FINANCE TURNS TAX STUPID.
My favourite graphic in this year’s fall fiscal update is Chart 3.5, which shows the combined federal-provincial-territorial tax rates on personal and corporate income in Canada from 2000 to 2017.
For the first dozen years or so the top rate on personal income is remarkably flat. If anything, it declines ever so slightly, from just above 45 per cent to just about 45 per cent. Then, after 2011, with inequality fever having struck, it starts rising to its current value of 51.6 per cent for 2017.
Corporate taxes move in the other direction, from above 40 per cent in 2000 to their current value of 26.7 per cent.
Taxes on small business don’t fall as dramatically. But they’re down from 20 per cent in 2000 to 14.4 per cent now and of course they will now fall more as a result of Ottawa’s decision to lower them to 10 per cent next January 1st and nine per cent the following year.
The commentary accompanying the chart is even more interesting. “The move towards more competitive corporate income tax rates since 2000 has widened the gap with top personal income tax rates from about 26 percentage points in 2000 to over 37 percentage points today.”
A couple of things about that: Use of the word “competitive,” which somehow got through the political screeners, is revealing. “More competitive corporate income tax rates since 2000” is just a way of saying “lower corporate income tax rates since 2000.” Yes, “lower” and “more competitive” really are synonyms. There is a competition going on in our economy and around the world.
But if lower corporate taxes make your system of capital taxation more competitive, higher personal taxes make your system of people taxation less competitive, and that’s what’s been happening here since 2011.
The Finance Department attributes the widening gap between personal and corporate rates entirely to lower corporate rates. In fact, judging by their chart, the 11- point difference is about half from rising personal rates and half from declining small-business rates. Who’s responsible for rising personal rates? The Finance Department. Higher top rates are a feather in the finance minister’s cap. They were plank number one in the Liberals’ 325-plank election platform and they’re one election promise the new government delivered on and right away.
What’s the effect of this widening gap between the top personal rate and the small- business rate? More professionals are routing their income into their own incorporated small businesses. As the update explains: “The shift towards incorporation is gradually eroding Canada’s tax base … A shift to incorporation has been especially acute in services industries … and particularly among professional services ( e. g., lawyers, accountants and physicians) — the annual growth in the number of professional corporations has been 14.9 per cent from 2001 to 2015.”
So the widening gap in tax rates creates a tax- reduction opportunity for people who incorporate. Utterly unsurprisingly, people respond by incorporating.
How does Finance react? Not by closing the wider gap it has created but by cracking down on popular tax-reduction techniques that take advantage of it.
When people whose tax reductions will be reversed respond with surprisingly effective outrage, then what does Finance do? It eases back on the crackdown and also announces it will reduce the small-business rate by two more points.
What is the effect of an even lower small-business rate? It is a truth universally acknowledged that if income taken in one form is taxed at a much lower rate than income taken in another form, people will arrange their affairs so as to take their income in the lower-taxed form. An even wider gap between the top personal rate and the small-business rate creates an even greater incentive for people to incorporate and find ways of paying the low, low business rate rather than the high, high top personal rate.
As I say, it’s a great chart. But its lesson should be: Mind the gap. Don’t have big differences in tax rates based on the precise form in which people earn their income. If you do have different rates for different legal forms of earning income, keep them as close together as possible. If you don’t, people will game the system, sure as the sun will rise and the Opposition will hunger to replace you on the government benches.
Talk about stupid policy tricks. The government tries to plug a problem of its own creation. When people object, it throws them precisely the favours that caused the problem in the first place. The only winners in this sadly comic story are federal tax auditors, who for years and years to come will have more work than they can handle.
THE GOVERNMENT OFFERS PRECISELY THE FAVOURS THAT CAUSED ITS PROBLEM IN THE FIRST PLACE.