The tax system can’t possibly do what people want it to do

Posted on September 10, 2017 in Governance Policy Context – Full Comment – Outraged small-business owners can’t expect the system to compensate them for every hardship of life
September 8, 2017.   ANDREW COYNE

There’s a theory that the Liberals deliberately set out to provoke the absolutely lethal fury among professionals and small business owners their tax changes have aroused: something something polarize the debate something NDP vote collapses … something.

Perhaps the Grits hoped a few top-hatted fund managers might be prodded into publicly complaining of being ill used. But I can’t imagine it was part of the strategy to convince every shop owner, farmer and garage mechanic in the country that the government of Justin Trudeau hated them and wanted them dead.

The proposals have attracted two groups of critics. In the first are those tax experts and economists who, while supportive of the reforms’ intent — to limit the ability of high income earners to avoid taxes simply by incorporating themselves — find the government’s particular solutions needlessly complex, intrusive, or burdensome.

The second, far more vocal group do not concede there is any problem to be addressed. These are the many doctors and small business owners who stoutly defend their right to pay less tax than a person of equivalent income, as a matter of principle.

It’s tempting to write this off as the usual special pleading. But the squall would not have reached the intensity it has were it not infused with a hefty amount of genuine outrage.

For many, it is the insult to their class identity as professionals or small businesses owners that most offends: the suggestion that, by taking advantage of a legal tax preference, they were “tax cheats” (though in fact no one in the government has suggested any such thing), certainly, but also the insult of being compared with mere employees.

Any attempt, thus, to compare what they pay in tax with what a salaried employee would pay will inevitably elicit a long list of all the ways in which the two are not comparable: the benefits that are not available to them, from maternity leave to pensions to employment insurance, or the hardships and uncertainties that an employee will never have to face.

Whether the differences are quite as stark as all that is not the issue. It is the assumption that they are entitled to be compensated by the tax system for the vagaries of their chosen careers that marks what can only be described as an alternative worldview: a vision of how economies work and what a tax system is for, quite at odds with the conventional one.

Often this is expressed in terms of “incentives.” What’s the “incentive” to start up a business, they cry, if there’s no tax advantage to it?

This is, as I’ve written before, attached to the notion that small business owners take more risks than others, and should be rewarded for this in policy. But as my answer — the reward for risk is the return, not a cookie from the government — does not seem to have satisfied, we will have to take a lengthier detour into first principles.

What’s the ‘incentive’ to start up a business, they cry, if there’s no tax advantage to it?

A market economy relies upon individuals as proxies for the public interest. This is highly simplified — it ignores such matters as externalities — but as a first approximation it is useful to think of private costs as social costs, and private benefits as social benefits.

The costs of a good or service are the resources used to make it, which are thus unavailable to others; the benefits are its value to others, as measured by the price they are willing to pay for it. Profit is in this sense not so much a private reward as a social obligation: unless your product provides more benefit to society than it costs society to make, you are obliged to go out of business.

But your decisions will only be a good proxy for society’s if they’re working off the same information about costs and benefits. That won’t be the case where government policy hides or distorts the real costs of things in some way — whether by subsidies or tax preferences. This does not change, just because you call them “incentives.”

Neither does it change because the decision involves some bet on the future: a risk. There is no social interest in promoting risk-taking, indiscriminately, just for the sake of risk-taking. Rather, we want people to take sensible risks, clear-eyed risks, comparing expected returns to costs. Again, that’s an argument for as neutral a tax system as possible.

But it is all those other items on the list that really take us into the wilds: the long hours a doctor works, the vacations a small business owner never takes, and all the rest. I’m sure all this is true but — how to put this — the tax system is not intended or designed to compensate for every hardship of life, or to weigh in the balance all of the pluses and minuses of one job versus another. It can’t possibly do so.

Rather, there has long been a consensus that the tax burden should be apportioned on the basis of “ability to pay.” There’s no perfect measure of this, but income is the best we’ve got: income, not income-adjusted-for-hours-worked or income-adjusted-for-job-satisfaction. The definition of income could certainly be expanded — that was the case for the short-lived attempt to tax employee health benefits — but the principle is the same. The basis of the income tax is income.

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