Canada’s cluttered tax system in need of reform

Theglobeandmail.com
April 21, 2016
By Glen Hodgson and Daniel Muzyka

Canada’s tax system is highly complex, cluttered and opaque to the average citizen. The system at the federal level is complex enough - even before adding an array of provincial tax systems to the mix, with remarkably little alignment among the provinces in how they tax. Forthcoming Conference Board research will provide a detailed comparative analysis of provincial taxation and the surprising lack of consistency. Such a balkanized system is not good enough for Canada’s economy in what is a period of weak growth.

The recent federal budget opened the door for a review of the income tax system. Such a review is welcome and long overdue. There are at least four reasons why tax reform should be treated as a policy and economic priority.

First, the tax system is not providing the best incentives for work and investment. In general, we tax work and investment income too much and consumption too little, which rewards short-term activity but discourages long-term investment - this in an economy with problems of productivity and growth.

We give an income tax break to firms based on size, not their growth ambitions. The tax system does little to provide adequate income support for the weakest in our society and conceals a “welfare wall” of high effective marginal tax rates, discouraging low-income Canadians from fully participating in the work force. And we are about to make the system more complex by using it to deal with emerging issues such as climate change.

In a time of feeble economic growth, the tax system needs to provide the best array of incentives for labour force participation, growth-oriented entrepreneurship and sustainable wealth creation.

Second, the system is imposing high compliance costs on individuals and businesses. Available estimates suggest up to three-quarters of individuals now pay someone else to complete their income tax filings, in what is supposed to be a self-administered system. Tax compliance costs a typical firm 1 to 2 per cent of operating costs.

While tax management by skilled professionals adds to economic activity, the money spent by firms and individuals on tax advice is not available for other purposes. Few of us would identify tax compliance as our highest marginal spending priority. A better-designed tax system would cut the costs of tax compliance and public administration, reduce the incentives for tax avoidance and support the nation’s productivity and competitiveness.

Third, the value-for-money proposition is questionable for many tax expenditures. There is remarkably little public analysis or debate about whether specific tax expenditures have delivered the promised economic or social benefits. In contrast, most federal and provincial public spending programs - from national defence to health care - are intensely debated. Furthermore, tax expenditures add complexity to the tax system, putting more pressure on the Canada Revenue Agency for enforcement - which is at best inefficient and at worst illogical.

Once introduced, tax expenditures have often gotten a free pass from the news media, researchers and thought leaders. This is more likely a sin of omission than commission, but it represents a major gap in the public finance debate.

Finally, thanks to the myriad tax expenditures, the tax system is leaking revenue. Finance Canada recently (and thankfully) published a full list of federal tax subsidies or exemptions that totalled $157-billion in annual forgone federal revenue - equal to over half of current federal spending programs. Now, many items on the list may be priorities for Canadians, but the sheer volume of tax expenditure items suggests that many are worth reviewing. Some of the exemptions were put in place long ago to address a particular issue at the time, but have led to subsidy-addicted sectors, firms and individuals.

Of course, if tax revenue is leaking because of low-priority tax expenditures, current tax rates on income and consumption are by necessity higher than they could be. A more simple, transparent and even-handed tax system would create room to reduce marginal tax rates- perhaps significantly - which should be attractive to policy makers. It would also lead to the development of a better portfolio mix of businesses - one that is more productive and built on the relative strengths of the country.

A comprehensive review of the tax system is long overdue, perhaps starting with income taxes - but not ending there. Kicking the can down the road won’t make the structural issues with our cluttered tax system go away and will not support the country’s need for increased productivity and entrepreneurship.