What is a Harmonized Sales Tax?

A harmonized sales tax is one in which the tax paid at each level of the manufacturing and supply chain takes account of the sales tax paid in previous stages. This has the effect of only taxing the additional value created by each level of the process. The harmonized sales tax is now the most popular form of sales tax worldwide. It is also the specific name used for a system in Canada.

The harmonized sales tax is a specific type of tax known as a turnover tax. This means that sales tax is not solely paid on the finished product sale to the end consumer. Instead, tax is paid at each stage of the manufacturing process. For example, a timber company pays sales tax on the revenue from selling wood to a furniture company. The furniture company pays sales tax on the revenue from selling the resulting chair to a furniture retailer at a wholesale price. The retailer pays sales tax from the revenue from selling the chair to a consumer at the retail price.

There are two main types of turnover tax. The simplest is the cascading tax, in which each seller simply pays tax based on the value of each sale. This tax payment takes no account of the price the seller paid for the goods or how much tax was paid at earlier stages of the process.

There are two main arguments against this type of tax. One is that it is unfair, as it means the government takes more tax with more transactions, even though the total profit of all the sellers put together remains the same. Another is that such a tax artificially distorts the market by making vertical integration more attractive. This is where participants at different stages of the manufacturing process take one another over, such as a furniture manufacturer buying out timber company.

The alternative is the harmonized sales tax, sometimes known as a value added tax. The principle is that each company in the manufacturing and supply chain only pays tax based on the value it adds to the process — in other words, its profit. This is usually achieved by each company keeping a running total of the sales taxes it pays suppliers and then deducting them from the sales taxes it accrues from sales to customers. The company then only pays the remaining sales tax.

The term Harmonized Sales Tax is also the specific name of a sales tax system in five of the 10 Canadian provinces. In this situation, the name is applicable in two ways. As well as covering the way the tax operates, it also refers to the fact that it brings together both the national and provincial sales taxes into one collection.