Taxman eyes top 1% of doctors

How much doctors get paid — combined with the seemingly disparate topics of population aging, top-end income concentration, small business tax regulation and federal-provincial transfers — is emerging as one of the thorniest policy issues facing Canadian governments.

Most health-care costs are typically incurred in the last few years of one’s life, and demographers are predicting that the proportion of Canadians 85 years and older will increase from 2.2 per cent in 2016 to more than 5.5 per cent in the next 30 years. Provincial governments are well aware of the fiscal challenges, and doctors are expensive. In Quebec, where population aging is well under way, Health Minister Gaétan Barrette is already telling physicians that his government will be expecting doctors to deliver more services at lower cost.

Nobody will be surprised to learn that doctors generally make a good living, but the link between doctors’ incomes and the increase in top-end income concentration in Canada has attracted little attention. When people think about increase in the share of income going to the top one per cent, they usually think of higher pay for CEOs and other corporate executives, not doctors. Senior managers are the largest single group within the top one per cent, but not the majority: three top earners in five are working in other occupations.

Doctors’ incomes more than kept pace with the rest of the one per cent as its share of total income increased. In the 1981 census, doctors accounted for just under 12 per cent of those with incomes in the top one per cent. In the 2006 census — when top-end income concentration peaked in Canada — that share had increased to 13 per cent. Put another way, 1.3 per cent of all income went to doctors in 1981; by 2006, their share had increased to 1.9 per cent. And these numbers probably understate growth in physicians’ incomes.

This increase in doctor’s incomes could not have happened without the cooperation of governments. Physicians’ incomes are not explicitly set by governments: doctors in private practice are independent entrepreneurs who run their businesses as they see fit. But they are limited in how much they can charge for services. Public-health insurers — like all insurers — set out how much they will reimburse their clients for a given service. It is up to the doctors to decide what services will be provided and how, but the fee schedule is set by the government, usually in consultation with medical associations.

Like many other professionals, doctors set up small businesses to administer their operations; the technical term is Canadian-Controlled Private Corporation, or CCPC. But evidence is mounting that these professionals are using CCPCs and their associated tax treatments as instruments of increasingly aggressive tax avoidance. (It’s important to distinguish between tax avoidance and tax evasion. Tax avoidance is legal; tax evasion is not.)

There are several ways in which small businesses can be used to shield income from personal income taxes. Since income taxes are only paid on the salaries the owners pay themselves, revenues can accumulate in CCPCs at the much lower small business tax rate that applies to profits less than the $500,000 threshold. There are several ways that this money can be accessed without paying taxes at the top personal income tax rate.

For example, CCPCs can be used as a form of incomesplitting. If ownership of the CCPC is shared with family members, then its profits can be paid out in the form of dividends to other family members who would then pay the lower tax rate. Or professionals could execute an “estate freeze” so that their heirs can make use of their lifetime capital gains exemptions to avoid paying taxes.

Not all CCPCs are set up as tax dodges, of course, but as the University of Ottawa’s Michael Wolfson and University of Waterloo’s Scott Legree note in a recent study, a natural experiment in Ontario is revealing. In its 2005 budget, the Ontario government extended the share structure of physician professional corporations to include non-voting shares for family members. This measure affected only doctors in Ontario, and the number of doctor-owned CCPCs in Ontario increased from 2,000 in 2005 to 16,000 in 2011. Meanwhile, the number of doctor-owned CCPCs in other provinces and in other industries remained relatively stable.

This provides the context for the federal proposal to limit the use of hierarchical ownership structures that make it possible to extend the threshold for the small business rate beyond $500,000. It also explains why doctors’ associations are up in arms about the measure: these tax structures are intrinsically linked with doctors’ after-tax incomes.

This story will not end here. In the 1990s, when the gap between U.S. and Canadian tax rates was high and the Canadian dollar was low, doctors were the group for whom the “brain drain” threat was most credible. In 1996-97 alone, net emigration of physicians amounted to just under 1 per cent of Canadian doctors. What finally staunched the outflow was a combination of a stronger Canadian dollar, higher fees, lower taxes — and the introduction of new tax-avoidance strategies. All of these changes are in the process of being reversed. Medical associations will be returning to the next round of fee negotiations with renewed bargaining power, and it’s going to be difficult for the provinces to refuse their demands. Doctors are going to become even more expensive.