Is it time for major tax reform?
By Michael Wolfson
On the same day that Minister of Finance, Bill Morneau, clarified the federal government’s proposals to limit “income sprinkling” as a way for high income owners of private companies to reduce their taxes, the Senate Finance Committee released its report recommending that all his tax changes should be scrapped. Instead, the Senate Committee recommended the government of Canada undertake an independent and comprehensive review of the tax system with the purpose of “reducing complexity, ensuring economic competitiveness and enhancing overall fairness.”
The last time Canada had such a comprehensive review was the Carter Royal Commission which reported in 1966, with many but not all of its recommendations finally implemented in legislation in 1972. This process took a decade from the start of the Royal Commission. The Senate Committee’s proposal, if taken seriously, looks very much like the proverbial “kicking the can down the road” — a massive delaying tactic.
This is not to say that more in-depth review of Canada’s income tax system would be wrong. But instead of a massive “big bang” review as extensive as that of Carter, it would be more prudent to make ongoing in-depth analysis of various facets of the tax system a full-time activity of the Department of Finance. As Canada’s Auditor General observed, “information provided by the Department of Finance Canada on tax-based expenditures does not adequately support parliamentary oversight.”
In some cases, these regular reviews could address more structural aspects of the tax system, as compared to the “tax-based expenditures” identified by the Auditor General. The firestorm of protest that dogged Minister Morneau over the proposed changes in the taxation of private companies raises the broader question of just how individual and corporate income taxes should relate to one another. In tax jargon, the topic is corporate-personal income tax integration.
Basic principles of income taxation require that incomes not be taxed twice: once when received by a corporation, and again when the income is paid out as salary or a dividend to individual shareholders. At the same time, income flowed through a corporation should not be under-taxed, compared to the way this income would be treated if it were received directly by individuals in the first place – precisely the concern being addressed by the controversial proposals recently detailed by the Finance Minister.
A second possible focus could be the tax incentives for retirement savings in RRSPs and workplace “registered pension plans” (RPPs). In this case, the basic structure of comprehensive limits, one of the Carter commission’s original recommendations, was only implemented in the 1980s. But there are important questions about the overall costs of these incentives, and their targeting, as they are mostly used by those with higher incomes, compared to middle class taxpayers.
A third possible area for in depth review is the taxation of offshore income, not least given the scandals revealed by the “Paradise Papers.” However, this is an area that Canada cannot address on its own. Major improvements in enforcement against tax evasion (which is illegal), and even in detecting serious tax avoidance strategies (which are legal, but may be highly abusive), require more extensive international collaboration.
The OECD has been leading work in the area of what’s known as “base erosion and profit shifting” (BEPS). But so far, it is not delivering nearly as much as needed to tackle the major issues.
It could be that “tax reform” (or in the words of the Senate Committee report, “ensuring economic competitiveness”) is actually code for simply cutting corporate income tax rates. The recent U.S. tax reform legislation has raised fears that a lower corporate income tax rate there will place intolerable pressure on Canadian companies, inducing them to cut investment here. But tax cuts themselves are not tax reform. The U.S. changes did include some base broadening by cutting back on some “tax based expenditures,” but primarily it increased the deficit by almost $1.5 trillion.
In any case, any reviews of Canada’s tax system should be based on solid evidence. The recent proposals regarding income sprinkling, passive income and avoiding equitable capital gains tax on disposition of a private company have been notable, at least for data nerds, for the weakness of the evidence provided. The recent PBO study seems to have done a better job.
Even more important than another Royal Commission on taxation would be for the government to provide itself with high-quality data and analytical capacity so it can understand what’s really going on, and (subject to confidentiality restrictions) enable bona fide external researchers to provide Canadians with ongoing independent evidence-based analysis.
Instead of attempting once in a generation “big bang” tax reform, it would be far more effective to follow the Auditor General and invest in ongoing analysis and regular review of all major tax provisions.
Michael Wolfson is an expert adviser with EvidenceNetwork.ca and a member of the Centre for Health Law, Policy and Ethics at the University of Ottawa. He was a Canada Research Chair at the University of Ottawa. He is a former assistant chief statistician at Statistics Canada.