Conservative tax reform panel a good idea

One intriguing promise in the Conservative platform is to establish an expert panel to study comprehensive tax reform to improve competitiveness, bring down tax rates and simplify rules. I say “intriguing” because the rest of the Conservative platform is chock-full of tax credits and new tax gimmicks and wrinkles that in many instances would make the tax system less simple, fair and efficient.

I counted at least 31 tax promises in the platform. Some are sensibly temporary and aim to get people back to work, such as the “Rebuild Main Street” tax credit (a 25 per cent credit for up to $100,000 of investment in a small business) and the “Canadian Investment Accelerator” of five per cent over two years. Others are permanent, such as the “patent box” (a onehalf exemption for income from patents held in Canada), the “Employee Ownership Trust” (capital gains relief for shares donated by owners to a trust for employee ownership), flowthrough shares for equity investments in tech companies and a tax on digital sales of large tech companies, luxury non-electric vehicles, secondary luxury homes and frequent flyers.

What would an expert panel recommend in a comprehensive review of the tax system? I had personal experience dealing with these issues when I chaired a federal business tax review in 1997. The panel started off with basic principles. Business taxes should discourage work, investment and risk-taking as little as possible. Tax reform should lead to lower compliance and administrative costs. Business taxes should be fair and competitive, which is best achieved by having similar tax burdens on all business activities at the lowest possible rates. The panel’s recommendations, some of which were controversial, aimed to scale back things like preferential manufacturing and small business tax rates in favour of lower general corporate income tax rates. We even looked at a shift from the federal gasoline tax to a broad-based environment tax that would also help reduce business tax rates.

As ours did, other tax reform panels typically recommend scaling back special incentives like flow-through shares, which attract poor investment projects, in favour of a general reduction in tax rates to reduce distortions and improve fairness. A panel might also look at a shift in the mix of taxes — less reliance on income tax, say, in favour of other levies, such as health premiums, tolls or consumption taxes. What panels would not recommend is to introduce dozens of the kinds of targeted tax cuts we have seen in recent years, such as accelerated depreciation and the public transit tax credit.

For its part, the NDP promises to introduce a three-point hike in the corporate tax rate, a two-point hike in the top personal income tax rate and a new one per cent tax on wealth of more than $10 million. It largely avoids targeted tax reductions but does propose a host of new spending programs for pharmacare, dental care, homecare and a guaranteed income. Its proposals are overwhelmingly focused on redistribution — a consistent philosophy but a misdirected one given our lacklustre economic growth.

The Liberals so far have shown little interest in boosting growth through the private sector, believing instead that growth comes through more public spending. Two of their few tax relief measures targets first-time home buyers and seniors. They also promise to raise the corporate tax rate by three points on bank and insurance company profits of more than $1 billion. I calculate the tax could raise about $1.5 billion in 2022 on the top five banks. Other estimates suggest a total of $2.5 billion on all financial institutions.

The new tax is just fiscal piling-on. Banks and insurance companies already pay more taxes than other sectors due to unrefunded GST/ HST taxes on their investments in buildings, equipment, ATM machines and technology and federal and provincial capital taxes. In earlier work, I have shown that the effective tax rate on new investment in the finance and insurance sector is 56 per cent, far higher than the 19 per cent average for other sectors.

Nor would the new tax be fair. Many Canadians believe a tax on bank or insurance profits will be paid by the institution’s shareholders. Economic studies suggest, on the contrary, that they are shifted forward to consumers or result in lower wages and stock market valuations. The new tax will thus fall on many in the very middle class the Liberals claim to esteem so highly. They could face higher mortgage costs, lower deposit rates, smaller pensions and higher bank or insurance fees.

In sum, there is little good to say about the Liberals’ special tax on financial institutions. It is a pure tax grab on one sector with no underlying rationale other than that is where the money is. Its aim may be to collect some of the oligopoly profit the financial sector supposedly earns due to concentration in the industry. But taxation will lead to a reduction in financial services. To improve competition, regulatory reforms are best. Removing obstacles to fintech development and foreign ownership rules in banking would be a good place to start.

To their credit, the Conservatives at least focus on growth, investment and work incentives that would strengthen the economy’s productive capacity. Tax reform costs money so with the current deficit, it is hard to pursue broad tax reductions without increasing other taxes. Whoever wins the next election, an expert panel might be just the right medicine to get us back on the path to a tax system that would support growth, simplicity and fairness.