As one would expect during an election campaign, the party leaders are busy promising us all kinds of goodies that we, the taxpaying public, will ultimately pay for. Recently the Conservative Party, led by Stephen Harper, promised us that he would reduce the GST (Goods and Services Tax) by 2% - lowering it from 7% to 5%. Unfortunately, this won't really mean much of anything to the average person.
Imagine that you are buying an item for $100. Currently the after tax cost of this purchase is $107. This tells us something about the consumer's willingness to pay. Now, suppose that the tax is lowered by 2% so that the item now sells for $100 plus $5 tax for a total of $105. Unfortunately, that is not the end of the story. Depending on how competitive the market for that good is we can expect the seller to increase the price of the good a bit since we know that the consumer was willing to pay $107 for it previously. Suppose that the price of the good increases to $101 before tax. The after-tax price is now $106.05 and the consumer's total cost has only been reduced by $0.95 and not the $2.00 that we first thought. This can be seen by looking at a supply and demand curves as shown below.
What has happened is that the law of demand says that as the price of a good decreases, the quantity demanded increases. Reducing the does lower the after-tax price slightly and this induces an increase in the quantity demanded. However, the law of supply (and the upward slope of the supply curve) tells us that this increase in quantity demanded will only be met by an increase in the quantity supplied if the price rises. Thus, in our example from above, the decrease in the sales tax of 2% really only lowers the after-tax price by 0.9%.
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