Feb 14, 2013

Fairness by design: a framework for tax reform in Canada


A new CCPA (National) report by Marc Lee and myself argues that Canada’s tax system needs a “fairness” overhaul and presents a framework for progressive tax reform. Those of you who have been following our tax work so far will find this study a great complement to the BC Tax Options Paper.

Tax policy is an important lever for governments to tackle income inequality, which is why it is particularly important to strengthen tax fairness now, given the increased concentration of income and wealth we’re seeing in Canada. We also call for a comprehensive tax review of the entire system of taxation (as opposed to the current practice of making ad-hoc changes to different elements of the system independently) and remind Canadians that the last comprehensive review of federal taxation, the Carter Commission, was convened more than half a century ago.

The report is a slightly more technical think piece on taxes, but the brief Summary at the start provides a very accessible digest of our tax reform ideas. These are the seven priority areas we’ve identified (from said Summary):

1. Broaden the income tax base to reflect the individual’s actual command over resources. We recommend taxing income from all sources according to the same progressive rate schedule, including self-employment income, property, savings and dividend income and capital gains. This would eliminate the preferential tax treatment that currently exists for many sources of income for high earners — investment income form stock options and capital gains, for example — that are taxed more lightly than income from wages and salaries. In some cases, such as lottery winnings, sales of principal residences, other long-held assets or family farm/business bequests, provisions for income averaging over several years should be implemented to accommodate large fluctuations in annual income.

2. Rationalize tax expenditures. Canada’s income tax system contains a large number of deductions and tax credits (both refundable and non-refundable), known collectively as tax expenditures, many of which dispropor- tionately benefit high-income earners. Given that they are very expensive to the public purse, we recommend that their effectiveness and distributional impacts be carefully evaluated. A number of tax deductions and credits may need to be modified, scaled down or eliminated, in particular the RRSP and registered pension plan deductions, the basic personal amount, spouse or common-law partner amount and the amounts of eligible dependents and children, the employee stock options deduction, and the charitable donations tax credit.

3. Increase top marginal income tax rates. We recommend the addition of one or more high income tax brackets (for example, at the top 1% and 0.1% of income) to improve tax fairness and tackle income inequality at the top end. A recent U.S. study estimates that the optimal top marginal tax rate for the top 1% of earners is 73% (and as much as 80% if there are no deductions and loopholes to allow tax avoidance).1 These rates are substantially higher than the prevailing Canadian top marginal tax rates.

4. Stop the corporate tax “race to the bottom”. We recommend increasing corporate income tax rates, which are currently the lowest among G8 countries. A shift of business taxation to a cash-flow tax base should replace the current system of arbitrary rules of depreciation and capital cost allowances that differ by sector. This would fully tax pure economic rents, the re- turns from ownership of assets. Higher taxes on natural resources should also be considered.

5. Implement inheritance and/or wealth taxes. These taxes help improve social mobility and reduce the concentration of wealth at the very top by limiting the extent to which capital (and the opportunities it buys) is passed across generations. Canada is currently one of the few developed countries that does not tax bequests and inheritances. We recommend that large inheritances and gifts be included in the recipient’s taxable income. In addition, large holdings of wealth should also be taxes at an annual rate, broadening the base of existing property taxes to include financial market assets.

6. Use consumption taxes cautiously. Value-added consumption taxes may be used to supplement revenues collected from a progressive, broad- based income tax, but should not form the main basis of the Canadian tax system. On the other hand, carbon taxes and financial transactions taxes are examples of specific consumption taxes aimed at internalizing external costs, which should be embraced.

7. Implement a basic or guaranteed income. We recommend amalgamating the various income-tested tax credits and benefits into a single, stream- lined income transfer that would phase out gradually similar in structure to the OAS and the CCTB. The transfer would be broad-based, and designed to take into account individual circumstances such as family size, number of young children, family members with disabilities, etc. Such a transfer would be flexible and could easily accommodate new tax measures introduced in the future.

The exact combination of reforms should be developed on the basis of a comprehensive review of the tax system. A Fair Tax Commission should be convened to examine how federal taxes and transfers work together as a system and make recommendations for changes. Ideally, the Commission would include an expert and well-respected team made up of both academics and practitioners, and would engage Canadians from all walks of life in a meaningful and broad-based public dialogue and deliberation process to produce a framework for restoring fairness to our tax system.

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