Tax neutrality is an economic Maltese Falcon.

In the highfalutin world of tax theory, what Canada needs — and what the Trudeau/Morneau private-corporation tax reforms claim to be aiming for — is a neutral tax system. Tax neutrality is seen as the gold standard for tax policy. It is frequently described in glowing language, as it was by Kevin Milligan, professor of economics at the University of British Columbia, who recently portrayed neutrality as the ultimate perfection, the highest political and economic value to which all nations should aspire.

Speaking last week in Calgary at the Canadian Tax Foundation’s conference on the Trudeau/Morneau reforms, livestreamed online across the nation, Milligan presented a grand outline of neutrality’s golden objective.

“A neutral tax system is one in which the government has the lightest possible touch on economic decisions,” said Milligan. “The target is for people to make the same decisions under taxation as they would without taxation. This is a freemarket goal: business decisions based on business merits.”

For added emphasis, Milligan, who edits the Canadian Tax Journal, rephrased the point. “A neutral tax system is one in which the decisions made by a corporation or an individual in a world where we have taxation are the same as the decisions that would be made in a world without taxation.”

Since Milligan’s Canadian Tax Journal helped lay the foundation for the Trudeau/Morneau reforms (see “Why the rich should revolt — and it’s not for the reasons they think”), it is not surprising that the Liberal reform package advocates neutrality. “Fairness and neutrality require that private corporations not be used as a personal savings vehicle for the purpose of gaining a tax advantage,” said a government brief. “Passive investments held within privately-controlled corporations should be taxed at an equivalent rate to those held outside such corporations.”

As more Canadians now understand, tax neutrality is the Maltese Falcon of Canadian tax policy, a gold standard that contains no gold. The Canadian tax system is not even remotely neutral as defined by Milligan or the government, and the announced reforms are a ruse that will do nothing to make it neutral. Because that’s not really the plan.

The government claims that owners of private corporations — small entrepreneurs, doctors, farmers, lawyers, famous novelists, filmmakers — are using their corporate structures to gain a tax advantage. Money is being tucked into private corporations where it produces “passive” returns at low tax rates that are unfair to the rest of us.

Exactly how much money is slithering around private corporations is unclear. Some $27 billion in “passive income” is said to exist within private corporations that are taxed at lower rates. We know for certain, however, that when it comes to tax neutrality, owners of private corporations are mere tiny fish swimming among the tax-avoiding whales. Millions of Canadians use equivalent passive-investment vehicles to duck billions in taxes on personal and investment income every year. They’re called pension plans.

Finance Canada estimates the annual tax loss from the taxfree operation of registered government and corporate pension plans will cost Ottawa $37 billion this year. When Canadians put money into the plans, they pay no tax on the contribution ($16 billion annual lost revenue) and the earnings in the plans accumulate tax-free ($21 billion in lost revenue). The pension benefits paid out are taxable ($11 billion revenue gain), totalling a net tax loss of $26 billion.

The RRSP regime, another passive-investment vehicle, allows Canadians to save billions at an annual tax cost of $12 billion.

In essence, the government’s tax reform is a two-faced sham. By its standard, it is a breach of the high principles of tax neutrality if passive investments are held within privately controlled corporations — but it is fair and desirable if millions of civil servants, corporate employees and other salaried individuals can park passive investments in pension plans and other retirement vehicles.

While Morneau justifies his small-business reforms by claiming that “private corporations (should) not be used as a personal savings vehicle for the purpose of gaining a tax advantage,” the entire pension system is designed to do exactly that. A Bank of Canada report said Canada’s pension funds in 2015 held assets of $1.5 trillion in assets, invested tax free. The top eight funds include the Canada and Quebec pensions plans ($600 billion), the Ontario Teachers’ Pension Plan ($263 billion), the Ontario municipal workers’ plan ($129 billion), and Alberta pensions held by AIMCo ($57 billion), all operating tax free.

Tax neutrality is a fake falcon, a dead-as-lead concept that Ottawa and assorted economic advisers are dishing up using fancy econo-jargon about free markets and images of a nondistortionary tax ideal that is not even remotely plausible — and one they do not actually believe in.

There’s talk of millionaires and the one per cent who are not paying appropriate taxes “at an equivalent rate” to the middleclass tax rate. Well, the middle-class tax rate on passive pension investments is zero — zero on the investment and zero on the investment returns over decades. The tax is only paid on pension benefits on retirement, very likely at a lower rate. Pension benefits can also be split with spouses, and passed on taxfree to spouses after death.

That’s where many tax-escaping, neutrality-avoiding millionaires are hiding. A retiring Ontario teacher receiving pension benefits of $65,000 a year ($51,000 teacher’s pension plus $13,000 CPP) essentially holds an annuity worth close to $1 million, all accumulated tax free. And when the teacher dies, money can be sprinkled to his or her spouse and dependents.

According to StatCan data, 125,000 individual Canadians collect pensions greater than $70,000, equal to an annuity worth at least $1 million. At the household/family level, hundreds of thousands of pensioned Canadians are receiving benefits valued at more than $1 million, all accumulated tax free. They also probably own other assets and live in a house that appreciates free of capital gains tax, another affront to neutrality that Finance Canada estimates costs the government $6 billion a year. All this exists in blatant contradiction of the declared principle of tax neutrality and on a scale that dwarfs the alleged non-neutrality of the private-corporation regime.