Economic Policy and Growth

choicesVol. 10, no. 1, March 2004 ISSN 0711-0677 www.irpp.org

Tax Design for a Northern Tiger

Jonathan R. Kesselman ounded in 1972, the Institute for Research on Public Policy is an independent, national, F nonprofit organization. IRPP seeks to improve public policy in Canada by generating research, providing insight and sparking debate that will contribute to the public policy decision-making process and strengthen the quality of the public policy decisions made by Canadian governments, citizens, institutions and organizations.

IRPP's independence is assured by an endowment fund, to which federal and provincial governments and the private sector have contributed. Jonathan R. Kesselman is a professor in the Public Policy Program at Simon Fraser University and holds the Canada Research Chair in Public Finance. He is principal investigator of the Social Sciences and Humanities Research Council of ondé en 1972, l’Institut de recherche en Canada/Major Collaborative Research Initiatives politiques publiques (IRPP) est un organisme (SSHRC/MCRI) “Equality/Security/ Community” F canadien, indépendant et sans but lucratif. project. His research focuses on applied theory and policy analysis of taxation, income security L’IRPP cherche à améliorer les politiques publiques and social insurance. His work has been canadiennes en encourageant la recherche, en mettant recognized by the Reserve Bank of Australia’s Professorial Fellowship in Economic Policy de l’avant de nouvelles perspectives et en suscitant des (1985), the Doug Purvis Memorial Prize for débats qui contribueront au processus décisionnel en Canadian economic policy research (1998), and matière de politiques publiques et qui rehausseront la the Canadian Tax Foundation’s Douglas J. Sherbaniuk Distinguished Research Award (2002). qualité des décisions que prennent les gouvernements, les citoyens, les institutions et les organismes This publication was produced under the canadiens. direction of France St-Hilaire, Vice-President, Research, IRPP. The manuscript was copy-edited L’indépendance de l’IRPP est assurée par un fonds de by Barry A. Norris, proofreading was by dotation, auquel ont souscrit le gouvernement fédéral, Francesca Worrall, production was by Chantal Létourneau, art direction was by Schumacher les gouvernements provinciaux et le secteur privé. Design, and printing was by Impressions Graphiques.

Copyright belongs to IRPP. To order or request permission to reprint, contact:

IRPP 1470 Peel Street, Suite 200 Montreal (Québec) H3A 1T1 Telephone: 514-985-2461 Fax: 514-985-2559 E-mail: [email protected]

All Choices and Policy Matters are available for download at www.irpp.org

The opinions expressed in this paper are those of the author(s) and do not necessarily reflect the views of IRPP or its Board of Directors. Economic Policy and Growth

Project Director France St-Hilaire

his series comprises individual Choices and Policy Matters studies on T economic policy issues, including fis- cal policy and factors affecting economic growth. Topics recently covered include the brain drain, the effects of Canada’s aging population, and Canada’s remarkable fiscal turnaround.

ette série comprend des études Choix et Enjeux publics qui portent sur les C questions de politique économique, y compris les mesures fiscales et les fac- teurs agissant sur la croissance. L’exode des cerveaux, les effets du vieillissement de la population canadienne, et l’amélioration remarquable de la situation fiscale au Table of Contents Canada figurent parmi les sujets récemment traités. 2 Introduction 3 Tax Policy Achievements 5 Taxes and Competitiveness 8 Taxation Principles 16 Personal Taxes 23 Payroll Taxes 26 Taxes on Goods and Services 30 Business Taxes 34 Tax Design for a Northern Tiger 38 Notes 42 References

1 IRPP Choices, Vol. 10, no. 1, March 2004 Jonathan R.Kesselman Northern Tiger Tax Designfora rather thanonincomebases. increasingly favourgreaterrelianceonconsumption productive andfaster-growingCanadianeconomy for makingCanadaa“NorthernTiger”? and vibranteconomy?Whatisthetaxpolicyagenda changes inCanadacontributetoamorecompetitive ices tax(GST)orsalestaxes. of consumptiontaxationsuchasthegoodsandserv- goal bepursuedviagreaterrelianceonindirectforms Introduction cuts wereahighpriority. federal budget,announcedthatfurtherpersonaltax Even thefinanceminister, justdaysafterthe2003 the firstinstalmentofneededtaxpolicychanges. lysts wouldsay, however, thatthesemovesareonly of theneedforacompetitivetaxsystem.Mostana- ernments respondedsofaithfullytoformalanalysis business andthinktanks.RarelyhaveCanadiangov- R open economy withadominanttradingpartner. crucial dimensions oftaxpolicyforCanada asan economy, theseanalyseshavenotconsideredallthe reference totheneedbe“competitive” withtheUS partner, the UnitedStates. remains toohighrelativeto thatofitsmaintrading academic quarters,thatCanada’soveralltaxburden complaints, emanatingmorefrombusinessthan Economists assessingthetaxrequisitesforamore and Stewart-Patterson 2001, 307) an incometoaconsumptionbase.(d’Aquino a fundamentalshiftofitstaxstructurefrom heavily…What Canadamustconsidernowis our taxburden,butfromwhatwemost flows predominantlyfromtheoverallsizeof competitive problemasacountrynolonger reduction totaxreform.Ourmostserious lic debateontaxationneedstoshiftfromtax At thisstage,wethinktheemphasisinpub- prescriptions oftaxeconomistsinacademia, remarkable forhowwelltheyhaveheededthe ecent federalandprovincialbudgetsare 2 1 4 So howcanfuturetax Yet, despitetheirfrequent 3 2 There havealsobeen Some suggestthatthis To become more competitive, Canada must pursue a series of increases in the rate and coverage of the taxation and related public policies that will mini- (pre-GST) manufacturers’ sales tax through the mize impediments to specialization, investment and 1980s, with a final rate of 13.5 percent; trade. Tax policies should complement other policies repeated freezes on scheduled rises in contribution in pursuing further economic integration with the US limits for registered pension plans (RPPs) and regis- in ways that reduce the effect of the border between tered retirement savings plans (RRSPs) through the the two countries.5 The parallel challenge is to create 1990s (thus reducing their real value); a competitive advantage for Canada within an a high-income personal surtax and a corporate increasingly integrated North American economy. income surtax (1985); Reducing border frictions is important, but so is cre- a general personal income surtax (1986); ating unique attractions to situate and conduct busi- a cap on indexation of personal taxes to inflation ness on the Canadian side and for skilled and above 3 percent (1986), which meant no changes in talented people to work here. Tax policies can play a tax brackets for most of the 1990s and thus a stea- central role in this broader policy strategy, but the dily rising tax bite; goal must not be simply to create a lower tax envi- a “temporary” capital tax on financial institutions ronment. More critical is to fashion a tax system that (1986); can efficiently generate the revenues to support the a capital tax on large nonfinancial corporations public services and infrastructure that will attract (1989); high-value-added business and workers and that will an income test on the age credit for personal tax increase living standards for all Canadians. (1995); This paper addresses the broad architecture of tax an increase in the corporate income surtax (1995); policy and offers concrete recommendations for increased gasoline excise taxes (1995); future tax policy initiatives as part of a strategy to a reduced age limit for mandatory disbursements make the Canadian economy more competitive.6 I from tax-deferred savings plans (1996); and begin by reviewing recent tax policy achievements tightened tax provisions for unincorporated and cor- of the federal and provincial governments and porate business through the 1990s. assessing whether Canada’s overall level of taxation The provinces undertook many parallel tax hikes over is an impediment to a competitive economy. I then this period, and several instituted new corporate capital examine the comparative tax mixes of Canada and taxes (including Alberta’s introduction of a financial the US and how far Canada needs to go to compete institutions capital tax in 1990). with US tax levels. Next, I examine the key econo- Most of these tax increases were driven purely by the mic issues in the design of tax policies: determining revenue needs required to address uncontrolled deficits the best base for taxation, how best to implement and, as a result, often neglected concerns for economic the desired tax base and whether to rely more on efficiency and long-run growth. Political considerations direct or indirect taxes. Then, I apply the analysis to caused many of the tax hikes to be targeted dispropor- Tax Design for a Northern Tiger by Jonathan R. Kesselman the major types of taxes (personal, payroll, sales and tionately at higher-earning individual taxpayers and at excise and business taxes) at both the federal and business and corporate taxpayers — though even mod- provincial levels, and I suggest directions for reform erate earners were not entirely spared. When fiscal room for each of the main tax areas. I conclude with began to emerge in the late 1990s, the first tax cuts thoughts on the tax strategy that Canada should focused on low- and moderate-income individuals and pursue to become a Northern Tiger. on relief for special groups such as the disabled, stu- dents and poor families with children.7 In recent years, more fiscal room has opened up, and tax policy has Tax Policy Achievements begun to pay proper attention to the neglected criteria — economic efficiency and long-run growth. These he tax cuts and reforms that Canadian govern- objectives remain paramount in designing a tax system ments have undertaken since 1998 should be for Canada as a nascent Northern Tiger. T seen in the context of the string of tax hikes that had taken place over the previous dozen years. Recent Federal Tax Reforms At the federal level, these hikes included: The 2003 federal budget continued important tax policy thrusts introduced in federal and provincial government

3 IRPP Choices, Vol. 10, no. 1, March 2004 sonal andcorporate ratecuts.Sharpphased hikes in enues haveprovided thefiscalmeansfor larger per- large surplusesrelativetoprogram costs.Theserev- (EI) premiumratessoslowly astogenerateongoing government’s decisiontotrim employmentinsurance the taxsystemtowardlabour incomewasthefederal the overallmoveawayfromcapitalincometaxation. some provinces.Thesetaxchangesservetoreinforce over severalyears,againfollowingtheactionsof tax onnonfinancialcorporationswillbephasedout tives attheprovinciallevel,andfederalcapital the current$200,000to$300,000,followinginitia- tion forcorporatetaxwillberaisedovertimefrom over thenextseveralyears,smallbusinessdeduc- cut willbegraduallyextendedtotheresourcessector a resultofthe2003budget,thiscorporatetaxrate percent, thesamerateasformanufacturingfirms.As income taxratefornonmanufacturingsectorsto21 phased reductionofthefederalbasiccorporate across industries.Centraltothischangewasthe and capitaltoprovidemoreuniformtreatment been toreducethetaxburdenoncorporateincome plans resultinpolicyaction. 2003 budget’splanstoconsidertax-prepaidsavings will movefurthertowardalabourincomebaseifthe savings plans(RRSPsandRPPs).Thepersonaltax by increasedlimitsforcontributionstotax-deferred cuts inthecapitalgainsinclusionrateand,2003, further shiftedtowardaconsumptionbasebytwo indexation. In2000,thepersonal“income”taxwas expansion ofratebrackets andtherestorationoffull lowed bycutsintheratesforallincomes, tion ofthegeneralandhigh-incomesurtaxes, fol- began in1998,forpersonaltaxes, withtheelimina- ever, representsjustonestepinataxstrategythat centrepiece offederaltaxcuts.Thatdocument,how- nomically efficientandgrowthoriented. finance analysisformakingthetaxsystemmoreeco- consistent withtheprescriptionsofformalpublic implement aconsumptiontax.)Thesechangesare paper showslater, taxinglabourincomeisonewayto direct taxes towardindirectandpayrolltaxes. (Asthis direct taxes andbymovingtherevenuemixfrom these changesthroughbothpersonalandcorporate consumption basesanduserfees.Ottawahaspursued income andplacedgreaterrelianceonlabourincome, cies havereducedtaxburdensoncapitaland budgets sincethelate1990s. Further reinforcingtheshiftofoverallbase The othermajorstrandoffederaltaxpolicyhas The fall2000budgetupdateisoftencitedasthe 8 Essentially, thesepoli- in itsgeneroustaxexpendituresforbusiness. is thelowestofanyprovince,hasinitiatedsharpcuts dingly. Quebec,whosecorporatetaxrateof9.3percent major provinces,andhasbegunreductionsaccor- eral corporateratecompetitivewiththatoftheother planned). BritishColumbiahaspledgedtokeep itsgen- (instead ofthe11 percentthepreviousgovernmenthad from 12.5percentin2003to142004 ment isbacktracking—raisingthecorporatetaxrate was onasimilarcourse,butitsnewLiberalgovern- percent. OntarioundertheProgressiveConservatives general corporateincometaxrates,eventuallyto8 have ledinimportantrespects.Albertaisreducingits tal incomeandtowardlabourincome;infact,they their overallrevenuemixawayfromcapitalandcapi- Like thefederalgovernment,provincesareshifting sued thesamegeneralgoalsasfederaltaxpolicies. Provincial taxchangessincethelate1990shavepur- Recent ProvincialTax Reforms indirect consumptiontaxes. unchanged, thusraisingtherelativerevenueshareof rate andcoverageoftheGSThaveremained 2003 budget).Overthesameperiod,moreover, the Security Charge(auserfee,whichwasreducedinthe cco taxes anditsimpositionoftheAirTravellers from suchpoliciesasthe2001 budget’shike intoba- enues tosupporttheoveralltaxstrategyhavecome shift towardlabourincomebases.Additional rev- from 1998to2003havealsoincreasedtherevenue premium ratesfortheCanadaPension Plan(CPP) ing Ontarioand Quebec)haveleftthemintact, sothatthis stringencies thathavecaused ittodelaythesecuts. taxes, butitsnewLiberal governmentisfacingfiscal year plantohalveratesonboth ofitscorporatecapital drawn thatcommitment.Quebec announcedamulti- capital tax,butthenewLiberalgovernmenthaswith- action byOttawa,theprovince’snonfinancialcorporate budget pledgedtoeliminate,concurrentlywithsimilar general corporatecapitaltaxin2002.The2003Ontario porations in2001 andBritish Columbiaremovedits ital taxes —Albertaabolisheditstaxonfinancialcor- new governmentwillalsopursue. Conservatives setanewtargetof$400,000,whichthe federal policy);inthe2003Ontariobudget,Eves porate taxofatleast$300,000(thetargetnowfor ward alreadyhavesmallbusinessdeductionsforcor- for smallbusinesses.AllprovincesfromOntariowest- provinces havealsoreducedtheircorporatetaxrates The fourprovinces withemployerpayrolltaxes (includ- Some provinceshaveeliminatedtheircorporatecap- 4 9 Several source is generating a rising share of total provincial tax Taxes and Competitiveness revenues. Some provinces have also shifted their revenues toward greater reliance on sales taxes and targeted them o become a Northern Tiger, Canada requires a tax more directly at consumption. For example, British system that enhances its economy’s competitive- Columbia followed its large personal tax cuts in 2001 with T ness, especially vis-à-vis that of the US. To deter- a hike in its sales tax rate in 2002, and it reduced the taxa- mine the kind of tax system that will achieve this end, tion of business inputs. Saskatchewan paired its personal however, several questions must be addressed. First, tax rate cuts with a major expansion in the coverage of its does Canada’s overall level of taxes pose a handicap to sales tax, but it included additional business inputs as well the economy’s competitiveness? Second, how does as many consumer items. The provinces have also Canada’s tax mix compare with that of the US? (I increased their revenues from fees and user charges — examine the comparative structures of each type of tax hikes in medicare premiums by both Alberta and British later in the paper.) And third, does it make sense for Columbia are examples. Canada to compete with the generally lower tax rates In 2001 the federal government allowed the found in the US? provinces to shift from a “tax-on-tax” system to a “tax-on-income” system for their personal taxes.10 Tax Burdens and Comparative Advantage Most provinces responded by reducing their tax rates Some business and academic analysts have asserted and flattening their rate structures. Most notably, that Canada’s higher overall tax burden relative to that Alberta moved to a flat rate of 10 percent above a of the US represents a competitive disadvantage. In much higher taxable income threshold. Saskatchewan assessing this claim, it is important to distinguish and British Columbia have significantly lowered their between the effects of taxation on real standards of liv- top marginal rates of personal tax and partially flat- ing and on international competitiveness. Moreover, it tened their rate schedules. Ontario has cut personal is essential to include in real living standards both pri- taxes sharply at low and middle incomes but contin- vate consumption (after-tax and after-transfer real ues to impose a steep surtax that keeps marginal rates incomes) and public consumption (the value placed on on upper incomes high. The Conservative government publicly supplied goods and services). If Canada’s rela- had promised to reduce the number of taxpayers sub- tively higher tax burden is borne fully by households ject to surtax and had even referred to its ultimate in the form of lower net incomes, then that burden abolition, but the new Liberal government has said it affects neither businesses’ costs of production nor their will not proceed with these items. Quebec has reduced competitive position internationally.11 Whether this sce- personal tax rates but increased their progressive tilt. nario reduces or raises real living standards hinges on The province’s new Liberal government entered office whether Canadians value the incremental increase in committed to a further reduction of personal taxes by publicly supplied goods and services at less than or 27 percent, or $5 billion annually, over the next five more than their loss of real disposable income. years and to having personal tax rates competitive

If part of the higher tax burden is borne by busi- Tax Design for a Northern Tiger by Jonathan R. Kesselman with those in Ontario within ten years (Parti Libéral nesses, it still will not reduce their international competi- du Québec 2003). As with corporate taxes, however, tive position so long as there are additional public Quebec’s fiscal strains are delaying the start of these services or facilities (such as highways, medicare or bet- cuts as well, and Ontario’s change of government ter courts) that reduce their production costs or raise may make the goal itself less ambitious. their productivity. Higher taxes could impair Canada’s Since the provinces, apart from Quebec, use the fed- trade competitiveness only if those taxes were borne in eral definition of taxable income, they have also implic- part by businesses and did not carry offsetting business itly adopted the federal shift of the personal tax base benefits. Examples include pork-barrel regional spend- toward consumption and labour income. In fact, Ontario ing, servicing public debt incurred for noncapital pur- was planning to reduce the capital gains inclusion rate poses or redistributive programs. Under this scenario, for provincial tax purposes to 50 percent in 2000, and production costs would rise for Canadian producers, was negotiating with Ottawa over whether this would be making them less competitive with US and other foreign permitted within the tax collection agreement, but this producers, at least initially. was pre-empted by the federal change. In 2000, Quebec A tax-induced increase in Canadian production costs also mirrored in its provincial income tax rules the fed- is not, however, the end of the story. The resulting eral reduction of capital gains inclusion rates.

5 IRPP Choices, Vol. 10, no. 1, March 2004 competitive positionofCanadianbusinesses. the Canadiandollartodepreciate,thusrestoring decline inthecurrentaccountbalancewouldcause choice of taxes andfortheprogressivityofpersonaltaxes. important implicationsforthedesignofbusiness total revenuesystem.AsIshowlater, thispointhas labour inCanadaandtotheefficiencycostsof income andthepersonalofhigher-skilled must betaken withrespecttothetaxationofcapital jobs, productivityandrealwages.Particular care be tailoredtomaximizethegrowthofinvestment, design. Canadiantaxbases,structuresandratesmust production willinfluenceCanada’soptimaltax and thehighpotentialmobilityofthesefactors Canadian-US markets forcapitalandskilledlabour not affectCanada’schoiceoftaxlevel,integrated national competitiveness. means), butitwouldnotaffecttheeconomy’sinter- lower netincomes,higherimportpricesandother would reduceCanadians’reallivingstandards(through “wasteful” purposes,shouldnotharmexports.True,it taxes inCanadaabovethosetheUS,evenfor costs vis-à-visthoseofitstradingpartners.Raising not onitsabsoluteproductivityorlowerproduction comparative to gainfromspecializationandtradehingesonits According tostandardtradetheory, acountry’sability den wasabout 6percentagepointshigher than thatof gross domestic product(GDP),Canada’stotal taxbur- mixes oftaxes inthetwocountries?Relativetoits and theUnitedStates,what arethecomparative What istherelativeoveralllevel oftaxes inCanada Canada-US Tax Comparisons higher taxes thandoestheUS. national outputtopublicconsumptionthrough economy evenifitchoosestodevotemoreofits pursue thegoalofastrongerandmorecompetitive efficient thanthatoftheUS.Insodoing,Canadacan Canada shouldformulateits should befinancedatthelowestefficiencycost.Thus, consumption). Still,thechosenlevelofspending this doestoreallivingstandards(privatepluspublic tailed andtaxes reducedsolely becauseoftheharm spending ismisdirectedorwasteful,itshouldbecur- of tradecompetitiveness. weighs thecostofassociatedtaxes —notamatter priorities —whetherthevalueofpublicservicesout- The bottomlinetothisanalysisisthatCanada’s Although beinganopeneconomy tax level advantage inproducingsomeproducts, can bepurelyamatterofdomestic 13 If partofCanada’spublic tax design per se to bemore 12 should Canadian governments applysuchtaxes moreheavily excise andusetaxes, but atthesubnationallevel, At thefederallevel,bothcountries applycomparable of goodsandservicesisnearly twicethatoftheUS. tax, itstotalrelativereliance onbroad-basedtaxation degree. ButbecauseCanada alsohasafederalsales on valueaddedorretailsales)toroughlythesame level, bothcountriesapplysales-typetaxes (whether and serviceslike Canada’sGST. Atthesubnational three timesaslargeinCanadatheUS. in 2001, butatthesubnational leveltheywereabout taxes wereroughlycomparableinthetwocountries income tax.Atthefederallevel,corporate taxes, andsomeUScitiesalsohaveapersonal commonly imposesalestaxes ontopofstatesales cities. Unlike inCanada,theUScitiesandcounties much higherthanthoseleviedbyUSstatesand taxes thatCanadianprovincesimpose,whichare cent ofGDP).Thisis,however, offsetbythepersonal cantly smallerthantheyareintheUS(evenasaper- federal level,personaltaxes inCanadaaresignifi- the twocountries’taxsystemsarenoteworthy. Atthe taxes jointly. collected about40percentofitsrevenuesfromthese taxing consumption)revealsthatin2001 eachcountry services taxes (bothofwhicharewaystomovetoward Canada. However, addingpayrolltaxes andgoods taxes forsocialsecuritymuchmoreheavilythandoes heavily thandoestheUS,which,inturn,usespayroll Canada usestaxes ongoodsandservicesmuchmore of taxrevenues.Themostnotabledivergenceisthat enues, andpropertytaxes accountforabout10 percent tax revenuesjointlyaccountforabouthalfoftotalrev- well, inbothcountriespersonalpluscorporateincome lar taxmixes. Bothrelyheavilyonpersonaltaxes. As some basicrespects,thetwocountrieshavequitesimi- two countriesusetofinancegovernment(table1).In them toreducetheirneedapplydistortingtaxes. Canadian governmentstoobtainrevenuesthatallow in theUS,andareaneconomicallyefficientwayfor oriented westernandAtlanticprovinces,thantheyare important inCanada,particularlytheresource- points in1990(seetable1). the USin2001, downfrommorethan9percentage extract naturalresources. and royaltypaymentstogovernmentfortheright — itemssuchasfines,usercharges,mostlicencefees ures donotinclude“nontaxrevenues”ofgovernments The UShasnobroad-basedfederaltaxongoods At amoredetailedlevel,somedifferencesbetween More economicallyimportantisthemixoftaxes the 6 15 Such royaltiesaremore 14 Significantly, thesefig- Table 1 Finally, the two countries rely to a similar degree on Comparative Tax Mixes in Canada and the US, taxes on real property and wealth. Canada has no coun- 2001 terpart to US governments’ use of estate, gift and inheri- tance taxes, but such taxes generate relatively little Canada United States revenue and are scheduled to be reduced in future Total tax revenue as % of GDP 35.1 28.9 years.16 The bottom panel of table 1 shows that taxes for Tax type as % of total tax revenue both countries are levied primarily at the federal level [as % of GDP] but that the federal share of total taxes is significantly Personal income tax 38.1 [13.3] 42.3 [12.2] larger in the US than in Canada, reflecting the provinces’ Federal 24.5 34.5 relatively larger spending responsibilities. Subnational 13.7 7.8 Corporate income tax 10.2 [3.6] 6.4 [1.9] Competing with US Taxes Federal 6.6 5.2 Subnational 3.6 1.2 As explained above, Canada’s overall tax level need not be a competitive concern so long as both the mix and Payroll taxes and social security contributions 16.8 [5.9] 24.6 [7.1] structure of taxes are efficient, but there are further rea- Social security sons not to pursue blindly US tax levels. These reasons contributions (federal)a 14.2 23.5 Payroll taxes include the unsustainability of US tax levels, differing (subnational) 2.7 1.0 visions of society’s objectives and the economic returns

Taxes on goods and services 24.9 [8.7] 16.1 [4.6] to smartly focused public expenditures. A key reason is Broad-based taxes 14.5 7.7 that US fiscal policy is on an unsustainable path that Federal 7.2 0.0 Subnational 7.3 7.7 will require either sharp future tax rate hikes or severe Excise and use taxes 10.3 8.3 spending cuts — either of which will be economically Federal 3.2 3.0 and socially costly. Subnational 7.2 5.3 According to the latest estimates by the US Taxes on property 10.0 [3.5] 10.6 [3.1] Congressional Budget Office (CBO), US federal deficits Property and wealth 10.0 9.3 Estates and gift transfers 0.0 1.2 are projected to total US$1.9 trillion for 2005–14 (United States 2004, xii). Some independent experts, however, Total 100.0 100.0 have asserted that the CBO figures seriously underesti- a All federal taxes 55.6 [19.5] 67.2 [19.4] mate the real fiscal challenge, projecting total deficits on All subnational taxesa 44.4 [15.6] 32.8 [9.5] the order of US$4.4–US$9 trillion (Gale and Orszag 2004). They attribute this fiscal deterioration to declining Sources: OECD. 2003. Revenue Statistics, 1965-2002 (Paris: OECD), tables 45, 71, 142, and 168; author’s calculations. revenues as a result of economic slowdown and the 2001 Note: Figures do not always add up due to rounding. and 2003 tax cuts. They conclude that the US is on an a Most social security contributions have been classified as federal taxes, although for Canada this includes Quebec Pension Plan premiums; provincial “unsustainable fiscal path” once the longer-term impli- hospital insurance premiums and state taxes for unemployment insurance have cations of an aging population are factored in. The US

been classified as subnational. Tax Design for a Northern Tiger by Jonathan R. Kesselman fiscal problem will be further compounded by recent leg- than do US governments. Comparative use of taxes islation to expand the scope of Medicare coverage to on goods and services is of particular interest with include prescription drugs. Even the normally staid respect to the issue of reducing border costs, as this Financial Times opined editorially about US federal po- might entail loosened border controls on the move- licy: “On the management of fiscal policy, the lunatics ment of commodities. are now in charge of the asylum...Watching the world’s The US relies much more heavily on payroll taxes economic superpower slowly destroy perhaps the world’s 17 for social security than does Canada. However, US most enviable fiscal position is something to behold.” states have little counterpart to the general payroll It would hardly be prudent for Canada to cut its tax taxes that four Canadian provinces apply, nominally rates to imitate US tax rates that, in the long run, are to finance health care and education but in practice unsustainable and some of which are already slated to to supplement general revenues. These employer rise. US federal revenue in 2004 will be smaller as a payroll taxes are an important source of revenues share of GDP than at any time since the 1950s. US leg- for Ontario, Quebec, Manitoba and Newfoundland islation specifies that many of the key tax cuts enacted and Labrador. in 2001 and 2003 will “sunset” in various years from 2005 through 2011, and it has been estimated that

7 IRPP Choices, Vol. 10, no. 1, March 2004 than abouttaxburdens erance, diversity, “coolness” andculturalamenities attracting talentedworkers; theycare moreabouttol- focused ontheroleofvitalurbanenvironmentsin technology andotherknowledge-basedsectorshas research onwhatdeterminessuccessinthehigh- sumption butmorepublicconsumption.Recent burdens thandoAmericans—thatis,lessprivatecon- 2002, 2003).Hence,Canadiansmaychoosehighertax infrastructure (see,forexample,Adams 2003;Jedwab all ofwhichrequiresupportivepublicservicesand equality, safeandvitalcity centres andcivilsociety— Canadians placegreaterweightontolerance,diversity, often haveadifferentvisionfortheirsocieties.Many tax levelsblindlyisthatCanadiansandAmericans form ofmorepublicbenefitsandservices. dividends fromdecliningdebt-servicechargesinthe Alternatively, Canadiansmaywishtotake partofthe program spendingrelativetotheeconomy. percentage ofGDPwithoutsacrificingthesizeits be abletoreduceitstaxburdenthatoftheUSasa will diminishandthenreverse.Eventually, Canadawill least modestsurpluses,thisdifferentialininterestcosts tive debt,whiletheCanadiangovernmentmaintainsat tinues torackupmassivedeficits,addingcumula- countries in2001. AstheUSfederalgovernmentcon- cent ofGDPdifferentialinthetaxburdenstwo cent differentialaccountsfortwo-fifthsofthe6per- against 3.2percentforUSgovernments. ment paid5.6percentofGDPininterestcharges than inCanada.In2001 alllevelsofCanadiangovern- den ofservicingpublicdebtwillbecomegreaterthere combined (ConferenceBoardofCanada2003). surpluses areexpectedforallCanadiangovernments mostly asaresultofrisinghealthcarecosts,fiscal provinces areprojectedtorundeficitsoverthisperiod, remain soforthecomingdecades.Although federal budgetiscurrentlyinsurplusandprojectedto sures, itisonamuchbetterfiscalfooting.Canada’s es. WhileCanadafacessimilarlong-runfiscalpres- require bothspendingreductionsandrevenueincreas- Addressing budgetproblemsintheUSwillevidently governments arealsoconfrontingfiscaldifficulties. (Gale andOrszag2004).Moreover, stateandlocal enues byaboutUS$2trillionoverthenextdecade making thetaxcutspermanentwouldreducerev- nelled tocreating thosevitalandattractive cities. economic payoff iftherevenuesareeffectively chan- Therefore, highertaxburdens canhaveasignificant Yet anotherreasonforCanadanottopursueUS Given thegreaterfiscalstressesinUS,bur- per se (Florida 2002a,2002b). 19 This 2.4per- 18 that hightaxburdens gressive ratesonlabourincome.Thelessonisnot low flatratestocapitalincomealongsidesteeppro- or theUS;theirpersonaltaxes alsoapplyrelatively (value-added andpayrolltaxes) thanthoseinCanada mixes putheavierweightonconsumption-typetaxes Co-operation andDevelopment(OECD).Theirtax are membersoftheOrganisationforEconomic and arethethreehighestofall30countriesthat to 14percentagepointsofGDPhigherthanCanada’s three Nordiccountrieshavetaxburdensthatare10 respectively; theUnitedStatesplacedsecond.Yet the Finland, SwedenandDenmarkfirst,thirdfourth, tiveness, theWorld EconomicForum(2003)ranked an economy. between overalltaxlevelsandthecompetitivenessof mists andtaxpolicyspecialists. and publicfinancewillbefamiliartotaxecono- draws ontheresearchfindingsofeconomictheory T Taxation Principles the following key findings: with economicanalysis—should beawareofatleast tax policiesinthenextsection —andthoseimpatient in ahurrytomoveonthe examinationofspecific likely benefitfrom areviewofthismaterial,butthose structured, efficienttaxsystemevenmoreimportant. fiscal resources,whichmakes theroleofawell- positive factorsneedtobesupportedbyadequate university researchcollaboration.Mostofthese nity leaves,Internetaccessinschoolsandindustry- surplus, soundbankingsystem,generouspaidmater- the competitivenesssurveycitesCanada’sbudgetary and regulation,notintaxpolicy. Onthepositiveside, however, aretobefoundinimprovedgovernance ship restrictions.Theremediesfortheseproblems, decisions, bureaucraticredtapeandforeignowner- as distortivesubsidies,favouritismingovernmental Canada, theWorld EconomicForumcitesissuessuch the previousyear. To accountforitsdowngradeof competitiveness rankings,downseveralspotsfrom tured, neednotbeahindrancetocompetitiveness. but, rather, thathightaxburdens,ifproperlystruc- Cross-national evidenceconfirmsthedisconnect Canada placedjustsixteenthinthe2003global tion principles.Mostoftheensuingdiscussion requires anunderstandingofsomebasictaxa- he analysisofspecifictaxpoliciesforCanada 20 8 In itslatestsurveyofglobalcompeti- per se create economicstrength 21 Other readerswill A consumption base is superior to an income base sumption base, 0.27 for a tax on payroll or labour for reasons of economic efficiency and growth; an income, 0.56 for a tax on personal income (labour plus alternative way of implementing a consumption capital income) and 1.55 for a tax on corporate income base is through heavier taxation of labour income or capital income.22 Hence, taxing capital income is relative to capital income or, at the limit, a tax on much more economically costly than taxing consump- labour income and zero tax on capital income. tion or labour income. A consumption base for taxation is also more equi- By shifting its tax bases from capital income (at both table in its treatment of individuals with the same the individual and corporate levels) toward consumption lifetime labour earnings but different preferences and/or labour income, a government can reduce the eco- about when in their lives they wish to consume. nomic costs of raising any given amount of revenues. A full and complete conversion of the tax system Using the MEC values cited above, one can illustrate the to a base of consumption and/or labour income potential economic gains from a more efficient mix and would be excessively costly in terms of foregone structure of taxes in Canada. For example, assume that revenues, convey large tax windfalls to the $50 billion of revenues (out of the total of more than wealthy and pose severe problems of compliance, $400 billion per year) is shifted from less efficient bases enforcement and international harmonization. (such as capital income) to more efficient bases (such as Partial conversion to a consumption base would consumption or labour income).23 The ongoing gain in avoid such problems and could fulfill most of the the level of real consumable output would be in the economic goals; such an implementation strategy range of $20 billion to $65 billion per year — a pure is best pursued at the personal level via greater gain apart from any associated costs of implementa- access to tax-recognized savings (especially tion.24 Moreover, if simpler forms of tax were put in through a new tax-prepaid format) and at the place in the process, further potential saving of adminis- business level via greater moves toward a cash trative and compliance costs would be possible. flow base (with faster deductions or full expensing of capital outlays). Definitions of Alternative Tax Bases It would be better to pursue a consumption base It is useful at this point to preview the alternative tax through the direct tax system than through indi- bases and their definitions; this discussion covers all rect (sales-type) taxes, because of issues relating to the major taxes on flows of economic resources and vertical equity, tax enforcement and minimization ignores taxes on stocks of wealth (such as property of border effects. taxes and corporate capital taxes). Table 2 groups the Provincial tax policy has less leeway for excess tax bases into three categories: indirect, direct and tax burdens than national policy, since the transitional. An indirect tax is one applied to the sale exchange rate cannot offset the competitive disad- or purchase of goods and services and is applied on vantage; provincial tax policy also has less room each transaction. Indirect taxes cannot be adjusted to to pursue redistributive goals than national tax reflect the taxpayer’s situation or tax-paying ability; Tax Design for a Northern Tiger by Jonathan R. Kesselman policy because of the greater mobility of labour they tend to be regressive, at least from an annual per- within Canada than across the border. spective on tax burdens. In contrast, direct taxes are Transiting readers should also be aware of the imposed on businesses or individuals and can be wide divergence of efficiency costs related to differ- adjusted to reflect their specific situation (through ent types of taxes. Economists use a concept called exemptions, deductions or credits) and their tax-paying the “marginal efficiency cost” (MEC) to measure the ability (through progressive rate schedules). Some extra loss of valued output per extra dollar of rev- direct taxes, such as corporate income or payroll taxes, enue generated by raising the rate on a given tax are nevertheless applied at flat rates. base. For example, an MEC of zero would indicate The principal types of indirect tax include two single- that a tax has no efficiency cost — it extracts the stage forms: the retail sales tax, imposed only at the extra dollar of revenue without any economic distor- point of final sale to consumers, and the excise tax, typ- tions. An MEC of 0.10 would mean that 10 cents of ically imposed at the wholesale or distributor level. real valued economic activity is destroyed in the There is also a multistage form, the value-added tax, process of raising the extra dollar. One study of the imposed at each stage of production and distribution of Canadian economy found the following MEC values products but only on the value added at that stage. for alternative taxes: 0.17 for a sales tax or a con- Canada’s GST applies the commonly used credit-invoice

9 IRPP Choices, Vol. 10, no. 1, March 2004 tal purchaseprice (oftencalled“expensing”) butno base allowsan immediatedeductionofthe fullcapi- financing capitalpurchases. Incontrast,acashflow of thecapitalplusadeduction forinterestcostsin cost allowance”inCanadian taxjargon)overthelife costs throughanallowance for depreciation(“capital inputs bythefirm.Anincomebasereflectscapital two basesrelatestothetaxtreatmentofcapital As canbeseenintable2,thedifferencebetween whether touseanincomebaseoracashflowbase. stances ortax-payingabilityoftheconsumer. but, like indirecttaxes, theycannotreflect thecircum- on thesaleorpurchaseofgoodsandservices “transitional” taxbasesinthattheyarenotimposed consumption tax).Theseformsmightbelabelled those accountspluspaymentstolabour(thedirect accounts ofbusiness(thetransfertax)orto nomically equivalentyetappliedtothefinancial ways toimplementavalue-addedtaxthatareeco- method ofvalue-addedtaxation.Therearetwoother uiescs lwtx ae nemdaeiptcss-lbu ot aia ucaecssO/TD O/TD O/TP Sales-intermediateinputcostslabourcapitalpurchase Employer payrolltax* Business cashflowtax* Labourincome(generalpayrolltax)+businesscashflows Sales-intermediateinputcostscapitalpurchase Business incometax Direct businesstaxbases Direct consumptiontax* Business transfertax* Transitional taxbases noetxLbu noe+cptlicm O O/TD O Labourincome+capital Income-netsavings(orincome+dissavings) Interest+dividends +capitalgainsnetrents Consumption tax* Income tax Capital incometax d c b a * Thisbaseisequivalenttoaconsumptiontaxinthattherenooncapitalincomeordistortionofsavingsandinvestmen consumption tax. D/TD Wages +salariestaxablefringebenefitsemployerpensioncontributions Note: Transfer receiptsandmiscellaneousnoncapitalincomesarealsoincludedinbasesofthedirectconsumptiontax,labouri Labour incometax* Employee payrolltax* Direct personaltaxbases Eachtaxablesale(toconsumerandbusiness)-eachpurchasebybusiness Eachtaxablesaletofinalconsumer Value-added tax(GST)* Retail salestax*andexcise Indirect taxbases Major AlternativeTax Bases Table 2 income canberemovedbytaxingtheself-employedonabusinesscashflowbasis. Note thatself-employmentincomeincludesacombinationoflabourandcapitalincomeshencehassomeaspectsi Payroll taxesmayalsoincludetaxablefringebenefitsand/oremployerpensioncontributions. D denotesdestinationtype;OoriginTDtax-deferredmethod;TPtax-prepaidmethod. This formusesinputtaxcreditstorebatetaxespaidbybusinessoncapitalandintermediateinputs. For directtaxes onbusiness,thekey distinction is c c ae nemdaeiptcss-lbu ot aia ercain-itrs iacn ot O interestfinancingcosts capitaldepreciation- labourcosts- intermediateinputcosts- Sales - ae aais(o ahwre)O/TP O/TP Type self-employment income Wages +salaries(foreachworker) Wages +salaries(inaggregateorforeachworker) Definition ofbase per se d income. Payroll taxes areusuallyapplied atflatrates cost notedearlier fortaxes onpayrollorlabour a payrolltaxcaneliminateeven themodestefficiency ual worker andhis orherfuturebenefitentitlements, between thetaxpaidby(or on behalfof)theindivid- general revenues.To theextentthatacloselinkexists programs, buttheycanalsobeimposedtocollect taxes areimposedtofinancespecificsocialinsurance applied toemployers,employeesorboth.Mostpayroll a normalreturntocapital)fromtax. expensing fullyshieldsthecostofcapital(reflecting economic distortiontofirms’investmentdecisions,as tion ondiversetypesofcapital.Anditavoidsthe and bookkeeping burdensofaccountingfordeprecia- advantages. Itavoidsthecomplexity, inaccuracies cash flowbasehasbothoperationalandeconomic more favourabletofirmsthananincomebase.The depreciation ofnewcapitalmakes acashflowbase value ofmoneytoafirm,theexpensingratherthan deduction forfinancingcosts.Becauseofthetime Payroll taxes aredirectformsoftaxthatcanbe 10 t decisions. ncome tax,incometaxand ncome tax;taxonthecapital b D/TD O/TP a but sometimes have annual exemptions and/or ceil- income would yield significant benefits. It would ings on the taxable earnings per worker. In most cir- improve the lifetime horizontally equitable treatment of cumstances, the burden of a payroll tax falls fully or households with different savings preferences — that is, mostly on the worker regardless of whether the tax is individuals with the same lifetime labour earnings nominally paid by the employer or by the employee. would pay the same total discounted taxes despite dif- Although payroll taxes typically are applied to wages fering choices about when to consume. Shifting tax and salaries, the base can also include fringe benefits bases toward consumption and labour income would and employer pension contributions. In some cases, a also improve incentives for savings, and to the extent parallel tax is applied to self-employment earnings to that savings did increase, it would promote long-run avoid a tax bias against employees. growth of both the economy and living standards. Even Many jurisdictions prefer to make heavy use of if aggregate savings were not affected, such a shift direct personal taxes because their rates and provisions would improve the efficiency of resource allocation over can be tailored to achieve both vertical and horizontal time, thereby raising real living standards.25 Total sav- equity. The key distinction for direct taxes is whether ings would be allocated to different types of capital for- their base is income or consumption. A tax on income mation (such as business investment versus housing) on applies to the full accruing returns to capital as well as a more neutral basis. Additional benefits would arise to labour income and miscellaneous receipts (such as from simpler record keeping and tax reporting and transfer payments). A tax on consumption — imple- potentially from reduced opportunities for tax avoid- mented through either a “tax-deferred” method that ance and evasion using complex investment schemes. exempts savings or a “tax-prepaid” method that taxes In shifting tax bases, several possible problems labour income and exempts capital income — does not would need to be considered in designing the new distort individuals’ choices about when in their life- taxes. For example, without proper formulation, the times to consume. It also does not distort savings or vertical equity of the tax system could be unduly com- investment decisions and does not insert a “tax wedge” promised. Total revenues might also be reduced unless between the gross and net rates of return on invest- they were offset elsewhere in the tax system. In particu- ment or savings (see Bradford 1988). Hence, any tax lar, revenues might be lost in the form of windfall gains on capital income, such as that on an income base that to holders of “old” capital at the time the transition took includes both labour income and capital income, place without any concomitant incentives for incremen- departs from consumption tax criteria. tal savings. Since the largest holders of capital have Taxes can also be characterized by whether they are high incomes, this issue also relates to the preservation origin type or destination type, a distinction that is of vertical equity. In addition, it would be important in important for the freer movement of goods and services shifting tax bases to avoid creating new kinds of oppor- across borders at minimum cost to business and con- tunities for tax avoidance and undue burdens on house- sumers. A destination-type tax is one applied in or by holds and businesses. And any such reform would also the jurisdiction where the ultimate consumer resides; have to be coordinated with the tax systems of other Tax Design for a Northern Tiger by Jonathan R. Kesselman for exports, this requires that the tax not be applied in countries, principally the US. the producing jurisdiction, but for imports, the tax must There are two ways to implement a consumption- be collected at the border or in a manner closely related based personal tax. One way is the “tax-deferred” or to each shipment. An origin-type tax is applied in the “registered-assets” method, which permits a deduction jurisdiction where the good or service is produced or from the taxpayer’s income of savings in the form of where the productive factors are located and paid; this contributions to trusteed plans. In effect, this method obviates the need for border controls or the taxing of provides for the deferral of tax on both the principal the movement of goods and services. Only the retail amount saved and the accruing investment returns to sales tax, excise tax and value-added tax are destina- such savings; when the funds are withdrawn for con- tion type. All other transitional and direct taxes (both sumption, they become taxable. RPPs and RRSPs business and personal) are origin type. embody the tax-deferred method within the direct per- sonal tax. If all limits were removed from contributions Implementing a Consumption Base to tax-deferred plans, the scheme would become a There is growing consensus among tax economists “personal consumption tax,” which could retain tax that shifting tax bases away from income, particularly rate progressivity of any desired degree. Indirect sales capital income, and toward consumption and labour taxes on consumption also embody the tax-deferred

11 IRPP Choices, Vol. 10, no. 1, March 2004 values, rate ofreturnequaltotheuseddiscountfuture the sameintwoperiods, prepaid methods.Assumethatthemarginaltaxrateis trate theequivalenceoftax-deferredandtax- treatment ofsomeinsuranceproducts. inclusion rateonothercapitalgainsandthetax on owner-occupiedhousing,thepreferentialtax already manifestedinthetax-freetreatmentofgains bution amounts.Thetax-prepaymentprincipleis tax-prepaid savingsplanswithlimitsonthecontri- in thisdirectionwouldrequiretheestablishmentof labour andothernoncapitalincomes.Apartialmove consumption taxwouldbeaprogressiveon reflects thereturntosavings.Atax-prepaidpersonal is exempted fromtax;thecapitalincomesimply income. Labourincomeistaxablebutcapital the tax-prepaidmethodconsiders“sources”of tion versussavings)asinthetax-deferredmethod, than workingwiththe“uses”ofincome(consump- times calleda“labourincome”or“wage”tax.Rather based taxisthroughthe“tax-prepaid”method,some- are spent,buttheytendtoberegressiveinpractice. method, asnosalestaxispaidonearningsuntilthey allocative efficiency andgrowthpotential. However, if ble realinvestment, whichpromotestheeconomy’s is thenequaltothegrossrate ofreturnonthetangi- choices. Thenetrateofreturn toanindividualsaver tax doesnotdistorteitherconsumer orinvestment choices madeaboutwhento saveandconsume,sothe son’s lifetimestreamofconsumptionirrespective That is,theyyieldthesamepresentvalueforaper- economically equivalentunderparticularconditions. Both thetax-deferredandtax-prepaidmethodsare Equivalences andDifferencesinMethods 1 tion taxdueinthefirstperiod,butdollargrowsto consumption inthenextperiod.Thereisnoconsump- B similarlyearnsanextradollar, butshesavesitfor part ofcurrentconsumptionandincurstax immediately spends,withtheresultthatitistaxed as t( its valueinthefirstperiodyieldsapresentof tax of independent ofwhentheychosetospendtheearnings. would paythesametaxof income ratherthanconsumption,bothindividuals paid. Alternatively, ifthetaxisappliedtolabour 1 +r A simplenumericalexamplecanbeusedtoillus- The secondwaytoimplementaconsumption- r)/( + in thesecondperiod,whenitisspent,incurring t( r 1 . Person Aearnsanextradollar, which he 1 + r) + r)=t . However, discountingthattaxbackto , thesameastaxthatpersonA t , andthatallsavingsyielda t in thefirstperiod,again t . Person prepaid method,thereis exempts thenormalreturntocapital).Withtax- supernormal returns(aconsumption-basedtax yielding above-averagereturnsaretaxed ontheir deferred methoddisplays the samelevelofeconomicresources.Thetax- horizontal equity—theequaltaxationofpeoplewith the twomethodsgiverisetodifferingconceptsof fer fromthatusedtodiscountfutureconsumption, in table3.Ifsomeassetshaveratesofreturnthatdif- prepaid methodswillhavedifferenteffects,asshown from theseassumptions,thetax-deferredandtax- efficiency (seeKesselmanandPoschmann 2001). equivalent, withpossibleconsequencesforequityand and consuming—thenthetwomethodsarenolonger individual’s marginaltaxrateisidenticalwhensaving rate usedfordiscountingfuturevalues,andthatthe tions —thattherateofreturnonallassetsequals there aredeparturesfromeitherofthestatedcondi- individual’s MTR. Tax prepayment,incontrast,does personal taxbecause savingsaredeductible atthe deferral reducestheeffective rateprogressivityofthe summarized intable3.Interms ofverticalequity, tax choices aboutwhentosave and whentospend. ment affords“intertemporal”economicefficiencyin system withprogressiveannualtaxrates;prepay- undertake lifetimeaveragingoftheirtaxburdenina personal tax.Tax deferralallowsindividuals to the twomethodscanbecombinedusefullywithina ing MTRs.Thesedifferingattributesalsomeanthat rising MTRsandunfavourableforthosewithdeclin- more advantageousthantaxdeferralforthosewith to savingforlaterconsumption,makingthismethod changes inMTRshavenoimpactonthenetreturns consume. Incontrast,underthetax-prepaidmethod, rise betweenthetimetheysaveand Conversely, taxdeferralpenalizesthosewhoseMTRs and thewithdrawaloffundsforconsumption. the individualwhoseMTRdeclinesbetweensaving tion. Withthetax-deferredmethod,thereisagainto (MTRs) betweenthepointsofsavingandconsump- depending onthedivergenceofmarginaltaxrates which methodisadvantageousorunfavourable under thetax-prepaidmethod. returns thataccruetosomeassetswillescapetax prove toyieldhighratesofreturn.Thesupernormal that theydonotknowbeforehandwhichassetswill that taxpayersaretreatedequallyonlyinthesense When ratesofreturnormarginaltaxdepart Additional attributesofthetwotaxmethodsare Table 3alsoshows,under“individual’sposition,” 12 ex ante ex post 26 equity, whichmeans equity inthatassets Table 3 Tax-Deferred vs. Tax-Prepaid Method

Tax-deferred method Tax-prepaid method

Allows deduction Taxes labour for net savings, taxes net dissavings income, exempts capital income

Issue Pros Cons Pros Cons

Horizontal equity Ex post equity: supernormal Ex ante equity: super- returns to capital are taxed normal returns to capital escape tax

Vertical equity Reduces effective Maintains effective progressivity of tax rate progressivity of tax rate schedule schedule

Individual’s position Advantageous for those who Unfavourable for those who Advantageous for those who Unfavourable for those expect to be in a lower expect to be in a higher expect to be in a higher MTR who expect to be in a MTR at time of withdrawal MTR at time of withdrawal at time of withdrawala lower MTR at time of withdrawala

Treasury’s position Accumulates future tax High near-term revenue Little near-term revenue Reduces future tax revenues, matching cost (relative to income base) cost (relative to income base) revenues, poorer matching revenues to needs to needs

Lifetime tax averaging Facilitated Not facilitated

Intertemporal economic Upset when MTRs differ Facilitated regardless of efficiency across periods for individuals MTR patterns

Simplicity for taxpayer Adds complexity Very simple

Note: MTR = marginal tax rate a Relative to the outcomes under the tax-deferred method. not allow for the deduction of amounts saved, and the tax-prepaid method entails revenue costs that are hence treats savers in different tax brackets in a more small at the outset but grow over time and are not uniform manner, thus preserving greater effective reversed when savers retire and spend their savings. progressivity of annual tax burdens. Another way of Hence, tax prepayment may aggravate future revenue viewing this difference is that tax deferral offers a problems when the baby boomers retire, unless budget- form of lifetime averaging of taxes. It is also much ary surpluses are generated in advance. Tax Design for a Northern Tiger by Jonathan R. Kesselman simpler for taxpayers to comply with tax prepayment Another issue arises when there is a shift between the than with tax deferral, since only the latter method two methods of taxing consumption. Although the two requires complex calculations and forecasts about methods are equivalent for individuals who live their future income for the individual to decide when to entire lives under them, they are not the same if applied make tax claims or when to withdraw funds. to individuals at different stages of their lives. To illus- From the treasury’s position, the tax-deferred trate this point, suppose the tax-deferred method is method entails large current revenue costs because of applied through an indirect sales tax and the tax-prepaid the tax deductibility of savings. These costs may grow method through an employee payroll tax. Clearly, a shift for an extended period as the middle-aged population from a sales tax to a payroll tax would favour retirees increases, but eventually they will reverse as individu- and those late in their working lives, since most of their als retire and withdraw their tax-sheltered savings. lifetime labour earnings would escape the payroll tax, The deferral of tax means that additional revenues but it would be unfavourable to those who were young will be generated in the future, which, in Canada’s or early in their working lives. Conversely, a shift from a case, could be helpful for financing public pension payroll tax to a sales tax would favour younger workers and health care needs when the large population of while penalizing older workers and retirees (who would baby boomers retires (see Mérette 2002). In contrast, have already paid payroll tax on most of their earnings

13 IRPP Choices, Vol. 10, no. 1, March 2004 desirable touseabalancedmixofthetwo. methods oftaxingconsumptionandthatitmaybe policy shouldavoidsharpshiftsbetweenthetwo spent theirlifetimesavings).Thispointsuggeststhat and whowouldpayagain,insalestaxes, whenthey of neitherregistered savingsnorhomeequity. the highconcentration ofwealththatisin theform sharply reduceeffectivetax progressivitybecauseof the reform.Thiskindoftax avoidance wouldalso ings, whichwouldundermine theefficiencygainsof be appliedtotaxableconsumption andlabourearn- substantially highermarginaltaxrateswouldneedto ficulty ofachievingsuchagoal,however, meansthat they werenotbeingusedfortaxavoidance.Thedif- accounting ofallinitialwealthholdingstoensure would benecessarytoestablishcomprehensive prevent thisrevenuelossduringthetransition,it consumption withoutincurringanydirecttaxes. To existing wealthcouldbeusedtofinancepersonal many years.Underthetax-prepaidmethod,pre- reducing thetaxliabilitiesofhigh-wealthholdersfor tered savingsplansas“new”savings,thussharply undocumented sourcescouldbecontributedtoregis- deferred method,suchpre-existingwealthtaken from accumulated atthetimeoftransition.Undertax- how tohandlecapitalorsavingsthatwerealready of aconsumption-basedtax.Acentralproblemis rate imposedatthetopofpersonaltax. progressive personaltaxratesandaflatbusiness Rabushka scheme,Bradford’s“X-tax”(1986)combines not endorseitasofficialpolicy. AvariantoftheHall- Party favourablyassessedaschemeofthiskindbutdid tion forhouseholds).InCanada,theformerReform cash flow(thisisthebusinesscounterparttoconsump- financial capitalreturnsandabusinesstaxbasedon scheme isacombinationofpersonaltaxthatexempts presidential candidateSteveForbes.TheHall-Rabushka tax plan,promotedbycongressmanDickArmeyand elaborated intheUSHall-Rabushka(1985)flat schedule (Walker 1994).Thetax-prepaidmethodwas sumption tax”thatcouldretainaprogressivetaxrate proposals forreplacingtheGSTwitha“personalcon- Canada, itwassupportedintheFraserInstitute’s1994 (unlimited savingsallowance)tax(Boskin1996);in Nunn andPeter DomeniciintheirproposedUSA the tax-deferredmethodwasendorsedbySenatorsSam ommended inprevioustaxreformproposals.IntheUS, Both methodsofconsumptiontaxationhavebeenrec- Partial ImplementationMethods Major problemsarisewiththefullimplementation elsewhere. Acash flowbasealsoleadstodifficult tran- rate taxrevenues andthesewouldneedto be replaced exempts thenormal returntocapital,itreducescorpo- flow taxation.However, becausethecashflow base component oftheHall-Rabushka planembodiescash tions forfinancingcosts).Indeed, thebusiness chases canbefullyexpensed(andtherearenodeduc- need fordepreciationaccounting,asallcapitalpur- further simplifiestaxaccountingbyeliminatingthe ted inCanadabythedividendtaxcredit. paying equities,thoughthelatterispartiallymitiga- equities, relativetoholdingsofdebtanddividend- is furtherbiasedtowardequities,especiallygrowth traded). Inaddition,partialexclusion ofcapitalgains and businessassetsotherthanthosethatarepublicly not qualify(forexample,tangibleassets,realestate ties isfavouredrelativetokindsofsavingsthatdo exclusion, theholdingofmarketable financialsecuri- With registeredplansandanannualfinancialincome of savingsthatqualifyforconsumptiontreatment. some limitations.Oneisthattheyrestricttheforms sion ofrealizedcapitalgainsfrompersonaltax. given amountsoffinancialincomeandpartialexclu- tax-prepaid approachareannualexemptions on tion amounts.Twoothermethodsofapplyingthe eral provisionsforthecarry-overofunusedcontribu- percentage limitandanannualdollarlimit,withlib- Canadian RPPandRRSPschemes,whichhavebotha labour earnings.Thisapproachisusedinthecurrent prepaid —canbelimitedasapercentageofcurrent istered savingsplans—whethertaxdeferredor than fully. Forexample,annualcontributionstoreg- consumption-based personaltaxonlypartially, rather tives onincrementalsavingsistoimplementa reduce potentialrevenuelossesandfocustheincen- and neutralforrealinvestmentdecisions. a businesscashflowbaseaseconomicallyefficient for householdsisacashflowbase.Economistsregard in personaltaxprogressivity. windfall gainstothewealthyandasharpreduction ing largeandeconomicallyinefficientrevenuelosses, lems ofeliminatingtaxes onallcapitalgains,includ- contributions avoidssomeofthemostsevereprob- Moreover, tax-prepaymentwithlimitsonannual tral treatmentofinterestanddividendincomes. Grubel 2003a)havebacked —butitalsooffersneu- capital gains—whichsomeanalysts(forexample, tax-prepaid methodisequivalenttoazerotaxon Partial implementationmethodsdo,however, have One waytocontrolopportunitiesforavoidance, The businesstaxcounterparttoaconsumptionbase 14 28 27 Such abase The sition problems for firms with high debt loads, since purchases that individuals make across the border and their interest financing costs would no longer be consume at home — typically through controls on com- deductible. Most of these difficulties could be avoided mercial and private purchases of goods shipped or car- by allowing highly accelerated depreciation, or full ried across the border. expensing, only for new capital investment. Canadian tax design must heed the last point in partic- ular if the goal is to increase the country’s competitiveness. Direct versus Indirect Application Existing border controls to enforce the GST and provincial The choice of whether to apply a tax directly or indi- sales taxes impose large real burdens on businesses, indi- rectly pertains mostly to consumption-based taxes, viduals and governments. These burdens include customs for which there are both direct and indirect forms, officers, brokerage and Canada Post import fees, shippers’ but it raises similar issues in comparing an indirect costs of preparing export documentation and higher couri- consumption tax with various forms of direct perso- er and postage fees for shipments between Canada and the nal and business taxes. The first consideration is that US than for shipments within either country. On top of an indirect tax is of limited use because its operation these tangible costs are the time costs imposed on truckers prevents adjusting rates based on the taxpayer’s abil- and individuals queued at the border and on Canadian ity to pay or on other attributes such as family size or businesses waiting for the delivery of needed materials, health status. For this reason, an indirect tax is suit- parts and supplies.29 All these items are added to the costs able only as a supplementary means of collecting of doing business in Canada, perhaps rivalling the costs of revenues where substantial use is made of direct having a separate currency, which have been much- taxes on households. An indirect tax’s lack of dis- discussed in the dollarization debate. criminatory power often leads to the use of compen- Any plan to spur Canadian economic growth should satory provisions such as income-tested refundable thus seek to minimize border costs. Canada might also tax credits for lower-income households. contemplate an eventual customs union with the US, Second, it has been argued that diversifying tax whereby trade between the two countries is tariff free collection between direct and indirect methods and both apply common tariff rates to trade with other reduces the potential for tax avoidance and evasion. countries. Such an arrangement would allow Canadian Spreading taxes over multiple bases and collection producers to operate in the North American market with points reduces the incentive to cheat on any one tax, as little friction to doing business as US firms experi- it is claimed, and increases the cost of cheating on ence. Gains to Canadians’ real living standards also multiple taxes. Yet this argument is easily overstated, might result from reducing the use of Canada-specific in that a business that cheats on its collection or distributors for many products.30 However, present sales- remittance of GST will consistently misreport its type taxes, with total rates averaging about 15 percent gross revenues and costs on its income tax return. If for all provinces except Alberta, are roughly double it did not, an audit for one of the taxes would reveal their US counterparts, a tax differential that is a major that the other tax had not been properly reported. barrier to relaxing border controls on trade. Hence, Tax Design for a Northern Tiger by Jonathan R. Kesselman Hence, multiplicity of tax bases and collection points Canada should consider reducing total indirect taxes does not necessarily improve the tax authorities’ toward the average US level, which would entail chang- detection powers, but it typically increases their ing the form of federal and provincial sales taxes.31 administrative costs and taxpayers’ compliance costs. In switching from a destination-type indirect tax to Third is an aspect of tax collection and enforce- an origin-type direct tax, two notable effects would ment of particular salience for Canada in choosing arise. First, Canadian residents would be taxed on their between direct and indirect tax formats. As noted consumption abroad, to the extent that it was financed above, an indirect tax is applied on a “destination” out of domestic earnings. Unless the direct tax effect- basis, whereby the tax is levied, paid and collected in ively captured their foreign earnings, Canadians might in the jurisdiction in which the final consumer of the part escape taxes here. Second, switching to an origin- good or service resides. In contrast, a direct tax is type tax would raise domestic production costs; howev- applied on the basis of the “origin” of the income er, as explained earlier in the discussion of tax levels, an used to purchase the good or service, and it is levied automatic adjustment of the exchange rate would offset by the jurisdiction in which that income is generated this effect. With flexible exchange rates, domestic auton- and in which the factor owner resides. Hence, an omy over tax rates would be preserved even with more indirect tax requires the means to collect taxes on relaxed border controls on trade.

15 IRPP Choices, Vol. 10, no. 1, March 2004 the taxes highearnerspayandthe servicesthey payers fullyvalue; itmustalsodosowith respectto only providepublicgoodsand servicesthatalltax- the highestlevels.Asaresult, aprovincemustnot lity arisesacrosstheskillsspectrum butisgreatestat within thecountrythaninternationally. Suchmobi- federal taxpolicyisthegreatermobilityoflabour value ofpublicexpenditures. ernment ontheirabilitytoovertaxrelativethe severe market constraintsthandoesthefederalgov- ance towardindirecttaxes. ease theformertypeofevasionandthustiltbal- workers couldreadilyobtainUSearnings,wouldalso Indeed, onlyafullcommonmarket, inwhichaverage tax mixawayfromindirectandtowarddirecttaxes. mer type.Hence,itwoulddictatesomeshiftofthe evasion easierwithoutchangingtheeaseoffor- movement ofgoodswouldmake thelattertypeof nation basis.Relaxed bordercontrolsonthe ping withrespecttoanindirecttax,leviedonadesti- levied onaresidencebasis;andcross-bordershop- underreporting offoreignearningsforadirecttax, Dahlby citestwotypesofcross-bordertaxevasion: of BevDahlby: approach mightappeartoruncountertheadvice needed tobereducedminimizebordercosts.This system couldbearheavierusageifindirecttaxes economy. provincial leveltotheexchange rateforthenational ally. Thereisnoadjustment counterpartatthe province tocompetebothnationallyandinternation- and businesseswillimpedetheabilityoffirmsinthat fully valuedpublicgoodsandservicesforhouseholds province thatraisesitstaxburdenwithoutproviding for householdsandbusinesses.Incontrast,any regardless ofwhetherthetaxes providegoodvalue to restoretradecompetitiveness;thisprocessoccurs accommodated throughanexchange-rate adjustment national level,anydifferentialtaxburdenwillbe federal taxes intwoimportantrespects.First,atthe The analysisofprovincialtaxes differsfromthatof Provincial Tax Principles The secondfactorthatdifferentiatesprovincialand One mightquestionwhetherCanada’sdirecttax (2003, 100–01) sumption taxsystemleviedatthefullrate. a moderaterate,ratherthanhaveonecon- tems ofconsumptiontaxation,eachleviedat Therefore, itispreferabletohavetwosys- ferent formsoftaxevasionandavoidance… sumption taxes becausetheyaresubjecttodif- We shouldlevybothdirectandindirectcon- 32 Consequently, theprovinces facemore provincial levels. sonal taxratestructureatboththefederaland most economicallybeneficialwaystomodifytheper- those intheUS.Thisprovidesabasisforassessing them atboththefederalandsubnationallevelswith top taxratesonvarioustypesofincome,andcompare examine personaltaxratesinCanadaaswellthe further movestowardaconsumptionbase.Ithen and reformingthebase—including,mostimportantly, US base.Thisleadstoproposalsforbothexpanding Canadian personaltaxbaseandcomparingitwiththe any taxdesign.Myanalysisbeginsbyassessingthe P Personal Taxes policies forredistributivepurposes. government intheirabilitytousetaxandspending provinces maybemoreconstrainedthanthefederal (Feldstein andWrobel 1998).Accordingly, the pursuing muchredistributionthroughthetaxsystem gests thatthismobilityprocesspreventsthemfrom taxes ontoemployers.EvidencefromUSstatessug- tions andshiftingtheburdenofmoreprogressive province, thusraisingthegrosspayforthoseoccupa- enjoy. Otherwise,someofthemwillleavethe the expenseofbusinessinvestment. biases savingstowardinvestmentinhomeequityat from consumption,favourscurrentspendingand mortgage interest,whichmovestheUSbaseaway in theUStaxbase.Oneoftheseisdeductibility advantages bynotreplicatingseveralleakagesfound at thefederallevel.Fortunately, Canadaenjoyssome income taxisbyfarthelargestsourceofrevenues equity. ForbothCanadaandtheUS,personal base forpersonaltaxes, withdueregardforhorizontal should seektoimplementthebroadest,mostefficient In itseffortstobecomeaNorthernTiger, Canada The BaseforPersonal Taxes by afurtherUS$295 billion,oranother7percent. taxes, whichinthe 2000taxyearshrankthebase income taxes, real estate taxes andpersonalproperty base isthefederaldeductibility ofstateandlocal adjusted grossincome.Another leakageintheUStax totalled US$300billion,orabout7percentoftotalUS year, itemizeddeductionsformortgage interest and provinciallevels,makingthemcriticalin Canadian revenuesystematboththefederal ersonal taxes arethelargestcomponentof 16 33 34 In the2000tax 35 A third type of personal tax base erosion in the US To improve efficiency, growth and competitiveness arises through the tax-free treatment of interest on with the US, however, the most critical change that state and municipal bonds (“munis”).36 As of late could be made to Canada’s personal tax base is a further 2002, the total volume of munis outstanding was shift toward consumption. Currently, high earners in US$1.76 trillion, of which about 70 percent was held Canada can take advantage of only about one-third of by individuals (either directly or through funds).37 At the tax-recognized savings of their US counterparts, a tax-equivalent interest rate of 4.5 percent (almost which raises their relative tax burdens and distorts their all munis are long term), this treatment removes more savings behaviour. The 2003 federal budget’s proposed than US$55 billion from the tax base of upper- phased hikes in the dollar ceiling for RPP and RRSP bracket US taxpayers. Tax-free treatment is an ineffi- contributions from $13,500 to $18,000 over several cient method for making intergovernmental transfers. years is long overdue, but it does not go far enough. It also reduces the progressivity of the tax system and Any dollar ceiling on contributions eliminates the effi- encourages excessive spending by governments that ciency gains for individuals who are constrained by that have access to cheap financing. For these reasons, ceiling; for them, it is like a lump-sum tax reduction Ontario’s issuance of tax-free Opportunity Bonds in with no marginal incentives to save. Moreover, there is 2003 is a troubling Canadian precedent, one that no reason to keep high earners from undertaking life- other jurisdictions should eschew.38 time savings on the same consumption-tax basis as low Although the deductions and exclusions available and middle earners. in the US lessen effective tax burdens, they do so in a Maintaining the link between contributions and way that is economically inefficient. They necessitate labour earnings is an effective way both to limit con- marginal tax rates that are higher than would other- sumption treatment to lifecycle savings and to prevent wise be needed to generate the same total tax rev- the large revenue loss of a full consumption tax base. enues. These higher MTRs carry larger efficiency The existing 18 percent rate is adequate for those not costs than necessary by distorting taxpayer choices constrained by the dollar limit, given the ability to carry with respect to work, saving and investment.39 Hence, forward unused contribution amounts — a point con- by avoiding such base-eroding tax deductions, firmed by the fact that very few of those individuals Canada can either raise the same relative revenues as actually contribute their full allowance. However, along the US with lower MTRs and lesser economic distor- with eliminating the dollar ceiling on contributions, it tion or raise greater revenues than the US with com- might be sensible to apply a lower rate (such as 15 per- parable MTRs and economic distortion — either way, cent) for allowable contributions on earnings above a useful competitive advantage. $100,000 per year. Such a change would reflect the pro- Canada’s personal tax base is broader than that of gressivity of the tax rate schedule, the application of the the US, but it still has some areas in which efficiency percentage limit to gross earnings and the need for and horizontal equity could be improved.40 The most retirement savings to replace only part of net earnings.41 notable of these areas is the omission of employer- Further moves toward a Canadian personal consump- Tax Design for a Northern Tiger by Jonathan R. Kesselman paid health and dental insurance benefits as a taxable tion tax will invoke the choice between tax-deferred and fringe benefit for employees. This omission reduces tax-prepaid methods. The 2003 federal budget the tax base while causing inefficient overprovision announced plans to consult on the possible adoption of of such coverage relative to taxable compensation. It tax-prepaid savings plans (Canada 2003a, 341–42). In also penalizes disproportionately workers at lower fact, several considerations support the expansion of earnings levels, who have little or no such coverage. access to tax-recognized savings along tax-prepaid, Another example is strike pay, which is nontaxable, rather than tax-deferred, lines (Kesselman and while the union dues that finance it are tax Poschmann 2001). These include lower immediate rev- deductible, an arrangement that is inconsistent and enue costs, greater economic efficiency, less sacrifice of encourages more and longer work disruptions. vertical equity, and greater benefits for low-income earn- Moreover, some transfer payments to individuals are ers whose higher MTRs in retirement make tax-deferred nontaxable, which may make sense for income-tested savings unattractive. Yet another virtue of the tax- transfers, where taxability would exacerbate work prepaid approach is that high earners would not be disincentives, but transfers such as workers’ compen- tempted to emigrate to skirt their tax-deferred liabilities sation benefits should be taxable just as are employee on dissaving; at present, after emigrating, such earners compensation and unemployment benefits. can reduce their tax on withdrawals from tax-deferred

17 IRPP Choices, Vol. 10, no. 1, March 2004 holding taxes oninterestanddividends paidtonon- 1999) andshould becompletelyeliminated. Thewith- savers withnooffsettingbenefits (seeFriedandWirick ate tothedisadvantageofCanadian workers and content inregisteredsavings andpensionplansoper- economic benefits.Forexample, thelimitsonforeign ters intheinternationalarenawouldalsobringgreater The UStaxsystemalreadyusesasimilarmethod. and maintaintheconsumptiontaxbase’sintegrity. cient taxarbitrageonleveragedequityinvestments complexities oftracing,preventeconomicallyineffi- in futureyears.Thisapproachwouldeliminatethe Any excess amountcouldbecarriedforwardforuse from interest,dividendsandtaxablecapitalgains. payer’s annualinterestdeductionstototalincome way toreformtheseruleswouldbelimitthetax- capital gainsratherthantodividends.Anattractive deductions forinteresttofinanceequitiesoriented butions; andFinanceCanadahasproposedbarring cannot bedeductedonloanstofinanceRRSPcontri- deductions onhomeownerorconsumerloans;interest borrowed fundstospecificfinancialassetsblock would beappropriate.Currentrulesrequiretracing base, changestotherulesforinterestdeductibility over emergenciesorjoblessspells. fund outsidetheirregisteredsavingstohelptidethem encourage familiestoaccumulateamodestrainy-day exemption forinterestanddividendswouldalso not bereadilylinked tolabour earnings.Afixed be usedforpre-existingsavings,andaccesstoitcan- much largerTPSPs,however, sincetheexemption can tion methodwouldnotbeasuitablesubstitutefor plans orrecordkeeping ofcontributions.Anexemp- savings withouttheneedforformalregistrationof consumption-type treatmentofsmallamounts $2,000 peryear. Thisprovisionwouldallowfor appropriate contemporaryfigurewouldbeabout could exempt $1,000ofsuchincomeeachyear;an Prior tothetaxreformsoflate1980s,individuals on alimitedamountofinterestanddividendincome. Canada couldusefullyreinstateannualexemptions grated withexistingtax-deferredsavingsplans, Retirement Accounts totax-prepaidschemes. posed convertingexistingtax-deferredIndividual tax-prepaid linesisthattheUSadministrationhaspro- move towardtreatingtax-recognizedsavingsalong withholding rates.StillanotherincentiveforCanadato plans bytakingadvantageoflownonresidenttax- Reform ofCanadianpersonaltaxes relatingtomat- As partofthemovetowardaconsumptiontax In additiontoinstitutingnewTPSPsthatareinte- 42 to remedythismatter. specialized skills.CanadashouldnegotiatewiththeUS the benefitstoCanadianeconomyfromtapping the purchasingpowerparity(PPP)rate(US$0.84). exchange rates:arecentmarket rate(US$0.76)and brackets convertedintoCanadiancurrencyusingtwo the twocountriesin2003,withUStaxableincome federal-subnational incometaxes. tional levelandfinallythetopMTRsforcombined federal levelinthetwocountries,thenatsubna- I examinethecomparativetaxratestructuresat their USstateandlocalcounterparts. provincial incometaxes arenearlytwiceaslarge eral incometaxes arelowerthanintheUS,but differs sharplyinthetwocountries.InCanada,fed- tion betweenfederalandsubnationalusageofthePIT Despite thisroughaggregatesimilarity, thecomposi- and aslightlylargershareofGDP(seetable1). smaller shareoftotaltaxes inCanadathantheUS Personal incometaxes (PITs)representasomewhat Rates ofPersonal Taxes technical workers toworkinCanada, more burdensomeforUSmanagers,professionalsand else unilaterallylifted.OtherUStaxprovisionsmake it removed throughbilateralagreementwiththeUSor economy (seeMintz2001b), andtheyshouldbe residents imposesignificantburdensontheCanadian for marriedseparate filers).InCanada,acouple with taxable incomes aboveUS$312,000 (orUS$156,000 percentage pointshigherat 35 percentandappliesfor above $104,600, whilethetopMTRinUSis6 percentinCanadaapplies fortaxableincomes 29 an MTRof25percentinthe US.ThetopMTRof Canadian federalMTRof22percentcompareswith $120,000 earnedequallybymarriedpartners,the US. Atataxableincomeofabout$60,000,or by largerpersonalexemptions anddeductionsinthe below thoseinCanada,adisparitythatisaugmented $65,000 forcouples,USfederalMTRsaredistinctly offers themostappropriatecomparison. rate scheduleformarriedseparatefilers(table4e) couples withpartnershavingequalincomes,theUS those formarriedjointfilers.Hence,Canadian face taxratebrackets thatarejusthalfthewidthof couples intheUSopttofileseparatereturns,they has justoneratescheduleforallfilers.Whenmarried presents schedulesforthreetypesoftaxfilers;Canada The tableincludesthemajorUSratecutsof2003and Table 4presentsthefederalPITrateschedulesfor At incomesbelow$30,000forsingleearnersand 18 43 44 thus reducing In thissection, 45 Table 4 Comparative Canada-US Federal Personal Tax Rates, 2003

Table 4a Table 4b Canada: All Filers (actual) Canada: All Filers (proposed)

Basic personal amount = $7,800 MTR (%) Basic personal amount = $10,000 MTR (%)

Taxable income range ($) Taxable income range ($)

0–32,200 16 0–40,000 16 32,200–64,400 22 40,000–80,000 20 64,400–104,600 26 80,000–160,000 24 Above 104,600 29 Above 160,000 28

Table 4c US: Single Filers

Personal exemption + standard deduction = US$7,850a MTR (%)

Taxable income (US$) C$ = 0.76 US$ C$ = 0.84 US$

0–7,000 0–9,200 0–8,300 10 7,000–28,400 9,200–37,400 8,300–33,800 15 28,400–68,800 37,400–90,500 33,800–81,900 25 68,800–143,500 90,500–188,800 81,900–170,800 28 143,500–312,000 188,800–410,500 170,800–371,400 33 Above 312,000 Above 410,500 Above 371,400 35

Table 4d US: Married Joint Filers

Personal exemption + standard deduction = US$15,700a MTR (%)

Taxable income (US$) C$ = 0.76 US$ C$ = 0.84 US$

0–14,000 0–18,400 0–16,700 10 14,000–56,800 18,400–74,700 16,700–67,600 15 56,800–114,700 74,700–150,900 67,600–136,500 25 114,700–174,700 150,900–229,900 136,500–208,000 28 174,700–312,000 229,900–410,500 208,000–371,400 33 Above 312,000 Above 410,500 Above 371,400 35 Tax Design for a Northern Tiger by Jonathan R. Kesselman Table 4e US: Married Separate Filers

Personal exemption + standard deduction = US$7,850a MTR (%)

Taxable income (US$) C$ = 0.76 US$ C$ = 0.84 US$

0–7,000 0–9,200 0–8,300 10 7,000–28,400 9,200–37,400 8,300–33,800 15 28,400–57,300 37,400–75,400 33,800–68,200 25 57,300–87,400 75,400–115,000 68,200–104,000 28 87,400–156,000 115,000–205,300 104,000–185,700 33 Above 156,000 Above 205,300 Above 185,700 35

Source: Canada Customs and Revenue Agency and US Internal Revenue Service. Note: All figures rounded to the nearest $100. a Assumes no dependent children.

19 IRPP Choices, Vol. 10, no. 1, March 2004 age pointsfor self-employed workers. Thesefigures 1.45 percentage pointsforemployeesand2.9 percent- applied toallearningswithout anupperlimit;thisadds income includeapayrolltax forMedicarethatis viduals whoarenotintheircountry’s toptaxbrackets. the tabledoesnotshowpatternofMTRsforindi- the fourmostpopulousCanadianprovinces.Ofcourse, 9.3 percent.Forcomparison,thetablepresentsratesfor percent,andhigh-taxed California,withatop MTRof 4 relatively low-taxed Michigan,withatopMTRof labelled “federalonly.” Theillustrativestatesinclude states withnoPIT, theresultscorrespond tothecolumn each countryandformajortypesofincome.ForUS and state/provincialPITsforillustrativejurisdictionsin all Canadianprovincesexcept Alberta. percent,andtheirratesareexceeded bythoseof 10 (Montana andNorthDakota) havetopMTRsabove Canadian PITatthefederallevel. with thegreaterprogressivityofUSPITthan gressive thanCanadianprovincialPITs;thiscontrasts means that,overall,USstatePITsaremuchlesspro- several stateshaveeithernoPIToraflatrate couples) inNewYork. Thispatternandthefactthat erate incomes,suchasUS$20,000(orUS$40,000for schedules, thetopMTRisattainedatrelativelymod- rate schedules.FormanystateswithprogressivePIT most ofthosewiththelowesttopMTRs,applyflat ing onlyinterestanddividends.Sixstates,including with sevenstateshavingnoPITandanothertwotax- (though thisisnotdisplayedintable5). considerable progressivityofMTRsacrossincomes schedules oftheprovincesotherthanAlbertadisplay old andSaskatchewanapproachesit.Overall,therate although NewBrunswickmatchesthefederalthresh- the $104,600 thresholdforthetopfederalMTR, rate brackets applytoincomessubstantiallybelow percent orjustbelow. Inmostprovinces,thesetop- Columbia andSaskatchewanhavetopMTRsof15 rebate offederaltaxtoQuebectaxpayers).British teens forseveralprovinces(afteradjustingthe cent forAlberta(withitsflatratePIT)totheupper for 2003.InCanada,thetopMTRsrangefrom10 per- Canadian provincialandUSstatelevels,respectively, filing jointlywouldpayanMTRof33percent. comparable incomeusingPPPintheUS,couple ing acombinedtaxableincomeof$209,000.At equal incomesdoesnotincurthetoprateuntilreach- As table7shows,theUSfederal topMTRsonlabour Table 7displaysthetopMTRsofcombinedfederal Table 6classifiestheUSstatesbytheirtopMTRs, Tables 5and6showthetopMTRsforPITat 46 Only twostates California andmid-taxed Ontario.ButtopMTRsfor and low-taxed Albertaandalsobetweenhigh-taxed between low-taxed USjurisdictionssuchasMichigan incomes, toptotalMTRsareroughlycomparable by themratherthanshiftedtoemployees.Forlabour assume thatthepayrolltaxpaidbyemployersisborne taxpayers: withoutthisadjustment,thetopMTRforQuebecis24%. nearest 0.1%. to thenearest$100. let A10.0 14.7 17.4 17.4 15.0 NA 19.2 88,300 18.3 65,000 17.8 67,300 100,000 54,200 18.4 79,500 British Columbia 104,600 Alberta Saskatchewan Manitoba 61,500 Top Ontario Quebec New Brunswick Nova Scotia Taxable income Prince EdwardIsland Newfoundland Province 2003 Provincial IncomeTaxes, Top MarginalTax Rates, Table 5 c b a Corporations Source: PriceWaterhouseCoopers LLP, deducting federalincome taxes. 00+Montana(11%), NorthDakota(12%) b a California,Oregon,RhodeIsland, * Flatratetax Rates forTax Year 2003”(February2003).www.taxadmin.org/fta/rate/ind_inc Hawaii,Iowa,Maine,NewMexico,North Source: FederationofTax Administrators.“StateIndividualIncomeTaxes: Tax Idaho,Minnesota,Ohio,Oklahoma, 10.00+ 9.00–9.99 Arkansas, Georgia,Kansas, Kentucky, 8.00–8.99 Alabama,Arizona,Delaware, 7.00–7.99 Colorado,*Connecticut,Maryland, Illinois,* Indiana,*Pennsylvania* 6.00–6.99 5.00–5.99 4.00–4.99 Alaska,Florida,Nevada,SouthDakota, 2.80–3.99 States Interest/dividends only Zero (nostatetax) Top MTR(%) Rates, 2003 State Personal IncomeTaxes, Top MarginalTax Table 6 This figurereflectsanadjustmentfortherebateoffederaltaxtoQuebec Threshold abovewhichthetopMTR(includinganysurtax)applies,rounded Personal taxappliesto interestanddividendincomesonly. Figures includeanyprovincialsurtaxonincometaxandareroundedtothe Separate schedules,with ratesrangingupto10%, applytotaxpayers n ardr5,0 19.6 59,200 and Labrador (Canada, 2003).www.pwc.com/ca 20 a New Hampshire,Tennessee threshold ($) Vermont Carolina South Carolina,Utah Wisconsin Jersey, NewYork, West Virginia, Louisiana, Missouri,Nebraska,New Massachusetts,* Virginia Michigan,* Mississippi Texas, Washington, Wyoming Tax FactsandFiguresforIndividuals a MTR (%) c b b Table 7 Top Marginal Tax Rates by Type of Income, US and Canada, Combined Federal and State/Provincial, 2003

US Canada

Type of income Federal Federal Federal Federal Federal Federal Federal Federal only plus plus only plus plus plus plus Michigan California Alberta BC Ontario Quebec (%) (%)a (%)a (%) (%) (%) (%) (%)

Labour income

Employment 36.5b 40.5 45.8 29.0 39.0 43.7 46.4 48.2 Self-employment 37.9c 41.9 47.2 29.0 39.0 43.7 46.4 48.2

Capital income

Interest 35.0 39.0 44.3 29.0 39.0 43.7 46.4 48.2 Dividends 15.0 19.0 24.3 19.6d 24.1 31.6 31.3 32.8 Short-term capital gains 35.0 39.0 44.3 14.5 19.5 21.9 23.2 24.1 Long-term capital gains 15.0e 19.0 24.3 14.5 19.5 21.9 23.2 24.1

Sources: PriceWaterhouseCoopers LLP, Facts and Figures for Individuals and Corporations (Canada, 2003), www.pw.com/ca; and author’s calculations. a Ignores itemized deduction of state income tax in federal income tax, which could reduce the effective MTR by up to 1.4% in Michigan and up to 3.3% in California if the filer is not constrained by the high-income limit on certain itemized deductions or the alternative minimum tax. b Includes Medicare employee payroll tax of 1.45% (as do the state-inclusive figures). c Includes Medicare self-employed payroll tax of 2.9% (as do the state-inclusive figures). d Dividends received from taxable Canadian corporations, eligible for dividend tax credit (similarly for the province-inclusive figures). e Assets held more than one year (excludes collectibles and depreciable business assets).

Quebec and the Atlantic provinces (not shown in the tem, however, such cuts are best targeted on particular table) exceed even the most highly taxed states. income ranges.47 They are most important at upper- The top MTR patterns diverge much more for dif- middle and relatively high incomes (covering many ferent types of capital income. MTRs for interest high-technology, knowledge-based, managerial, entre- income are somewhat lower in the illustrative US preneurial and professional workers) but not at the very states than in their Canadian counterparts. And with highest incomes. They are also important at moderate the 2003 cut in the US federal tax rate for dividends incomes, where clawbacks of benefit programs com- of higher-bracket taxpayers to a flat 15 percent, the pound with PIT rates to yield high total effective MTRs. top US MTRs on dividends are now substantially Another way of cutting MTRs for particular income lower than those in Canada. The US federal tax rate ranges is simply to extend the income brackets for exist- on long-term gains on assets held for more than one ing statutory rates so that more individuals are shifted Tax Design for a Northern Tiger by Jonathan R. Kesselman year has also been cut to a flat 15 percent. Yet, into a lower MTR. Canada’s 50 percent tax exclusion rate on capital Further reductions in Canadian federal tax rates gains leaves top Canadian MTRs on long-term capital would be useful to offset at least partially the gains fully competitive with those in the US except in provinces’ high PIT rates relative to those of US states. zero-tax states; most of the other states tax long- Federally, the US PIT is considerably more progressive term gains fully without any preferences. For short- than the Canadian tax, largely because of the relatively term capital gains, top MTRs are sharply lower in low income levels at which the Canadian tax hits its Canada than in the US, since the US taxes such gains upper rates. At the subnational level, Canadian perso- at full statutory MTRs while Canada does not distin- nal taxes are more progressive than US taxes but not guish between short- and long-term gains. by enough to offset the greater progressivity at the fed- eral level in the US and the fact that state taxes are Changing Tax Rates and Brackets typically small. But the goal of Canadian tax reform is Reductions in MTRs for personal taxes are economi- not simply to compete with the lower personal tax bur- cally useful for the entire income spectrum; in terms den in the US. Rather, it is primarily to reduce the dis- of efficiency, incentives and a competitive tax sys- incentives and inefficiencies Canadians face as workers,

21 IRPP Choices, Vol. 10, no. 1, March 2004 face. erbate thedisincentivesandinefficienciessuchearners planned enrichmentstothesupplementwillonlyexac- in the$21,500 to$33,500range, andrecent above 60percentforNCBbeneficiarieswithincomes rates, includingPITandbenefitclawbacks,canrise considerably widened; reduced by2percentagepointsandtheirbrackets tax brackets of22and26percentcouldeachbe hike inthetaxableincomethreshold.Thetwomiddle income workers wouldobtainreliefbya25percent could beleftunchangedat16percent,butlow- to achievethedesiredgoals.Thebottom-bracket MTR could bereducedandtheirincomebrackets expanded productive workers. vate, attractandretainthemostskilled,talented savers, investorsandentrepreneurs—tomoti- special needsnot targetedbyfamilyincome. saved resources toin-kindbenefitsforchildren with would betocurtailNCBsupplements andredirectthe without crossingintothenext taxbracket. Evenbetter lower incomesandextending ittohigherincomes could bereducedbystarting thebenefitphase-outat marginal ratestheyface. to $40,000wouldfacilitatereliefofthehigheffective supplement, wideningthebottomfederalMTRbracket income withintheaccount. equivalent toazeromarginaltaxrateonallcapital tend tobehighsaversaswell.SavingviaTPSPsis point thatisparticularlysalientforhighearners,who than fromreducingtaxratesonlabourearnings,a reducing taxratesonsavingsandcapitalincome The economicefficiencygainswouldbegreaterfrom savings wereremovedandTPSPsintroduced. the dollarceilingoncontributionstotax-recognized schedule. High-incomeearnerswouldgainthemostif match thethird-highestrateinUSfederal unchanged, orreducedslightlyto28percent workers thattheirtalentswerewelcomeinCanada. it wouldalsosendanimportantsignaltoproductive current 29percenttothenew24ratebracket); MTRs forupperearners(5percentagepoints,fromthe old wouldbringtheincentivesofalargedropin top MTR.AlargeincreaseintheCanadianthresh- compared withtheUSfederaltaxthresholdfor slated torise$113,800 in2004,thisisstillverylow 2003 top-bracket thresholdof$104,600 isalready could beraisedbyatleast50percent.Althoughthe Table 4billustrateshowCanadianfederalPITrates For beneficiariesoftheNationalChildBenefit(NCB) The topCanadianfederalMTRcouldbeleft 50 With awidertaxbracket, theclawbackrate 48 the topbracket threshold 49 At present,totalmarginal Canada muchclosertoUSrates. also bringtopeffectivetaxratesondividendsin the basisofdomestictaxpolicyalone,butitwould dividend taxcredit.Thismovewouldbejustifiedon This imbalanceshouldbecorrectedbyenhancingthe rates oncorporatedividendsandretainedearnings. credit, whichleftanimbalancebetweeneffectivetax no paralleladjustmentwasmadeinthedividendtax gains wascutfrom75percentto50in2000, However, whenthetaxinclusionrateforcapital rates belowthoseoninterestandlabourincomes. tions, thedividendtaxcreditactstoreduceeffective to thetaxratesondividendsfromCanadiancorpora- ning andavoidancethatariseintheUS.Withrespect Canadian taxobviatesthecomplexitiesofplan- tinctions basedonasset-holdingperiods,the rates onshort-termgains.Moreover, byavoidingdis- long-term gainsandmuchlowerthancomparableUS Canada’s toptaxratesarealreadycompetitiveon cuts oncapitalgainsanddividends.Astable7shows, reason forCanadatofollowtheUSfederaltaxrate participation andsavings,ratherthandependency. individuals intheformof,forexample,labourforce particularly tolinkthempositivebehaviourby found tostructurethebenefitsofsuchprograms— tax andtransferpolicies.Betterwaysneedtobe tion andwork,itshouldbecurtailedinfuture This practiceworsensincentivesfortraining,promo- for manytaxpayersatmoderatetomiddleincomes. of cashandin-kindbenefits,raisingeffectiveMTRs have usedthepersonaltaxsystemtodeliverarange tend topushup thegrosswagesofitsskilled pursued greater progressivitythanOttawa would does thefederalgovernment. Indeed,aprovincethat provinces toexercise lessPITrateprogressivitythan across theborderwithUS, onewouldexpectthe tions fortheverywealthy. incremental savingsandpreventmassivetaxreduc- method wouldfocusthetaxincentiveseffectivelyon outside registeredplanspriortothechange.This would avoidlargewindfallgainstoholdersofwealth tying thecontributionlimitstolabourearnings returns toassetsheldintheseaccountsiszero,but particularly TPSPs.Theeffectivepersonaltaxrateon increased accesstotax-recognizedsavingsaccounts, policy forCanadawouldbetopursuegreatly on allcapitalgainsanddividends,amoreeffective One mightaskwhetherthereisanygoodpolicy More generally, federalandprovincialprograms Since labourismoremobile withinCanadathan Rather thanattemptingtoundercutUStaxrates 22 52 51 workers to compensate for their higher taxes, thus federal PIT, and they should follow any future increases driving out businesses that employ high-skilled in the federal threshold. This change would further workers. Before 2000, all the provinces (except improve the Canadian PIT climate for highly skilled Quebec) were restricted from pursuing flatter rate workers and specialized talents. In the event that many schedules by the operation of the federal-provincial provinces pursue much flatter PIT rate schedules, the tax collection agreement. With the shift to a tax-on- appropriate response to maintain vertical equity would income system in 2001, the provinces were be to steepen the rate schedule of the federal tax. unleashed from the federal rate schedule and can Yet there are limits on the progressivity of the federal now choose any degree of rate progressivity they personal tax rate structure, too. Although labour mobi- like. Several provinces have exploited this new flex- lity is typically much greater interprovincially than ibility. Alberta has gone so far as to introduce a flat internationally for Canada, this may not be true for rate tax, albeit one that applies above a much higher some of the most skilled and highest-paying occupa- taxable income threshold that actually raises the tions. The relevant point of comparison and potential effective progressivity of average tax rates over low relocation for some workers may not be elsewhere in to middle incomes. Saskatchewan has also pursued Canada but, rather, in the US. An investment banker is rate flattening.53 British Columbia cut personal taxes more likely to move from Toronto to New York than to considerably in 2001, but the cuts were roughly pro- Calgary, a neurosurgeon from Vancouver to Los Angeles portionate across-the-board, leaving progressivity than to Montreal. Overall, though, the federal govern- little changed and higher than that of the federal ment is better suited than the provinces to exercise tax- rate schedule — although the province did signifi- ation’s redistributive function. cantly reduce its top MTRs. Interestingly, Ontario and Quebec have departed from the predicted outcome of decreased personal tax Payroll Taxes progressivity. Quebec has increased the progressive tilt of its rates and is likely to do so further as it cuts he premiums levied to finance social insurance personal taxes sharply in future years. This might be programs can carry tax-like distortions, depend- explained by the lesser mobility of Quebecers, espe- T ing on how they are structured. Although they cially francophones, in response to higher progressiv- are denoted “premiums,” they are mandatory levies and ity; it may also reflect a greater preference by hence similar to taxes. They are applied mainly to an Quebecers for redistributive policies. In Ontario, a economically efficient base of labour income; to the surtax makes the province’s tax much more progres- extent that premiums are applied to the net income of sive than the federal tax, which might be explained unincorporated self-employed workers, they may also by the high gross wages paid for top skills in Toronto, strike some capital incomes. Moreover, such premiums the nation’s pre-eminent business centre. The Ontario can be structured as a kind of user charge for the asso- surtax may be capturing economic rents of the top ciated program’s benefits. If there is a tight linkage Tax Design for a Northern Tiger by Jonathan R. Kesselman earners without causing them to leave for other between taxes and benefits — in an ex ante sense of provinces where their net earnings would be lower “expected” benefits — then the tax distortions of labour even with lower tax rates. market decisions are attenuated. To the extent that the Regardless of whether the predicted economic ten- premiums individual workers and their employers pay dencies play out in further flattening of provincial PIT are disconnected from their prospective benefit entitle- rate schedules, some changes would be desirable. To ments, they become a distorting general payroll tax achieve more competitive overall tax rates for the (see Kesselman 1996, 1997). most skilled workers, further reductions in upper Canada and the US differ sharply both in the rate of MTRs would be helpful. This issue is most acute for premiums they levy for social security and in their dis- the Atlantic provinces and Quebec but also applies to torting effects.54 As table 8 shows, CPP premiums have a Ontario’s PIT surtax. An ultimate goal for top MTRs in total rate (split evenly between an employer levy and a all provinces should be no higher than 15 percent — worker levy) of 9.9 percent, while the total rate for US near the current top rates in British Columbia and Social Security, including Medicare, is more than half Saskatchewan. Moreover, the provinces should move again as high at 15.3 percent. Even more dramatic is the the income thresholds for the application of their top difference in the amount of annual earnings per worker rates toward the much higher threshold applied for the

23 IRPP Choices, Vol. 10, no. 1, March 2004 their premiums. higher lifetimelabourearningsgetapoorreturnon strongly redistributivetilt,sothatUSworkers with retirement. Incontrast,benefitsintheUSsystemhavea worker’s lifetimeandhisorherbenefitentitlementsin tight linkagebetweentotalCPPpremiumspaidovera ing generalpayrolltax.InCanada,thereisarelatively times higherintheUS,theyalsoactmorelike adistort- the exchange rateused). US (equivalentto$17,500or$15,800,dependingon premiums are$3,600inCanadaandUS$13,300the at thePPPexchange rate.Thus,totalmaximumannual $114,500 atarecentmarket exchange rateor$103,600 to annualearningsofUS$87,000,whichequates in theUS,levieshavenoexemption andapplyup up to$39,900withanexemption forthefirst$3,500; miums areleviedonlyonaworker’s annualearnings subject tothepremiums.In2003inCanada,CPPpre- are widelyagreed tohavemassiveunfunded liabili- US SocialSecurity andMedicaresystems, incontrast, stantial reservesagainstfuture benefitliabilities.The financial viabilityoftheprogram bybuildingupsub- CPP premiumratesdesigned toensurethefuture Canada hasnowcompleted a multiyearincreasein social securitysystemsfavoursCanadaovertheUS. points abovethecurrentCanadiantopfederalMTR. labour incomeis37.9percent,nearly9percentage at thehighestincomes, 2.9 percentagepointstothetaxes onlabourincomes including boththeemployerandemployeeshares,add those oftheUSsystem.SinceMedicarepremiums, tions oftheCanadiansystemcouldstillbelessthan sumption andlabour-incomebases,thetotaldistor- Canadian personaltaxbaseisreformedtowardcon- in therangeof$50,000to$120,000.Solongas incomes, Canadacouldimposeheavierpersonaltaxes between thetwocountriesarisesatupper-middle Given thatthelargestdifferentialinpremiums cantly heavierburdensfromotherkindsoftaxes. remain competitivewiththeUSevensignifi- because ofitssharplylowerpayrolltaxes, Canadacan where intheCanadianrevenuesystem. miums meansthatthetaxdistortionsarefoundelse- through generalrevenuesratherthanCPPpre- Old AgeSecurity(OAS) program. through universalpaymentsoffixed amountsunderthe ings, andthereforelowCPPbenefits,butitachievesthis income redistributionforretireeswithlowlifetimeearn- Not onlyarethemaximumpremiumsfourtofive Yet anotheraspectofthecomparativepositions of An importantpointfromthiscomparisonisthat, 55 Canada doesprovidesubstantial 57 the topUSfederalMTRon 56 The financingofOAS with expectedprogramcosts”(Canada2003a,26). of transparencyandbalancingpremiumrevenues regime for2005andbeyond,basedontheprinciples Government willconsultonanewEIrate-setting fits. The2003federalbudgetannouncedthat“[T]he bring revenuesdowntothedecliningcostsofbene- small; cumulatively, theyhavebeeninsufficientto um ratecutsoverthepast10 yearshasbeenquite over programcosts.EachofthenumerousEIpremi- can beattributedtothelargeexcess ofEIpremiums cess ingeneratingbudgetarysurplusesrecentyears medicare programs. through itsgeneralrevenuefinancingofOAS and remain exposedtosomeunfundedfutureliabilities range of30to50percent.)Ofcourse,Canadadoes countries commonlyhavetotalpremiumratesinthe trast, thesocialsecuritysystemsofEuropeanUnion premium rateslookevenmorefavourable.(Bycon- premium ratescouldrisefurther, makingCanadian financing ratherthanthroughcurtailingbenefits,US If thoseadjustmentsaremadeprimarilythrough ties thatwillnecessitatemajorprogramadjustments. Maximum annual lo ,0 0 87,000 87,000 US$ 36,400 39,900 3,500 Maximum C$ Ceiling Floor Taxable earnings the employer’s shareisshiftedintoloweremployee compensation. ums” forUSworkerswithearningsaboveUS$87,000. ceiling, sothatthelevyrisesbeyondtabulated “maximumannualpremi- employee foratotal2.9%).Thelatterisapplied toalllabourearningswithno and employeeforatotal12.4%)Medicare (1.45%onemployerand b a Note: Allfigureshavebeenroundedtothe nearest$100. Service. Source: CanadaCustomsandRevenueAgencyUSInternal 7.65 7.65 % 4.95 4.95 % Total rate Employer rate Employee rate Premium rates 2003 Canada andUSSocialSecurityPremiumRates, Table 8 These figuresincludethepremiumsforSocial Security(6.2%onemployer This totalrateapplies tobothworkersandtheself-employed,assuming that premiums Much oftheCanadianfederalgovernment’ssuc- b 24 eso lnincludingMedicare Pension Plan aaaUSSocialSecurity Canada 58 ,0 13,300 3,600 .015.30 9.90 (C$103,600 @C$/US$=0.84) (C$114,500 @C$/US$=0.76) (C$15,800 @C$/US$=0.84) (C$17,500 @C$/US$=0.76) a Yet, there was no mention of whether the EI pro- ciency by allocating program costs to those industries gram’s cumulative surplus would be counted in this and products generating the most layoffs. It would also future “balancing” act or, more likely, simply be remove the EI program’s cross-industry subsidies, swallowed by the federal treasury in a one-time which retard the growth of high value-added and accounting change since the funds actually ended up knowledge-based sectors. It would not, however, as part of federal general revenues. achieve the additional gains of inducing individual One consequence of these large EI surpluses is to tilt employers to stabilize their employment. the overall revenue system further toward labour Another useful element of a redesigned tax system income. Although this might be viewed as a positive for Canada might be a general payroll tax (GPT).59 In move toward promoting Canadian competitiveness, principle, the best way of taxing labour income is there are good reasons to reduce EI premiums to self- through the personal tax, since it already exists and financing rates and to collect any lost revenues else- any desired exemptions and rate progressivity can be where in the tax system. Growing surpluses in the EI applied through it. However, since many Canadians account are an open invitation to increase program may perceive that personal taxes are already too high, spending through new and expanded benefits. Such both domestically and in comparison with those in the benefits, however, should be carefully assessed on their US, the use of a payroll tax could be a more acceptable merits, not pursued simply because funds are at hand. alternative to raising personal taxes. Indeed, the US Moreover, the use of EI premiums to collect what makes heavy use of payroll taxes, such as its 2.9 per- amounts to a labour income tax provides an inefficient cent flat levy for Medicare, and many EU countries bias toward self-employment, a regressive tilt because apply payroll taxes at high rates to compensate for of the ceiling on taxable earnings, and a disincentive their lighter relative use of personal taxes. A Canadian to hiring, particularly lower-skilled workers. federal GPT could generate the revenues to facilitate In addition to being reduced, EI premiums should other desirable tax changes and rate cuts described in be experience rated, as Kesselman (1983, chap 9); this paper. At a rate of just 2.5 percent, a Canadian tax Canada (1998, 8.7–8.11); and Poschmann and Robson could raise more than $15 billion per year. Labelled or (2001), among others, have suggested. Experience rat- earmarked for a popular national purpose, such as ing makes premiums like a user charge, whereby the health care, the new tax might gain public acceptance.60 rate for each employer reflects its own record of gen- The formulation of a GPT would have to address a erating the usage of program benefits through lay- variety of issues (see Kesselman 1997, chaps 4–7). A key offs. This change would provide incentives for choice would be whether to structure the tax as one on employers to find ways to stabilize their labour employers, on employees, or on both. A tax solely on demand — such as inventory policies, adjusted work employers could be operated as a tax on aggregate pay- hours and complementary seasonal lines of activity — rolls but would be deductible in their business taxes, thereby reducing their layoffs. The US unemployment and therefore would require a higher GPT rate than a insurance system has used experience rating for tax on employees to collect a given amount of net rev- Tax Design for a Northern Tiger by Jonathan R. Kesselman decades, and it has been found to reduce rates of enues. A tax on employers, moreover, would arouse less benefit claim and unemployment. In Canada, regional public resistance, but it would also reduce accountabi- and industry opposition to such a reform undoubt- lity relative to a tax on employees. In addition, a tax edly would arise from affected sectors (principally solely on employers might run afoul of constitutional construction and resource industries), but political bars on Ottawa’s taxing provincial governments. To be resolve will be required in order to improve the coun- economically neutral, the base for a GPT should encom- try’s competitiveness. pass fringe benefits, employer pension contributions As an interim step to experience rating, the EI pre- and self-employment earnings. A base exemption for miums of employers could be set on an industry- taxable annual earnings per worker or an enrichment of rated basis. This would be administratively simpler refundable tax credits would also be needed to insulate and could mute opposition from groups concerned the lowest earners from the impact of the tax. about a tightening of EI benefits for voluntary depar- If a GPT were instituted for other fiscal purposes, it tures. It would also follow the practice of some would be desirable to reform the financing of the CPP. provincial workers’ compensation programs that use Part of the premiums (though a declining share over a mix of premium rating by employer and by indus- time) is needed to pay for benefits received by earlier try. Industry rating of premiums would improve effi- retirees under the plan, who paid premiums that were

25 IRPP Choices, Vol. 10, no. 1, March 2004 in Canada. Internet purchasesofgoods from theUSfordelivery Canadians aswelltelephone, mail-orderand major incentivesforcross-border shoppingby mix andalmost3percentof GDP—wouldcreate A gapofthismagnitude—7percentthetotaltax indirect taxonconsumptionintheformofGST. the nationallevel,Canadaappliesabroadlybased their relianceonindirectconsumptiontaxes, butat level, thetwocountriesareroughlycomparablein does theUS(astable1shows).Atsubnational on broadlybasedtaxes ongoodsandservicesthan policy isthatthiscountryreliesmuchmoreheavily would entailsomerelaxationofbordercontrols. toward thefreermovementofgoodsacrossborder Short ofacustomsunion,evenincrementalsteps individuals orcontainedincommercialshipments. be aneedtocheckforgoods,eithercarriedbyprivate other thanforsecurityreasons,therewouldnolonger some checksonimmigrationacrosstheborder, border. Thetwocountriesmightstillwishtomaintain toms unioncouldallowforunimpededcrossingofthe formed aNorthAmericansecurityperimeter, thecus- between thecountries,suchaswhethertheyhadalso ing forservices.Dependingonotherarrangements controls onthemovementofgoodsandcontract- with eachother. Thisallowstheeliminationofborder eliminate alldutiesandnontariffbarrierstotrade set ofcustomsdutieswiththeexternalworldandto toms unionisthatcountriesagreetoadoptacommon simply toreducebordercosts.Theessenceofacus- I Taxes onGoodsandServices to investtheirCPPfunds. open thepotentialofinnovativeoptionsforworkers age betweenpremiumsandbenefitentitlements regressive impactofCPPpremiums,tightenthelink- premiums). Suchanapproachwouldreducethe to aGPTwithnotaxableceiling(like USMedicare ings levels,theprogram’sfinancingcouldbeshifted $39,900 peryear. To spreadthisburdentoallearn- program, bypremiumsthatfallonearningsofupto the CPP’scostisfinanced,alongwithrestof well shortofthecosttheirbenefits.Thisportion The reasonthisposesachallengeforCanadiantax sought toformacustomsunionwiththeUSor the mostchallengingfiscalissueforCanadaifit ndirect taxes ongoodsandserviceswouldpose 62 Since mostCanadians residerelatively 61 but, forming orreplacingthem. eral andprovincialsalestaxes thatfallshortoftrans- base. Inaddition,Iexaminewaystoimprovethefed- employs aneconomicallyefficientconsumption-type rect taxshouldbereplacedwithanother revenue source.Ineithercase,theofanindi- provinces’ replacingtheirsalestaxes withamoredirect alternative, andperhapspreferable,policyofthe sion throughcross-borderpurchases.Ialsoconsiderthe collected moredirectlyandwouldnotbeopentoeva- its GSTwithanotherformofrevenuethatwouldbe comparable revenues. or thesubnationalsalestaxwithanothersourceof would havetofindawayreplaceeitherthefederal with theUSorsimplyamuchfreerborder, Canada tainable. Inshort,incontemplatingacustomsunion consumer goods,thisdifferentialwouldnotbesus- relative tothetaxsavingsonmanyhigher-value close totheborderandsinceshippingcostsaresmall 1994. the federalgovernmentreviewedGSTalternativesin consumption tax(DCT);bothwerecontenderswhen would bethebusinesstransfertax(BTT)anddirect ment andbusinessbehaviour. bate theeconomicdistortionsoftheirsavings,invest- wealthy individuals,andhigherMTRswouldexacer- tax wouldretainelementsofanincomebasefor relative tothoseoftheUS.Inaddition,personal making Canadianpersonaltaxratesuncompetitive rise politicallythorny, anditmightalsobeviewedas bility ofpersonaltaxrateswouldmake suchasharp by about35percentofexistingrates.Thehighvisi- eral MTRswouldhavetoberaisedacrosstheboard culties. First,tomaintainexistingtotalrevenues,fed- Such anapproachwould,however, entailsomediffi- then simplyraisepersonaltaxratesacrosstheboard. more consumptionbased,assuggestedabove,and revenues wouldbetomake thedirectpersonaltax If theGSTwereabolished,onewaytoreplaceitslost Federal SalesTax was opentothe movementofconsumergoods. tive taxes couldbeappliedeven with aborderthat (in thecaseofDCT).Therefore, boththesealterna- of theBTT)oronsources tofinanceconsumption transaction, butonthecosts ofproduction(inthecase type taxes. Thatis, thetaxiscollectednotoneach service isconsumed,boththeBTTandDCTareorigin- is collectedbythejurisdictioninwhichgoodor In thissection,IconsiderhowCanadacouldreplace The twoprincipalcandidatesforreplacingtheGST 64 In contrasttothedestination-typeGST, which 26 63 that also Moving from a destination-type to an origin-type tax The tax should be removed from snack foods, baked would not affect the competitiveness of Canadian goods and other nonrestaurant food items. business because the exchange rate would adjust to Distinctions between, for example, salted and compensate in much the same way as described earlier unsalted peanuts and between two cookies and half for differential tax levels.65 a dozen are not only arbitrary but silly, and they Both the BTT and the DCT would apply to the full tarnish the tax’s public image. range of consumption goods and services and would not Full rebates could be given for GST paid on purchas- allow for any exemptions, which would be more eco- es by entities in the MUSH sector (municipalities, nomically efficient than the GST. And because the base universities, schools and hospitals) to eliminate the of either tax would be wider than that of the GST, the current inefficient bias toward in-house labour serv- rate could be lower — a 3 percent DCT could replace the ices versus contracted-out services.67 revenues of the 7 percent GST (Kesselman 1997, 329). The application of GST to employee fringe bene- The BTT could operate as a simple adjunct to corporate fits, especially cars, should be greatly simplified or and unincorporated business income taxes — its base eliminated. would be cash flow plus total compensation to labour — The small trader exemption of $30,000 of annual while the DCT could operate as an adjunct to personal sales, below which firms are not required to register and payroll taxes in the form of an employee payroll tax for or collect GST, should be substantially increased plus a cash flow tax on business. The BTT would be to $75,000 or $100,000, in line with the levels typi- somewhat simpler to operate than the DCT, but it would cally found in other countries’ value-added taxes. also be a hidden tax for consumers, making the DCT This would exclude from the GST most self- preferable if one desires taxes to be visible for purposes employed workers without employees, including of political accountability. In terms of the competitive- most in the home repair and maintenance sector, ness of the Canadian tax system, the DCT’s new emplo- where tax evasion is widespread. A higher exemp- yee payroll tax component would be counterbalanced tion would also reduce the high compliance costs by the US’s higher rates of payroll tax on workers. small businesses face.68 The DCT would clearly thwart tax evasion on cross-border purchases because tax would be col- Provincial Sales Taxes lected from a payroll tax on employee earnings and Provincial retail sales taxes are likely better candidates a cash flow tax on business. In effect, the tax would for replacement than the GST if Canada wished to free be prepaid, whether the net amounts were spent up the border or pursue a customs union with the US, domestically, spent abroad or saved for future con- for several reasons. First, the provincial taxes bear sumption. It is perhaps less apparent how the BTT heavily on business inputs (about 35 percent of the tax would foil cross-border tax evasion. Prices of all revenues), thus penalizing production efficiency and consumer goods and services would rise in Canada investment incentives. Second, they have a narrower to reflect the origin-type tax, but what about base than does the federal GST, although some Tax Design for a Northern Tiger by Jonathan R. Kesselman Canadians’ purchases abroad? In fact, because the provinces have extended the coverage of services; shift to an origin-type tax would cause the broadening the base would improve efficiency and hor- Canadian dollar to depreciate, purchases made izontal equity for consumers. Third, eliminating the abroad out of Canadian-source earnings would also provincial taxes would reduce the burden on business become proportionately costlier, thus removing the of having to deal with two levels of sales taxes with incentive for cross-border shopping. differing taxable bases and operating procedures. If, instead, the federal GST were retained and As with the federal GST, the main alternatives for the provincial indirect taxes removed or reformed, the provincial retail taxes are a BTT and a DCT. The direct tax could still be improved in several ways: consumption tax would be more appealing if govern- The land component of building purchase prices mental accountability through tax visibility is a priority, should be removed from the tax base, as it is nei- since most revenues of a DCT would stem from an ther newly created output nor value added. This employee payroll tax. But there are reasons to expect that change would reduce the tax burden on buyers in the provinces would opt for the business transfer tax for- cities where housing prices are high on account of mat, since governments tend to prefer reduced tax visi- land prices, thus encouraging denser bility — indeed, most provinces have resisted development.66 harmonizing with the federal GST in part out of fear of

27 IRPP Choices, Vol. 10, no. 1, March 2004 number ofpracticalimplementationissues, for thatprovincewouldbelimited. eign customers.Hence,anycompetitivedisadvantage goods andservicessoldtoout-of-provincefor- borne bybusinessisalreadybuiltintothepricesof Yet, atpresent,theone-thirdofretailsalestaxes unless alltheotherprovincesalsochangedregimes. a BTTmightbeexpectedtoreducecompetitiveness— to mediatechangesinitstaxationregime,theshift For anysingleprovince,whichhasnoexchange rate tiveness, withthetaxnewlybuiltintoexportprices. exchange-rate adjustmenttorestoretradecompeti- level byaBTT, thischangewouldinducean Canada andin USstatesmightinduceunacceptable tax onpurchases relativetothoseintherest of provinces. Otherwise,theirhigh totalratesofsales the GSTformattoaBTTsuggested fortheother theless facepressuretoconvert theirsalestaxes from the US,these“harmonized” provinces wouldnever- freed uptheborderorformedacustomsunionwith remaining provincialretailsalestaxes. IfCanada have alreadyeliminatedmostoftheproblems sales taxes withthefederalGST. Indoingso,they Newfoundland andLabradorhaveharmonizedtheir on totheprovincialtaxrate. offered asabaseformunicipalitiestoimposeanadd- discussed laterinthispaper).ABTTmightalsobe taxes andpartofthenonresidentialpropertytax(as include thecorporateincometax,provincialpayroll some otherprovincialtaxes. Leadingcandidates offer aconvenientvehicleforreplacingorreducing economic efficiency, aprovincialBTTwouldalso governments. Becauseofitssimpleoperationand issues shouldfollowfromnegotiationamongthe at thefederalandprovinciallevels.Solutionstosuch BTT shouldbedeductiblefrombusinessincometaxes firms operatinginmorethanoneandwhetherthe ing themethodforallocatingtaxacrossprovinces imports. the taxwouldbepaidonexportsbutnot rather thanadestination-typetax,whichmeansthat BTT differsfromtheGSTinbeinganorigin-type base andstructureforthetax. participating provincesiftheycouldsettleonauniform and RevenueAgencymightagreetocollecttheBTTfor rate andpersonalincometaxes. TheCanadaCustoms ated asastraightforwardadjuncttoprovincialcorpo- adverse publicreaction.Moreover, aBTTcouldbeoper- The useofaBTTbytheprovinceswouldraise Quebec, NewBrunswick,NovaScotiaand Although bothareformsofvalue-addedtaxes, a 69 If theGSTwerereplacedatnational 70 includ- have aggravatedthisproblem. the coverageoftheirretailsalestaxes inwaysthat over thepastdecade,someprovinceshaveexpanded coverage ofbusinessinputsintheirsalestaxes. Infact, BTT format,theyshouldstillreducetheinefficient cross-border shoppingbyCanadians. sales taxrateswouldstillleaveabigincentivefor ery toCanada,buttheexistingCanada-USgapin their salestaxes fromUSvendorsonitemsfordeliv- would facilitateCanadiangovernments’collectionof vendors. FullimplementationoftheSSTPbyUSstates states tosimplifytaxcomputationforout-of-state Tax Project(SSTP), approved anagreementcalledtheStreamlinedSales in 2002theUSNationalGovernorsAssociation state vendorstocollectandremittaxes. Inresponse, simplify theirsalestaxlawsbeforerequiringout-of- cited thiscomplexityinrulingthatthestateshadto but alsotothetaxablebase.TheUSSupremeCourt vary bylocationwithrespectnotonlytothetotalrate tions intheUS.Withinagivenstate,salestaxcan that thereareabout7,500distinctsalestaxjurisdic- and countiesalsomayhaveasalestax,withtheresult the 45statesthatimposearetailsalestax,UScities (including salestoCanadiancustomers).Inaddition not collectsalestaxontheirout-of-state a result,mostmail-orderande-commercevendorsdo (such asawarehouseorretailoutlet)inthatstate.As state unlessthevendorhada“physicalpresence” did nothavetocollectthesalestaxofdestination ers sellingfordeliverytocustomersinanotherstate taxes. In1992,theUSSupremeCourtruledthatretail- on Canadatocurtailitsrelianceindirectsales that havenotalreadydoneso. an economicallyattractiveoptionfortheprovinces union, harmonizingsalestaxes withtheGSTcouldbe future movestowardafreerborderorcustoms tax. Conversely, ifCanadawerewillingtoforeclose any competitivepenaltyofshiftingtoanorigin-type to aBTT, theexchange rate wouldadjusttooffset does nothaveasalestax)convertedtheirtaxes avoidance. Ifallprovinces(otherthanAlberta,which levels ofcross-bordershopping,smugglingandtax though itmight requirerebateprovisionsin some equipment and supplies,motorfuelsandmachinery, tax fromsuchbusinessinputs aslegalservices,office and finalsales,stepscouldstill betaken toremovethe inherently difficulttodistinguish betweenbusiness stage methodofapplyingthe retailsalestaxmakes it If theprovinceschoosenottoshiftGSTor Developments intheUSmightreducepressure 28 71 which requiresparticipating 72 Although thesingle- cases. For the building of business and industrial struc- by state: 13 have entered “reciprocity” agreements that tures, provinces could rebate the sales tax paid on the allow the interstate shipment of wine without the need materials component, and they could extend their sales to pay excise taxes to the destination state; the other taxes to include the construction of residential proper- states have more restrictive terms that require payment ties. Provinces could also expand coverage to con- of excises or that prohibit retail shipments entirely. sumer items such as home heating fuels, local Similarly, in Canada, the provinces require payment of telephone and basic cable television.73 excises in the destination province for shipments of liquor, while interprovincial mail-order sales of ciga- Excise Taxes rettes have been outlawed since 1996. At the federal level, excise taxes represent a compa- Canadian federal and provincial excises on alcohol rable share of total tax revenues in Canada and the and tobacco products have already been constrained by US and are only about one-sixth larger in Canada as cross-border smuggling.75 Such activity reached its peak a percentage of GDP. Hence, differences in federal in early 1994, when an estimated 40 percent of all cig- excises are not likely to present a problem for Canada arette sales in Canada were contraband smuggled from if the two countries pursued a customs union or a the US (but mostly manufactured in Canada). Sharp, relaxed border with respect to trade. At the subna- coordinated cuts in cigarette excises by the federal and tional level, though, excises as a percent of total tax Quebec governments, followed by Ontario and most of revenues are about one-third larger in Canada than in the Atlantic provinces, put Canadian rates much more the US, and relative to GDP they are about 60 percent in line with US rates. The western provinces and larger in Canada (equivalent to an extra 1 percentage Newfoundland and Labrador have not followed these point of GDP). That differential might pose con- cuts, likely because pressure from cross-country smug- straints on provincial tax policy. gling has been controlled by spot checks of vehicles Although excise tax rates differ considerably and truck weigh stations. Similar controls might also across provinces and states, excise revenues in both be effective even with a more open border, although countries derive almost entirely from the same three one might expect downward pressure on alcohol and goods: gasoline, alcohol and tobacco products. tobacco excises in provinces with large populations Accordingly, some unique attributes of these products near the US border. and how their taxes are applied need to be consid- Gasoline offers contrasting characteristics for excise ered. Also, one must distinguish among three types of taxation, because it is not economical or safe for indi- cross-jurisdictional purchases: individual purchases viduals to transport much gas beyond that in their taken home for consumption, individual orders by vehicle’s tank. Thus, no province or state attempts to Web or phone delivered by mail or courier and legal enforce the payment of its excise taxes on gas brought commercial transactions by firms for resale. The fur- into the jurisdiction in personal vehicles. Moreover, ther opening of the border would not affect the need individuals returning to Canada with a full tank in for ongoing enforcement of taxes with respect to their car are not subject to Canadian taxes, and cus- Tax Design for a Northern Tiger by Jonathan R. Kesselman commercial transactions, nor would it present any toms officials do not even inquire. Clearly, gasoline is new issues at the policy level. However, with less not a product that the consumer can order by phone or scrutiny at the border, commercial-scale smuggling Internet for delivery in another jurisdiction. As a result would become more attractive. of these physical limits on the movement of gas, one Alcohol and tobacco products offer large tax sav- can contemplate higher excise tax rates since they are ings relative to the costs and ease of moving them to constrained only by personal cross-border purchases. lower-taxed states or provinces. Hence, they are sub- Much higher rates of excise tax on gasoline — at the ject to severe restrictions on purchases by individuals federal or provincial level — would be an economically transporting or shipping them to consume at home. attractive way to replace revenues lost when other In the US, the Jenkins Act requires firms shipping taxes are reduced. It is efficient to place high tax rates cigarettes to out-of-state customers to notify the tax on items such as gasoline that have demands that are department of the purchaser’s home state to help it to relatively unresponsive to price. This change would collect excise taxes.74 As for alcohol, the US constitu- also give consumers an incentive to conserve by shift- tion prohibits the cross-state movement of liquor ing to smaller, more fuel-efficient vehicles; to move (both commercial and private) except under policies closer to their workplaces, to carpool and to use public set by each state. These policies are complex and vary transit; and to drive less, thereby reducing traffic con-

29 IRPP Choices, Vol. 10, no. 1, March 2004 extra $4billionperyear. from thecurrent10 centsperlitrewouldraisean triple Canadianprices. retail gaspricestypicallyatleastdoubleandupto these benefitswithsteeptaxratesthatmake their clearly toreductionsintheratesofothervisibletaxes. timed withperiodsoffallingenergyprices,andlinked would bestbephasedinoverseveralyears,perhaps sell tothepublic.Higherexcise taxratesongas a taxshift,itwouldrequireastutepoliticalstrategyto nomic andenvironmentalgroundsforpursuingsuch the totalrevenuegain.Althoughtherearestrongeco- ate somerevenuelossbutnotmake amajordentin gap ingaspricesvis-à-visthosetheUSwouldcre- of mostotherindustrializedcountries.Theenlarged billion annually, andstillleavepricesfarbelowthose add 20centsperlitretotheretailprice,generating$8 warming. gestion, accidentrates,airpollutionandglobal tax creditsmeans thattheCanadiantreasury can from thetax.To someextent,theoperationofforeign and foreignshareholdersare evenfurtherinsulated domestic investmentthanon domesticshareholders, that theburdenofheavybusiness taxes fallsmoreon relatively smalleconomysuchasCanada’s,means high internationalmobilityofcapital,especiallyfora on corporateandbusinesstaxes isuseful.First,the policies, asummaryofthebasiceconomicfindings provincial levelandforsmallerbusinesses. issues thatariseforbusinesstaxationatthe taxes onlargecorporations;Ithenturntospecial taxation. Inthissection,Ifirstconsiderbusiness secured throughappropriatereformofbusiness productivity, employmentandrealwagescouldbe opportunities forincreasedgrowthofinvestment, revenue generatedofanytaxes. Hence,significant among thehighestefficiencycostsperdollarof on capitalincomeandbusinesscarry property taxes thatimpingeonbusinesses.Taxes corporate capitaltaxes, aswellsales,excise and These taxes consistofcorporateincometaxes and T Business Taxes For example,doublingthefederalexcise taxongas Before focusingonspecifictypesofbusinesstax tax strategyofanaspiringNorthernTiger. importance, relativetotheirrevenues,forthe axes onbusinessareofdisproportionate 76 EU countriesandJapanhavegarnered 77 Trebling thetaxratewould 79 78 ment inanyindustryorcountry. methods; itisacriticalfactorinincentivesforinvest- such asdepreciationratesandinventoryaccounting affected bothbystatutoryratesandtaxprovisions incremental investment(seeChen2000).TheETRis the impactofallbusinesstaxes onthereturnsto tax rate(ETR)oncapitalinvestment,whichreflects 2003). Theotherkey businesstaxrateistheeffective example, Clausing2003;BartelsmanandBeetsma cally orwithaforeignaffiliateparent(see,for they situatetheirdebtfinancing—whetherdomesti- transfer pricingonintrafirmtransactions,andwhere its intooroutofCanadathroughdevicessuchas affects firms’incentivetoshifttheiraccountingprof- lent burdenofcapitaltaxes. Thistotalstatutoryrate provincial incometaxes plustheincome-taxequiva- of taxoncorporateprofitsfrombothfederaland types ofbusinesstaxrates.Oneisthestatutoryrate nificantly lowerbusinesstaxes. pete forcapitalwithsourcecountriesthathavesig- capital-mobile world,Canadamustbeabletocom- flow intoforeigntreasuries.But,inanincreasingly benefit fromcorporatetaxes thatmightotherwise A federalsurtax rateof1.12percentremains forlarge except resources,whichwillreach thatfigurein2008. tax ratewillbereducedto21 percentforallsectors across sectors:in2004,thefederal generalcorporate Ottawa hasdeliveredinfullon levellingtaxrates gone somedistancetowardmeeting thesegoals. Policies eitherannouncedoralready implementedhave and thatthefederalcorporatesurtaxberemoved. eral rateplusatypicalprovincialof13percent) tions bereducedtoaround33percent(20fed- business sectors,thatthetotalrateforlargercorpora- tions werethatthecorporatetaxratebelevelledacross “spending” partofthefederalbudgetsurplus. tax cutsandreformsshouldbeapriorityareafor enues frombusinesstobereduced.Further since thereportwasreleasedhavepermittedtaxrev- tain totaltaxrevenuesfrombusiness,fiscalconditions was tosuggestbusinesstaxreformsthatwouldmain- the federallevel.Althoughcommittee’smandate for reformofCanadianbusinesstaxes, particularlyat remains themostsystematicandsagaciousroadmap report afterthecommittee’schairman,JackM.Mintz, Business Taxation (Canada1998),knownastheMintz The 1998ReportoftheTechnical Committeeon Business Taxes onLargeCorporations Second, itisessentialtodistinguishbetweentwo Among thereport’smostimportantrecommenda- 30 corporations; this surtax should be eliminated, as it The corporate tax rate cuts already planned by both was originally introduced to combat the deficit. levels of government will bring statutory rates in Progress on reducing tax rates for large corpora- Canada below most US rates, but will still leave them tions has been more uneven at the provincial level. above those of some other countries. Significantly, Quebec’s 9.3 percent rate and Alberta’s targeted 8 planned rate cuts will leave the ETR on corporate percent rate will put their total general corporate investment in Canada well above that on most sectors income tax rates into the 30 to 31.5 percent range — in the US (Chen and Mintz 2003) and in such countries even lower than that advocated in the Mintz report. as Ireland, Sweden, the UK and Italy (Wilson 2003). The However, the new Liberal government in Ontario has ETR is particularly important for investment incentives, reversed course on large corporate tax rate reductions and the provisions for capital expensing and “bonus” and raised its rate from 12.5 percent in 2003 to 14 depreciation in the US have a big impact on it. percent for 2004. Ontario would be wise to renew its Given the improved fiscal outlook, Canada should earlier commitment to reduce its corporate tax rate to pursue a more ambitious corporate tax strategy than the 8 percent, and the other provinces should follow suit. Mintz report recommended. Two alternative directions Total tax rates on corporations have been further warrant careful study followed by policy action. First, reduced by recent cuts to corporate capital taxes at further cuts could be made to the statutory rates of cor- both the federal and provincial levels, and those rates porate income tax to bring Canadian rates not only will fall still further with impending cuts. According below US rates but also closer to rates that other coun- to official calculations, capital taxes on nonfinancial tries have successfully pursued. The shining example of corporations added 3.6 percentage points to the effec- this scenario is Ireland, whose stunning rate of econo- tive corporate income tax rate in 2000 (Canada 2000, mic growth since the 1980s has been explained, in part, 159). Alberta, Newfoundland and Labrador and by its very low corporate tax rates. Canada would not Prince Edward Island have never had a capital tax, need tax rates as low as Ireland’s to become the pre- while British Columbia abolished its capital tax in ferred location for businesses wishing to serve the North 2002. However, Quebec is delaying, and Ontario is American market; in any case, it is doubtful whether perhaps shelving, earlier commitments to phase out Canada could pursue such low rates without some or reduce capital taxes for nonfinancial corporations; repercussions from the US, just as the EU has pressured accordingly, this item should be a high priority for Ireland to raise its rates.83 action as soon as the fiscal resources of those two The second approach would be to move Canadian cor- provinces permit.80 Capital taxes on financial corpora- porate taxes from an income base toward a cash flow tions by both levels of government also warrant base.84 A cash flow tax would be the most economically reducing or eliminating.81 efficient way to tax business, as it would remove the nor- Another of the Mintz report’s recommendations mal rate of return to capital from the tax base, and the was to trim capital cost allowances (CCAs) to rates ETR would become zero (apart from the impact of other that more closely approximate true economic depreci- taxes on investment such as sales and property taxes).85 Tax Design for a Northern Tiger by Jonathan R. Kesselman ation rates, with a view to introducing greater neu- Business taxes would then be collected only on “economic” trality across types of capital assets and providing an or “supernormal” profits. With a cash flow base, all capi- expanded tax base with which to finance corporate tal purchases would be fully expensed, thus eliminating tax rate reductions. This proposal, however, was all problems in measuring tax depreciation. Since the made in the context of the committee’s mandate to capital cost would be fully recognized for tax at the time maintain total tax revenues and warrants review now of purchase, no deductions would be allowed for interest that the federal fiscal situation is far rosier than when costs. Such a change would yield a balanced tax treat- the committee deliberated in 1996 and 1997. ment of the debt and equity costs of corporate finance. Moreover, subsequent changes to rates of capital Of course, using a cash flow base would reduce total write-offs in the US tax make it imperative to revisit revenues from the corporate tax unless higher statutory this issue. Notably, the 2003 US tax package rates were applied. One would thus have to examine increased first-year “bonus” depreciation deductions whether the gains in economic activity and productivity — from 30 percent to 50 percent for investments made which would yield at least partially offsetting revenues prior to 2005;82 for small business, it raised the from other taxes — could justify the switch to a cash flow amount of investment that can be immediately base. Key issues in such a reform are whether other coun- deducted from US$25,000 to US$100,000. tries would allow foreign tax credits with respect to a

31 IRPP Choices, Vol. 10, no. 1, March 2004 ited interestdeductibilitywouldbeworthexploring. costs, asunderacashflowtax,sovariantswithlim- eliminate thedeductibilityofcorporatefinancing inventories. Inaddition,suchanapproachwouldnot such asmachineryandequipment,structures short- andlong-livedcapitalacrosstypes ever, isthatbiasesmightbeintroducedbetween avoided. Onepotentialhazardofthisapproach,how- transition problemsofafullcashflowtaxcouldbe would fallshortoffullexpensing,andsomethe accelerate capitalcostallowances.Accelerated CCAs general corporatetaxratewithaggressivechangesto base wouldbetocombinefurthermodestcutsinthe cuts inthecorporatetaxandmovingtoacashflow to givethemsometaxreliefwithoutincorporating. porated businesses,bothtosimplifytheiraccountingand for corporations,itmightbeallowedsmallerunincor- implemented. Evenifacashflowbasewerenotadopted standing debtandinterestcostswhenthenewbasewas sions wouldbeneededforbusinesseswithlargeout- corporate taxofthisformatandwhattransitionalprovi- ceed morequickly incuttingtheircapitaltaxes. tion ofthischange mightinducetheprovinces topro- deductibility forprovincialcapital taxes. Phasedapplica- the reportrecommendeddenying federalcorporatetax credit forneutralityofcorporate distributions.Second, approach mightbesuperiorto adjustingthedividendtax revenue costthantheexistingdividendtaxcredit.This to dealwiththedoubletaxationofdividendsandatless a newcorporatedistributionstaxwouldbebetterway rant briefcommenthere.First,thereportsuggestedthat only tonewinvestmentsintheirfirstyear. US methodof“bonus”depreciation,whichapplies through aninvestmenttaxcreditorbyadoptingthe incremental investment.Thisgoalcouldbeachieved newly createdcapitalwouldfocustherevenuecoston dispersed. Incontrast,increasingCCAratesonlyon cost ofthiscut,therefore,wouldberelativelylargeand capital newlycreatedafterthetaxcut.Therevenue all capital—both“old”orpre-existingand income taxratewouldreducetheonreturnto remain vis-à-visothercountries.Acutinthecorporate income shifting,althoughsomesuchincentiveswould for corporationstoengageintransferpricingand Canada arebelowthoseintheUS,theylimitincentives corporate tax.Solongastotalstatutoryratesin CCA tofurthersharpcutsinstatutoryratesoffederal toward cashflowtaxationorsomeformofaccelerated An intermediatestrategybetweensignificantrate Two otherrecommendationsoftheMintzreportwar- There areeconomicreasonsforpreferringatilt 86 87 flow, alent tototallabourcompensationplusbusinesscash much lowerratesoftax,sincetheBTTbaseisequiv- same revenueascurrentcorporateincometaxes at accounts-based value-addedtaxcouldcollectthe their retailsalestaxes. ABTTorotherformof income taxrevenues,justasitwouldbetoreplace be anattractivewaytoreplaceprovincialcorporate ness taxes. Movingtoabusinesstransfertaxwould iency ofprovincialcorporateincomeandotherbusi- for majorimprovementsinthestructureandeffic- expedite CCAssimilarly. corporate incometaxes, wouldbewelladvisedto Alberta, OntarioandQuebec,whichcollecttheirown under federal-provincialtaxcollectionagreements. the taxes ofprovinceswhosecorporatetaxfalls tion inthefederalcorporatetaxwillbemirrored be desirable,andanyfutureaccelerationofdeprecia- for 2004).Furtherratecutsbytheprovinceswould ernment inOntariohasannouncedacoursereversal ted majorratecuts(althoughthenewLiberalgov- have beendecliningasthelargerprovincesinstitu- US. Since2001, provincialcorporateincometaxes were nearlyfourtimesaslargeinCanadathe As apercentageofGDP, subnationalcorporatetaxes tax mixcomparedwith1.2percentforUSstates. provinces accountedfor3.6percentofCanada’stotal In 2001 corporateincometaxes leviedbythe Provincial BusinessTaxes income, payroll andpartofpropertytaxes wouldbe highest ratesof BTTtoreplacetheirsales, corporate business decisions.Theprovinces thatwouldneedthe would stillbeneutralandconducive tounbiased level. Evenwithrelativelyhigh taxrates,aBTT serve asamultipurpose,major taxattheprovincial nonresidential propertytax.Inshort,aBTTcould den nowbornebybusinessthroughhighratesof provincial generalpayrolltaxes andpartofthebur- GST, whichisappliedtoeachtransaction. credit-invoice typeofvalue-addedtaxsuchasthe governments toadminister, anadvantage overa much lesscostlyforfirmstocomplywithand and financingdecisionsoffirms.Moreover, aBTTis neutral withrespecttotheproduction,investment advantages ofavalue-added-typetax,inthatitis ples describedearlier. ABTThasalltheeconomic labour income,consistentwiththeefficiencyprinci- shift muchofthetaxburdenoncapitalincometo larger thanafirm’scashflow. Ineffect,aBTTwould Beyond furtherincrementalchanges,thereisroom In addition,aBTTcouldbeusedtosubsume 89 and labourcostsaretypicallyseveraltimes 32 90 88 the four that currently apply a general payroll tax — Since the Mintz report was released, the provinces Ontario, Quebec, Manitoba, and Newfoundland and have been actively competing for boasting rights to the Labrador.91 A BTT could be operated as an adjunct to lowest small business tax rates. In 1998, the average the federal corporate income tax and, for unincorpo- provincial rate was 8 percent; by 2003, all provinces rated businesses above a threshold, as an adjunct to except Quebec and Prince Edward Island had rates of 6 the personal tax. A general payroll tax could also be percent or lower, and only Quebec applies the same applied to financial institutions and other sectors for corporate tax rate, 9.3 percent, to both small and large which a BTT would not be well suited. business. In 1998, the upper income limit for the small Bird and Mintz’s paper (2000) — the most exten- business deduction at the federal and provincial levels sive analysis of replacing selected provincial taxes was $200,000. Since then, all provinces from Ontario with a value-added tax — advocates the use of an westward have raised their limit to at least $300,000, income-type measure of value-added called a “busi- Ontario has committed to raising its limit to $400,000 ness value tax” (BVT). That tax has a base that is and the 2003 federal budget announced that Ottawa similar to the tax definition of net income — but would gradually follow suit over several years. without allowing labour costs to be deducted — so Although small business has the reputation of being that it would continue to deal with the cost of capital the economy’s wellspring of job creation and new prod- through deductions for depreciation. This approach con- ucts, this image may be overstated.94 In fact, there is trasts with the expensing of capital allowed by a BTT (or extensive job loss as well as job creation among small by the GST, implicitly), which is a consumption-type and medium-sized enterprises (SMEs), and the sector’s measure of value added. Both a BTT and a BVT would contribution to overall net employment growth is unre- work on the accounts of business and would be much markable. Moreover, relative to large corporations, simpler to operate than a transactions-type tax. On SMEs typically lag in their research and development, economic principles, however, a BTT’s consumption- productivity growth, export penetration and employee type base appears to be superior to the income-type compensation (both cash and benefits). Unless small base of a BVT.92 Moreover, a BVT would bear relatively business activity creates special external benefits, there more heavily on capital income, since it would strike appears to be a strong economic case for significantly the normal return to capital, while a BTT would bear reducing the favourable tax treatment of small firms more heavily on labour income, since it would tax relative to that for large business,95 which would result only supernormal returns. in more neutral treatment and a more level playing field for the efficient allocation of resources. Such a course of Taxes on Small Business action would, of course, be politically challenging — The Mintz report noted that “Canada’s income tax small business ranks alongside farmers, seniors and stu- treatment of small business…[is] among the most dents for sympathetic treatment that often leads to poor generous in the world” (Canada 1998a, 5.7). public policy — but Canada needs bold action if it is to Incorporated smaller businesses, through a small become a Northern Tiger. Tax Design for a Northern Tiger by Jonathan R. Kesselman business deduction, obtain a preferential tax rate on Despite inevitable opposition, the corporate tax a limited amount of active business income. This rate differential between SMEs and large corporations deduction cost the federal government an estimated should be reduced. If SMEs can claim deductions $3 billion in 2003, the largest of all the tax expen- worth $3 billion per year (plus corresponding provin- diture items tracked for corporations (Canada 2003b, cial revenue losses), the implication is that large busi- 26). The Mintz report recommended against raising ness is taxed more heavily to keep business tax the amount of income eligible for the lower tax rate revenues constant. The probable consequence of this and suggested only small cuts to corporate tax rates arrangement is a negative net impact on research and for small business.93 The report further suggested development, exports and the creation of high- that the differential taxation of large and small cor- quality, well-compensated jobs. I do not offer specific porations be narrowed mainly by lowering the gen- recommendations to remedy this major bias other eral corporate tax rate on large business. It argued than to suggest that the differential tax advantages that this approach would reduce existing economic for SMEs be narrowed by, for example, leaving the distortions in the tax system, as well as incentives corporate surtax on small business while eliminating for tax planning associated with the small business it for large business. Shifting corporate tax to a BTT deduction. at the provincial level would also offer a way to

33 IRPP Choices, Vol. 10, no. 1, March 2004 suggested bythe analysisinthispaper. Some ofthese reducing administrativeand compliance burdens. horizontal equityandsimplify thetaxsystem,thereby progressivity. Simultaneously, changesshouldimprove tured soastolimittheirnaturaltendencyreducetax labour incomeandefficientbusinesstaxbases,struc- should pursueajudiciousmixtureofconsumption, and provincialtaxpoliciesinrecentyears,Canada tive impactongrowth.Buildingreformsoffederal mix toraiserevenuesinwaysthatminimizethenega- strong positiveimpactongrowthandthatshiftsthetax design, onethatreducestaxes inareasthatwillhavea of theborder. situate andconductbusinessontheCanadianside must furtherworktocreateuniqueattractions technology andmanagerialpractices.Thosepolicies people andthecreationtransferofadvanced exploit thestrongcomplementaritiesbetweenskilled ness investment.Indeed,Canadiantaxpoliciesmust in nurturingandretainingskilledpeoplebusi- must seektocreateareasofcompetitiveadvantage to reducetheeffectofborder. Thesepolicies obstacles tospecialization,investmentandtrade Canadian taxpoliciesmustoperatetominimize I Tax DesignforaNorthern Tiger gains exemption. reasons toterminateorreplacethelifetimecapital recommended inthispaper, wouldprovidefurther access totax-recognizedsavings,allofwhichare personal tax,accelerateddepreciationandexpanded tem. Anenhanceddividendtaxcredit,lowerratesof exemption wouldalsosimplifythepersonaltaxsys- have beensharplycut.Eliminatingthelifetime special treatmentnowthatcapitalgainstaxrates remains valid,althoughthereislessreasontooffer farms withincreasedaccesstoRRSPs.Thisproposal time capitalgainsexemption forsmallbusinessand compensation aswellcashflows. this wouldrelatetoabasethatincludedlabour tration thresholdcouldalsobeofferedforaBTT, but reduce thetaxdifferential;anexemption orregis- Table 9summarizesthekey elements oftaxdesign These goalsrequireacomprehensiveapproachtotax The Mintzreportalsoproposedreplacingthelife- integrated NorthAmericanandglobaleconomy, goals fortaxpolicyareclear. Inanincreasingly f CanadaaspirestobecomeaNorthernTiger, the medium-term prioritiesincludethefollowingsteps: highest based onrevenuecostswouldbeneeded.The action, thensomeprioritizationoftaxpolicymeasures transformative taxchanges. policy makers wishedtoproceedquicklywithmajor excises ongasolinecouldoffsetthelostrevenuesif general payrolltaxandhigherfederalprovincial wise entertainoverthenextseveralyears.Afederal more thanpolicymakers orpoliticianswouldother- paper wouldabsorblargeamountsofrevenues,likely sweeping reforms. they fallshortofachievingthebenefitsmore achieving atleastsomeofthedesiredgoals,evenif smaller, incrementalchangesthatoffertheprospectof taxes. Thus,therewouldbeanaturalpreferencefor matters andunintendedeffectsofnewortransformed tainties aboutthedistributionalburdens,operational and theywouldberightlycautiousinviewofuncer- and politiciansfearfulofresistancefromtaxpayers, magnitude wouldbedifficulttosellpolicymakers tax (afederalgeneralpayrolltax).Changesofthis flow taxorabusinesstransfertax)introducenew changes wouldtransformtaxbases(suchasacash Federal Tax Policies If policymakers preferredamoregradualcourseof Implementing allthechangesproposedinthis at theoutsetand wouldgrowgraduallyover time. dollar ceiling; the revenuecostswouldbe minimal tion limitslinked toearnedincomebut withouta Introduce tax-prepaidsavings plans,withcontribu- interim step,make themindustryrated. toward experienceratingthe premiumsor, asan gram benefitsoverthebusinesscycleandmove Reduce EIpremiumratestocoverthecostofpro- removal ofthesurtax). cuts infederalcorporateincometaxrates(beyond corporated), andmake thisapriorityoverfurther investment forbusiness(bothcorporateandunin- Sharply acceleratecapitalcostallowancesonnew increase inthesmallbusinessdeduction. from smallbusinesses)andhaltthescheduled remove thesurtaxfromlargecorporations(butnot have alreadybeenbuiltintobudgetaryprojections, income taxratesfortheresourcessector, which Proceed withthescheduledreductionsincorporate capital taxonfinancialinstitutions. budgetary projections;considerthephase-outof enue costofwhichhasalreadybeenbuiltinto rate capitaltaxonnonfinancialentities,therev- Expedite thescheduledeliminationofcorpo- 34 Table 9 Summary of Major Components of a New Tax Design

Type of tax Federal taxes Provincial taxes

Personal taxes Eschew US-style base erosion with methods such as tax- Reduce top marginal rates to no more than about 15%; free bonds and deductions for mortgage interest and expand thresholds for upper tax brackets to match higher property taxes. federal thresholds. Broaden base to include employer-paid health and dental Address any future perceived deficiencies of vertical equity benefits, strike pay and workers’ compensation. through adjustments in federal personal tax-rate Shift base further to consumption: (i) remove dollar ceiling schedule. on RRSP and RPP contributions but limit to 15% of earnings above $100,000; (ii) introduce tax-prepaid savings plans and use them for all expanded contributions to tax-recognized plans. Introduce $2,000 annual exemption for financial income. Reduce tax rates to 16, 20, 24, and 28%, and raise thresholds of all brackets, especially for application of top rate to about $160,000; raise the taxable income threshold to about $10,000. Reduce high marginal effective tax rates from NCB supplement by expanding phase-out range, and shift resources from NCB to non-income-tested benefits. Undertake transborder changes: (i) remove foreign content limit on RRSPs and RPPs; (ii) remove Canadian and US withholding taxes on cross-border interest and dividend payments; (iii) negotiate provisions affecting personal tax on US citizens resident in Canada.

Payroll taxes Reduce EI premium rates to reflect actual benefit costs; Consider consolidating general payroll taxes of four set employer rates on an experience-rated basis by provinces into a provincial BTT. individual firm (or on an interim basis by industry). Consider introducing a federal general payroll tax to finance other tax-cutting and reform initiatives; shift part of CPP financing to this new tax.

Broad sales taxes If a customs union is pursued, shift either the GST or If a customs union is pursued, replace retail sales taxes provincial sales taxes (or both) to a simple and efficient (and harmonized sales taxes) with an origin-type tax of origin-type tax: either a BTT or DCT. either BTT or DCT format. If the GST is retained, reform it by: (i) removing land cost Otherwise, harmonize Canadian sales tax collections on from taxable base of new buildings; (ii) removing tax cross-border purchases for delivery in Canada with US from all food and drink items aside from prepared meals; initiatives in the Streamlined Sales Tax Project. (iii) giving full GST rebates to entities in MUSH sector; If provinces retain retail sales taxes, introduce (iv) simplifying or eliminating tax on employee fringe reforms to reduce application of tax to business benefits; (v) raising threshold for registration from intermediate and capital inputs and to expand the $30,000 to $75,000 or $100,000. coverage of more consumption items; alternatively,

harmonize provincial taxes with federal GST. Tax Design for a Northern Tiger by Jonathan R. Kesselman

Excise taxes Increase excise tax rates on gasoline. Increase excise tax rates on gasoline. If a customs union is pursued, provinces should reduce excise tax rates on alcohol and tobacco products.

Business taxes Pursue further reduction in corporate income tax rates Examine conversion of provincial corporate income taxes (beyond those already planned) and/or transform its into BTT-type value-added tax, which includes business base toward business cash flows to yield statutory rates cash flows and labour compensation. and marginal effective tax rates on investment well Possibly use provincial BTT to replace other taxes as well: below those in US. retail sales taxes (see above), general payroll taxes, and Preferred option is small further cut in statutory rates part of nonresidential property taxes. (eliminate federal corporate surtax) combined with sharp If provinces retain corporate income tax format, mirror increases in capital cost allowances on new investment proposed federal changes in depreciation and renew (first-year depreciation or tax credits). earlier commitments to cut general corporate tax rates. Complete removal of corporate capital taxes on Eliminate corporate capital taxes on nonfinancial firms in nonfinancial firms and examine removal of capital taxes remaining provinces. on financial institutions. Halt or reverse increases in income limits for small Halt scheduled increase in income limits for small business deduction. business deduction.

Note: BTT = business transfer tax; DCT = direct consumption tax; MUSH = municipalities, universities, schools and hospitals; NCB = National Child Benefit.

35 IRPP Choices, Vol. 10, no. 1, March 2004 Provincial Tax Policies children inneedbutnottiedtofamilyincome. devise waystoprovidein-kindbenefitstargeted Halt orreverseenrichmentofNCBsupplementsand income levelsatwhichtheuppertaxratesbegin. Child Benefitsupplementsandtoraisesharplythe bracket toallowreducedclawbackratesforNational larly toprovideawiderincomerangeinthebottom Expand PITtaxratebrackets substantially, particu- accounts. est anddividendincomefromnonregistered duce a$2,000exemption pertaxpayerforinter- on thecapitalgainsoflargecorporations;intro- restore neutralityvis-à-vistheeffectivetaxrate Reconfigure thedividendtaxcreditsoasto marginal taxrates donotexceed 15percent. Ontario andthe Atlanticprovinces,sothat top ther flattenrateschedules,particularly inQuebec, Reduce topmarginalratesof personaltaxandfur- top federalratethresholdand anyhikes toit. top provincialpersonaltaxrates apply, tomatchthe Increase sharplytheincomethresholdsatwhich broaden thecoverageofconsumptionitems. monizing themwiththefederalGST, andto whether byreformingtheirsalestaxes orbyhar- on theintermediateandcapitalinputsofbusiness, move vigorouslytoreducetheburdenoftax Provinces thatoperatearetailsalestaxshould allowances forfederaltaxes. mended sharpaccelerationofcapitalcost tax collectionagreement,shouldmatchtherecom- own corporateincometaxes outsidethefederal Alberta, OntarioandQuebec,whichcollecttheir the smallbusinessdeduction. Halt orreverseincreasesintheincomelimitsfor should make similarmoves. tive withotherprovinces—indeed,all its corporateincometaxratestoremaincompeti- Columbia shoulddeliveronitspromisetoadjust rate cutstowardan8percenttarget;andBritish ment’s promiseofscheduledcorporateincometax on thepreviousProgressiveConservativegovern- income taxratecuts;Ontarioshouldmake good Alberta shouldproceedwithscheduledcorporate system withratesof16,20,24and28percent. by 1percentagepoint;thiswouldyieldafour-bracket 2 percentagepointseachandcutthetop-bracket rate Cut marginaltaxratesforthetwomiddlebrackets by about 25percentto$10,000. Raise thetaxablethresholdforpersonaltaxby achieve thisgoal mightbetomovedramatically points. between $104,600 and$160,000by7.4percentage by about10 percentagepointsandforincomes implemented, wouldreducetheMTRforfirstgroup face anMTRof46.4percent.Myproposal,whenfully of 43.4percent;thosewithanincomeabove$104,600 with ataxableincomeabove$67,300facetotalMTR on theirefforts.Forexample,in2003Ontarioworkers talented workers whonowfaceundulyheavyburdens economic payoffsarelargest—forhighlyskilledand in marginaltaxrateswouldberangeswherethe and investorsacrosstheincomescale.Thelargestcuts for productivebehaviourbyworkers, entrepreneurs sonal taxratesandbrackets wouldimproveincentives nomic growth couldbehuge. payoff intermsofinvestment, productivityandeco- anything like those achievedinIreland,thepotential current officialplans.Ifthe resultsforCanadawere effective corporatetaxrates thanthosecontainedin Ireland, theCelticTiger, bypursuingmuchlower transformed. Canadashouldfollowthepathof the border, thebusiness taxationsystemshouldbe ing andexpandingbusinessontheCanadiansideof pressure fromaborderthatwasmuchmoreopen. rates onalcoholandtobacco,wouldalsobeunder local taxes. Excise taxrates,particularly provincial veniently subsumeotherinefficientprovincialand type businesstransfertaxes, aformatthatcouldcon- provincial salestaxes could beconvertedintoorigin- in administrativeandcompliancecosts.Alternatively, tax, eitherofwhichwouldalsobringmajorsavings type businesstransfertaxoradirectconsumption in the1994GSTreview—beconvertedtoanorigin- consumption taxes. TheGSTcould—aswasproposed reduction inCanada’srelianceonindirectformsof changes arerequired.Mostusefulwouldbealarge integration withtheUS,however, moredramatic der. To slashbordercostsandadvanceeconomic available forbusinessesandworkers acrossthebor- needed simplytokeep Canadainlinewithwhatis ductive andprosperous.Manyofthesechangesare to make theCanadianeconomymoreefficient,pro- National ChildBenefitsupplementphase-out. MTRs asaresultoftaxchangesandreformstothe would alsoreceivesignificantcutsintheireffective rate of43percent.Moderateearnerswithchildren MTR woulddeclineby3.4percentagepointstoatop The proposedchangesinfederalandprovincialper- To achievetheevenmorecriticalgoalofattract- Pursuing thesenear-termtaxchangeswouldhelp 96 For thosewithincomesabove$160,000,the 36 97 An evenbetter wayto away from business income taxation and toward cient and growth-oriented tax system would thus play cash flow taxation. Another candidate to replace a central role in enhancing Canada’s policy autonomy. corporate income taxes, perhaps more suitable at Only a lack of vision and resolve can keep Canada from the provincial level, is a business transfer tax. instituting a world-beating tax system, one that could Research into the economic, operational and legal help turn this country’s economy into a Northern Tiger. aspects of these approaches to business tax reform should be a priority — and the optimal design should be implemented. The changes to the design of Canadian taxation that I have suggested here may raise concerns about their adverse effects on the overall progressivity or vertical equity of the tax system. Indeed, changes to the taxation of capital income at the personal and corporate levels would, at least initially, reduce effec- tive progressivity. Yet, much more vital for house- holds with low and moderate incomes than big tax cuts for themselves is the adequacy of aggregate tax revenues to sustain and expand public services and benefits, on which such households rely dispropor- tionately.98 A revitalized economy, facilitated in part by an efficient and growth-enhancing tax system, offers these income groups the best long-run prospects. They would benefit not only from better- paying work opportunities, but also from the strengthening of Canada’s social safety net that a rapidly growing economy can finance. Moreover, the proposed reforms would shift only incrementally toward a tax base of consumption, labour income and cash flows. There would be no large windfall gains to current wealth holders and no resulting massive revenue losses. By making new investment more attractive, these changes would actually depress the returns to current holders of wealth and “old” capital. The distributional shift would be far less severe than under various propos- Tax Design for a Northern Tiger by Jonathan R. Kesselman als for a flat tax scheme (see Kesselman 2000). A revitalized economy would benefit high-skilled workers as well as less-skilled workers through more and better-paying jobs. In redesigning Canadian taxes, it is imperative to remember that the tax system is a tool, not a goal in itself. A well-designed tax system would generate higher levels of real income, which Canadians could allocate as they chose between more private con- sumption and expanded public services and benefits. So long as public expenditures were efficiently con- figured and responsive to public needs, they would raise real living standards despite their associated tax burdens. Hence, it is essential that the tax system be designed as a tool to raise revenues with minimal hindrance to the working of the economy. An effi-

37 IRPP Choices, Vol. 10, no. 1, March 2004 SimonTuck,“Tax CutsNextforManley,” 1 through December2003. those oftheauthoralone.Thisstudyreflectsdevelopments gratefully acknowledged.Allfindingsandanyerrorsare the MCRIprojecton“Equality/Security/Community”is ingly helpfulcomments.ThesupportoftheSSHRCthrough Schwanen andDavidStewart-Patterson fortheirexceed- Poschmann, BillRobson,FranceSt-Hilaire,Daniel The authorthanksBevDahlby, DonDrummond,Finn Notes Manyoftheelements examinedherehavebeensup- 6 Dobson(2002)assesses therequisitesandconse- 5 Somecommentatorsfromthebusinesscommunity, 4 Mintzsuggests“a sharpincreaseinsalestaxrevenues 3 Forearlyprecedentsintheanalysisofandrecommen- 2 and ameetingwiththe Mail current 29percent). total federalmarginal rateof51 percent(upfromthe tion tax,bothappliedatprogressive rateswithatop comprehensive incometaxand apersonalconsump- Kent (2003)recommendsacurious combinationofa Mintz (2000,2003);and and Poschmann (1999). Gingras (2000);FortinKesselman (1999,2000); example, seeBrown(2000);Dahlby(2003);Duclosand ported inpreviousresearchbyvariousauthors;for address thetaxationdimension). tial formationofacustomsunion(butdoesnot Goldfarb (2003)focusesonissuesrelatedtothepoten- of CanadaandtheUSunderdifferentstrategies; quences offurtherintegrationbetweentheeconomies finance them. relative totheeconomiccostsoftaxes neededto that marginalpublicexpendituresproducelittleofvalue for reducedCanadiantaxes, butmainlyonthegrounds quotation thatopensthispaper).Mintz(2001a) argues surprisingly mutedonthispoint(see,forexample,the such asd’Aquino andStewart-Patterson (2001), are solely theshiftbetweendirectandindirecttaxformats. from apartialincomebasetoconsumptionbase,not sales tax;notethatthisreflectsthegainsofmoving replacing itsprovincialincometaxwithaGST-type cant efficiencyandgrowthbenefitsforAlbertain Dahlby (2000)andMcKenzie(2000a)estimatesignifi- Expert Says,” Income Taxes, NotSalesTaxes DriveAway Workers, Beauchesne, “RaiseGSTto10 Percent: TDBank: achieved throughdirectpersonaltaxes. SeealsoEric ever, thattheshifttowardconsumptiontaxationcanbe provincial salestaxrates.Bothauthorsrecognize,how- Grubel (2003b)proposeshikes inthefederalGSTand (sales andexcise) toreduceincometaxes” (2003,49). Canada (1987). and St-Hilaire(1987);EconomicCouncilof consumption bases,seeBoadwayetal.(1987);Davies dations formovingtheCanadiantaxsystemtoward increased thresholdforthetopincometaxbracket. for lowertaxratesthanthoseintheUSandan board, thefinanceministerwasreportedtobeaiming , February21, 2003,A1.Basedonapublicspeech Ottawa Citizen Globe andMail , November22,2001, D1. ’s editorial Globe and 8 ManyUS stategovernmentshavebeenfacing fiscal 18 17 “Tax Lunacy,” AlthoughCanadaappliescapitalgainstaxonassets 16 AstheOECDanalysisstates,“Royaltypaymentsfor 15 Inpreliminarystatistics for2002,Canada’stotaltaxes 14 Forfurtheranalysisalong theselinesinthecontextof 13 Forexample,assumethat halfofCanada’sdifferential 12 Still,thedistributionoftaxburdenvis-à-vispublic 11 Underthetax-on-taxsystem,eachprovincespecified 10 Theinitialchangeswillincreaserevenuesby$760mil- 9 SeeDahlby(forthcoming)andKesselman(forthcom- 8 Themostnotablereliefforpoorfamilieswithchildren 7 crises, withgovernors in29statesrespondingwith through a“step-up”incostbasis forsuchassets. spouse), theUScompletelyexempts these gains held atdeath(unlessbequeathed toasurviving owned landorresources”(OECD2003,286). since theyarepropertyincomefromgovernment- resources arenormallyregardedasnon-taxrevenues right toextractoilandgasor…toexploitothermineral South Korea(27.2)andJapan(27.3). Finland (46.1);thebottomthreewereMexico(18.9), of GDP, wereSweden(51.4), Denmark(49.8)and tive taxes, includingsocialsecuritylevies,asapercent basis in2001. Thetopthreecountriesandtheirrespec- assumed avalueof36.9percentonanunweighted both themedianandmean,wherelatter Development (OECD2003,72),Canadaplacedbelow Organisation forEconomicCo-operationand with all30countriesthataremembersofthe vided fortheUS.Inabroaderrankingoftaxburdens income taxes. Nopreliminary2002statisticswerepro- accounted forbychangesinpersonalandcorporate percent to33.5percent.Allofthedeclinewas as ashareofGDPfellbysharp1.6pointsfrom35.1 an alleged“braindrain,”seeKesselman(2001). See Mintz(2001a, 101) fortheexactformula. depreciation ofabout2UScentsperCanadiandollar. of GDP, iffullybornebybusiness,wouldcausea trast, USgovernmentsdonotengage.That3percent reflects “wasteful”publicspendinginwhich,bycon- tax burdenvis-à-visthatoftheUS(6percentGDP) reduce businesscompetitiveness. fiscal systemdrivesaway“star”workers, itcould benefits acrosstheincomespectrummaymatter. Ifthe the federal-provincialtaxcollectionagreement. its owntaxrateschedule,asitdoesnotparticipatein rates atvariousincomelevels.Quebechasalwaysset each provincetospecifyafullscheduleofmarginal federal taxliability;thetax-on-incomesystemallows its personaltaxrateasapercentageoftheindividual’s deductions andholidaysforbusinesses(Quebec2003). depreciation inmanufacturing;andgeneraltaxcredits, tion oftaxcreditsfor“designatedsites”;accelerated lion overafullyearandincludetheeliminationorreduc- of the2003andearlierbudgets. ing) fordetailedassessmentsofthetaxpolicyaspects National ChildBenefitanditssubsequentenrichment. was theconversionofChildTax Benefitintothe 38 Financial Times , May23,2003. proposals for revenue increases in fiscal year 2003/2004. 30 These benefits would be further augmented by the adop- The revenue increases include rate hikes, credit cuts and tion of uniform testing and labelling standards for base broadening for sales taxes (15 states); personal Canada and the US, including the elimination of manda- income taxes (10 states); corporate income taxes (11 tory dual-language labelling (which a province such as states); and cigarette, tobacco and alcohol taxes (14 Quebec could retain if it wished). states). (National Governors Association and National 31 One could also consider legislative changes in both Association of State Budget Officers 2003.) countries to facilitate the collection of sales taxes on 19 The Canadian figures are computed from Statistics Internet and mail-order sales based on the locale of the Canada sources (three levels of government excluding purchaser, but this would pose major problems. Such the Quebec and Canada Pension Plans); the US figures changes would not address cross-border purchases where are from the US Treasury Board and the Bureau of delivery is taken in the other jurisdiction and the item is Economic Analysis. Canadian public debt-service transported privately. charges as a percentage of GDP have been rapidly 32 However, a province that squandered its tax revenues declining, reaching 4.3 percent in 2003. might so depress its economy that prices of labour and 20 For a review of empirical research on the relationship land decline, which would offset some of the loss of between national tax burdens and economic growth competitiveness. Also, the Ontario economy is a large rates, see Kesselman (2000). enough part of the entire Canadian economy that its 21 For a nontechnical presentation of similar material, see policies alone might influence the exchange rate. United States (2003a). 33 McKenzie uses this line of analysis to conclude that “the 22 OECD (1997, 85) reports on a study by the Department use of the personal tax system as a redistributive mecha- of Finance. Similar rankings of the tax bases by MEC nism should be confined largely to the federal govern- but with different estimates are reported in other stud- ment, and…provincial governments should not use the ies, such as Jorgensen and Yun (1991); see also the lit- tax system to redistribute income” (2000b, 362). erature review in Kesselman (1997, 39-49). Some 34 Ontario’s May 2003 Speech from the Throne promised a studies have found more dramatic differences between scheme of mortgage-interest tax deductibility, but this the MEC of capital income taxation and those of was not implemented. labour income and consumption taxation. 35 Author’s calculations from US Individual Tax Statistics, 23 For example, shifting one dollar of revenue from the available at the US Internal Revenue Service Web site, corporate income tax to a tax on labour income would http://www.irs.gov/taxstats/index.html save $1.55 of efficiency and would cost $0.27 of effi- 36 This situation followed from the US Supreme Court’s ciency, for a net efficiency gain of about $1.28. landmark decision on taxation (McCulloch v. Maryland, 24 This gain is pure in the sense that all individuals could 1819), which prohibited state governments from taxing potentially be made better off to that aggregate extent; the federal government and its agencies. Historically, this in practice, however, some groups would benefit more decision evolved to yield tax exemptions not only for than others, and there may be losers as well. In concept, state and local taxation of interest paid on US Treasury all losers could be compensated from the aggregate bonds, but also for federal taxation of interest paid on gains, but this would be unlikely to occur in reality. munis as well as state and local taxation of munis in the 25 Cross-country statistical analyses support the theoreti- state of issuance. cal finding that heavier relative reliance on consump- 37 Derived by the author from United States (2002a, 89). tion and labour income taxes would raise the growth 38 Because of the federal-provincial tax collection agree- rate of real incomes. See, for example, Kneller et al. ment, Ontario cannot simply make the interest tax free Tax Design for a Northern Tiger by Jonathan R. Kesselman (1999) and the discussion in Kesselman (2000). but must rebate the Ontario personal taxes paid on the 26 However, the tax-prepaid method should not produce any interest. lower expected tax revenues in aggregate, since the rate 39 One exception here is the US federal deductibility of used to discount future taxes should be an average that state and local income taxes for filers who itemize. The includes both above- and below-normal rates of return. result is to lower the total effective MTR, since incre- 27 Canada offers an offset against these savings biases mental income creates federal deductions that partially that excludes private business investment via the life- offset the MTRs of the state and local taxes. A similar time capital gains exclusion of $500,000 for shares in result would arise if the deduction were abolished and small business corporations and farm properties. the associated revenue gains were used to trim statutory 28 See Boadway et al. (1983); for an operational analysis, federal marginal tax rates. see Shome and Schutte (1993). For a related economic 40 For more detail concerning these matters, see Kesselman analysis that supports the efficiency of business cash (1999, 2000). That work further suggests converting flow taxation and that addresses the treatment of loss some of the nonrefundable tax credits (for medical carry forwards, see Diewert (1988). expenses and employee social insurance contributions) 29 Note that the increasing use of customs preclearance back to deductions, as they were before the tax reforms in some sectors, such as automotive parts, reduces of the late 1980s. Of course, some of the suggested congestion at the border but does not eliminate the changes would face political resistance from groups such real costs to the economy. as insurers and unions, and the benefits would be mod-

39 IRPP Choices, Vol. 10, no. 1, March 2004 1 InadditiontotheNCB,examples includetheGSTtax 51 Boththebasicandsupplementarychildbenefitsreduce 50 Severalanalysts,includingPoschmann andRichards 49 Notethatthesecondand thirdbracket thresholdsare 48 Ireferlaterinthisstudytotheeffective taxrate(ETR)on 47 Thecombinedeffects of federalandsubnationalPITs 46 Notethattaxablebrackets inthetwocountriesarenot 45 PITsandpayrolltaxes onemployeesoremployersare 44 ExamplesincludeapplicationoftheUSalternative 43 SeeUnitedStates(2003b)foradescriptionoftheproposed 42 Athigherincomelevels,personaltaxes andsocial 41 credits, theGuaranteed IncomeSupplementand claw- reduction thatincreasesinefficiencies anddisincentives. raises effectiveMTRs.Thus,they areexamplesofatax average taxrates,buttheydoso inawaythatalso family income.SeeKesselman (1994); Sayeed(1999). neighbourhoods withspecialneeds,ratherthanby delivered eitheruniversallyortargetedatchildren much moreheavilyonin-kindprogramsthatare that futurepoliciestoaddresschildpovertyshouldrely with enrichingtheNCBsupplements.Thissuggests for relief,therewillbeunavoidableincentiveproblems and assessedthisdeficiency. Despitesomepossibilities (2000) andLefebvreMerrigan(2003),havenoted 2004. slated torise$35,000and$70,000, respectively, in remain higherthantheUSETRs. those intheUSevenifCanadianETRsonlabour personal capital. Theaimistomake Canadianmarginalratesof because oftherelativelyhighefficiencycoststaxes on the US.Here,IstressreductionsinETRoncapital labour andfindsitsignificantlyhigherinCanadathan and salestaxes. Mintz(2001a, 86)computestheETRfor of personaltaxes, payrolltaxes (employerplusemployee) capital; ananalogousETRonlabourincludestheimpacts and Chung(forthcoming). in Canada;seethereviewoffindingsKesselman yield greateroverallrateprogressivityintheUSthan uses nonrefundablepersonalcredits. exemptions andastandarddeduction,whileCanada exactly comparable,astheUSoffersreliefviapersonal are ignoredinthisanalysis. tricts intheUS,butduetotheirdiversitythesetaxes also appliedbysomecities,countiesandschooldis- citizens withCanadianRRSPsandRPPs. and, morerecently, heavypaperworkburdensforUS minimum taxtopreventfulluseofforeigncredits package, buttheseproposalsarebeingrenewedin2004. from theseproposalstosecurepassageofits2003tax Savings Accounts. TheBushadministrationbacked off TPSP-style LifetimeSavingsAccounts andRetirement equates tomorethan22percentofnetearnings. gross income,sothat15percentofearnings insurance premiumsaccountforone-thirdormoreof mirrored intheUStaxsystem. tion ofemployer-providedhealthbenefits—isalso in thispaper. Thelargestoftheciteditems—nontaxa- est relativetotheothermajorchangesrecommended tax onlabourincomemorecompetitivewith 3 Itmightbepossibletoobtainagreementamongallthe 63 To theextentthatcoverageofservicesandutilities 62 Notethatacustomsunion,unlike acommonmarket, does 61 Theprosandconsoflabellingearmarkingpayroll 60 Severalanalystshave advocated removingthetaxable 59 Thisburdenhasbeen partially limitedthroughthetax- 58 Unlike thefigureshownintable7,thisassumesthat 57 Inaddition,bothcountries haveincome-testedsupport 56 BoththeCanadianandUS socialsecuritysystemsalso 55 Thiscomparisonignoresthepayrolltaxes usedto 54 Rateflatteningisgaugedherebytheratioof 53 Itappears,however, thattheUSspecialtaxratefor 52 destination jurisdiction werecollectedbyallbusinesses, relevant governmentstoensure thatsalestaxes of the through cross-borderpurchases. are consumed,andthuscannot beeasilysubstituted ices andutilitiesmustbepurchased locally, wherethey the US,thesefiguresoverstate the problem.Mostserv- is broaderinCanada’sindirecttaxes thaninthoseof not involvethefreemovementoflabouracrossborders. taxes are examined inKesselman(1997,93-94,174-76). general payrolltaxonemployees. tion tax,discussedinthenextsection,wouldcontaina and Robson(2001). Theproposalforadirectconsump- (2000); FortinMintzandPoschmann for example,Robson(1996);DuclosandGingras general payrolltax,especiallyanemployeetax;see, ceiling onexistingfederalpayrolltaxes orcreatinga after muchcriticismandopposition. proposed inthe1996federalbudgetandabandoned more substantiallybyaSeniorsBenefit,whichwas based OAS clawback,butitwouldhavebeenlimited employees, consistentwithempiricalfindings. the employer’sportionoftaxisfullyshiftedtoits Income intheUS. Supplement inCanadaandSupplementalSecurity programs forseniors—theGuaranteedIncome fits forearlyretireeswhodidnotpaytheirfullcosts. in thatpartoftheirrevenuesisneededtofinancebene- contain someelementofdistortinggeneralpayrolltaxes ly inthesection“BusinessTaxes.” taxes thatfourprovincesapplyarediscussedseparate- the differentialnotedintext.Theemployerpayroll for unemploymentinsurancedoesnotoffsetmuchof and EI.TheCanada-USdifferentialinpremiumrates finance otherprograms,mainlyworkers’ compensation Kesselman (2002,911) foratableoffigures. province’s topMTRtoitslowestpositiveMTR.See the Canadianprovision. 2007 andtozeroin2008,somethingnotmatchedby tax brackets isbeingcutto5percentin2003through capital gainsfortaxpayersinthe10- and15-percent Additionally, theUSfederaltaxrateondividendsand is limitedtopaymentsfromCanadiancorporations. corporations, whereastheCanadiandividendtaxcredit dividends willbeextendedtopaymentsfromforeign benefit income-testedprograms. higher earners,aswellprovincialin-kindandcash backs ofbothOldAgeSecurityandEIbenefitsfor 40 but this would still leave exposed individual cross-bor- 75 See Harrison (2003) for a historical account and insight- der purchases; see further discussion in the section on ful analysis of Canadian tobacco excise tax policy. provincial sales taxes. 76 The idea of a “green tax shift” has been promoted in 64 For detailed analysis of the BTT and DCT proposals, works such as Durning and Bauman (1998), which takes see Kesselman (1997, chap 8). Note that when the BTT an overly optimistic view of the potential for shifting tax was considered in Canada in the 1980s, it was ques- revenues in this direction. tioned whether the provinces could use that tax for- 77 The Sales Tax Division, Tax Policy Branch, Finance mat. A BTT might be construed legally as an “indirect” Canada, provided the author with an estimate that each tax, and the Constitution restricts the provinces to 1 cent per litre increase in the excise tax on gas raises “direct” taxation (the use of these terms in the legal revenues by about $400 million annually. This estimate context is different from that in the economic context). does not encompass behavioural responses by consumers 65 For a review of economic analysis of the trade compet- to higher gas prices, the additional impact on GST rev- itiveness effect of destination-type versus origin-type enues or the somewhat offsetting reduction of business taxes, see Kesselman (1997, 85-86). taxes from deductible purchases of gas for business use. 66 As a quid pro quo for this change, the GST rebate for 78 As shown in table 1, federal corporate income tax gener- new housing could be eliminated, thus adding another ates only about one-eighth of total federal tax revenues; simplification. adding corporate capital and excise taxes on business 67 More than half of the cost of this change — currently still leaves this share at less than one-sixth. Although about $900 million per year in total — would redound business pays more than half of total social security con- to the benefit of municipalities. Note that the MUSH tributions, their burden is believed to fall mostly, if not sector does not have the same constitutional immunity entirely, on workers via lower compensation. from federal taxation as do the provinces. 79 I do not deal with the issue of income trusts, which are rapidly 68 Some of these firms might still opt to register for GST eroding the Canadian corporate tax base; see Hayward (2002); in order to obtain input credits, at least in cases where Aggarwal and Mintz (2003). However, my proposals for an their sales were primarily to other GST-registered busi- enriched dividend tax credit, lower provincial corporate nesses rather than to final consumers. income tax rates and faster depreciation provisions would 69 One of the principal putative benefits from introducing partially blunt incentives for the creation of such trusts. the GST was to get the federal sales tax off exports 80 The Mintz report suggested that corporate income tax and thereby improve the country’s trade competitive- rate cuts should have priority over capital tax cuts in a ness. As the earlier discussion of exchange rate adjust- revenue-constrained environment but stated that the ment indicates, this was a fallacious argument; the real capital tax “would appear to be more a matter of fiscal deficiency of the manufacturers’ sales tax was that it necessity rather than a permanent feature of a well- applied at differential, distorting rates for various designed and integrated tax system” (Canada 1998, 4.21). goods that were exported or imported. There has been very little formal economic analysis of 70 See Bird and Mintz (2000) for an analysis of these the corporate capital tax, but the analysis by Dahlby issues; see also the discussion below in the section (2002) implies low rates of capital tax under certain con- “Provincial Business Taxes.” ditions. For a detailed chronology and comparison of 71 For details of the SSTP, see http://www.nga.org. As of Canadian capital taxes, see Clemens et al. (2002). March 27, 2003, 38 states had adopted the requisite 81 Dahlby (forthcoming) argues that the capital tax on legislation, and California had a bill pending banks entails undue economic efficiency costs. To date, approval. The National Governors Association cites a the most detailed analysis of this issue, by Dancey Tax Design for a Northern Tiger by Jonathan R. Kesselman study that forecast total state revenue losses of (1998), was undertaken for the Task Force on the Future US$45 billion from Internet sales by 2006. Greve of the Canadian Financial Services Sector. (2003) criticizes the SSTP as a “tax cartelization” 82 The “bonus” depreciation (introduced in 2001 at a 30 scheme, advocating instead that state sales taxes be percent rate) is allowed for capital with a life under 20 applied on an origin basis, in part to spur competi- years in addition to regular depreciation in the year of tion for lower tax rates. asset purchase. An example is given by the John Deere 72 For example, British Columbia extended sales tax cover- Company for prospective purchasers of a $100,000 piece age to include legal services and installation and repair of equipment with five-year depreciation using 200 per- of machinery, but in more recent years has made moves cent declining balance and a half-year convention; regu- to reduce the coverage of business capital. Saskatchewan lar depreciation in the first year would be just $20,000, financed its PIT rate cuts in part by expanding sales tax but with the addition of “bonus” depreciation, the total coverage to include more business inputs. becomes $60,000. See http://www.deere.com. 73 Enriched refundable sales tax credits could be used to 83 Actually, the EU targeted the discriminatory nature of offset the impact on the lowest-income households. Ireland’s corporate tax, which initially favoured exports but 74 Since violation of the Jenkins Act is deemed only a after 1990 favoured profits from the manufacturing industry misdemeanor, Internet sales of cigarettes to out-of-state and internationally traded services (see Walsh 2003). customers are growing rapidly (see United States 84 Fortin (2000) advocates moving to a corporate cash flow 2002b). tax; the Mintz report examined but rejected this approach

41 IRPP Choices, Vol. 10, no. 1, March 2004 8 Foraparallelmessageintheprovincialcontext, 98 Ofcourse,Irelandalsohadotherfactorstoitsadvan- 97 NotethatmanyoftheseMTRreductionsaretheconse- 96 Carrolletal.(2001) estimate, however, thatdecreased 95 TheMintzreport,after brieflyreviewingtherelevant 94 Itrecommendedacutof just1percentagepointon 93 Theonlyobviousadvantage ofaBVT overaBTTis 92 ThisoutcomecanbeseeninthetablesofBirdandMintz 91 Ofcourse,ifthefederalgovernmentkept theGSTin 90 Thisresultcanbeseenbycomparingthedefinitions 89 Nevertheless,HardenandHoyt(2003)foundthateven 88 Limitationsoninterestdeductionswouldadditionally 87 ThisapproachwouldparalleltheUSallowancefor 86 Theeliminationofprovincialretailsalestaxes oncapi- 85 particular forBritishColumbia, seeKesselman(2002). cation andofferedfreetuition. SeeWalsh (2003). It alsopursuedambitiousexpansion ofadvancededu- prosperous economiesandlarge subsidiesfromtheEU. tage, suchaslowinitialwages, convergencewithmore $113,800, respectively. slated toexpandin2004$35,000,$70,000 and tax bracket. Recallalsothatthefederalbrackets are addition tothereductioninratesapplyingeach quence ofworkers beingshiftedintolowerbrackets, in tax ratesdostimulatethegrowthofsmallfirms. deduction” (Canada1998,5.10). not growndespitetheavailabilityofsmallbusiness employment [forexample,theself-employed],orhave the smallbusinessdeductionprovidelittleorno evidence, gingerlyconcludedthat“manyrecipientsof reward jobcreation(Canada1998,5.10). using acreditagainsttheemployer’sEIpremiumsto 0.6 ofapercentagepointforthefederaltax,latter average fortheprovincesandancutofonly Bird andMcKenzie(2001). tax creditsofothernations;seeBirdandMintz(2000); that theformerwouldmorelikely begrantedforeign ingly higherifsalestaxwereaddedtothislist. of propertytax.Therequisiterateswouldbecorrespond- percent rate incomeandcapitaltaxes, payrolltaxes and5 cent forasimilarBVT toreplacetherevenuesofcorpo- percentrateandBritishColumbia aratelessthan4per- 8 (2000, 282-83),whichshowQuebecneedingnearlyan place, thoseoperationalcostswouldremain. flow taxintable2. for thebusinesstransfertaxandcash rate taxes wereuniquelyadversetoemployment. states areconcernedaboutemploymentlevels;corpo- ative tosalestaxes andpersonalincometaxes ifthe US statecorporateincometaxes weresettoohighrel- reduce incentivesforthecreationofincometrusts. tal purchasesannually. small businessestoexpenseupUS$100,000 ofcapi- (Chen andMintz2003,5). ETR oncapitalinvestmentby3percentagepoints tal inputs,notedinanearliersection,wouldreducethe national taxharmonization(Canada1998,A.7-A.11). for reasonsofadministration,implementationandinter- ——. 2000. Canada. 1998.DepartmentofFinance. Brown, RobertD.2000.“TheImpactoftheU.S.on ——. 1988.“What AreConsumptionTaxes andWhoPays Bradford, DavidF. 1986. Boskin, MichaelJ.1996.“TheNunn-DomeniciUSA Tax: ——. 1987. Boadway, Robin,NeilBruce,andJackMintz.1983.“Onthe Bird, RichardM.,andKennethJ.McKenzie.2001. “Taxing Bird, RichardM.,andJackM.Mintz.2000.“Tax Bartelsman, EricJ.,andRoelM.W.J. Beetsma.2003.“Why Aggarwal, Lalit,andJackMintz.2003.“IncomeTrusts Adams, Michael.2003. References Clemens, Jason,JoelEmes,and RodgerScott.2002.“The Clausing, KimberlyA.2003.“Tax-Motivated Transfer Chen, Duanjie,andJackM.Mintz.2003.“Taxing Chen, Duanjie.2000.“TheMarginalEffectiveTax Rate:The Carroll, Robert,DouglasHoltz-Eakin,MarkRider, and ——. 2003b. ——. 2003a. Department ofFinance. Technical CommitteeonBusinessTaxation. Canada’s Tax Strategy.” Them?” Cambridge, MA:HarvardUniversityPress. Institution Press. Reform Analysis andComparisons.”In Policy. Economica Neutrality ofFlow-of-FundsCorporateTaxation.” Commentary Business: AProvincialAffair?” McGill-Queen’s UniversityPress. Federalism Toward aNewMissionStatementforCanadianFiscal Canada: TheStateoftheFederation1999/2000: Assignment inCanada:AModestProposal.”In Economics Pricing inOECDCountries.” Pay More?CorporateTax Avoidance throughTransfer University ofToronto, CapitalMarkets Institute.Draft. Shareholder Taxation: GettingItRight.”Toronto: Public Policy Sources Corporate Capital Tax: Canada’s MostDamagingTax.” Public Economics Pricing andUSIntrafirmTrade Prices.” Backgrounder Investments: OntheRightTrack,butataSnail’sPace.” Backgrounder Only Tax RatethatMattersinCapitalAllocation.” MA: MITPress. Economy, Growth ofSmallFirms.”In Harvey Rosen.2001. “Personal IncomeTaxes andthe Ottawa: DepartmentofFinance. Finance. Department ofFinance.October18. Economic StatementandBudgetUpdate. Taxes onCapitalIncomeinCanada:Analysisand Tax ExpendituresandEvaluations2003. The BudgetPlan2003. , ed.MichaelJ.Boskin.Stanford,CA:Hoover Toronto: CanadianTax Foundation. Tax Notes 42 vol. 15,ed.JamesM.Poterba. Cambridge, , ed.HarveyLazar. Montreal;Kingston,ON: 87, nos.9-10: 2225-52. 50, no.1:49-61. 154 . Toronto: C.D.HoweInstitute. 72 . . Fire andIce , April18,383. 87, nos.9-10: 2207-23. Toronto: C.D.HoweInstitute. Toronto: C.D.HoweInstitute. Untangling theIncomeTax. 56. Vancouver: FraserInstitute. ISUMA Tax Policy andthe Journal ofPublic . Toronto: Penguin Canada. Ottawa: Departmentof Frontiers ofTax C.D. HoweInstitute 1, no.1:70-78. Report ofthe Journal of Ottawa: Ottawa: Conference Board of Canada. 2003. Performance and Fried, Joel, and Ron Wirick. 1999. “Assessing the Foreign Potential 2003–04: Defining the Canadian Advantage. Property Rule: Regulation without Reason.” C.D. Howe Ottawa. October. Institute Commentary 133. Toronto: C.D. Howe Institute. Dahlby, Bev. 2000. “Tax Reform and Economic Growth in Gale, William G., and Peter R. Orszag. 2004. “The Budget Alberta.” Calgary: Canada West Foundation. Outlook: Updates and Implications.” Washington, DC: ——. 2002. “Globalization and the Optimal Taxation of Brookings Institution. January 29. Capital in a Small Open Economy.” University of Goldfarb, Danielle. 2003. “The Road to a Canada-U.S. Alberta, Department of Economics. Draft. Customs Union: Step-by-Step or in a Single Bound?” ——. 2003. “Restructuring the Canadian Tax System by C.D. Howe Institute Commentary 184. Toronto: C.D. Changing the Mix of Direct and Indirect Taxes.” In Tax Howe Institute. Reform in Canada: Our Path to Greater Prosperity, ed. Greve, Michael S. 2003. Sell Globally, Tax Locally: Sales Tax Herbert G. Grubel. Vancouver: Fraser Institute. Reform for the New Economy. Washington, DC: AEI Press. ——. Forthcoming. “The Chrétien Government’s Legacy: A Tax Grubel, Herbert G. 2003a. “Why There Should Be No Capital System for the 21st Century?” In The 2003 Federal Budget: Gains Tax.” In Tax Reform in Canada: Our Path to Conflicting Tensions, eds. Charles M. Beach and Thomas A. Greater Prosperity, ed. Herbert G. Grubel. Vancouver: Wilson. Kingston, ON: Queen’s University, John Deutsch Fraser Institute. Institute for the Study of Economic Policy. ——. 2003b. “Don’t Just Cut Taxes — Reform the Tax System.” Dancey, Kevin J. 1998. Impact of Taxation on the Financial Fraser Forum (July), 14, 17. Vancouver: Fraser Institute. Services Sector. Research paper for the Task Force on Hall, Robert E., and Alvin Rabushka. 1985. The Flat Tax. the Future of the Canadian Financial Services Sector. Stanford, CA: Hoover Institution Press. Ottawa: Department of Finance. Harden, J. William, and William H. Hoyt. 2003. “Do States d’Aquino, Thomas Paul, and David Stewart-Patterson. 2001. Choose Their Mix of Taxes to Minimize Employment Northern Edge: How Canadians Can Triumph in the Losses?” National Tax Journal 56, no. 1: 7-26. Global Economy. Toronto: Stoddart. Harrison, Kathryn. 2003. “Follow the Leader and Dominoes: Davies, James B., and France St-Hilaire. 1987. Reforming Games Provinces Play in Tobacco Taxation.” University of Capital Income Taxation in Canada: Efficiency and British Columbia, Department of Political Science. Draft. Distributional Effects of Alternative Options. Ottawa: Hayward, Paul D. 2002 “Income Trusts: A ‘Tax-Efficient’ Supply and Services Canada for the Economic Council Product or the Product of Tax Inefficiency?” Canadian of Canada. Tax Journal 50, no. 5: 1529-69. Diewert, W.E. 1988. “On Tax Reform.” Canadian Journal of Jedwab, Jack. 2002. “Diversity Popular among Canadians.” Economics 21, no. 1: 1-40. Association for Canadian Studies, Montreal. Dobson, Wendy. 2002. “Shaping the Future of the North http://www.acs-aec.ca/polls/poll45.pdf American Economic Space: A Framework for Action.” ——. 2003. “Canada: Bastion of Individual Liberties?” C.D. Howe Institute Commentary 162. Toronto: C.D. Association for Canadian Studies, Montreal. Howe Institute. http://www.acs-aec.ca/polls/poll49.pdf Duclos, Jean-Yves, and Julie Gingras. 2000. “Tax Mix and Jorgensen, Dale W., and Kun-Young Yun. 1991. “The Excess Tax Size: Directions for Federal Tax Reform.” C.D. Burden of Taxation in the United States.” Journal of Howe Institute Commentary 126. Toronto: C.D. Howe Accounting, Auditing and Finance 6: 487-508. Institute. Kent, Tom. 2003. The Repair of Taxation. Ottawa: Caledon Durning, Alan Thein, and Yoram Bauman. 1998. Tax Shift. Institute of Social Policy. NEW Report no. 7. Seattle: Northwest Environment Kesselman, Jonathan R. 1983. Financing Canadian Unemployment Tax Design for a Northern Tiger by Jonathan R. Kesselman Watch. Insurance. Toronto: Canadian Tax Foundation. Economic Council of Canada. 1987. Road Map for Tax ——. 1994. “Public Policies to Combat Child Poverty: Goals and Reform: The Taxation of Savings and Income. Ottawa: Options.” In A New Social Vision for Canada? Perspectives Supply and Services Canada. on the Federal Discussion Paper on Social Policy Reform, Federation of Tax Administrators. 2003. “State Individual eds. Keith Banting and Ken Battle. Kingston: Queen’s Income Taxes: Tax Rates for Tax Year 2003.” University, School of Policy Studies. http://www.taxadmin.org/fta/rate/ind_inc.html ——. 1996. “Payroll Taxes in the Finance of Social Security.” Feldstein, Martin, and Marian Vaillant Wrobel. 1998. “Can Canadian Public Policy 22, no. 2: 162-79. State Taxes Redistribute Income?” Journal of Public ——. 1997. General Payroll Taxes: Economics, Politics, and Economics 68, no. 3: 369-96. Design. Toronto: Canadian Tax Foundation. Florida, Richard L. 2002a. The Rise of the Creative Class: ——. 1999. “Base Reforms and Rate Cuts for a Revitalized And How It’s Transforming Work, Leisure, Community Personal Tax.” Canadian Tax Journal 47, no. 2: 210-41. and Everyday Life. New York: Basic Books. ——. 2000. “Flat Taxes, Dual Taxes, Smart Taxes: Making the ——. 2002b. “The Economic Geography of Talent.” Annals of the Best Choices.” Policy Matters 1, no. 7. Montreal: Institute Association of American Geographers 92, no. 4: 743-55. for Research on Public Policy. Fortin, Pierre. 2000. “Less Taxes and Better Taxes: ——. 2001. “Policies to Stem the Brain Drain—Without Principles for Tax Cuts and Tax Reform.” Canadian Tax Americanizing Canada.” Canadian Public Policy 27, Journal 48, no. 1: 92-100. no. 1: 77-93.

43 IRPP Choices, Vol. 10, no. 1, March 2004 Poschmann, Finn, andJohnRichards.2000.“HowtoLower Parti Libéral duQuébec.2003.“RaisingQuebecers’Standard ——. 2003. OECD. 1997. National GovernorsAssociationand Mintz, JackM.,andFinnPoschmann. 1999. “Tax Reform, ——. 2003.“Taxation withtheLeastPain —ANewTax ——. 2001b. “WithholdingTaxes onIncomePaid to ——. 2001a. Mintz, JackM.2000.“ReformingtheTax CutAgenda.” Mérette, Marcel.2002.“TheBrightSide:APositive Viewon Lefebvre, Pierre,andPhilipMerrigan.2003.“Assessing ——. 2000b. “ProvincialTax PrioritiesinaGlobalandNational McKenzie, KennethJ.2000a.“ReplacingtheAlbertaPersonal ——. 2002.“FixingBC’sStructuralDeficit:What,Why, Kneller, Richard,MichaelF. Bleaney, andNormanGemmell. Kesselman, JonathanR.,andFinnPoschmann. 2001. Kesselman, JonathanR.,andRonCheung.Forthcoming. ——. Forthcoming.“UnfinishedBusiness:ATax Systemfor Taxes andImproveSocial Policy: A CaseofEating Our FullPotential forEconomicProsperity of Living:PrioritiesforPolitical Action in OrdertoReach Paris: OECD. States of StateBudgetOfficers.2003. Commentary Institute Tax Reduction:TheMissingFramework.” Vancouver: FraserInstitute. Path toGreaterProsperity Structure forCanada.”In Irritant.” Nonresidents: RemovingaCanadian-USBorder Howe Institute. Smart EconomicPolicy. Canadian Tax Journal Institute forResearchonPublicPolicy. the EconomicsofAging.” Children.” Family Policy inCanada:ANewDealforFamiliesand Gander.” Economy: What’sGoodfortheGooseIs Economic Sense.”CanadaWest Foundation,Calgary. Income Tax withaSalesTax: NotHeresybutGood Research onPublicPolicy. When, How?AndForWhom?” Countries.” 1999. “FiscalPolicy andGrowth:EvidencefromOECD Commentary149. Institute Savings—Tax-Prepaid SavingsPlans.” 40-101; abbreviatedas“A NewOptionforRetirement Canadian Tax System.” “Expanding theRecognitionofPersonal Savingsinthe Canadian Tax Journal “Taxation, Progressivity, andInequalityinCanada.” Institute fortheStudyofEconomicPolicy. A. Wilson.Kingston:Queen’sUniversity, JohnDeutch Conflicting Tensions the 21st Century.” In 50, no.3:884–932. Revenue Statistics,1965–2002. . Washington, DC.June. Most FavoredNation:BuildingaFrameworkfor OECD EconomicSurveys1996–1997:Canada Backgrounder Canadian Tax Journal Choices Journal ofPublicEconomics 9, no.5.Montreal:Institutefor , eds.CharlesM.BeachandThomas The 2003FederalBudget: 121 . 48, no.3:689–709. 49 Canadian Tax Journal Policy Study36.Toronto: C.D. . . Tax ReforminCanada:Our , ed.HerbertG.Grubel. Choices Toronto: C.D.HoweInstitute. Toronto: C.D.HoweInstitute. Toronto: C.D.HoweInstitute. 48, no.2:356-73. The FiscalSurveyofthe Canadian Tax Journal 8, no.1.Montreal: C.D. Howe 74, no.2:171-90. Paris: OECD. C.D. Howe .” Montreal. 49, no.1: . Robson, WilliamB.P. 1996.“PuttingSomeGoldinthe Quebec. 2003.MinistèredesFinances. PriceWaterhouseCoopers LLP, Canada.2003. Poschmann, Finn,andWilliamB.P. Robson. 2001. World EconomicForum.2003. Wilson, ThomasA.2003.“An Evaluation of BusinessTaxes Walsh, Brendan. 2003.“Taxation andForeignDirect Walker, Michael.1994.InCanada, ——. 2004.CongressionalBudgetOffice. ——. 2003b. DepartmentoftheTreasury. “President’sBudget ——. 2003a.Council ofEconomicAdvisers. “Tax Policy fora ——. 2002b. GeneralAccounting Office. United States.2002a.BoardofGovernorstheFederal Shome, Parthasarathi, andChristianSchutte.1993.“Cash Sayeed, Adil. 1999.“ImprovingtheNationalChildBenefit: oeIsiueCommentary Howe Institute Golden Years: FixingtheCanadaPension Plan.” 2004 Budget 2003 Figures forIndividualsandCorporations,Canada Backgrounder Employment InsurancePremiumsandPayouts.” “Reprogramming theEICashMachine:Matching Commentary Your Cake andHavingIt Too.” Institute. Rankings 2003–2004 Fraser Institute. Greater Prosperity in Canada.”In Vancouver: FraserInstitute. Path toGreaterProsperity Investment inIreland.”In 35th Parliament, 1stSession,March1,issue13:16–28. and EvidenceoftheStandingCommitteeonFinance Washington, DC.January. Economic Outlook:FiscalYears 2005–2014 release KD-3816. Washington, DC.January31. Security OpportunitiesforAllAmericans.”Press Proposes BoldTax-Free SavingsandRetirement Washington, DC:USGovernmentPrintingOffice. Growing Economy.” In Washington, DC. States: FlowsandOutstandings,FourthQuarter2002 Reserve System. 40: 638-62. Flow Tax.” Commentary Matching DeedswithIntentions.” Washington, DC:GeneralAccounting Office. Improve ReportingandEnforcement. Sales: GivingATF InvestigativeAuthorityMay . Available fromwebsite:http://www.pwc.com/ca. 44 International MonetaryFundStaffPapers . QuebecCity. 136. Toronto: C.D.HoweInstitute. 125 51. Toronto: C.D.HoweInstitute. Tax ReforminCanada:OurPath to Flow ofFundsAccounts oftheUnited . , ed.HerbertG.Grubel.Vancouver: Toronto: C.D.HoweInstitute. . Geneva. Economic ReportofthePresident. , ed.HerbertG.Grubel. Global Competitiveness Tax ReforminCanada:Our 76 Minutes ofProceedings . C.D. HoweInstitute Toronto: C.D.Howe Budget Plan:2003- C.D. HoweInstitute Internet Cigarette The Budgetand GAO-02-743. Tax Factsand . C.D. . . Tax Design for a Northern Tiger by Jonathan R. Kesselman Résumé

n régime fiscal mieux conçu contribuerait grande- régimes existants à impôt différé), de même qu’en élimi- ment au dynamisme et à la compétitivité de nant le plafond (le montant maximum en dollars) des U l’économie canadienne, ce qui favoriserait à terme cotisations. On devrait également élargir l’assiette fiscale la transformation du Canada en « tigre du Nord ». Ce texte et les tranches d’imposition (surtout à l’échelon examine la structure actuelle du régime fiscal canadien et supérieur), et réduire légèrement les taux applicables aux propose des réformes concrètes pour l’améliorer. contribuables à revenus moyens au niveau fédéral et S’appuyant sur un vaste éventail de recherches sur les supérieurs dans certaines provinces. finances publiques et la fiscalité, les recommandations de En ce qui concerne les charges salariales, les cotisa- l’auteur tiennent aussi compte des récents développements tions à l’assurance-emploi (AE) devraient être établies de en la matière aux deux niveaux fédéral et provincial. façon à financer les coûts réels du programme, et le taux Tout projet de réforme fiscale doit viser plusieurs de cotisation des employeurs devrait être modulé en fonc- objectifs : créer pour le Canada un avantage comparé au tion des dépenses de programme qui leur sont attribuées. sein d’une économie nord-américaine de plus en plus Ottawa pourrait aussi instituer un nouvel impôt sur la intégrée; minimiser les obstacles à la spécialisation, à masse salariale pour compenser les pertes de revenus dues l’investissement et au commerce, de même que les coûts aux autres réformes proposées; cette nouvelle source de de transaction occasionnés par la frontière avec les revenus pourrait même servir à financer en partie le États-Unis; attirer investissements et entreprises; et Régime des rentes du Canada. finalement, favoriser le développement d’une main- Pour réduire les coûts de transactions à la frontière, on d’œuvre qualifiée et compétente et faire en sorte qu’elle devrait convertir au moins l’une des taxes de vente fédérale demeure au Canada. ou provinciale en une forme plus directe (une taxe sur les En principe, le niveau d’imposition n’est pas un obstacle transactions commerciales, par exemple). Sinon, on devrait à la compétitivité si la composition et la structure des améliorer la taxe sur les produits et services (TPS), et modifier impôts sont efficientes. Il est alors possible de décider quelle ou harmoniser à la TPS les taxes de vente provinciales en vue part du revenu national consacrer aux services publics sans d’alléger le fardeau sur les intrants. Par ailleurs, une augmen- risquer de nuire à la performance économique du pays. Par tation des taxes d’accises sur l’essence pourrait être un contre, à cause des flux commerciaux et de la mobilité du moyen intéressant, sur le plan économique et environnemen- capital et de la main-d’œuvre qualifiée, la structure fiscale tal, d’accroître les recettes et de réduire l’utilisation de sources qui prévaut aux États-Unis et ailleurs est un facteur impor- de revenus beaucoup moins efficientes. tant dont nos gouvernements doivent tenir compte. Mais la réduction du fardeau fiscal sur l’investissement Selon l’auteur, l’un des moyens d’assurer une plus est l’élément le plus important de cette stratégie. Au niveau grande efficience et de favoriser la croissance économique fédéral, il faudrait abolir la taxe sur le capital, réduire un peu consisterait à privilégier une fiscalité basée sur la consom- plus les taux de l’impôt sur le revenu des sociétés et mation plutôt que sur le revenu. Il faudrait alors réduire en accélérer de façon marquée les dispositions d’amortissement priorité l’impôt sur l’épargne personnelle, l’investissement et (ou bien redéfinir l’assiette fiscale sur une base d’encaisses). les rendements du capital, sans trop sacrifier de recettes et Au niveau provincial, on devrait éliminer progressivement en évitant de créer une situation qui favorise de façon indue les taxes sur le capital et réduire les taux d’impôt sur le les détenteurs de capitaux. La consommation peut être taxée revenu des sociétés, ou encore les remplacer par une taxe sur par le biais des revenus du travail et d’une assiette fiscale les transactions commerciales. modifiée dans le cas des entreprises. Le régime actuel d’im- Ces réformes renforceraient l’économie du pays, assu- pôt sur le revenu des particuliers et des sociétés pourrait reraient à long terme une hausse réelle du niveau de vie des aussi être redéfini sur cette base. Canadiens et permettrait d’avoir une plus grande latitude en Pour ce qui est de l’impôt des particuliers, la priorité matière de politiques publiques. Avec un peu de vision et la absolue consiste à modifier encore plus la définition de volonté politique nécessaire à l’instauration d’un régime fis- l’assiette fiscale en faveur de la taxation de la consom- cal concurrentiel à l’échelle internationale, le Canada pourrait mation, préférablement en autorisant les comptes devenir un lieu d’activité économique exceptionnellement d’épargne enregistrés à impôt prépayé (en plus des attrayant. Autrement dit, un véritable tigre du Nord.

45 Tax Design for a Northern Tiger Summary by Jonathan R. Kesselman

anada’s tax system, if properly designed, could play a significant role in making the country’s C economy more competitive and vibrant, and thereby contribute to Canada’s emergence as a reform include broadening the base, widening tax brackets “Northern Tiger.” This paper addresses the broad archi- (especially at the top) and implementing modest cuts in tax tecture of tax policy and offers concrete recommenda- rates for the middle-income brackets of federal tax and the tions for policy action. Drawing on a large body of upper-income brackets of some provinces’ taxes. public finance and tax economics research, the propos- With respect to payroll taxes, employment insurance als in this paper build on recent tax developments at (EI) premiums should be set at rates that finance actual both the federal and provincial levels. program costs, and employers’ premiums should reflect Designs for an improved Canadian tax system should each firm’s EI costs. A federal general payroll tax could be keep several goals in mind. They should create a com- instituted to raise the revenues to finance other tax cuts petitive advantage for Canada within an increasingly and reforms; part of the financing of the Canada Pension integrated North American economy. They should mini- Plan could also be shifted to such a payroll tax. mize impediments to specialization, investment and Either the federal or provincial sales tax should be con- trade, and reduce the effects of the border with the verted into a more direct form (such as a business transfer United States. They should create unique attractions to tax) in order to reduce border costs. Alternatively, the goods invest and to conduct business on the Canadian side of and services tax (GST) should be simplified and reformed, the border. And they should serve to nurture and retain and provincial sales taxes modified to reduce the burden skilled and talented workers in this country. on business inputs or harmonized with the GST. Excise If the mix and structure of taxes are efficiently taxes on gasoline offer an economically and environmen- designed, the level of taxes in Canada will not hinder tally attractive way to obtain more revenues in order to competitiveness. How much of national output to lessen the reliance on other, more distorting tax bases. devote to public versus private consumption can then The most vital improvement in Canada’s tax design be decided without impeding economic performance. would be to reduce the burden of business taxes on Yet considerations of business investment, skilled work- investment. At the federal level, this should be achieved ers and trade flows do constrain the design of Canadian by eliminating capital taxes, making further small cuts taxes relative to those in the US and elsewhere. in statutory corporate income tax rates and sharply One way to promote efficiency and growth is to move accelerating depreciation provisions (and possibly shift- toward taxes based on consumption, rather than on ing to a cash flow base). At the provincial level, the income. The priority should be to reduce taxes on personal remaining corporate capital taxes should be phased out savings, capital income and business investment without and corporate income tax rates reduced; alternatively, forgoing too much revenue or creating windfall gains for corporate and other taxes could be replaced with a busi- wealth holders. Consumption could be taxed through labour ness transfer tax. income and reformed tax bases for business. Moreover, a Improved tax design would strengthen the economy, consumption base could be applied to direct personal and raise Canadians’ real, long-run living standards and business taxes, and indirect sales taxes could be converted increase the country’s policy autonomy. Given the vision into more direct forms to reduce trade frictions. and political will to create a world-beating tax system, For personal taxes, the highest priority is to shift further Canada could become a uniquely attractive place for eco- toward a consumption base, preferably by allowing tax- nomic activity — a Northern Tiger. prepaid savings accounts alongside existing tax-deferred accounts and by removing the dollar ceiling on contribu- tions to these. Other pressing needs for personal taxation

46