Ontario can overcome its flat-tax-phobia

Posted on May 12, 2009 in Debates, Governance Debates

NationalPost.com – Opinions/FullComment – Ontario can overcome its flat-tax-phobia
Posted: May 12, 2009.  Kevin Libin

There’s evidently something about a flat tax that breeds suspicion. To Canadians used to generations of soak-the-rich progressive taxation, that any government would propose such an easy to understand, bargain of a tax system, consciously abandoning the easy targeting of a minority of easily squeezed high-income earners, strikes us as impossible to comprehend. Like a politician cutting their own pay, this does too much to favour the taxpayer and offers no win for our self-interested politicians. Clearly it must be a thing of fantasy. When Christine Elliott, in her campaign to win the Ontario Progressive Conservative nomination, endorsed last week a flat tax for her province, Ontarians were mystified. Economic professor James Davies admitted he was floored, saying the idea “takes my breath away, a little bit, because I never thought it was a serious possibility.” He wasn’t saying it should be.

Being in Alberta, where we’ve had a provincial flat-tax for eight years now, I’ve received notes from incredulous Ontarians wondering what duplicitous tricks taxpayers can expect Ms. Elliott has up her sleeve: what she will someday come to take from them in this Faustian arrangement. Surely all tax deductions will come off the table. Surely some people, lured by the elegant simplicity of the flat tax, will discover only too late that they are actually paying more than they used to. Perhaps the treasury will be ruined. The whole thing sounding far too good to be true, they presume it must be.

Based on Alberta’s experience, it isn’t.

When Alberta introduced its flat tax in 2001, it came with no strings attached: 10% taxes for everyone, yet—despite the theory that flat tax should lead to an exceedingly simplified system (flat-taxers dream of postcard-sized tax returns, with just a few lines, completed in minutes)—no deductions were closed. The province continues to roll out tax credits as ways of encouraging you to do things they want you to do (among the latest additions: tax credits for health club memberships). Low income earners benefited more than anyone when the province, concurrently, raised the basic personal tax exemption from 8% to 13%, so the system retained its so-called “progressivity” (in that lower earners still pay a far smaller portion of their income in taxes than high income earners). I’m sure if you asked folks at Canadian Centre for Policy Alternatives they would probably argue that that’s not nearly progressive enough for their tastes. Then again, probably few modern tax systems are.

In 2001, Alberta was in a unique position to experiment with flat tax: those were back in the days when the province was actually making more money than it spent. Premier Ralph Klein could afford to take a short-term hit on income tax revenues, and he did: in 2000, the province collected $5.1 billion in personal income tax; the next year, after the new flat tax system began, that fell to $4.2 billion. It took spine to stick with it. By 2006, however, Alberta’s treasury was making more in income tax than it ever had, collecting close to $6 billion. Last year, income tax collected amounted to more than $8 billion. Yes, Albertans were richer last year than they were in 2001, thanks to the boom, and there were a few hundred thousand more taxpayers living here than at the turn of the century (though certainly one reason for that was our appealing tax policy); it’s nearly impossible to know how much of the additional revenues can be directly attributed to the flat tax. But for the personal income tax take to nearly double in seven years, with no increase in the rate, the province’s tax system has to be doing something right.

Other jurisdictions would seem to think so. Worldwide, there are more than 20 countries now that have flattened their tax systems (tax leveling is especially popular among former Eastern bloc countries—Lithuania, Czech Republic, Estonia, Latvia, etc.—which, at their independence, lacked the entrenched rent-seekers that generally resist radical tax reform for the damage it will do to their deduction-favoured sectors). In Canada, New Brunswick is on its way to flattening its four-bracket tax system to just two levels. If Ms. Elliott gets her way, Ontario’s flat tax will be an even better deal than Alberta’s, with an $18,000 personal exemption rate and an astonishingly low 8% tax rate for all income after that.

But the would-be PC leader may be having trouble making a properly convincing case for it, nonetheless. She’s honest enough to admit that the policy would probably cost Ontario $6 billion in the short term (as happened in Alberta). But she cannot reasonably say how much benefit might come in the long term. The “dynamic impacts” as the Fraser Institute’s Niels Veldhuis calls them—the added money that businesses would invest in a flat-tax Ontario, or the extra hours workers will put in, once their earnings are relieved of the diminishing returns imposed by the more-progressive multi-bracket system, are impossible to know. All she can say, and it is well worth saying, is that the flat tax has had success elsewhere and there is no reason to believe Ontario’s experience would be any different. Trying a new, fairly radical approach to taxation takes guts. But as Ms. Elliott told the National Post the other day: “We need to do something significant,” to boost Ontario’s economy. “Incremental change is not going to be enough . . . We need to be competitive with other jurisdictions … and this is the way we need to go to turn Ontario around.”

The fact that Ms. Elliott, at the same time has said she’ll scrap Ontario’s impending Harmonized Sales Tax looks funny, too, since like flat tax, it is seen as a way to increase competitiveness by lifting the burden of complicated tax compliance from corporations while making business investments more tax friendly (also, because her husband, federal finance minister Jim Flaherty, is a big fan of harmonization). It’s hard, though, to blame her: when Atlantic provinces introduced the HST, they offset the extra pain felt by consumers having to suddenly pay extra sales tax on necessities like clothes, houses and food, with a lower overall sales tax (rather than simply combining 7% GST with 9% PST and calling the HST 16%, they lowered the combined tax to 15%), and increased basic exemption levels. It took Dalton McGuinty to take what is a smart move and turn it politically revolting by refusing to either raise exemptions or lower the harmonized rate, leaving consumers to pay higher taxes to ensure a better tax regime for businesses. (Apparently that’s what passes for “Liberalism” in Ontario). With McGuinty having made the HST wildly unpopular in Ontario and synonymous with Liberal tax hikes—a mid-priced new home will cost buyers tens of thousands of dollars more—it’s easy to understand why Ms. Elliott believes her best political option is probably to promise to cancel both the baby of better business taxes with the bathwater, at least for the time being.

But with Ontarians now conditioned to see novel tax efficiencies as raids on their wallet, perhaps it’s understandable they would reflexively suspect something ominous in Ms. Elliott’s promises of turning their province into a flat tax nirvana. But we know Ontarians believe in the wisdom of tax cuts—which can ultimately boost revenue, thanks to Laffer Curve effects—so with sufficiently gentle reassurance, it’s possible someone like Ms. Elliott could coax them to understand how the same logic applies with a flat tax. Ontarians have been so mistreated by innovative new tax ideas (health care premiums, HST, etc.) it’s now wonder why they’d be wary of a flat tax. If only they could learn once again to trust tax reform, they might find Ms. Elliott’s flat-tax idea a  safe haven for their tax-abused souls.

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