking about. As far as the big equipment you're referring to, it's not used that often in most construction projects.

Consider this example. A house for instance only requires a crane for a day at the most. You'd have to build a heck of a lot of houses before a company was required to invest in a new crane. Even collectively all across Ontario very little is being spent on new cranes to service the residential construction industry. So while the cost of investing in them might go down, those savings are more than offset by the negative impacts of the HST to the residential construction sector.

The bottom line is that the HST has not been good for residential construction in Ontario.

[Robert McClelland]

Does it include materiels (2x4s, cement, nails, drywall)?

That's irrelevant. The cost of materials is already deducted from income.

[Determinant]

I stopped listening to Jack Mintz after his total hash of a retirement income study.

[Ben]

This should be useful reading if you're interested in this topic http://www.cdhowe.org/pdf/backgrounder_119.pdf

[Frances Woolley]

2x4s, cement, nails, drywall etc are all considered "materials" and therefore were not taxed under the old provincial sales tax. As a general rule, anything that gets made into something else doesn't get taxed under a retail sales tax. [Update: as Bob Smith points out below, construction materials are an exception to this general rule.]

The equipment that now enjoys more favourable tax treatment is things like hammers, saws, drills, sanders etc.

As Robert McC says - yes, those tools are often provided by employees, that was the rationale behind the federal employment expense tax credit introduced a few years ago.

As for heavier equipment e.g. saws - as Robert McC points out, these are a small fraction of the costs incurred by construction companies.

So, yes, this heavy equipment might have been subject to an relatively high effective tax rate of 40%. But that tax disadvantage was offset by the overwhelmingly favourable tax treatment enjoyed by new housing, i.e. not being subject to PST.

When it comes to discussions of corporate income taxes, forget about hitting the "like" button. The right answer is almost always: it's complicated.

[Mike Moffatt]

Question I don't know the answer to: What percentage of construction is 'residential housing'?

[Michael Smart]

Good points raised here.

Frances, estimates based on IO tables say construction industry was indeed paying a lot of tax on its hammers and nails - $1.5 billion per annum in Ontario according to this highly convincing study:

http://www.cdhowe.org/pdf/commentary_253.pdf

Final version is joint with Richard Bird in CPP but they are gated :-(

Think about how much fun it would be to send your workers to Home Depot everyday with a PST exemption certificate...

Mike, you're right. I think about half of construction is residential or so.

[Mike Moffatt]

Michael: Thanks for the estimate! That seems reasonable to me. If we're to break down construction into 3 types: consumer, business, government, the first third should be the biggest. And out of the consumer group you'd have to figure that 90-95% would be considered 'residential'. So 50% seems like a fair estimate.

[Robert McClelland]

Think about how much fun it would be to send your workers to Home Depot everyday with a PST exemption certificate...

Again, irrelevant. Companies don't pay for materials, the customer does. So reducing taxes on materials saves construction companies zero dollars and zero cents.

[Robert McClelland]

Residential construction typically accounts for approximately 65%-75% of all construction in Canada.

A couple of stats that may be germane to this post.
Capital expenditures in Canada was about $323 billion in 2010.
Capital expenditures for the construction in Canada was about $6 billion in 2010.

[Frances Woolley]

Michael - "Think about how much fun it would be to send your workers to Home Depot everyday with a PST exemption certificate..."

Actually, my experience has been that there's a lot of competition between companies like Rona, Home Depot, etc., for the home renovation/small contractor market, and they do everything they can to make their products attractive. Do you notice how some stores have special contractor desks staffed by special highly efficient sales staff?

But you do agree with the basic point that materials - anything that's made into something else - in principal are not subject to retail sales tax?

The basic point is: prior to the introduction of the HST, the non-taxation of residential housing gave the construction industry highly favourable tax status under provincial sales tax regimes. Any accurate assessment of the reduction in effective tax rates caused by the HST must take into account both the changes in the taxation of capital inputs *and* the changes in the taxation of the final product.

[Michael Smart]

"Residential construction typically accounts for approximately 65%-75% of all construction in Canada.

A couple of stats that may be germane to this post.
Capital expenditures in Canada was about $323 billion in 2010.
Capital expenditures for the construction in Canada was about $6 billion in 2010."

Sufficiently crazy numbers that I went to the National Income Accounts. (OK and avoiding my real job.)

2009 residential structures GFCF 98,152 million $
2009 non-residential GFCF 86,279 million $

So 53%.

The average for the last 30 years: 53%

[Bob Smith]

Michael: "Think about how much fun it would be to send your workers to Home Depot everyday with a PST exemption certificate..."
Frances: "2x4s, cement, nails, drywall etc are all considered "materials" and therefore were not taxed under the old provincial sales tax"

That would be unpleasant, since homebuilders couldn't rely on a PST exemption certificate. I imagine Home Depot would call security. Not to break it to you guys, but construction materials were alsways subject to the PST in Ontario. There was an exemption for goods purchase for resale, but that didn't cover construction materials. Rather they were considered to be consumed by the contractor (under an extended definition of consumption under the PST Act) when they were installed in the house. As such, the contractor was liable for the PST (and presumably passed it on through higher prices).

In any event, I can understand why homebuilders are up in arms, even if they shouldn't be. The introduction of the HST was a highly visible hit (or, at least, perceived hit) for new home buyers. Yes, everyone paid 8% PST on the materials that went into building a home, but we did so indirectly, through the builder. No one was presented with a bill for $X thousands of dollars when they closed on their house. And, of course, the labour that went into the house was PST exempt. Now, someone buys a house and they get hit with an extra 6, maybe 7, figure bill on top of the purchase price (in practice, home contracts are HST-inclsuive, but you had better be sure that the builder tells you exactly how much you're paying to the government). And yes, there's a rebate, but you don't see a nice big check (because it's assigned to the builder and factored into the purchase price - no fools those builders). In any event, the rebate was capped. In places like Vancouver or Toronto you couldn't buy a nice doghouse for the amount of the purchase price eligible for a rebate.

In that light, it's understandable that home builders aren't running around telling people how great the HST is. To the extent that higher overall prices have dampened the market, they wouldn't be enthusiastic, and to the extent that their customers are pissed about it, it wouldn't do to be too openly in favour of it. I would be curious to see, though, what has happened to new housing prices (pre-tax) in Toronto and Vancouver since the HST came into effect.

[Frances Woolley]

Bob, I should have just stuck to the last line of my post: "The point is: you can't believe everything you read about taxes on business."

Especially when it comes to economists talking about how taxes actually work!

Thanks for the reality check.

[Erin Weir]

Construction got the lion’s share of input tax credits precisely because construction materials had been subject to PST.

The “construction industry” includes different types of companies. It is no surprise that the Home Builders you quote would object to charging HST on their output even if they also get some input tax credits. Meanwhile, commercial builders get the input tax credits without any HST on their output.

[Bob Smith]

Erin,

What's the basis for asserting that commercial builders don't have HST on their outputs? They aren't obliged to COLLECT HST when they sell real property to GST registrants (see 221(2) of the Excise Tax Act), but the sale is taxable and the purchaser has to self-assess for the tax obligation (in practice, because the purchaser is a GST registrant, they should be able to claim an input tax credit, so it should offset). The better statement would be that most (but not all) purchasers of commercial real estate areindifferent to the HST because they can claim ITCs on anything they pay, but that has nothing to do with builders themselves (except that they don't have to deal with tax sensitive clients).

In fact, for the builder, having to collect HST is a good thing, not a bad thing, because it means it has cash in its accounts to offset the HST it pays (its net remittance to the government is HST collected less ITCs claimed). If it doesn't collect HST, then it has to finance its HST payments out of its own pockets until it gets a refund equal to the ITCs claimed (typically several months).

[Erin Weir]

Your point about short-term cash flow is well taken. But I was referring to the HST’s effect on demand by purchasers (which obviously matters to sellers).

The buyers of new homes have to actually pay HST, which could make it harder for home builders to sell their output (hence their criticism of the HST.)

The buyers of new commercial buildings do not really pay HST (because they get an offsetting input tax credit for the purchase), so the HST does not make it harder for commercial builders to sell their output.

[Bob Smith]

"But I was referring to the HST’s effect on demand by purchasers (which obviously matters to sellers)."

And had you actually said that, instead of saying what you actually said, I'd have agreed with you.

[Erin Weir]

I wrote that commercial builders do not have HST on their output.

In trying to disagree, you confirmed that commercial builders do not have to collect HST on their output and that their clients do not actually pay HST on this output.

You were making a distinction without a difference.

[Michael Smart]

The world would be a less interesting place without WCI. Hurray to Steve, Frances and all the rest.

1. 'Bob, I should have just stuck to the last line of my post: "The point is: you can't believe everything you read about taxes on business."'

In this case I must agree :)

Purchase exemption certificates applied for machinery and equipment and goods purchased for resale to others. Every small contractor paid RST on hammers, pickup trucks and other capital equipment, because the PEC system was completely impractical. Furthermore, renovation contractors were obliged to charge RST on services, and to pay RST on material inputs, which often resulted in double taxation of material inputs as well.

2. 'They aren't obliged to COLLECT HST when they sell real property to GST registrants [but] the purchaser has to self-assess for the tax obligation'

I am not aware of any reverse charging scheme for real estate in Canada, unless you are referring to the new place of supply rules (which do not single out real property). Sale of new and substantially renovated commercial property, and commercial leasing, are taxable in the normal way. Sales of used properties are of course exempt.

Bob, your statements on these topics are sufficiently important and interesting that I encourage you to provide supporting evidence for them in future.

Here is mine:

http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1597421

[Frances Woolley]

Michael, thanks for these comments, and especially the kind words on WCI. We will continue to endeavour to distract you from research!

The point still remains, however: a complete evaluation of the effects of HST must take into account changes in the price of the final product, as well as changes in the price of capital inputs.

When the elasticity of substitution between labour and capital is sufficiently low, a less favourable tax treatment of the final product can outweigh the effects of the more favourable taxation of capital. (Think about a case when a good is produced with exactly one worker and exactly one hammer - it doesn't matter if the worker is taxed, the hammer is taxed, or the final product is taxed).

The Canadian Home Builders Association didn't put it in exactly these terms, but they got the intuition all right.