The Liberals can and should win this fight against the rich

NationalPost.com – Full Comment – It remains to be seen whether the Liberals will get their way. They probably will and they almost certainly should, but this won’t be the end of the story
September 5, 2017.   STEPHEN GORDON

Sometimes it’s hard to see what is driving the fuss about the federal government’s proposed changes to the tax treatment of small businesses that have been incorporated as Canadian-Controlled Private Corporations (CCPCs). Heated rhetoric notwithstanding, the measures affect only a small group of CCPC owners: those with the sort of incomes that would put them comfortably among the top one per cent of Canadian earners.

Contrast this reaction with the last time the Liberals proposed a tax measure aimed at the top end of the income distribution. Their move to add four percentage points to the personal income tax rate for taxable incomes above $200,000 per year was not met with the sort of public relations counter-offensive that is being mounted against changes to the tax treatment of CCPCs. Why is CCPC taxation now such a big deal when the hike in the top rate was not?

Although the changes proposed to the CCPCs are easily defended on their own terms — CCPCs were set up to limit their owners’ liabilities, not to offer preferential tax treatment — these measures are best seen in light of the larger agenda of dealing with the concentration of income that has occurred in Canada over the last three decades. (The top end’s share of income has fallen since 2006, but is still higher than it was in the 1980s.)

Increasing taxes on high earners is an obvious strategy, but not a very effective one.

Increasing taxes on high earners is an obvious strategy, but not a very effective one — at least, not in Canada. Since high earners have the means and the incentive to make use of tax planning strategies to shelter income from taxation, higher tax rates typically result in lower amounts of reported taxable income. Tax revenues may increase, but not appreciably.

It turns out that Canadian high earners are particularly adept at tax avoidance: estimates for the “elasticity of taxable income” (ETI) in Canada are typically higher than those found using U.S. data. These estimates for Canadian ETIs explain why the proposal for increasing the tax rate on high earners was generally met with a collective shrug in policy circles: the higher top rate might have some symbolic value, but not much else. Higher top tax rates won’t have much of an effect on the distribution of after-tax income if the ETI is not reduced.

This brings us to why the Liberals are zeroing in on the tax treatment of Canadian-Controlled Private Corporations. As documented by the University of Ottawa’s Michael Wolfson and his co-authors, many high-earning Canadians have made use of CCPCs to shelter a significant share of their income from personal tax. A reasonable conjecture to make is that when the Liberals increased the top personal income tax rate, many high earners simply used their CCPCs to shelter more of their income. The goal of the Liberals’ proposals is to throw some sand in this particular mechanism of tax avoidance, in order to reduce the elasticity of taxable income.

When the Liberals increased the top personal income tax rate, many high earners simply used their CCPCs to shelter more of their income

This would explain why top earners were so relaxed about a higher personal income rate, and why they would be so upset about the changes to CCPCs: it will now be harder for top earners to avoid that new, higher top personal income tax rate.

To summarize the story so far: the Liberals raised the top personal income tax rate, many top earners were able to manoeuvre around it, and now the Liberals want to make it harder to shelter income from the top rate.

What happens next? One of the things to remember about high earners is that they have bargaining power — that’s why they have high incomes in the first place. They won’t simply take the tax hit and carry on with their lives; they will respond. Many will simply raise their fees so that their higher pre-tax incomes will offset their higher tax burdens.

Doctors, though, won’t be able to do that: their fees are set by the provincial health ministries. Many doctors — especially in Ontario — view the special tax treatment offered by CCPCs as compensation for accepting lower fees. Allowing doctors to incorporate probably seemed like a shrewd tactic on the part of provincial governments: it shifted the fiscal burden away from provincial health budgets and to the federal government.

One of the things to remember about high earners is that they have bargaining power

But now that these tax advantages have been eroded, doctors will be returning to fee negotiations with an eye to regaining lost ground. And doctors will likely have the upper hand in these negotiations: the threat of moving to the U.S. is most credible for medical practitioners, and especially for those just starting their careers. In the 1990s — when doctors’ fees last topped the policy agenda — it reached the point where almost one per cent of Canadian doctors were moving to the U.S. each year. Provincial health budgets are already the most vulnerable point in the Canadian public sector; increased fee schedules will only make a bad outlook even worse.

And of course, if provincial health budgets grow out of control because of a federal tax measure, then this will add further complications for future federal-provincial negotiations on health funding. And so on, and so on, and so on.

It remains to be seen if the Liberals will get their way on CCPCs: they probably will, and they almost certainly should. As I mentioned earlier, their proposal makes sense in its own right, even apart from the broader narrative about income concentration. But this won’t be the end of the story; it’s just the latest round in an ongoing match whose result is still far from predictable.

National Post

Stephen Gordon is a professor of economics at Université Laval.

http://nationalpost.com/opinion/stephen-gordon-the-liberals-can-and-should-win-this-fight-against-the-rich

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