Last Friday, a paper that I prepared on the BC economy was released. I hope readers will find it of interest. The paper can be found at:

http://www.scribd.com/doc/30728436/Looking-Forward-The-BC-Economy-at-a-Crossroads

The paper was prepared at the request of the Leader of the BC Official Opposition, who wanted a background study and analysis of the economy. My only conditions in agreeing to do so were that I have sole control over the content and that it be made publicly available. It was also used as a background paper for a conference convened by her on Friday.
The paper is largely a diagnostic. I want it to contribute to to a better understanding of the BC economy, as a necessary prerequisite for having a literate discussion about policy. I thus deliberately do not address specific policy measures to any significant degree.

I hope that readers will come away from reading the paper seeing that there are real concerns about the BC economy and the way that it has developed over the past few years. I also hope that it acts as a cautionary tale to those who hold many of the conventional wisdoms about what contributes to improved productivity, investment in research and development, and a transition to higher value activity. The proponents of the favourite themes of the last few years in BC – lower taxes and de-regulation – appear to have paid little or no attention to what has actually been happening. If they had, one would think they would show a bit more modesty in their claims. The truth is that BC has been a laboratory for their favourite ideas, but is lagging badly in all of the referenced measures. By way of interest, the problems I identify are substantiated by a paper just released by the BC Business Council, which for instance shows BC (shockingly) to be the only province in Canada for which business productivity dropped from 2003 and 2009.

I hope the paper will encourage some good discussion. And I hope that reading it and other papers will incline the academic and other purveyors of established ideas to be at least a bit more modest and to develop bit more of the healthy skepticism required of a good analyst.

Municipal governments all across the province are busily developing their budgets for the next tax year, which starts January 1, 2009.  Most will be trying hard to restrain their budgets.  The affects of the recession are now being felt full force and one can bet that taxpayers are not going to be receptive to paying substantially higher taxes.  Many city and local councils can expect vigorous public opposition to tax increases imposed to help close the revenue-expenditure gap.

But what is a responsible council supposed to do? After potential cuts reach a certain pain threshold, there will be tremendous pressure to raise tax rates.  But it is doubtful citizens are going to be as receptive to tax increases of the magnitude they swallowed last year. For instance in 2008 Vancouver residential taxpayers were stuck with an increase of almost 8%, almost 6% points higher than the rate of inflation. It doesn’t seem very likely that homeowners will have much appetite for a similar increase this year.

Part of the challenge for councils is to distribute the tax burden among different tax categories or property classes in a sensible and fair way.  The property classes each have their own tax rates or mill rates set by the councils as a percentage of market value of properties.  Getting the right balance of rates is challenging both politically and in terms of good policy.  There has been intense political lobbying over the past few years about differences in tax rates across classes of property. In particular business and industrial taxpayers have been active in protesting the fact that they typically pay tax rates that are significantly higher than homeowners as a % of the value of property.  These differences in most municipalities reflect a long standing view about fairness, responsibility and balance.

Last year Vancouver Council responded to this pressure by setting a lower rate of increase of taxes paid for business properties compared to residential properties. There was little public discussion about it, no doubt in part because the traditional anti-tax lobby, dominated by business, accepted it as a business friendly move.

While it is not clear what will happen this year if the same thing is done, it will not be surprising if there is a fairly strong negative reaction from homeowners, particularly if some vocal critics are inspired to take the lead.

An important question to ask is whether these differing rates of increases in property taxes are  the best way to help the business sector, if business needs or deserves a break.  The amount of tax paid by business depends on two things – the market value or sales price of business property and the tax or mill rate for business properties.  The market value of all business properties increases each year in response to the increase in the value of the small number actually sold.  This value is determined by the British Columbia Assessment Authority using formulae that relate properties that have not changed hands to comparable properties sold in the market.  Market values depend upon the revenue and costs including property taxes of businesses actually sold on the market.  The lower the taxes the higher the market values of properties actually sold, and the higher the value of all business properties on the tax rolls.

One of the clear results of a property tax break for business is that the market value of business properties increases in response to the lower tax rate. Indeed, based on the iron law of economics, the increase in property values will exactly offset a tax decrease.  In other words a tax cut or a lower rate of increase is in a short time translated into an offsetting increase in business property values.  Of course other things may affect property values as well, but that doesn’t change the argument about tax changes taken separately.

In part to deal with this potential erosion of tax changes, changes in property values are determined ahead of tax changes because assessments are done the year previous to the tax year.  In this way the municipality can shelter the property taxpayer from immediately having the gains of lower tax rates being undermined as a result of direct consequent increases in property values.  The municipality sets a target revenue number for business properties as a class each year, based on a rate against last year’s assessed values.  But what should be the basis for determining the share of revenue attributed to each class of property? Typically the question is approached by looking at the relative share by class of aggregate assessed values.  For instance, should business share of the change in the overall tax bill be proportionate to its share of the increase in total assessed values for all classes of property?  Or proportionate to its share of residential and business property values in aggregate?  Or a lower proportion, as the tax shift advocates propose? But because the tax rate will be an important factor in determining the following year’s assessed values, relative assessed values do not provide a fixed continuing basis for determining how much of the burden each class of property should bear.   Objectively, the relative shares can only be determined by drawing on some other means upon which to base the appropriate proportionate share of the tax load by class.

If the share is to be shifted in favour of a particular class, upon what underlying  principle is the proportion to be based?  If it is based on the relative aggregate assessed values for each class, changes in this proportion will be driven to a considerable degree by the relative changes in tax rates themselves.  Indeed it must be that the aggregate value of business properties is increasing more rapidly under this scenario so far as the affects of taxes are concerned, undermining in part through time the argument for tax relief.  There is something odd about following a principle for these purposes that has, as one of its major impacts, changes in assessed values through time that work against the principle.

There is also an important question about who really gains.  Since relative tax relief increases the market value of business properties over time, the cost of acquiring properties goes up and so too does the cost of doing business, eroding the benefit of the tax relief.  And this erosion falls immediately and most heavily upon new, usually young start-ups who are purchasing or renting property.  Indeed the supposedly preferred tax treatment puts the new and younger business operators at a competitive disadvantage, which is the opposite of what most people would want to see.

Of course factors other than taxes affect increases in aggregate market values in each class as well.  If prices of residences rise more rapidly than business properties because of demand, there will be a more rapid growth in assessed values of residential properties compared to business properties without any additional servicing costs.  But we can also ask, is this a good reason to increase the share of taxes paid by homeowners? Perhaps, but then the opposite should hold when business properties in aggregate increase in market value at the same rate or more rapidly than home prices, as could very well be the case in a number of municipalities over the next few years.  Will there then be a pause in the shifting of the tax burden when this happens?

It is time for a principled discussion by councils and their taxpayers about the reasons for and affects of the tax shifts that some are pursuing away from business and to homeowners, and for transparency about the shifts.  Otherwise tax changes go to those who push the hardest and who are most successful at winning the lobby game.  This never a good basis for setting tax rates but it is a particular concern now when homeowners and new start-up businesses are under financial pressure and thus very vulnerable to tax burdens.

And if business needs special help, it might be better to look at things that will be more effective in terms of results, like targetted support for young start ups, as well as high growth and high value sectors, knowledge dependent hubs and small independent business.  Or to lobby hard for a lower corporate tax rate for small business.  More on this last point another time. But these arguably make a lot more sense than blanket property tax shifts from business to residential taxpayers.

Saturday, September 19, saw rallies all across BC against the HST. Predictably organizers claimed they were a great success, brining together the leaders of the opposition parties and Bill Vander Zalm in common opposition to the Liberal Government’s plan.

However, one has to wonder whether something more than 1,000 people at the largest of the rallies held in Vancouver really represents a passionate and deep rooted feeling of outrage.  While a good turnout, it hardly suggests that people are prepared to go out of their way to invest in this fight.

As I have said before, the opposition parties including the NDP are right in fighting this tax, mainly because the Liberals had a clear obligation to make the plan  known in the recent election.  Their claim to have not seriously considered it until after the election is either disingenious or suggests a degree of incompetence that is hardly believable.

However it is not clear where this fight is going.  In particular is it the intention of the NDP to make it the major focus of its legislative and public efforts to dislodge the Liberals in the next election?  That appears to be the case to many.  If so has it anticipated the implications of that?  And what is the plan to achieve that?

Mixed messages were given at the Vancouver meeting about what the present coalition of opponents intend.  Bill Vander Zalm said the goal is a referendum of voters on the issue.  BC is the only province that has legislation making a referendum possible thanks to legislation passed by the NDP in the mid-1990’s.  This requires signing up 10% of voters in each constituency, after which a campaign and a vote must take place.  Carol James suggested something quite different.  She called upon the public to put pressure on Liberal MLA’s suggesting that up to 7 can be pressured to vote against the HST.  This would mean that they would have to cross the floor to sit under some other label.  Others have suggested using the recall legislation to go after vulnerable Liberal MLA’s who had small margins of victory in the last election.

Each of these strategies has its vulnerabilities.  Both referendum and recall require massive organization in order to be successful.  Vast amounts of money are required, as well as the marshaling of vast platoons of volunteer organizers and foot soldiers.   This would suck away resources from virtually all other political organizing.  Both recall and referendum are all or nothing propositions.  They either work and the government is blocked, or they fail and the government gets its way.  Of course the government may suffer a lot of damage along the way, but it is not clear that these expensive and difficult processes are the best way to inflict that damage.

The biggest risk of this concentration of effort and resources is to the NDP.  It is in the best position to raise money and contribute organizers and foot soldiers.  But it is also the Official Opposition in the Legislature.  It needs to have a four year plan that carries it into the next election as the clear alternative to the Liberals.  Is the HST really the right platform to carry an extended fight?  Or this best treated as an opening salvo in a fight that will move on from increased taxation, not natural ground for the NDP, to a broader critique of the government and a plan for the future.

The NDP is not known for spending huge amounts of money on campaigns mounted outside of the official election campaign.  Indeed in the period running up to the last two elections, the NDP badly under performed, apparently because it wanted to preserve resources for the official campaign.  Is it now planning to commit to extremely expensive recall and referendum campaigns on a single issue?  And expensive they will be. The major business leaders and organizations will commit their almost limitless resources to oppose any recall or referendum.  The apparent business support for the opposition to HST from some sectors affected is already weakening and will virtually disappear in any organized campaigns that require real money and commitment.

And the Liberals themselves are not to be underestimated.  They claim to already have had success in selling the tax as a shift rather than an increase that will be good for jobs, productivity and investment.  They have most of the tax experts speaking out in the media on their side.  And Campbell has in the past showed that he can best his opponents with his “Nixon to China” moves, where he embraces positions, this time a tax increase, most commonly associated with the NDP.

There is of course another possibility.  A high profile fight over the next few months could help a new party of the right gain popularity, taking votes away from the Liberals.  Perhaps that is why Carol James suggests lobbying MLA’s as her preferred strategy.  Perhaps she feels that enough pressure on them could drive some to a new party like the fledgling provincial Conservative.  Perhaps this is a signal that the NDP will not be embracing referendum and recall to fight this battle. It may be happy to have other chase this elusive goal, while conserving its resources and organizers for fights yet to come.