This blog builds on the solutions to Employment Insurance, a Guaranteed Basic Income, and government supported personal savings. Taken together with these solutions, broad based tax reform in Canada focusing on value added taxes (HST, GST, PST) and income taxes should position Canadian society to better take advantage of economic opportunity, be more financially resilient, and reduce government interference in the economy and society.
The numbers used here to demonstrate the concepts. Brighter minds at Canada’s Department of Finance I am sure could calibrate the tax rates and deductions to optimise incentives to work and societal outcomes. That said, here is my stab at it!
The last time Canada benefited from broad based tax reform was in the 1970s via the Royal Commission on Taxation. The world, business, and society has moved on quite a ways since the 1970s. For Canada to create wealth and increase the economic wellbeing across all segments of society, it is time for Canada to dramatically simplify its tax system. For instance, Canada’s Income Tax Act was 4,000 when first enacted, the document now contains 1.1 million words. Other countries, like the UK, have taken steps to modernise their tax systems, it is time Canada did the same.
Below I propose some dramatic ways to simplify the tax system, remove ‘loopholes’, eliminate discrimination by income type or industry, and reduce the cost of compliance. I focus on valued added taxes such as the Goods & Services Tax (“GST”), Harmonised Sales Tax (“HST”), and Provincial Sales Tax (“PST”); personal income tax, and corporate income tax.
Value Added Tax
Canada has several forms of value added or consumption tax. Federally there is the GST, shared between some provinces and the federal government is the HST, and there are some provinces with a PST. Just this patchwork of consumption taxes and acronyms highlights the complexity of just this part of the tax system. Other non-sensical complexities in the system are explored in more detail below.
The GST/HST has some exemptions that don’t make sense in a modern economy such as printed books being exempt from tax, but online and e-books subject to GST/HST. In some provinces children’s clothes are tax exempt, while in other they are not. What makes something a child’s shirt — size, colour, brand…. what if a small adult buys a child’s shirt to wear? These types of exemptions add needless complexity.
Running a business with a national patchwork of consumption tax exemptions and systems is confusing and costly to comply with. Furthermore, exempting goods from consumption taxes erodes the tax base, reduces tax revenue, and introduces the ability for industries or special interest to lobby for tax exempt status.
Businesses need to register with the federal government for GST/HST remittances and with relevant provincial tax authorities for PST. This requires businesses that operate nationally to maintain records and remit consumption taxes to multiple agencies, at different times, at different tax rates, and with some good sold being tax exempt in one province and not another. While large multinationals may be able to cope with this, for smaller businesses and those involved in the e-commerce business, the cost of compliance is high. Even if a business sells just $100 via e-commerce to a customer in Saskatchewan, for instance, they need to register with the Saskatchewan government, collect, and then remit Saskatchewan’s PST.
Recognising some of the inefficiencies of Canada’s patchwork consumption tax regime, the federal government created the HST, which combines both provincial and federal consumption taxes into one, with the same exemptions, registration, and reporting requirements for the GST and HST. However, the combined system still enables provinces to set their tax rates so the HST rate in one province may not be the same as in another. The change resulted in several provinces eliminating their PSTs and replacing them with the more efficient HST. Canada should go further.
Canada’s federal GST and the federal portion of the HST currently sits at 5%, with provincial portions of the HST or stand-alone PSTs ranging from 0% to 10%. Given the decentralised nature of Canada’s federation developing a singular HST level across the country will be challenging. However, I believe that the following approach could work.
National HST of 20%
Canada should move to a national standard HST of 20%, split 8% to the federal government and 12% to each province. This would bring Canada in-line with consumption tax levels in much of the EU. It would also result in more revenue for the federal government and each province. This last point is key as the additional revenue for the provinces could be used by the federal government to encourage them to ‘sign-on’. For provinces like Alberta where only the 5% GST applies, the provincial government could ‘blame’ the federal government for the new tax while at the same time being quietly grateful for a large stable revenue source that is much less volatile than oil and gas royalties.
To simplify tax compliance and administration for business, reduce economic favouritism for certain industries, and to maximum revenue generation most HST exemptions would be eliminated (e.g. utility bills, kids clothes, books). This would ensure that all industries and sectors are treated the same. It would also make compliance with the tax quite simple to administer. Supports for families should be managed via HTS rebates and not exemptions. Importantly, housing costs would not be subject to HST, for instance home sales and rent would both be exempt from HST (currently new homes sales are subject to HST). The taxation of housing will be addressed later in the income tax section of this article.
Canada Revenue Agency (“CRA”) Administered
The HST would be centrally administered by the CRA, eliminating the need for businesses to register and remit in multiple provinces and territories, as well as federally. This would make tax compliance much simpler for businesses, particularly small ones. It would also reduce compliance costs for business.
Expanded Income Tied HST Rebates
Canada has had GST rebates since the tax was implemented nationally in 1991. Canada provides GST/HST rebates tied to family income and size with rebates paid quarterly. The current maximum credit for an individual is $443 a year, with no rebates given for individual incomes over $44,000. These credits recognise that lower income families spend a greater share of their incomes on goods and services subject to GST than wealthier families, making consumption taxes ‘regressive’. For instance, families in the bottom 10% of income in Canada devote 3.8% of their income to GST, while the top 10% of families devote 2.1%. However, when adjusted for current GST rebates, the bottom 10% of families actually devoted (1.7%) of their income to GST, meaning they profited from the rebates.
CRA research has found that with GST rebates tied to income that the GST is largely progressive. Interestingly, residents in provinces with a higher HST don’t receive larger rebates versus those with a lower HST, the rebates are funded by the federal government out if their 5% share of any GTS/HST. I propose that the the rebates be increased by 400% recognising that the HST would be increasing the GST by 4 times (5% to 20%). This would also expand the HST rebates to the provincial shares of HSTs, which is not currently the case.
This change would materially benefit lower income households and ensure that the a higher uniform national HST would not adversely impact poorer households. Importantly, the provincial share of the HST remitted to each province would be after deducting HST rebates provided to provincial taxpayers, meaning both the federal and provincial governments would fund the rebates.
I think it is possible to sell such an approach to Canadians and the provinces. Consumption taxes are reliable and stable forms of tax revenue generation, are known by economist to be the least economically damaging tax, and when combined with generous HST rebates won’t adversely penalise lower income families.
Corporate Income Tax
Corporate income tax is a hot topic. Those on the left often accuse business of avoiding tax, while business owners complain about high taxes and the complexity of the current system. Canada’s current income tax system is full of special exemptions for different industries, numerous tax credits, accelerated tax deductions, and complicated loopholes that add maddening complexity to the system, while reducing the government’s tax take.
In order to address this, remove industry bias in the system, and dramatically simplify tax calculations, I propose three fundamental reforms.
Corporate Audited Accounts as Tax Base
Currently the profit that you see in company financial statements is not the profit that gets taxed. That is because the accounting principles used by companies and their auditors (Generally Accepted Accounting Principles — “GAAP”) is not the same that tax authorities use. For instance, a company may buy a piece of equipment and then depreciate 10% of its value each year in their GAPP accounts to best match the projected 10-year life of the equipment with the revenue it generates over its lifespan. While this may be the appropriate strategy for audited financial statements, the tax authorities may require a different depreciation schedule, at say 25% a year. Or tax authorities may only enable some expenses to be fully tax deductible. These mismatches mean that determining the corporate income tax bill of a company is not as simple as taking the tax rate and multiplying it by the company’s profit.
But why can’t it be this way? It would require all firms to prepare independently audited financial statements, which is not the case, but perhaps a threshold of businesses with revenue of less than $200k would not need an audit. However, the Directors would need to attest to the accuracy of the financial statements and be personally liable for any purposely misleading accounts. What would make a system like this work even better would be for all companies to be required to share their financial statements via open corporate registers, that are freely accessible, as in the UK and much of Europe. This transparency would do much to enable investigative journalists to track down corporate tax avoidance and the transparency should increase social trust in the corporate tax system.
Imagine a world where tax authorities accepted the accounting principles used by auditors and then simply took the pre-tax profit, multiplied it by the tax rate, to come to the company’s tax liability. This would make compliance for companies much easier while making corporate tax more transparent to the public, which can only increase public trust in the system. Yes accountants get accused to using ‘tricks’ in the financial statements, but these same accountants get accused of using ‘tricks’ to avoid tax. Why not take the potential of one kind of ‘trick’ away from unscrupulous accountants and companies?
Dividends Tax Deductible
Currently only interest expenses from debt financing for a company is tax deductible in Canada. This is odd as companies are generally funded by debt and equity. Equity being shares where dividends are often paid to shareholders by companies.
Because dividends are not tax deductible, but paid out of a company’s after-tax profit, Canada has a complex system of ‘grossing-up’ dividends received by individuals to try to ensure that individuals don’t pay tax on 100% of dividend income, because a company has also paid corporation tax on their profits. In practice, few people understand how this system works and the system actually incentivises businesses to take on more debt, as it is tax deductible.
It has been documented that businesses with more debt are riskier than those with less and that the deductibility of interest makes companies favour debt financing over equity financing. One simple way to remove these distortions and complexity is to enable dividends paid to shareholders to be tax deductible. This would leave the shareholders receiving dividends to pay tax on them. For this system to work dividends paid to foreign shareholders would be subject to a 45% withholding tax, in line with the flat tax proposal I have made. Without this, corporate profits going to non-Canadian taxpayers would be very lightly taxed.
Corporate Tax Rate
Because the profits generated by business paid out as dividends would be taxed when in the hands of shareholders, the corporate tax rate could be lowered. This is because foreign shareholders would be taxed at 45% of dividends paid and Canadian shareholders would be pay tax on the dividends at a rate of 45% above the basic personal exemption. This approach would also encourage businesses to reinvest profits in the business, leading to more economic activity, employment, and wages rather than pay them out as dividends.
One could argue that because of this there is no need for corporation income tax. While theoretically that may be true, politically that solution does not seem reasonable at this time. Because of that, I propose a relatively corporate income tax rate of 10%. This would make Canada’s headline corporate income tax rate one of the most competitive amongst OECD countries and partially offset the perceived ‘pain’ of a 45% withholding tax for foreign shareholders. However, it needs to be clear that this approach would mean that corporate profits in the form of dividends would be taxed at a higher rate.
For example, say a company has a profit before tax and before dividends of $2,000; it then pays a $1,000 dividend to its shareholder reinvesting the rest in ongoing operations; that leaves a taxable corporate profit of $1,000 — resulting in a $100 corporate tax bill. However, the Canadian based shareholder will also pay (for simplicity) 45% tax leaving a bill of $450 on the dividend. Taking the corporation tax of $100 and the personal tax bill of $450, the total tax paid on the corporate profits would be $550 or %55 of the dividend or 27.5% of the $2,000 pre-dividend corporate profit. What this example demonstrates, is that the corporate profits would not be taxed at 10%, the actual rate would be much higher.
Taken together, these three corporate tax reforms would make Canada’s corporate income tax system very simple, efficient, and competitive. This should enable businesses to focus on innovation and not tax avoidance. Also, by putting the taxation of dividends firmly in the personal tax sphere, the corporate income tax proposal I make fits seamlessly with the personal income tax reforms I propose.
Personal Income Tax
Canada’s personal income tax regime is just as complicated as the corporate tax regime. It is estimated that the average Canadian family spend $500 annually to comply with tax rules. This compliance burden is a sunk cost, it does not provide Canadian’s with a valuable service. So how should Canada’s personal income tax regime change?
In my previous blog I outlined how Canada should adopt a flat tax system of 45%, with a very high personal tax free allowance of $33,090. This system would also provide a guaranteed minimum income to Canadians of $18,200. Under this system nearly 50% of Canadian taxpayers would not pay income tax, the system would provide a guaranteed minimum income, and would result in significant savings from the elimination of social programs, poverty reduction, better health outcomes, and improved education results. However, for this system to be fair and to encourage a couple of socially beneficial outcomes, this flat tax system needs to include a few other features.
Because individuals, families, and society benefit from a system where retired people can support themselves, a tax deduction for retirement savings should be retained. I propose retaining a retirement savings tax deduction of 18% of all types of income up to a maximum annual contribution of $50,000 per person. This is quite similar to the existing Canadian system, however, incorporates an annual cap ensure that the very wealthy don’t use pension savings as a means to reducing current income tax bills. Setting the maximum annual contribution at $50,000 is reasonable, as it is currently just slightly higher than the average annual income of $48,000.
As above, pursuing post-secondary education has been shown to benefit not only the person taking the course but wider society, a tax deduction for tuition should be retained. I propose that 50% of tuition costs can be deductible from income for tax purposes.
Equal Treatment of Income
All income received by a taxpayer would be taxed at the same rate — 45%. This is where changes to corporation tax previously discussed come in, the recipients of dividends would pay tax on this distribution of corporation profits.
Currently, employment, rental, interest, capital gains, or dividend income can be taxed differently. This adds complexity to the tax system and often benefits the wealthy who pay less tax on capital gains and dividend income under the current system than they would on equivalent employment income.
I propose that all income received by a taxpayer be taxed at the same rate. This would avoid complicated tax planning where the wealthy attempt to convert higher taxed employment or interest income into lower taxed capital gains income. It would also reduce the attractiveness of people using personal corporations to reduce their tax bill by paying dividends rather than salaries.
Removal of Primary Residence Exemption
One of the biggest changes I propose is to remove the exemption for capital gains tax on a primary residence. What this would mean in practice is that when you sell your house, if it has increased in value, you would pay 45% tax on this gain. This would equalise the tax preference that exists towards home owners, something that is not available to renters. It would also address the current inequality in the tax system whereby because someone choses to buy versus rent, the buyer gains a large tax advantage.
Taken together these three key tax reforms to the personal income tax system in Canada will greatly improve the efficiency of compliance, maintain the system’s progressive nature, reduce tax avoidance, and remove tax preferences that have in the past tilted the system in favour of the wealthy.
Readers will note that I have not mentioned inheritance tax. That is because Canada does not have a true inheritance tax. What happens is the deceased taxpayer’s assets and property are treated as all being sold (e.g. a deemed sale) the date they die. Tax is then paid via a final tax return before any residual cash or assets are distributed to beneficiaries of an estate. This reduces the need for an inheritance tax in Canada as the assets are taxed before an inheritance is received. With my flat tax of 45% this would mean that many estates would pay a 45% tax on the gain in assets that accrued to the deceased taxpayer before they passed and before the residue of estates is paid out to beneficiaries.
There is a lot in this blog to digest. Some of the concepts are complex and I have tried to simplify them here. However, when taken together with some other proposal I have blogged about, they will position Canadians for a more prosperous future.
Having a tax system that is simple, transparent, efficient, and that does not favour certain industries or income types over another is one that will be deemed fair, equitable, and acceptable to more Canadians. Canadians need to believe that the tax system ‘works for them’ — the changes I propose will ensure that it does.