By Jason Clemens, iPolitics, March 20, 2012
The focus to-date on the Conservatives' first majority budget has been on spending cuts needed to balance the budget and the more recent frenzy on suggested changes to Old Age Security (OAS). What has been lost in the discussion thus far are the enormous benefits available to the Canadian economy from tax reform, which should be a top priority in the coming budget.
There are two aspects of tax reform to consider. The first relates to the costs and benefits of complicating the tax system through the introduction of special tax credits, exemptions, and deductions.
Nearly all economists agree that the best tax system is the one that imposes the lowest possible costs on society while providing sufficient revenues to finance government programs and services. The result of such principles is that the tax system should have the broadest base possible allowing for the lowest tax rates possible. The introduction of tax credits, deductions, and other allowances narrows the tax base, which means a higher tax rate to raise the same amount of revenues.
The key question regarding such tax credits and allowances is whether they improve the economy or at the very least achieve their stated purpose. The worst outcome is when these credits and deductions simply lower the tax burden for certain individuals, businesses, or activities without necessarily improving incentives or behaviour. Indeed, in many cases they simply benefit individuals and businesses for what they were already doing, which implies a cost but no net benefit.
Governments publish the cost of these programs, which are referred to as tax expenditures, on an annual basis. There are a number of expenditures that enhance the Canadian economy by improving the incentives for work effort, savings, investment, and entrepreneurship. For example, the reduction in the capital gains tax is counted as a tax expenditure as are the costs associated with registered pensions, RRSPs, and the new Tax Free Savings Plans. All three have made savings more attractive and accessible for Canadians, thus making the Canadian economy more efficient and productive.
Tax credits have moved far beyond those listed above, which all have the potential to benefit every Canadian citizen while improving the overall economy. We now have, for example, specific tax credits for children's art classes, school text books, children's fitness programs, tools for tradespeople and apprentice mechanics, professional and union dues, political contributions, volunteer firefighters, artists, musicians, caregivers, child-care, first-time home buyers, small business, Northern residents, students, miners, farming and fishing properties, and the list goes on.
And this is only a sampling of the 100-plus carve-outs or special treatments offered for personal income taxes. These special preferences totalled $130.2 billion in 2011, which is significant given that the federal government only collected roughly $120 billion in personal income taxes. In other words, the value of the various tax credits and other exemptions exceed the value of the revenues collected in personal income taxes. And this list ignores the value and nature of tax credits offered for corporate income taxes and the GST, which adds roughly another $44.6 billion in exemptions and carve-outs.
Far too many of these carve-outs benefit a small group or sector of the economy at the expense of the larger economy. Remember that every carve-out shrinks the tax base, which means a higher resulting tax rate to raise the same amount of revenues. A far better approach and one whose time has come would be to cull or even eliminate many of these special-interest tax credits and use the resulting revenues to reduce marginal personal income tax rates. Reducing personal income tax rates would strengthen the incentives for work effort, savings, investment, and entrepreneurship, which are the foundation for a prosperous economy.
The second aspect of tax simplification to consider is the cost imposed on Canadians to comply with the tax code. Simply put, the more complicated the tax code, the more costly it is to comply with for both individuals and businesses.
A 2010 survey of Canadian tax-filers found that 51 percent used a tax preparer such as an accountant or lawyer to complete their taxes while another 18 percent relied on friends or non-profit organizations. Less than a third of Canadian tax-filers were able to complete their tax returns without outside assistance.
When one compiles these costs along with the costs of organizing receipts, corresponding with tax preparers and/or competing one's own taxes, the total annual cost to comply with just personal income taxes was estimated at between $4 and $5.8 billion.
Additional costs are incurred for business, property, and other taxes. The last comprehensive study of tax compliance costs was completed in 2008. It estimated that the total costs incurred by individuals and businesses to complete and comply with all taxation was between $16.2 and $25.0 billion dollars. An additional $2.7 to $5.8 billion was incurred to administer the tax code by the federal, provincial and municipal governments. Thus, the total cost to comply with and administer Canada's tax code was estimated at between $18.9 and $30.8 billion. The costs to comply and administer the tax code have likely increased as it has become more complicated over the last half-dozen years.
Simplifying the tax code should be a top priority in the coming budget. Such simplification offers the opportunity to both reduce the compliance and administrative costs of the tax code as well as improving the economy by strengthening the economic incentives for productive behaviour like savings, investment, and entrepreneurship.
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