The real problem with the Liberals’ tax-reform plans — they aren’t big enough

Posted on September 1, 2017 in Governance Debates – Full Comment – There are two approaches to tax reform: triage and big bang. Perhaps it’s time to consider a broader reform of the tax system
September 1, 2017.   Andrew Coyne

Since coming to power the Liberals have proposed or at least contemplated three separate reforms to Canada’s complex, inequitable, preference-riddled tax system.

The first would have capped the deduction for income from employee stock options at $100,000. The second would have taxed employee health and dental benefits, currently tax-free, as ordinary income. The third, the subject of so much recent controversy, would limit some of the ways individuals who incorporate themselves can take advantage of the much lower rate of tax on small private corporations.

The first two were abandoned in the face of opposition from those who stood to pay more tax as a result. The third, if the nervousness on the face of Liberal MPs is anything to go by, may well meet the same fate.

By contrast, consider the relative ease with which another Liberal tax change, increasing the top personal rate by four percentage points, went through. Like the other reforms, it was aimed at ensuring upper income taxpayers bore a greater share of the tax burden. Unlike the others, it did so not by closing tax preferences, but by raising the rate of tax itself.

That made it worse tax policy: economists generally look with favour on measures that make the tax system more neutral, less so on increasing rates, at least from the standpoint of efficiency. Neutrality encourages people to focus on activities that earn the highest return, rather than those that qualify for the juiciest tax breaks. Higher rates punish them for the same thing.

And yet it was much better politics. Why? Because it was simple, rather than complicated. In all of these cases, the beneficiaries tend to be well to do, and relatively few in number. You’d think that would make them easy targets, politically — and when the issue is raising tax rates on top earners, that most always proves to be the case. Who’s going to take the side of “the rich” against everyone else?

But when it comes to stock options, or health benefits, or the tax treatment of small private corporations, the picture gets muddier. Are these really income? Are their beneficiaries really rich? The very complexity of these measures tends to give them the benefit of the doubt. Surely there must have been some valid public purpose to them at the time they were enacted, even if no one can quite remember what it was.

Complexity, in short, is the special interests’ best friend: in its protective thickets can be secreted all manner of mischief. That’s how the tax system got so full of preferences in the first place. Were it proposed simply to subsidize the incomes of the rich, or corporations — for that is what they amount to: transfers of income from the general public — the outcry would be deafening. But call it an “incentive” for this or that or an “accelerated depreciation allowance,” and it is easier to pretend it has some sort of underlying economic rationale.

And, once in place, they become almost impossible to remove: protected, not only by their complexity, but also the tyranny of the status quo. It is fascinating, in this regard, to see the split between the free-market right, for whom “a buck is a buck,” and the populist right, for whom a “tax is a tax.” The former tend to favour closing tax breaks and taxing all income at the same rate, for the reasons described above: it leaves investors to make their own decisions based on their own calculation of their best interests, rather than leading them by the tax-preference nose to the designs of central planners.

The latter, on the other hand, are opposed to anything that raises anyone’s taxes, no matter how inefficient or unfair the tax break in question may be. It’s not a terribly rational position, since any tax break for some leaves others having to pay more, but it is deeply felt. And in the current controversy, it is proving devastatingly effective.

What those defending the right of doctors who incorporate to pay less tax than wage-earners of equivalent income — or unincorporated small businesses — lack in numbers, they make up for in intensity. Those footing the bill, on the other hand, which is to say the general public, are barely engaged with the issue.

Perhaps there is a larger lesson in all this. There are two approaches to tax reform: triage and big bang. The first deals with tax issues one at a time, depending on their perceived seriousness. The second attempts to tackle, if not all of them at one go, then a critical mass.

The first is usually considered more politically realistic: who needs to fight all those special interests at once? And yet recent experience suggests the opposite. By taking on just one reform, the government allows its opponents to train all their fire on a single point. At the same time, it leaves itself vulnerable to the charge that it is playing favourites: why this tax break, and not others? Why tax doctors’ perqs, for example, having backed off on employee health benefits?

And, perhaps most critically, it takes something away from people, without giving them anything in return. In the current reform, there are only “losers,” and no perceived “winners.”

So perhaps it’s time to consider a broader reform of the tax system. By goring everyone’s ox, the government would avoid the charge of favouritism. And with the revenue gained by closing so many tax breaks at one go, it could cut taxes across the board, creating “winners” with a stake in reform’s success, to set against the complaints of those who would lose from it.

I don’t say this would be easy. But I think we can say the other approach has not exactly been a walk in the park, either.


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