One item sorely missing from Finance Minister Mike de Jong's recent provincial budget was a plan to make BC's business taxes more competitive and attractive for investment. When the province shifted back to the PST last year, the cost of doing business and investing increased dramatically. Disappointingly, de Jong's budget did nothing to address this shackle around BC's economy. Tax reform, however, might be the light at the end of tunnel.

Before getting into the details of our proposed solution, it's important to understand why the PST is so harmful to our economic well-being. Under the PST, BC entrepreneurs now pay sales tax on the goods and services they purchase and use to produce what they sell to their customers. This means they pay a seven per cent tax on things like machines, equipment, technology, materials, and energy. The taxation of these business costs is unique in the developed world and increasingly in Canada where most major provinces have adopted a sales tax that exempts these costs.

According to calculations by tax policy expert and University of Calgary professor Jack Mintz, BC's overall tax rate on new investment is now the highest in the country at 27.5 percent, up from 17.8 per cent before the PST's reintroduction. For perspective, the rate in neighbouring Alberta is 17.0 per cent.

BC is competing with other provinces (and U.S. states) for investment, so the harsh reality is that BC risks losing investment and jobs that will instead gravitate to jurisdictions with more competitive tax policies.

Despite inaction on this issue, de Jong seems to understand the magnitude of the problem. At recent presentation on his budget, he acknowledged as much but worried about finding the fiscal room necessary to take action.

With the HST a political non-starter, a second-best tax reform option begins with the government's own Expert Panel on Business Taxation recommendation: introduce a refundable investment tax credit equal to the PST paid on machinery and equipment.

Our best estimate is that 40 per cent of the government's $5.6 billion in PST revenue is from sales tax on business inputs (the amount on capital-based inputs would certainly be less). That means de Jong needs to make up at most a $2.2 billion gap.

One place to look for the money is in the government's nearly $6 billion in tax expenditures. The province currently provides special tax breaks for certain activities through the personal ($2.5 billion), corporate ($558 million), property ($986 million), fuel ($57 million), and sales ($1.9 billion) tax systems. These tax expenditures represent foregone revenue and in many cases are economically ineffective, reward activities that would be undertaken anyway, and disproportionately benefit certain groups and industries at the expense of the broader population.

For instance, in 2012 the BC government announced the introduction of the Children's Fitness Tax Credit, piggy-backing on the federal program. However, a recent study published in the Canadian Tax Journal found that the tax credit has done little to actually influence parent decisions on enrolment in a fitness program and has disproportionately benefited higher income households. Similar inequities have been found with tax credits for tuition and education.

Research on corporate tax expenditures also casts doubt on the effectiveness of special industry privileges. The tax credit for film and TV is a clear example, which is slated to cost the provincial treasury $167 million this year. Contrary to industry claims, independent research including by the U.S.-based Tax Foundation concludes that film subsidies cost the treasury more than they recoup from taxes on induced economic activity.

A tax credit for capital inputs is different from other tax expenditures in that it would partially correct a highly distortionary feature of the PST system: the taxation of intermediate inputs. The provincial government tried to fix this problem in 2001, but limited the sales tax exemption by narrowly interpreting the types of machinery, equipment, and companies that qualified. In the end, the exemption was not available to most businesses, which resulted in an administra¬tive disaster and eventually deterred many compa¬nies from seeking eligibility.

If de Jong is serious about improving BC's tax competitiveness and the future economic prospects of the province, he should consider tax reform that exempts business inputs from the PST in exchange for eliminating or significantly scaling back ineffective tax expenditures.