Canada needs comprehensive tax reform

The House of Commons finance committee has completed its consultations for the upcoming federal budget. Many of the witnesses who appeared before the committee — including myself — recommended that an independent and non- partisan panel be established to carry out a comprehensive review of the Canadian tax regime. Committee members seemed indifferent. They should not be.

It has been more than 50 years since the Royal Commission on Taxation ( the “Carter Commission”) tabled a six- volume report with recommendations for sweeping change to Canadian tax rules. That report led to tax reform in 1972 that included innovations such as the taxation of capital gains for the first time. Carter 2.0 is long overdue. There are two fundamental reasons why.

First, many of our tax rules do not make sense. Here are a few examples.

Individuals who receive dividends from Canadian corporations receive “dividend tax credits” for taxes that the corporation is presumed to have paid at the full statutory rate, even if the corporation actually pays tax at a much lower rate or does not pay any tax at all. These credits come at an annual cost of about $ 9 billion (including provincial credits).

Our “income sprinkling” rules prevent a high- taxed individual who owns shares of a private corporation from diverting income such as dividends to family members who are at lower rates. There is an exemption for family members over the age of 24 provided the corporation is not in a service business. But, according to Statistics Canada, over 75 per cent of small businesses are in the service sector. So we have an exemption for small businesses that most small business owners can never access.

Our international tax rules allow multinational enterprises (MNES) to establish foreign subsidiaries in low- or zero-tax jurisdictions to avoid Canadian tax. There is little if any tax either when the foreign subsidiary earns business income or when the MNE receives dividends from the subsidiary. And this erosion of the Canadian tax base can occur even if most of the business activities of the subsidiary are carried out by employees of the Canadian parent company.

In short, our tax code is dilapidated and leaky and in need of major repair.

Second, our tax regime needs to be re- evaluated with a view to enhancing job creation and economic growth. The primary purpose of taxation is to raise revenue to fund public expenditures and transfers to individuals. But taxes reduce the amounts that taxpayers can spend or invest. In other words, taxes always damage economic growth. So what mix of taxes and rates of taxation might minimize that damage?

Should the government place less reliance on personal and corporate income tax, for example, and more on the goods and services tax ( GST)? Economists say that shifting from income taxes to the GST would encourage economic growth by eliminating the double taxation of saving and investment.

What rates of tax should Canada impose on corporations? It is generally agreed that lower rates and a broader base, with special rules that favour one industry or business activity over another being kept to a minimum, is the best recipe for fairness and economic efficiency? Over the years our system has strayed far from that ideal. It may be time for a re-set.

Should Canada introduce an annual wealth tax? And should personal tax rates be adjusted so the top rate is below 50 per cent for most individuals but higher for those who earn millions of dollars a year?

These types of structural issues can only be considered in the context of a dispassionate, non- partisan review of Canada’s entire tax regime.

Total government revenue as a percentage of gross domestic product ( GDP) should not necessarily change as a result of tax reform. Canada’s tax-to- GDP ratio ( including provincial levies) was 33 per cent in 2018, close to the average of 34.3 per cent for the 36 member countries of the OECD. But the elephant in the room is the United States. The U. S. had a tax-to-GDP ratio of only 24.3 per cent, the fourth lowest in the OECD. Any tax reform exercise must therefore be sensitive to the possible flight of investment capital from Canada to the U.S.

The arguments in favour of a comprehensive review are compelling. The government should get on with it.

OUR TAX CODE IS DILAPIDATED AND LEAKY AND IN NEED OF MAJOR REPAIR.