Returning to the fairness of the ‘a buck is a buck’ principle of taxation

Posted on in Equality Policy Context

NationalPost.com – Full Comment
November 26, 2014.   Andrew Coyne

It has been nearly 50 years since the Royal Commission on Taxation, chaired by Kenneth Carter, revolutionized Canadian thinking on taxation. It is to Carter, of course, that we owe the now seemingly common-sense idea the base of the income tax system should be, well, income: all income, from whatever source — “a buck is a buck,” in the famous catchphrase — without preference or exemptions. That in turn gave rise to today’s integrated corporate and personal income tax systems, in recognition that the investment income an individual receives comes out of corporate profits on which tax has already been paid.

Five decades on, there is a growing sense among tax experts that the time has come for a similarly sweeping overhaul of the tax system. Earlier this year, the Mowat Centre published a paper by the economists Robin Boadway and Jean-François Tremblay calling for, in effect, the abolition of the corporate income tax, to be replaced by a tax on “rents” — profits in excess of a “normal” return. Now, the economist Kevin Milligan, via the C. D. Howe Institute’s annual Benefactors’ Lecture, has gone further, proposing the personal income tax system be converted into a “dual income tax,” as seen in some northern European countries: a single, low rate on all capital income, coupled with an escalating, more sharply progressive tax on wages and salaries.

In part this revival of interest in radical tax reform is driven by a desire to get back to Carter principles: over the years, a number of deductions, exemptions and credits has crept back in, undermining both the efficiency and the fairness of the system. But in part it is also driven by a perceived need to move beyond Carter, a sense that the world has changed since then in fundamental ways.

Milligan, for example, observes that the concentration of income among top earners has reached a level undreamt of in Carter’s day. At the same time, there is much greater understanding today of the limits of taxation — of how individuals and corporations adjust their behaviour in response to rising tax rates, whether in an economic sense (less savings, investment and work effort) or simply by taking advantage of the various avenues available to them to reduce their tax exposure, including moving to lower-tax jurisdictions.

I would add a third fundamental change: the advent of tax-free retirement and other savings vehicles, from RRSPs to RESPS to the new Tax-Free Savings Accounts, which have enabled millions of Canadians to shelter some or all of their savings from tax, at least until they are withdrawn for consumption. Indeed, for the vast majority of taxpayers who do not “max out” their RRSPs, the system is no longer an income tax at all, but a consumption tax. This is in keeping with the evolution in tax thinking, post-Carter. Exempting savings ensures all income is taxed only once, regardless of when it is consumed — whereas a “pure” income tax biases decisions in favour of current consumption.

But that development has exposed further cracks in the Carter foundation. If individuals are able to shelter substantially all of their capital income from tax, the case for integrating the corporate and personal income taxation systems loses much of its force. Which is just as well, because our attempts to do so — via the partial inclusion of capital gains and the dividend tax credit — have proven rickety at best: cumbersome, complex and above all incomplete. Interest costs are fully deductible to the corporation and fully taxable to the individual, skewing corporate investment decisions toward debt finance.

How much simpler, then, to do as Boadway and Tremblay propose: allow corporations to deduct their cost of capital, in whatever form — including a “normal” return on equity — and tax the corresponding payouts to individual investors, whether interest, dividends or capital gains, at the same rate as ordinary income. (That is, for those investors who pay any tax at all on their capital income, i.e., whose savings exceed the limits imposed by RRSPs and other shelters.)

Which makes it a puzzle why Milligan wants to recomplicate matters. To be sure, he would tax all capital income at the same rate (effectively, he would compensate for the end of integration by cutting rates, the new statutory rate being simply the old effective rate, give or take a few percentage points). But taxing capital income at a lower rate than labour income, with the widest gap for the highest earners, only invites more avoidance games by sharp-eyed accountants, the kind the rich are best able to afford.

Maybe there’s a case for redistribution — greater redistribution, that is — but a symbolic slap at the well-off isn’t going to do it

And for what? The trend in recent years in Canada is not to greater concentration of income but to less: the share going to the top 1% has been falling since 2006, and is now at its lowest level since 1998. But even if it were growing, and even if there were some reason to be vexed about it (as long as poverty is falling, which it is, and median incomes are rising, which they are, who cares if a handful of superstars are getting super-rich?), raising rates on top incomes isn’t going to turn that around, for the reason Milligan himself suggests.

He points to research showing an increase in the top rate to 35% on incomes over $250,000, as Brian Topp proposed during the New Democratic Party leadership race, would raise at most — assuming no behavioural response — $2.9-billion; include the inevitable tax avoidance, and “between one-third and the entirety of this revenue gain would be wiped out.” So how is it any different with his own proposal: a top rate of 35% on incomes over $400,000?

Maybe there’s a case for redistribution — greater redistribution, that is, than already takes place — but a symbolic slap at the well-off isn’t going to do it.

If we really want to soak the rich better to focus on closing tax preferences, which research again shows mostly benefit those with higher incomes: the small-business tax deduction, for example, or the lifetime capital gains exemption. A buck, after all, is still a buck.

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