I want to thank the Standing Committee on Finance for its invitation to discuss Canadian taxation and international comparisons. I will raise some of the topics outlined in the committee's news release, as well as those found in the notice of motion tabled by Mr. Dysktra.
Obviously, in a span of 10 minutes, we will not have time to make all of the comparisons possible; I will make a few observations about the Canadian tax system and its current state. In keeping with the mandate of the committee, I will also talk about tax mechanisms that can be created in light of the current economic scenario in the second half of my presentation.
The most recent year for which it is possible to compare Canadian tax revenue, as a percentage of GDP, with that of other G7 countries, is 2005. At the time, Canada stood below the average. Taking into consideration tax amendments made by federal and provincial governments in 2006, 2007 and 2008, it can be said that Canadian taxation will be further reduced. We compare favourably to other G7 countries. However, as regards income tax taken in isolation as a percentage of GDP, our performance is less sterling: income tax in Canada is the highest among all G7 countries. Obviously, we include taxes collected by both federal and provincial orders of government.
Income tax as a percentage of GDP is not only high, but rather heavy for earners whose income is rather modest. There are three factors which explain this situation. For a low-income earner, income taxes rise taking into account social premiums, such as the Quebec pension plan, the Canada Pension Plan and the Employment Insurance Plan, whereas state benefits such as the Canada Child Tax Benefit are reduced.
Take for example a single or two-parent family seeking to raise its income by $5,000, from $35,000 to $40,000, a rather modest amount for 2008. Under federal and provincial taxation, once social and tax deductions are made on the combined income, the family takes home only 25% of the $5,000 in additional income.Therefore, the implicit tax rate in this case is 75%. Obviously, there's not a great incentive to work more.
In Canada, the weight of consumption taxes as a percentage of GDP is the lowest among G7 countries. We established an index to compare our standing to that of other countries. We took the weight of consumption taxes divided by the weight of income taxes. A ratio higher than one means that consumption taxes are higher than income taxes; inversely, a ratio lower than one indicates that income taxes are higher than consumption taxes. Canada sets itself apart with a significantly lower ratio than the average of G7 countries. In fact, with the exception of the United States, Canada has the lowest ratio.
All of these factors argue in favour of an increase in consumption taxes which would result in a decrease of income taxes having no impact on total tax revenue. Some claim that the exact opposite occurred with the recent cut in the GST, that went from 7 to 6%, then 6 to 5%. These claims are correct.
Companies are taxed on their profits, payroll, and capital. Canada finds itself below the average of G7 countries in terms of weight as a percentage of GDP. Taking into consideration the effect on government revenue of the government's plan to reduce taxes, effectively bringing the rate down from 22.12% in 2007, to 15% by 2012, this indicator in terms of percentage of GDP will continue to drop. Therefore, Canada will find itself in an enviable position in the eyes of G7 countries.
Let us turn now to taxation and how it can be used as a tool that takes into consideration the changing economic situation. What do I mean by "changing economic situation"? I mean that in Canada, economic growth for last year, this year and next year is different according to whether you are in Quebec, Ontario or the rest of Canada. This can be explained by the crisis that hit the manufacturing sector, and between January 2005 and January 2008, 280,000 jobs in Canada were lost. In fact, 92% of these jobs were lost in Quebec and in Ontario. This means that economic growth in these provinces is markedly different, and clearly weaker depending on whether you are in Ontario, Quebec, or the rest of Canada.
If the government is to intervene, the problem that the Canadian economy faces must be clearly identified. To do so, we must assess three elements: productivity per hour worked, growth of this productivity per hour worked, and the level of investment in production equipment.
If we start with productivity per hour worked, Canada stands below the average of G7 countries. Each hour worked in Canada produces less output than the average of G7 countries. We are less productive than our American neighbours. This is the first observation.
Another element concerns the growth of this productivity, and how it has changed over the years. Between 2001 and 2006, the average annual growth rate of productivity for Canada placed this country second-last, just before Italy, of all the G7 countries. This means that the productivity gap between Canada and other countries is widening. To understand growth and productivity, and the determinants of growth and productivity, three factors must be considered: technological progress, human capital, and physical capital. Physical capital can be quantified by an average rate of investment in production equipment for all G7 countries between 2001 and 2005. This rate is a percentage of GDP. Of all G7 countries, investment in production equipment in Canada is the lowest, which explains which factors we need to emphasize if we are to increase productivity. These last three slides are rather eloquent on the situation.
Let us now turn to choices that governments can make, and what has been done recently to help the industrial sector. It has been noted that the industrial sector is experiencing a crisis. In January, assistance was given to traditional sectors. This slide shows the percentage of jobs lost between January 2005 and January 2008, as spread across Quebec, Ontario and Alberta. Conversely, you have here an illustration of the percentage of assistance given last January broken down on a pro rata basis. Ontario suffered 57% of job losses, and received 36% of the assistance targeted to traditional sectors. As for Quebec, this province lost 34% of jobs between January 2005 and January 2008, and received 22% of the assistance. Alberta suffered only 2% of job losses between 2005 and 2008, and received 10% from the same envelope. If we are to convert these amounts into dollars per job lost, then Alberta received approximately nine times more than Quebec and Ontario, on a per capita basis. Seen in this light, it can be said that apportioning assistance on a per capita basis to help the industrial sector is an insufficient measure.
Other measures were implemented to spur economic growth and stimulate certain economic activities. There were corporate tax cuts. I don't know if it's worth bringing up again, but earlier I talked to you about cutting taxes on profits. There was also the accelerated capital cost allowance. I will not focus on these points, but we can certainly discuss them if you wish. Rather, I want to talk about what would be helpful if we want to help companies invest.
We saw a rapid rise in the Canadian dollar—I think you're in a good position to know that—and this harmed our exports. However, this rapid increase in the value of the Canadian dollar had a positive effect as well because businesses have been able to acquire imported equipment at a better price. Therefore, these economic circumstances have to be used in order to help businesses modernize. How? One way would be to use last year's surplus for the purposes of helping businesses. Thus, over the next 12 months, we could tell them that for every dollar of investment a certain percentage will be given back to them. I illustrated this using 20¢ for every investment dollar but it could be done another way. Therefore direct action would have to be taken given the low level of investments over the past few years.
Regardless, it should be pointed out that we're moving in the right direction. Reducing corporate income tax means that in 2012 there will be an attractive corporate tax rate, however, we could have moved faster by directly helping businesses to invest between now and then.
In conclusion—I know that I do not have much time left—Canada's tax system compares favourably internationally even though income tax measured as a percentage of GDP was higher than in all the G7 countries. Furthermore, in some income tax cases, the implicit income tax rate results in 75% of additional income earned by some families being confiscated, and there is an under-utilization of consumption taxes in this country compared to other G7 countries.
The tax system could also be used to help the manufacturing sector get through the current crisis. The tax system could also be used to counter slow productivity growth. There has been a lack of investment in production equipment and businesses could be told that they will receive assistance if they make short-term investments.
Even if this does not take place—although I believe it should—the Canadian tax environment for businesses and investments will be an attractive one in 2012, based on the information we have now.
Thanks very much for the opportunity to speak to you about a very important issue.
I would like to take the opportunity to touch on some basic principles of taxation, rather than the specific details of the current system, because I think the time is ripe for some fundamental rethinking about basic taxation in Canada. The nature of the international economy has changed since this issue was last visited, and there have been some major reform initiatives elsewhere in the world.
VAT has been adopted in a vast majority of countries, with the notable exception of the U.S., and accounts for a significant proportion of revenues raised in most.
There have been some major reforms of the personal tax system in many countries, including such things as the dual income tax in western Europe and flat tax systems in some transitional economies.
Some important tax reform studies have been completed or are under way elsewhere, such as the President's commission on tax reform in the U.S., the so-called Mirrlees review in the U.K., and the comprehensive documents on tax reform recently put out by the OECD. Some of these call for some new thinking in the area of personal and business taxation especially, and we should heed them.
The basic objectives of a good tax system are widely accepted. The ideal is to raise revenues fairly, efficiently, and with the least administrative cost to both the taxpayers and the taxing authority. Achieving these objectives in a decentralized federation is a major challenge. In my view, the following priorities are particularly important and necessarily involve some provincial contrivance.
First of all, with respect to sales taxation, by international standards the GST is a very good tax. It's broad-based, well administered, and accompanied by an effective refundable tax credit to achieve fairness. This structure should be protected.
However, there is much work to be done. The federal tax rate is now relatively low, so the share of revenues raised is small compared with that in many countries.
Harmonization with the provinces is a high-priority issue, as I'm sure you've heard before, and a very difficult one in a federation. In my view, the only sensible, workable reform is to adopt an HST type of scheme for Canada as a whole, which amounts to a national GST accompanied by provincial revenue-sharing. This is the system that's used in Australia very effectively, and also in Germany and other countries.
The alternative of allowing provinces to run their own harmonized sales taxes is administratively too cumbersome and has too few benefits. A harmonized GST obviously requires provincial agreement, and that can best be facilitated by federal leadership and the federal government having a significant stake in the outcome. This goal is made more difficult by reductions in the federal GST rate.
The Séguin report recommendation to turn over the sales tax completely to the provinces made little sense for the rest of Canada, in my view. It would, of course, be difficult to replace the Quebec sales tax in Quebec with a harmonized federal sales tax. The best option is therefore to allow the QST to coexist alongside a harmonized GST elsewhere in Canada, rather than trying to replicate the QST elsewhere.
With respect to individual income taxation, we have had a series of piecemeal reforms over the years, some of which go in the right direction, others of which do not. I think it's time to ask the basic question: what kind of personal tax system do we want? Some considerations are the following.
I would not favour a move to a full consumption-based personal tax system. Unlike most other countries, ours does not have an inheritance tax, and that alone means that we need some taxation of asset income.
An option that has attracted a lot of attention is the dual income tax system used in the Scandinavian countries and increasingly taking shape in other European countries—and incidentally, recommended by the President's commission on tax reform in the U.S. This system imposes a progressive rate structure on labour income and a flat tax on personal capital income at the rate corresponding to the lowest tax bracket. The system reduces administrative costs significantly and can be made virtually as fair as our current system.
The main fairness issue with the current system concerns those at the bottom end of the income distribution. The single most important thing that could improve fairness for them and that would remove inconsistencies in the existing tax system would be to make all tax credits refundable, and not just those for the GST and children.
The temptation to use the tax system, whether the income tax or the GST, to achieve social objectives should generally be resisted unless clear and persuasive objectives are at stake. This compromises the simplicity, efficiency, and fairness of the tax system. Examples that one could think of would be to offer tax breaks to homeowners, to induce people to change their spending patterns, to subsidize books, and so on. On the other hand, a clear and persuasive objective that might warrant special treatment and that is kept constitutionally mandated is equality of opportunity. This might justify special measures to ensure that children have equal opportunities and access to education, whether in early childhood or in post-secondary institutions.
Payroll taxation. Payroll taxes are nominally earmarked to social insurance programs, but there is no real connection between taxes paid and benefits received. This is as it should be, given that the programs are social insurance programs. However, it does imply that the contributions are really more like taxes than payments for future transfers. As such, they're highly regressive, even compared with the GST. I would favour relaxing the limits to contributions to correct this, making them more like proportional taxes, with correspondingly lower rates.
Business taxation. There's been much focus on tax rates and far too little on structural aspects of the business tax system, which in my view are the most important. At the outset one must ask, what is the main purpose of the corporate income tax? Traditionally we have thought of the corporate tax basically as a withholding tax against both retained earnings of domestic shareholders and foreign owners. This was the view of the Carter report many, many years ago. However, the tax also plays an important role as a device for collecting rents, particularly in the resource sector, and this orientation had been the focus in tax reports in other countries, especially in Europe. With that in mind, some important issues are as follows.
As documented by the Mintz report, the federal corporate tax system has long favoured the resource sector at the expense especially of services, such as by excessive deductions. This should be corrected, both on the grounds of economic efficiency and on the grounds of the federal government maintaining some access to resource rents. There are various models of efficient rent-collecting taxes--cashflow taxes, allowance for corporate equity taxes, which was recommended by the European Union and is likely to be recommended by the Mirrlees review.
More generally, the use of the federal corporate tax system as a means for the federal government to obtain a share of resource rents is an important one, especially given the federal constitutional commitment to equalization. Traditionally the federal government has obtained a significant share of resource revenues through the income tax system. The tendency to reduce federal corporate tax rates is problematic in this regard. This too reinforces thinking of the corporate taxes, at least partly, as a rent-collecting device and designing it accordingly.
A closely related issue to this is that there is no good rationale, in my view, for the deductibility of royalties from the federal tax. It's largely a transfer of resource revenues from the federal government to resource-producing provinces.
The corporate tax discriminates against small, growing firms and highly risky ones, precisely those that are major sources of productivity growth and employment generation. One measure that would be very helpful here, that would help compensate for financial difficulties faced by new firms, would be to allow for full refundability of tax losses.
On the issue of vertical balance, the federal government collects more in tax revenues than it needs for its own spending, transferring the difference to the provinces. This is as it should be. Federal-provincial transfers play a critical role in our federation, and their size needs to be protected. At the same time, federal dominance in taxation is necessary for maintaining an effective and harmonized tax system. Income tax harmonization through the tax collection agreements relies on the federal government being dominant. In sales tax harmonization, which as I mentioned most reasonably would involve a national sales tax with revenue sharing, would be difficult without a significant federal presence in the GST.
The final category is environmental taxes. Most economists would agree that environmental taxes should be an important part of the program for addressing environmental pollution. Such taxes yield an important double dividend: they provide free revenues to the government as well as correcting the problem of pollution. To exploit that, I would just make two points. The first is that a carbon tax should be contemplated, and if so, if it's used to maintain the competitiveness of Canadian industries, it should also be imposed on the carbon content of imports as well as on domestic-source carbon use.
Finally, revenues from a carbon tax should ideally go into general revenues rather than being earmarked for environmental subsidies. For example, abatement technologies or subsidies to reduce pollution should not be financed by revenues from environmental taxes.
Thanks to the committee for inviting me to speak with you today and actually, more generally, for conducting a comprehensive study of tax issues in Canada. I think it's a good moment for this in Canada. It's necessary to do these things on a regular basis. The world changes. We need to rethink our tax system on a regular basis.
As members of the committee are undoubtedly aware, tax policy has important implications for the quality of life that Canadians enjoy, both because of its effects on the efficiency and competitiveness of the Canadian economy, but also because of its impact on the distribution of economic resources in Canada.
In my comments today I'd like to address two sets of issues, considering first the goals or objectives of the tax system, especially at the federal level in Canada, and second, some of the implications of these goals for the kinds of taxes that the federal government should collect and the specific design of these taxes.
First of all, I'll consider the goals of taxation. The preamble, of course, to the mandate of the committee rightly identifies as an important goal “to collect sufficient revenue to provide required services in the least costly manner”. Other things being equal, of course, a tax system should be as efficient as possible, so as not to distort market behaviour in an inefficient manner; it should be as simple as possible, so as not to consume resources unnecessarily in administration and compliance; and of course, it should be as competitive as possible, so as to encourage economic activity in Canada and not to encourage the relocation of economic activities to other jurisdictions.
That said, we also know that a tax system must be fair and must be perceived to be fair. It's important to remember that one of the most efficient and least costly kinds of taxes to collect is a poll tax. It would impose the same amount of tax on each individual, regardless of their economic behaviour. It's also instructive to note that the attempt to introduce such a tax in the United Kingdom led directly to the downfall of Margaret Thatcher. As a result, tax scholars typically suggest that a tax system should seek to collect revenues in a manner that is fair or equitable as well as efficient, simple, and competitive.
In addition to revenue raising, moreover, a tax system has two other important goals, which tax scholars generally refer to as the so-called “allocation function” and the so-called “distribution function”. Consistent with the allocation function, certain taxes should be designed not only to raise revenue to finance public goods and services, but also to correct for market prices where these do not reflect the true social costs to produce a given good or service. A classic example of a corrective or so-called Pigouvian tax—this is how economists refer to it—along these lines is an environmental tax such as a carbon tax, which would correct for market transactions that do not currently take into account the environmental costs from carbon emissions. Although such a tax would inevitably raise revenues—and these revenues, of course, could be used to reduce other taxes or public debt or to finance public goods and services—the primary purpose of a carbon tax, or an environmental tax, is not actually to raise revenue, but rather to correct for the market failure that results from not putting a price on the environmental harm.
In addition to the allocation function, taxes can also be used, and are used, to redistribute economic resources, moderating inequalities in economic outcomes that result from market transactions as well as from transfers of property from one generation to the next. Although some tax scholars suggest that this distribution function is best accomplished on the expenditure side after raising revenues in the most efficient manner, others, myself included, contend that distributive fairness is best accomplished not only by a so-called “end state approach” that looks at the ultimate result and redistributes towards those who might be most needy, but also through a process-based approach that defines individual entitlements to income, as well as gifts and inheritances, in terms of after-tax amounts that moderate extreme inequalities that might otherwise prevail.
What implications then do these three goals—efficient, simple, and competitive revenue collection; market correction; and redistribution—have for the design of the tax system, particularly at the federal level?
Beginning with revenue collection, of course, experience demonstrates that one of the most efficient, simple, and competitive kinds of taxes that most countries do impose, and can impose, for revenue collection is a value-added tax like the GST. These taxes are levied by almost all developed countries around the world, generally to a larger extent than Canada, with the exception, of course, of the United States. They are effective taxes for raising revenues. They have very few implications for competitiveness if, as in Canada, they're imposed on a destination basis rather than an origin basis, so that you tax imports and you strip away the tax on exports.
As such, I think it's unfortunate that the federal government chose to lower the rate of GST while initially increasing, and then subsequently leaving untouched, personal income tax rates, particularly of course since the leverage from the reduction in federal rates could have been used more effectively to encourage provinces that have yet to harmonize their retail sales taxes with the GST.
I think there are lots of good arguments that the provinces should abandon their retail sales taxes where they exist. There's this full story of cascading effects on businesses that purchase business inputs and don't get the credit that the GST would provide. And something has to be done to encourage the provinces that haven't harmonized to harmonize. It's now much more difficult, unfortunately, to do that.
Turning to the allocation function of the tax system, I endorse the arguments, first of all, that Professor Boadway made, but also those that I notice Professors Kesselman and Davies made earlier to a session of the committee, that Canada should introduce a carbon tax in order to put a price on carbon emissions. Now, such a tax can raise competitiveness concerns. That's one of the biggest concerns about introducing a carbon tax. On the other hand, it's quite likely that the U.S. is going to be moving in this direction in the near term.
Furthermore, there are ways to try to design a carbon tax that would take into account the competitiveness concerns, generally by imposing the tax on a destination basis like the GST, imposing a tariff on imports based on the carbon content, and unfortunately--but I think this is probably necessary, it's a short-term step--trying to strip away the carbon tax on exports. Otherwise, of course, you simply encourage the flight of those industries to countries that don't levy the carbon tax themselves. So you could try to levy a carbon tax on a destination basis, like the GST, and address a lot of the competitiveness concerns.
Finally, with respect to the distribution function, I believe this is best accomplished by moderately progressive income taxes, like the current federal income tax, that moderate the results of market returns and, I believe, by a progressive gift and inheritance tax that would moderate the inequalities in wealth and the opportunities that wealth generates resulting from the transfer of wealth from one generation to the next.
Although the federal government currently levies the progressive income tax at rates that are not significantly out of line with comparator jurisdictions like the U.S., which will probably be increasing income tax rates after the next presidential election, it does not tax the transfer of wealth from one generation to the next. It hasn't done so since 1972, except to the extent that it taxes capital gains through a deemed realization at death. My view is that that's not an adequate substitute for a comprehensive gift and inheritance tax.
As well, I believe a number of changes over the last several years have caused the federal income tax to increasingly take the form of what scholars call a personal consumption tax, through increases to the capital gains exemption, reduction in the capital gains inclusion rate, increases in RRSP contribution limits, and now the introduction of tax-free savings plans. This kind of personal consumption tax effectively exempts income from savings from tax.
Economists often tout the alleged efficiency of personal consumption taxes over personal income taxes, but I believe the sufficiency case is seriously overstated. Experience suggests that, for the most part, savings are responsive to changes in income levels rather than changes in the return from savings. In fact, you see that in evidence about who contributes to RRSPs. Lots of low-income people with potential contribution room don't contribute to RRSPs, simply because they don't have the ability to contribute. I think the movement in this direction doesn't necessarily increase savings, but rather shifts savings from a taxed form to an untaxed form.
And I think that's going to be the case with tax-free savings plans, which by the way creates an amazing intergenerational transfer of wealth issue. You start transferring $5,000 a year to kids once they turn the age of 18, and if you contribute for 10 years to your kid--a colleague of mine did some numbers with standard rates of return--by the time they're 65 they could have $1.5 million that is not subject to tax. That's just through the rate of return on the tax-free savings plans.
So the conclusion on this, then, is that the shift toward a personal consumption tax not only is not necessarily required by efficiency considerations, but has significant implications for the fairness and redistributive function of the tax system, and I think it is a disappointing direction that we've headed in.
I'll share my time with Mr. Wallace, because he's just chomping at the bit to get some questions here.
On this chart on some choices for government, I find that 10% of the assistance went to Alberta. I find it terribly misleading and a little too easily confusing. I don't think it's helpful to pit province against province with something like this. I would suggest the low unemployment numbers in Alberta are probably pretty important in here. The only unemployed people we have in Alberta right now are the Liberals after the last election. We'll take that into account.
I'd like to pursue a number of things, but corporate investments by government.... Right now we're dealing with the issue of MDA, and we put a lot of taxpayers' dollars into this company. In the big picture, now we're all wondering if we're going to lose those dollars. So when you look at putting government money into supporting industries to make sure they're competitive and viable, how do we make sure those dollars don't then leave the country? Now we have a difficult decision ahead of us: how we protect the tax dollars that went into it. How do we protect a Canadian investment?
I look at the forest industry, which said we shouldn't give them money, that they should sort this out, that the government shouldn't distort the market further. Further to 's comments, they said we shouldn't set them up for tariff intervention against their products.
So the government has a very difficult balancing act. How do we support them? We've suggested the tax cuts, the accelerated capital cost allowance, those sorts of things, helping the communities that help the people, putting money into the communities. But funnelling money into companies that don't have an anchor tied to them, that don't have to stay in Canada, that's what concerns me.
Perhaps all three of you could address that.
Perhaps I can add a few things.
Indeed, we do not want to keep companies artificially alive or throw money out the window, especially when we are dealing with taxpayers' money, which is our money. We cannot do the investing for companies. But if we give them a tax credit or help them with investment support measures, such as 20¢ on the dollar, they would still have to find the other 80¢. Companies have to make the decision to invest. If you reduce their investment costs, you make investing more interesting. It might the only way for companies to become productive and profitable in a sector which, today, is feeling a lot of pressure.
We do not want to invest for them, nor tell them what to do. We do not want to tax at a lower rate the profits of companies in a single sector, as was done in the 1970s, 1980s and 1990s, on the pretext that they are less profitable than companies in other sectors. Everyone has to pay the same rate. The rate could be applied across all sectors, regardless of the level of investment, but the process would be benchmarked and companies would be helped.
I said 20¢, but it could just as well be 10¢, 12¢ or 15¢; it's up to you to decide. Quebec introduced this type of credit in its most recent budget and it was adapted to the particular characteristics of each region. The rate varies between 5% and 40%, depending on the region. I don't think that in Canada we could vary the rate by region, but the least we could do is offer an interesting rate to signal to companies that we encourage investment and that we want to help them invest for a certain period of time.