Okay. Translating the entire study will be a major work project for someone.
At any rate, the major message I hope you take away from the study and my presentation is that an economically efficient and socially equitable tax system hinges on its overall structure and design, not its overall level.
Other countries have applied taxes at much higher levels than Canada while still attaining very good levels of productivity growth and enviable standards of social programs. The key to achieving an efficient and growth-oriented tax system, whatever the desired overall level of taxes and size of government, is to shift the taxable base further toward consumption and labour income, and away from capital and investment income.
In the four years preceding my 2004 study, Canadian governments at both the federal and provincial levels made significant progress in pushing the tax system in the desired direction, and further constructive changes have been made in the four years since then. Some examples include large reductions in corporate income tax rates, reduction and elimination of corporate capital taxes, expanded allowances for depreciation of business investment, reduction in personal tax rates, reduced tax rates on capital gains, the rise in contribution limits for pension plans and RRSPs, and, most recently, the introduction of tax-free savings accounts. All of these measures move the tax system further toward consumption-based levies, and away from income- and capital-based levies.
But there remains room for further improvements in the tax system at all jurisdictional levels in Canada. I will briefly describe what I believe to be the eight most important areas for future tax reforms.
First, I begin by noting an item that applies at the provincial and municipal levels, the disproportionately high rates of property tax applied to business and industrial properties relative to residential properties across most of Canada. This discourages productive business investment, and it sends the wrong signals to provincial and municipal actors about what voters are willing to pay for additional local services. That, of course, is because most voters are homeowners rather than business owners.
Reforms to restrict the differential rates between business-industrial and residential property tax rates could easily be implemented through provincial legislation—though, undoubtedly, issues of public acceptance would arise.
Second, at the combined federal and provincial levels, the most urgent tax reform is to achieve a harmonization of indirect consumption taxes for the five provinces that still utilize a retail-level tax. In those provinces, nearly 40% of the total sales tax revenues are paid by business inputs rather than final consumers, inhibiting business investment and the efficient allocation of resources.
The federal government missed an opportunity to achieve this goal when it reduced GST rates without any linkage to provincial sales tax harmonization. To get the provinces on board with this change—especially Ontario and B.C.—the federal authorities will have to provide greater fiscal compensation than they have offered to date, and greater flexibility to the provinces as to the taxable base of the harmonized tax.
Third, at the federal level, one of the more important tax changes would be to raise the annual dollar limit for contributions to tax-deferred savings plans, like registered pension plans and RRSPs. The introduction of the tax-free savings accounts is helpful for individuals in efficiently arranging their lifetime savings on a consumption tax basis, particularly for lower and moderate income households. But Canada lags other countries, such as the U.S. and the U.K., in its limits on tax-recognized savings for higher earners. The current annual limit of $20,000 should be substantially increased, say to $30,000. This change would also make the Canadian tax system more competitive with other countries in attracting and retaining highly skilled technical and managerial talent.
Fourth, also at both the federal and provincial levels, the upper-bracket personal tax rates bite at incomes that are low, relative to where they bite in some competing countries. The top federal marginal tax rate of 29% kicks in at just over $123,000 of taxable income. This could be raised substantially—for example, to $180,000. The provincial personal tax schedules mostly hit their top marginal rates at taxable incomes below $100,000, with three provinces reaching their top rates in the $60,000 range. While the federal top tax rate is not excessive internationally, some of the provincial rate schedules are more steeply progressive than they should or need be.
These changes, as well as stretching out some of the intermediate tax brackets and reducing their rates, will be helpful in improving incentives for individuals and in attracting and retaining the most productive workers for our economy.
Fifth, while on the topic of direct personal tax, which is still called an income tax but in reality is closer to a consumption-based tax, another aspect warrants change. The major tax reforms of 1987 converted a number of items that had previously been deductible in computing taxable income into non-refundable credits. However, a few of those items are more properly allowed as tax deductions because they define the taxpayer's ability to pay tax. Thus, they should not be credited at a common rate independent of the individual's marginal tax rate. Three items in particular should be restored to tax deductible items: employee contributions for Quebec and Canada pension plans, employee contributions for employment insurance, and medical expenses.
Sixth, another aspect of the personal tax also deserves careful thought and reform. Unlike most other countries' tax systems, Canada seeks to attribute taxable income on assets transferred between spouses to the donor for tax purposes. This leads to highly complex attribution rules and equally complex manoeuvres by taxpayers to skirt the rules.
Based on my analysis and a study on income splitting published also by the IRPP, but just last month, I recommend that Canada follow the British practice of allowing full splitting of investment incomes between spouses when there is a bona fide transfer of assets. In conjunction with that change, I would also recommend that Canada simplify its complex and cumbersome rules for deductibility of investment interest expenses by allowing them up to the filer's taxable investment income, following U.S. practice.
Seventh, the payroll taxes, or so-called premiums, for the employment insurance program are levied at uniform rates on employers and employees, independent of the risk of unemployment in particular industries and firms. This structure leads to highly inefficient cross-industry and cross-firm subsidies as well as to disincentives for individual employers to stabilize their employment levels. A remedy to this problem is to differentiate the premium rates—at least those applied to employers—to reflect the differential rates of layoffs and employment stability. This system of so-called experience rating has been applied to good effect in many of the provincial workers' compensation programs as well as in the U.S. states' unemployment insurance programs.
And eighth and final on my list, which is certainly not an exhaustive list, is an item that appeared in a limited form in my 2004 paper, which was increased excise taxes on transport fuels, mainly gasoline. Given changes since then in our thinking about environmental issues and climate change, we should pursue higher taxes not only on gasoline but on a wide range of carbon-dioxide-emitting fuels and activities. The revenues from these levies, which could become very large over time, should be recycled in the economy through reductions in other taxes, such as some of the reforms that I've suggested here. Sensibly pursued, such environmental levies will yield the so-called double dividend; that is, reduced climate and environmental degradation along with a more efficient economy through reduction of distorting taxes.
You might note one item that was not on my list of tax reform priorities—tax-free rollovers of capital gains as promised by the current government in the last election. I would cite several reasons for not including that on a list of priorities.
The TFSAs and expanded access to tax-deferred savings that I've recommended provide tax-free treatment for capital gains and also for interest and dividend incomes. So unlike a capital gains rollover, they do not distort portfolio holdings.
Tax-free rollovers of past-accrued gains provide an inefficient windfall for past behaviour rather than incentives for future savings behaviour. Tax-free rollovers would provide large tax savings highly concentrated in the very top income classes. Tax-free rollovers are technically more difficult to implement and enforce than the existing tax-deferred saving schemes and the forthcoming TFSAs. And finally, Canada's effective tax rates on capital gains are already competitive with those in the United States, especially for short-term gains, where the U.S. applies full tax rates. So I commend the government in choosing not to pursue that particular item of its campaign platform.
To conclude, Canada at both the federal and provincial levels has made major strides since 2000 to improve our tax system, but additional steps are needed. These changes will move our revenue system further toward an economically efficient consumption base. Regardless of whether one seeks larger government or smaller government, it is important that revenues be collected using an efficient, smart design.
I have outlined briefly what I believe to be the top priorities and I'll be glad to answer any questions that members of your committee might have.
Like John, I'm very pleased to be here. I think it's very important work that your committee is embarking on, and I wish you well in this enterprise.
My goal today is just to talk about some important areas in the federal tax system that I think still require attention. My comments will reflect my particular interests, which are mostly in the personal income tax area. I'm by no means presenting something exhaustive or comprehensive. It's not possible to do that; the tax system is too huge a thing.
When I started to think about this, I thought it would be useful to cast my mind back, and I'm going to invite you to cast your minds back as well, 10 years to 1998 and think about what's happened since then. A lot of good things have happened, in addition to some problems continuing. I think it's important to remember that Canada has a pretty good tax system, and it's the result of a lot of people thinking about it very seriously and trying to improve it over time, just as this committee is trying to do at the moment. We shouldn't have any notion that there are horrendous, terrible problems in the Canadian tax system that need to be fixed up.
At any rate, here's my little list of things that were wrong 10 years ago.
The first thing is the top tax rate, as John has pointed out, kicked in at too low a threshold. That problem has been quite significantly addressed. I think the $123,000 threshold for 2008 is still a bit low. I was talking to an Australian economist yesterday, and their top rate kicks in at $150,000, so I think we could move further there.
We used to have surtaxes in the PIT, and we don't have them any more. The last surtaxes and the corporate income tax were removed this year. These are good things because those raised the top marginal rates quite a bit.
Ten years ago we only had partial indexation of the personal income tax, which is a bad thing. It increases tax rates every year. We've had full indexation since the year 2000, so that's a big improvement.
Again, the RRSP contribution limit was too low. Ten years ago it was only $13,500; now it's $20,000. We should keep going up, but we've made some progress.
We didn't have a tax-free savings account. Actually, by the way, a better term for this, and it's a term that John has used in his previous work, and others have used, is tax prepaid savings account, because you've paid tax on that money you're saving; you're just not going to get nailed with a second tax in the future. This is something economists have called for, for a long time, in the theory of a consumption tax approach. You should have both the RRSP-type vehicle and you should have the TFSA-type vehicle. It's not some strange thing that came from nowhere; it's been thought about for a long time. I also think the contribution limit should go up, and I hope it will rise more than it's slated to do as we go forward.
Personal income tax progressivity was too strong ten years ago, partly because the top rate kicked in at such a low tax level. But that does have some interesting impacts. One thing I've worked on in my research is the impact of that progressivity on the incentive for people to invest in human capital. So people are thinking about taking graduate programs at university, becoming doctors, lawyers, engineers, whatever, and they ought to think about the material as well as the moral rewards to doing that. Those are reduced the more you enter into high tax brackets after you graduate. This is the impact of progressivity, and it's now been well established that it really does reduce the rate of return to investing in human capital. If people are thinking along these lines, it reduces that incentive.
That's something where the situation has improved quite a bit, and this is something that I don't think people expected. Raising the threshold for the top marginal tax rate has an impact, and there are a lot of other initiatives that have been pursued over the last 10 years to increase the assistance through the tax system for students.
Back in 1998, my research with Kirk Collins at Western indicated that for a median person taking a bachelor's degree in Canada, the effective tax rate on that investment was 15%. A neutral tax system would have an effective tax rate of 0%. Our 2006 results indicate that for this median person this rate is now down to 1%. So it's gone down from 15% to 1% as a result of various changes in the tax system. That is an important victory.
The child tax benefit in 1998.... Due to the clawback, if your net income was above about $70,000, there was no tax recognition for having children, which is a violation of horizontal equity. So, as John pointed out in a paper in 1994, if you had an income of $100,000 and three kids, you paid the same tax as somebody else with an income of $100,000 and no kids. The tax system was effectively treating the kids as if they were a fancy boat. This has been addressed with recent initiatives like the universal child care benefit and the tax credit for kids that was introduced in 2007.
There's a problem a lot of people talk about, about high effective marginal tax rates for low-income people. It's a very difficult problem. It's been addressed to some extent through the working income tax benefit. Federal capital taxes are gone, and it's a very good thing. The corporate tax rate has come down. It was 28% ten years ago and this year it's going to be 19.5%. So there's real progress there.
Lack of harmonization of the GST and provincial sales taxes is still with us. There's a problem with the GST that there are relatively high compliance costs. This is partly or perhaps largely due to the complexity that comes from having multiple rates and different treatment for different kinds of goods. In principle, as an economist, that's a problem that I would like to see addressed in the future, even if it's probably not very high on the agenda for non-economic reasons.
Okay. So that's my little checklist from ten years ago. Now, we could also talk about what's changed. Have problems arisen that we didn't have then? I have a little list of those. There have been some improvements in other areas that I just haven't had a chance to talk about.
Now I'm going to talk about some problems that have arisen more recently. I wouldn't like you to think that I just think it's problems that have come onstream. On these problems that have arisen, the new ones, the introduction of the credit for interest on student loans was unnecessary. In the tax system, the main approach, the way the costs of getting educated are recognized is through immediate expensing. If you have immediate expensing of capital expenses, you don't need interest deductions later. Quantitatively it's not a huge issue, but in terms of a precedent for how we treat interest deductability or credits, I wasn't too happy about that.
Tax mix.... Most economists across the country have been disappointed that the GST rates were reduced rather than having PST rate reductions. We're certainly in favour of rate reductions, but we are more concerned about the impact of PIT, personal income tax, and also about corporate income tax on incentives to save and invest.
It appears, and I think it's probably true, that there's been a bit of an increase in the use of special purpose tax credits to achieve social objectives. This is not something I would rule out entirely. I'm thinking of the public transit tax credit, the children's fitness tax credit, for example. If we want to change people's incentives and if we're convinced that through the tax system is really the best way to do it, then we should do it. We need to be on our guard about trying to do too many things through the tax system. It makes the tax system more complex, but it also reduces the revenue. So you have to keep the rates up, in general, to pay for these additional credits.
The final thing I would touch on is carbon tax. Like many people now, I'm in favour of carbon taxes. There's this benefit that you certainly don't want to use as some kind of revenue grab. If it's introduced in a revenue-neutral way, then you can reduce other taxes that are distorting things like labour supply and saving and investment. So there could be economic payoffs from introducing these taxes if we feel we need to reduce our emissions.
So that's more or less all I had on that.
Yes, I think you're making a good point. It's a complicated issue, because there are downsides as well as upsides.
If you tax a husband and wife together and one of the partners has been out of the labour force and is thinking about perhaps taking a job, their effective marginal tax rate is the marginal tax rate of the family. If the primary earner is earning $70,000 or $80,000, that is a high marginal tax rate; whereas in our system, when the secondary earner thinks of going into the labour force, the first $10,000 approximately is at a zero tax rate. Actually, that's not quite right, but they enter independently, so they enter at the bottom of the tax schedule and there is more incentive for them to enter the labour force, as they're taxed more generously.
Another point to make is that as tax structures are flattened, this becomes a less serious issue. Now, if you actually move to a flat tax, the issue would largely go away. So I would hope that we would continue to flatten the tax structure in the future, and maybe then it won't be so important.
These are good points that you're raising, ones that are well worth examining, I think.
That's another area in which we differ.
I think a flat tax is a progressive tax as well, because there always is a basic exemption of a certain amount. If you look at Alberta, it's fairly healthy. Normally in flat-tax proposals what people put forward is an increase in the amount of basic income that's exempt, so that the proposals normally deliver a benefit to low-income people. They also deliver a benefit to very high-income people—that's inescapable—but if you arrange it so that there's sufficient benefit to the low-income people, then many observers who look at it will say that on distributional grounds it may improve things.
Another point to keep in mind is that the marginal tax structure doesn't just come from the personal income tax system. It also comes from the CPP, EI contributions, and clawbacks. When you add them all together and look at the effective structure of marginal tax rates, actually the marginal tax rates are at the highest for some of the lowest-income people. Beyond that it's a bit jagged if you add the whole thing up, but the marginal tax rate on average is about constant as you go up, because the very high-income people are not making EI and CPP contributions, for example, on their marginal income, and the two things just cancel out.
Some people think one could rationalize this whole system and simplify things by having one constant marginal tax rate for everybody. This would be a very radical reform. It would require a wholesale rethinking of the whole system, but I think if people are thinking about flat-tax ideas, they ought to think in those terms.
I have a short statement in light of developments that have happened since we last discussed this subject. Like most of you, I've been hearing from many of the over 1,700 retail investors who have been unable to liquidate their asset-backed commercial paper holdings since the market collapsed last August. I've been speaking to them, Mr. Purdy Crawford, and others about the restructuring plan that is currently under consideration.
I think it's desirable to encourage a private sector solution to this extraordinarily complex problem. But many of us also want to see that the special position of many of these smaller retail investors is recognized and appropriately dealt with in that process. Meetings with these investors are going on in Montreal and Toronto today, in Edmonton and Calgary tomorrow, and in Vancouver on Wednesday.
That brings me to what we are discussing today. I believe the results of these discussions over the next few days will have an important effect on who the members of this committee will want to hear from if we decide to proceed with hearings. Even if the special situation of the smaller retail investors can be resolved through this private sector process, I believe this committee will still want to get to the bottom of what went wrong from a regulatory perspective and what must be done to prevent a similar situation from recurring in the future. I believe there are some serious market oversight issues that need to be understood.
Mr. Crawford has confirmed to me that he will be happy to appear before this committee after the April 25 vote on the restructuring plan. We also need to hear from the federal and provincial regulatory authorities, the Superintendent of Financial Institutions, the various provincial securities commissions, investment dealers associations, rating agencies, and the ombudsman for the banking system. What went wrong? We need to understand how governments and regulators are responding to this failure in the U.S. and other jurisdictions.
If the retail investors are not satisfied by the results of discussions over the next few days, that's a different story. In that case, I feel our committee should hear from these investors directly as well as from the regulatory agencies that allowed this to happen under their watch.
So for these reasons, rather than bring my motion forward for a vote today, I would like to reschedule the vote on this motion for Wednesday of this week.