Taxation Systems 

Some time ago, I watched a news story which said that people working in the tax system believe that it is unfairly biased in favour of the rich. It went on to discuss what the survey information meant and how tax loopholes are being used to enable tax avoidance.

More recently we went through an election campaign in which each party strove to tell us that they would ensure we had a fair tax system. I generally understood that “fair” meant that they would find a way to obtain needed tax revenues without affecting any voter who might vote for their party. That all drove me to start writing down some thoughts on tax systems in general.

First of all, let’s stop talking about a fair tax system. There is no such thing as a fair tax system and there cannot be such a thing, at least in absolute terms. Fairness is like beauty – it lies in the mind of the beholder.

The rich are likely to think that their fair share of the tax burden would be that amount which represents their proportionate share of the money required to provide the goods and services that the government provides. Anything over and above their pro rata share of government spending is asking them to be personally responsible for providing those services to people who are less productive than themselves. Now, lower productivity may reflect lower capability, and perhaps the rich should feel blessed that they are more capable in today’s economy. But lower productivity may also reflect lower effort, less diligence, or greater apathy. Rich people might well be justified in feeling that they should not have to provide a disproportionate share of the government’s spending as a reward for their greater efforts.

The poor are likely to feel that they are working hard just to feed their families. They can ill afford to pay extra to create National Parks, or support the Canadian Council for the Arts, or contribute to immigrant housing. They believe that richer people are more capable of finding the extra monies required for some of the government services that might be considered to be not core requirements. They might also feel that the wealthy are more likely to enjoy the fruits of government investment in those things that enhance quality of life, and that they should therefore pay more than a pro rata share. And that’s also, in my opinion, a reasonable and supportable point of view.

So, fair is not the goal. The best tax system might be one that is felt to be somewhat fair by everyone…. but, it might just as well be one that is felt to be fair by almost no-one. The perception of fairness is, therefore, a sales task for the politicians and their supporting bureaucracy. It is not, in my opinion, a defining characteristic of a tax system.

What is really needed is a tax system that works. It must reliably produce the money that governments need. It should be simple, so that people all understand how it works. It would be great if it was so simple that the vast majority of people felt confident to do their own tax returns. And in support of simplicity, it should have minimal loopholes.

Let’s talk about loopholes for a bit. I hear people, politicians mostly, complaining about people who take advantage of loopholes to avoid taxes. I have little patience for that kind of whining. “Loopholes” are mechanisms (tax credits and the like) built into the tax system to encourage certain behaviours on the part of tax-payers. For example, the government wants to encourage charitable giving, so it provides a tax credit which recognizes that charitable donation. We want to encourage investment in Canadian companies and so there are credits for that kind of investment. I find it hypocritical of politicians to build those mechanisms into the system and then complain when some people are seen to benefit from the behaviours that the politicians are trying to encourage.

 I recognize, of course, that some people claim credits and avoid taxes in ways that qualify for a benefit under the letter of the tax law, but somehow avoid the spirit and intent of that credit. And yes, we have some right to complain about that. But instead of, or perhaps in addition to, blaming the profiteering tax-avoiders, we might spend some time criticizing the tax system that allows that to work. And we might think about ways to encourage desired behaviors without imposing another complexity on the income tax system.

There’s another reason I dislike tax credits. Probably a simplistic view, but there you go. In my cynical and twisted view, a tax credit is often a way for the government to provide funding without seeming, obviously, to provide that funding. After all, it’s not money spent by the government, so it doesn’t need to show up as a government expenditure. It’s simply money forgone by the government – money they might have collected but decided not to. And if you never collected the money, you don’t really have to defend how you spent it. The tax credit will get some publicity when it’s announced, usually at the start of an election campaign when we’re busy trying to buy people’s votes with their own money, but it will soon fade into the background and we won’t be very aware of the impact of that loophole a year down the road.

I looked up a list of Canadian personal income tax deductions, credits and expenses published by the CRA. There are 99 items on the list! Many of them I have no real objection to. They deal with things like equalizing income for those who have fairly unstable income, so they don’t get hit too hard in a good year. They allow income splitting between married pensioners. They try to account for expenses incurred while earning the splendid income for which your about to be taxed.

But there are other deductions and credits that I have problems with. I was unaware that there was such a thing as a clergy residence deduction and for reasons that I will explain in some future article, I disapprove. There is a credit for investment in exploration and development of oil and natural gas sites. (I find that odd given the government’s current efforts, as part of climate action politics, to avoid visibly supporting the oil industry. Is it possible that they speak with forked tongue?) There is a whole network of tax incentives for film, television and animation designed to create employment. I have little problem with the goal. We could use a good vibrant movie making industry. But the patchwork quilt of Federal, Provincial and Territorial credits for supporting the industry is quite astonishing.

My concern about that list of credits and deductions etc isn’t so much about the specifics of each wrinkle in the system. My problem is with the fact that there are 99 loophole envelopes to deal with, and that inside each such envelope there are hidden layers of complexity that probably only the best CPAs understand. Is that really a transparent system that the average Canadian understands and approves?

Removing loopholes would oblige the government to dream up other ways to encourage certain behaviours, or support certain forms of financial activity. But maybe they can do that in a way that results in a clear and unambiguous measure of the level of support provided to industry X, which would allow voters to decide whether they are fully supportive of government policy in that regard. In other words, I want the government to say “we took a great whack of your money, and here’s how we spent it”, and not “we took money from everyone except Billy-Bob and Bubba, but they got a break which you don’t need to know about, and we’re not certain how much it really cost.”

If we try to eliminate tinkering with the tax system as a means of encouraging economic behaviours, we will have to replace it with a much more comprehensive system of direct government grants. I think that’s ok. I’d rather have a somewhat expert bureaucrat in the Dept of Environment deciding whether an applicant fulfils the expectations of a climate action program than having some all-purpose tax gnome deciding that it seems to meet some criteria that broadly describe a tax credit. And at the end of the year, the Department of Environment will be able to say “here’s what we spent, here are the companies that profited, and here’s what we think we achieved”. CRA will never be able to provide that kind of accounting for what tax credits achieved and how much we really spent.

Possibly political parties wouldn’t welcome that kind of transparency lest it illuminate some political patronage in the grants system, but I think the rest of us might be OK with it.

The more loopholes we take out of the system, the harder it will be to avoid paying taxes. The CRA reports that their audit programs identified $13.6B of fiscal impact of tax avoidance attempts in 2017/2018, with $8B of that centred around off shore tax avoidance schemes. Wouldn’t it be great if we simplified the tax system so that it was much more difficult to avoid $13.6B worth of taxes? And remember, that $13.6B is a measure of those they detected, not those who got away scot free.

The tax system should be difficult to avoid. There is a significant underground economy in Canada – lots of people finding ways to provide services that aren’t subject to HST, or to gain income in ways that are not readily discoverable by the CRA and thus can be hidden from income tax. I’ve seen reports that estimate the value of Canada’s underground economy at over $40B with tax implications of $15B to $20B. So, one of the targets of a simplified tax system ought to be the underground economy.

It would be effective if many taxes were imposed in ways that are hard to avoid.

So, in summary:
– If you hear a political leader trumpeting his plans for a fair tax system, ask yourself “fair for whom?”
– If you hear a political leader describing how they are going to encourage industry to invest in some activity, ask yourself whether the proposed mechanism is the simplest and most effective way of getting this done.
– If you get a chance to demand that the tax system is made simpler and more effective, go ahead and beat that drum.
I plan a few follow-up articles on more specific changes that I’d like to see implemented in the tax system.