Canada's tax system needs to be reformed, writes Sean Speer. A tax expenditure checklist would provide a way to inform this process.
By Sean Speer, Feb. 23, 2017
One can bet that Finance Minister Bill Morneau’s office desk is presently covered by stacks of binders containing hundreds of budget proposals. Some of them are good. Others are bad. Choosing what’s in and out of a federal budget is a challenging task, as every finance minister invariably learns.
The minister may face no tougher choices than the ones stemming from his recent review of the federal tax code (which was incidentally the subject of the government’s annual tax expenditures report released today).
Any resulting changes to the myriad of tax credits, deductions, and other special provisions – known as tax expenditures – that comprise the tax system are bound to generate considerable media and political attention. It’s crucial therefore that these decisions are rooted in basic principles that are clear and transparent, and ultimately able to withstand policy and political scrutiny.
Last year’s budget announced the government’s intention to review the federal tax code. A high-profile group of tax experts was subsequently assembled to advise on the review. Expectations are that its results will be reflected in Minister Morneau’s upcoming budget.
It’s been nearly 30 years since Ottawa undertook a serious reform of federal tax expenditures.
Such a review is certainly warranted. It’s been nearly 30 years since Ottawa undertook a serious reform of federal tax expenditures.
Tax expenditures range from tax credits for using public transit to donating to political parties, and seemingly everything in between. Some support or promote individual activities and behaviours that confer significant benefits to society as a whole. Others complicate the tax code, drive up tax rates for everyone, and contribute little to society.
The cost to government is significant. Depending on one’s definition, tax expenditures in the personal income tax system alone now represent as much as $85 billion in forgone revenue for the federal treasury and roughly $4,500 per tax filer. There’s a good case for a review that leads to a better, fairer, and simpler federal tax system.
Yet the government’s review isn’t without challenges. Speculation is rampant about which tax expenditures may be eliminated and what Ottawa will do with any resulting revenues. The media and opposition parties are bound to closely scrutinize these decisions. It’s poised to be among the major story lines of the 2017 Budget.
How will the government and its expert panel evaluate which tax expenditures ought to remain and which should be eliminated? What constitutes a “good” tax expenditure and what’s a “bad” one? What principles will guide these judgements? These questions must be properly answered if the process is to be evidence-based, substantive, and able to produce meaningful results.
One needs to avoid the notion that the tax code is chock full of self-evidently indefensible “boutique tax credits.”
One needs to avoid the notion that the tax code is chock full of self-evidently indefensible “boutique tax credits,” particularly ones that represent significant foregone revenue. That is overstated. Recall that last year’s budget eliminated the Children’s Fitness Tax Credit and the Children’s Arts Tax Credit. Their combined cost is estimated to be roughly $250 million per year, or a relative drop in the bucket in a world of $30-billion deficits.
This perception is the result of two factors – one is political and the other is more substantive.
The first is a result of politics and political preferences. One political party’s “boutique tax credit” is another’s tax relief. It’s one of the reasons a partisan can decry the arts tax credit as waste of public resources and describe the newly-expanded tax credit for television talk shows as important public support and vice versa. This tendency to politicize definitions of good or bad tax expenditures leads to competing views about the federal tax code as well as the scope and focus for changes.
The second is a lack of consensus about what constitutes the benchmark tax system against which deviations are judged. A study published by the Department of Finance explains:
a variety of possible benchmarks have been developed. These benchmarks vary in their treatment of certain fundamental components such as the tax unit, tax base and tax period. Each benchmark is unlike the others in how it defines one or more of these components and, therefore, each benchmark produces a different set of tax concessions.
The upshot is tax expenditures can sometimes be in the eye of the beholder, claimant, or economist. Is the Foreign Tax Credit that protects against the double taxation of non-domestic income part of the benchmark or a tax expenditure? What about the capital gains inclusion rate? Or the deduction of employment-related expenses? How one answers these questions has significant implications for how one views the tax code and the potential for reform.
It’s further complicated by the extent to which a small number of tax expenditures are disproportionately responsible for revenue loss. New analysis from the federal department estimates that 15 measures (out of a total of 182, including personal and corporate income taxes and the GST) are responsible for 77 percent of overall foregone revenues. Many of these tax expenditures – such as those related to Registered Retirement Savings Plans – would be difficult to change or eliminate without significant economic and social effects.
All this to say, the idea that there’s a long list of costly yet ineffective tax expenditures that can be eliminated with minimal political risks is mostly a foolhardy assumption. That the government has restored the Labour-Sponsored Venture Capital Tax Credit, despite plenty of evidence of its ineffectiveness, and succumbed to political pressure to maintain the current tax treatment of employer-provided health and dental benefits speaks to the challenges of tax reform.
Future reviews of the federal tax code need to adopt a principles-based methodology for analysing the rationale and utility of tax expenditures, and judging which ones ought to be maintained, reformed, or eliminated.
A new study by the Macdonald-Laurier Institute seeks to help in this regard. It establishes a basic framework to ensure that such a review is rooted in basic principles and is less susceptible to political whims, special-interest calculations, or simply about paying for new spending or balancing the budget.
Our analysis is neither pro-tax expenditure nor anti-tax expenditure per se. Instead we set out a checklist of questions and tests – including for instance “what is the tax expenditure’s purpose and is it being achieved” – that the government can apply to the tax code in order to reach principles-based decisions about specific tax expenditures.
Not only can such a checklist ensure that the review is rooted in basic principles and evidence, it can help to communicate and defend any subsequent decisions. As an example: the previous government successfully communicated spending reductions in the 2012 budget with solid rationales and clear evidence but struggled to defend decisions such as the experimental lakes closure, which were not backed by data or facts and therefore seemed arbitrary.
The short-term goal should be to draw on this checklist to inform budget decision-making and to publicly release its analysis as part of the 2017 Budget.
The short-term goal should be to draw on this checklist to inform budget decision-making and to publicly release its analysis as part of the 2017 Budget. This would help to ensure that the review process is clear, transparent, and defensible.
Using the checklist would lead the government to sustain tax expenditures such as the Charitable Donation Tax Credit that contribute to significant societal benefits, reform others such as the Disability Tax Credit to enhance equity and fairness, and eliminate superfluous or ineffective ones such as the Age Credit and the Public Transit Tax Credit.
A long-term goal can be to publish ongoing, regular reviews of federal tax expenditures using such a checklist. A reasonable goal could be to apply it to one quarter of tax expenditures per year, which would allow a full review every four years.
The result of such an exercise can be to augment or reform existing tax expenditures, flatten and lower tax rates for all Canadians, and ultimately advance the government’s objective of inclusive growth.
Minister Morneau’s review of federal tax expenditures is laudable but not without its challenges and risks. His budget decisions will predictably face an onslaught of criticism and second-guessing. It therefore has be to more than an exercise in political preferences or special-interest calculations. He’ll need to be armed with the facts. Adopting a principles-based checklist will help. We wish him luck.
Sean Speer is a Munk Senior Fellow at the Macdonald-Laurier Institute.