The Need for change.
In general, the current tax system is outdated in a globally competitive, information economy.
More specifically, there are four basic reasons why the tax system is in urgent need of reform.
A Quiet But Disturbing Tax Revolt Movement
A Loss of Respect for the Tax System
The Shrinking Tax Base
An Erosion of the Economy
1. A Quiet But Disturbing Tax Revolt Movement
Taxpayers are quietly resisting the tax burden by both legal and illegal means.
The Department of Finance has itemized 105 available exclusions, deductions, allowances, credits, deferrals, etc. that allow personal taxpayers to reduce their assessed income, and 59 rate reductions, exemptions, credits, deferrals, etc. that allow corporations to reduce their assessed income.
These are all perfectly legal means to reduce tax liability.
[Source: Personal & Corporate Income Tax Expenditures (1993) - Department of Finance]
The "Underground Economy" has been estimated at anywhere from:
The Flight of Labour & Capital
A recent Price Waterhouse study shows that highly paid Canadians can substantially increase their after-tax income by taking an equivalent job at the same gross salary in the USA.
Traders and investors are now allowed access to work in the USA.
Price Waterhouse has seen a steady increase in people asking for advice about working in the USA.
The Growing Tax Burden
Why do taxpayers avoid, evade or leave the tax regime altogether?
Because they feel over-burdened by taxes and with some justification. [See following table below].
[Source: BRIAN BETHUNE "The Competitiveness of the Canadian Tax System"The Canadian Tax Journal - Vol. 41/6,1993]
Table 1: The Growing Canadian Tax Burden
Total Canadian Tax Revenues as a Percentage of GDP
This table shows the increasing amounts of personal and corporate income earned by Canadians (GDP) that is being taken in taxes of all kinds. This means less and less disposable income is available for spending, saving or investment.
SOURCE. Brian Bethune, "The Competitiveness of the Canadian Tax System" The Canadian Tax JournA 4116,1993
2. Loss of Respect for the Tax System
Taxpayers have lost trust and respect for the system because they can't understand it, they don't perceive it as fair and it's accountability is in question. In addition, we feel it is fair to conclude that most Canadians' respect for the tax system has been eroded by the sheer burden of recent tax increases. These sentiments appear to have contributed to an erosion of the moral censure that was previously directed at tax evaders.
Notwithstanding the recent increases in the civil and criminal penalties associated with tax evasion, this type of activity continues to flourish.
The Income Tax Act in 1917 was 20 pages.
The Income Tax Act in 1994 is more than 1,400 pages and there are more than 100 pages of rules and more than 600 pages of regulations. Added to this are all the Revenue Canada interpretations, bulletins and court opinions.
The average taxpayer cannot possibly understand all the detail that is now embedded in the system. A survey by Southam found that 70% of Canadians could not find their way to the end of an income tax form.
Even tax experts are increasingly specializing in order to keep abreast of developments. Currently there are more than 36,000 tax challenges before the courts in Canada.
Unequal Treatment of Income Sources
Workers, savers and investors are needed equally in our economy yet their economic activity is taxed differently:
As MP Charles Caccia has pointed out, some financial activity - lotteries, for example - are not taxed at all.
The Tax Expenditure Mystery
Most taxpayers do not perceive the tax system as fair because of the preferential tax treatment accorded certain groups of individuals and companies. [See Table 2 below, for some effects of differential treatment].
Because tax "expenditures" are sometimes hard to evaluate, they are not presented to Parliament in the budget as expenditure items - they simply become "foregone revenues".
Many experts believe that tax expenditures would be better dealt with more openly via department budgets, which would make them more accountable, and less easily entrenched beyond their needed life.
Table 2: Taxes Payable as a
Percentage of Total Income Assessed:Current System
This table shows how the current tax system provides differential treatment for various groups of taxpayers at various income levels
|ASSESSED||AVERAGE %||EMPLOYEES %||INVESTORS %||PENSIONERS %|
|$1 00,000 Plus||30.5||34.1||21.3||30.7|
SOURCE. Calculations based on Taxation Statistics 1994 (Tax Year 1992) Table 8
3. The Shrinking Tax Base
Aside from the tax preferences that reduce the tax base, high administrative costs, disincentives owing to high tax rates and errors and omissions all take their toll on the system.
The Disincentive of High Tax Rates
According to a Stanford University study, when the US raised its maximum capital gains tax rate from 20% to 28% in 1986, capital gains realization fell from $350 billion to $100-150 billion.
When the US put a 10% luxury tax on boats, furs, jewelry and planes, prices rose, demand was reduced, sales decreased, unemployment increased and the government actually lost revenue.
Errors & Omissions
According to a former Auditor General, "a significant amount of taxable economic activity in Canada goes untaxed. This is due in part to taxpayer error or unfamiliarity with tax laws."
A complex system obviously incurs higher costs than a simpler one.
Revenue Canada estimates their staffing for 1994-5 will be about 26,000 full-time equivalents.
Revenue Canada taxation (not including Customs and Excise) will spend about $1.4 billion according to their Main Estimates.
The resources available to audit (police) the system are stretched to their limits.
Frank Capon, former chair of the Canadian
Chamber of Commerce Tax Reform Committee:
"To understand [the complexities], to comply with them, to take advantage of them, to avoid being hurt by them, to minimize tax costs, and to compile returns is a time consuming task for many of the finest brains in Canada."
4. An Erosion of the Economy
High compliance costs, distortions, and the creation of an uneven tax playing field which hinders Canadian business in global markets all combine to reduce economic activity.
According to economists Jack Mintz and Paul
[...] the corporate tax system creates a number of distortions in the allocation of capital across industries in Canada."
Companies investing in machinery and/or inventory (value-added economic activity) are at a disadvantage compared with companies that invest in land and/or structures under the current tax system.
Certain tax measures, such as child care deductions, also distort the allocation of resources at the household level. For example, as MP Paul Szabo points out, neighbours can pay each other to care for the other's child and get a child care expense deduction, but a family in which one parent is a wage earner and the other remains home to care for the children cannot get similar tax relief.
The Bumpy Playing Field
Canadian corporate profits as a percentage of GDP are at an all time low.
From 1973 to 1991:
- GDP increased at an average annual rate of 3.3%
- Personal incomes rose at an average annual rate of 4%
- Real corporate profits rose at an average annual rate of 0.9%
Yet tax revenues from corporations continue to rise.
From 1983 to 1991:
- Federal revenues from corporate taxes rose 60%
- Corporate profits fell 10%
Our tax regime is not competitive with that of our major trading partner, the US. Canadians pay 7.5% more of GDP as taxes than Americans and this gap is widening. [See Table 3 - next page].
Table 3: Comparing Canadian and American Tax
This table shows that Americans pay a smaller percentage of their personal and corporate earnings in taxes than Canadians. This is why there is a flight of labour and investment capital away from Canada, especially to the U.S.
|Tax Revenues as a % of GDP|
SOURCE. Brian Bethune, "The Competitiveness of the Canadian Tax System" The Canadian Tax Journal 41/6,1993