Tax reform? Go big, there’s a glacier coming
Okay, now can we get serious about tax reform? With the passage of a landmark tax bill now seemingly assured in the U. S. Congress — the final vote should come next week — what was until lately a maybe-someday issue has become an urgent priority.
Whatever the bill’s impact, for good or ill, on the U. S. economy, there can be little doubt that, with a top personal rate of 37 per cent (down from 40 per cent) and a corporate rate of just 21 per cent (down from 35 per cent), it puts Canada under significant competitive pressure.
The top rate of personal income tax in much of Canada is in excess of 53 per cent, federal and provincial combined; south of the border, in most states it will now be in the mid- 40s or less. As for the corporate tax, the economist Jack Mintz has calculated, based on an earlier version of the bill, it will result in a near-halving of the marginal effective tax rate on investment, federal and state combined. Where before it was about 15 points higher than in Canada, it will now be the same or even lower.
If the success of U. S. tax reform demands a matching effort at reform here, there are more compelling reasons to do so in the long run. Put simply, the Canadian tax system is a creaking, productivity- killing wreck: hugely over- complicated, and riddled with unjustified deductions and exemptions that distort economic decisions and bleed the government of revenues, recouped by much higher tax rates than would otherwise be the case.
Yet so attached are their beneficiaries to these tax preferences that governments are reluctant to touch them. Just to reform one of them — the special low rate of tax on small private corporations — was enough to set off the current brawl, and the government wasn’t even proposing to take it away: just to limit, somewhat, people’s ability to exploit it.
One lesson of this experience is the inadvisability of piecemeal reform. A broader reform effort that eliminated a large number of preferences at the same time would avoid charges that a given sector had been unfairly singled out; as important, it would generate the revenues needed to make deep cuts in tax rates, ensuring there are as many winners from the exercise as losers.
The Senate Finance Committee may have been off the mark this week in recommending the government withdraw its proposed small business tax changes, but it was right to say a more fundamental reform of taxation is in order. The committee, what is more, is hardly alone: calls for sweeping tax reform have lately been coming from a number of quarters, including the Business Council of Canada as well as the government’s own Advisory Council on Economic Growth.
Yes, but do we have to? Hasn’t Canada done pretty well with our present tax system? Aren’t I the one who’s always rabbiting on about how median incomes have grown by 25 per cent after inflation over the last 20 years? Don’t we enjoy among the highest standards of living in the world?
Yes, we do. But the factors that made that prosperity possible are no longer present. The long boom in the prices of oil and other commodities we sell on world markets is over, and unlikely to be repeated. More certain is the epochal demographic change on which we are embarked: the growing numbers of the elderly, and the consequently smaller share of the popu- lation of working age.
Much of the growth we have experienced until now has been fuelled, not by increases in productivity — more output per worker — but simply by adding more workers: between the Baby Boom and the historic surge in the numbers of women seeking paid work, labour was in plentiful supply. With the workforce projected to grow much more slowly in future years the long- run growth rate in the economy is likewise projected to slow: to just 1.5 per cent annually, according to the Advisory Council’s latest report, from the three per cent typical of recent decades.
Which would be bad enough, even without its corollary: massive increases in costs, mostly for health care, to look after all those now retired Boomers. The Parliamentary Budget Office’s recent report projects the share of GDP going to health care will rise by seven percentage points in the coming decades.
This implies a similar increase in revenues ( as it happens, seven percentage points of GDP is about as much as the federal government now collects in personal income taxes). Yet there’s only so much money governments can squeeze out of an economy by raising taxes. Better by far to raise output — the base on which taxes are applied. And the only way we’re going to be able to do that is by a sustained increase in national productivity, at much higher annual rates than we have been used to.
Enter tax reform. While there are other things we can do to spur productivity ( for example, opening protected sectors of the economy to greater competition), tax reform is essential. The tax preferences now on the books never made much sense. In our current circumstances, they are intolerable.
The aging of the population is sometimes likened to a tsunami, for dramatic effect. As Bill Robson, president of the C. D. Howe Institute has argued, it is better compared to a glacier. To be sure, glaciers move slowly, almost imperceptibly so. But if you’ve noticed, they also tend to crush everything in their path.