To the Editor:
With falling oil prices and declining revenues, some analysts are now predicting the Conservatives may not eliminate the federal deficit next year. This, they warn, would mean no fiscal room for new policy announcements in the upcoming federal budget.
That may be true based on narrow thinking, but with Canada’s economy weakening now is the time for the federal government to think big. Personal income tax relief for middle income families should be at the top of the list.
The last fundamental reform to the personal income tax system took place in 1987. The changes stemmed from a major federal Department of Finance report on taxation, identifying the proliferation of “special preferences” and the maintenance of high marginal tax rates. Specifically, the report stated: “an income tax system with high rates relieved by an unfair patchwork of special incentives is not what Canada needs. What Canada needs is a fundamentally different approach: lower tax rates and a broader, fairer tax base.”
The government responded with a series of changes to the federal personal income tax system. The top marginal tax rate was cut, the number of federal tax brackets was reduced, and several exemptions and deductions were eliminated to broaden the tax base.
Fast forward to the present and the number of “special preferences,” otherwise known as tax expenditures (tax credits, deductions, and exemptions), has been increasing steadily. Virtually every federal budget since 2006 has contained new or expanded tax credits related to a specific activity or group of individuals. There are, for example, credits for using public transit, placing a child in an athletic or recreational activity, and even for those who volunteer in search and rescue operations. These tax credits rarely change desired behaviour. Rather, they subsidize behaviour that taxpayers would likely have undertaken anyway.
Tax expenditures currently cost the federal government approximately $124 billion a year, close to the $130 billion the government collects annually in personal income taxes. The result: higher tax rates are required overall to raise the same amount of revenue.
Eliminating some of these tax expenditures would allow for lower tax rates. Of the $124 billion in annual tax expenditures, there are about 68 specific expenditures totalling $20.2 billion that could be done away with.
And what would $20.2 billion buy?
The federal personal income tax system has four brackets: 15 per cent tax on incomes between $11,139 and $43,953; 22 per cent on incomes between $43,954 and $87,907; 26 per cent on incomes between $87,908 and $136,270; and 29 per cent on incomes above $136,270.
Eliminating $20.2 billion in tax expenditures would allow the government to scrap the two middle rates (22 per cent and 26 per cent), leaving just two tax rates with an overwhelming majority of Canadians paying a single 15 per cent marginal tax rate and a small minority - roughly 2 per cent of tax filers - paying the higher rate.
This proposal would dramatically reduce the tax system’s complexity, improve economic incentives, and greatly diminish the need for income splitting. Altogether, this tax reform package, fully implemented, would cost $21.4 billion (in static terms).
To make Canada’s personal income tax system more competitive, the government could also decrease the top rate to 25 per cent and increase the income threshold to income over $250,000. The estimated annual cost of this more ambitious package, including scrapping the two middle rates, is $28.6 billion and could be phased-in as revenues rebound.
Such tax reform would help Canada’s economic performance by improving the incentive for many Canadians to work, save, invest, and undertake entrepreneurial activities. Once these behavioural effects are accounted for, the initial revenue loss would at least be partially offset.
The big barrier is that tax reform is an inherently political exercise and certain voices may wish to retain the tax expenditures. But consecutive federal governments, both Liberal (in 2005) and Conservative (in 2006), have identified the destructive effect of Canada’s personal income tax rates.
The federal government does not need a healthy surplus to reduce personal income tax rates. It needs to think big on tax reform.
Charles Lammam and Niels Veldhuis are economists at the Fraser Institute and co-authors of, Reforming Federal Personal Income Taxes: A Pro-Growth Plan for Canada, available at www.fraserinstitute.org.
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