Tax Policies for a Fair & Productive Economy – Boadway

By Robin Boadway

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Recent years have witnessed slow growth rates and persistently high rates of return on wealth, leading to an erosion of real incomes for most people and windfall gains for the top 10 percent. Investment has yet to recover from the 2008 financial crisis, and the creation of good full-time jobs has been disappointing.

This is consistent with an economy whose manufacturing base was racked by the natural resource boom of the early 2000s and which was slow to recover when resource prices collapsed. Dare we admit that this is symptomatic of classical Dutch disease?

Now Canada is faced with the possibility of reforms in the US that reduce corporate tax rates and increase protectionism. The challenge is to adopt policies that encourage competiveness and growth, and ensure that the benefits reach those who are least well-off.

Fundamental tax reforms will help us achieve these goals. Following some EU countries, our corporate tax can be made investment friendly without sacrificing its objective of taxing high rates of return by adopting an Allowance for Corporate Equity tax system. This system allows a deduction for the cost of equity finance, thereby removing the distorting effect of corporate taxation on investment and its unwise encouragement of debt finance. This would pre-empt a similar tax reform that is being touted by the Republican Congress for the US. It would also mitigate the pressures for corporate tax reduction and, when combined with reforms of the small business deduction and capital gains taxation, would minimize the opportunities for tax planning that erode the corporate tax base.

Reforms to the personal tax system can make it fairer, more efficient and less susceptible to tax avoidance. The existing system of refundable and non-refundable tax credits, which disproportionately benefit higher income taxpayers, could be simplified and reformed. Most such credits could be collapsed into a single refundable tax credit, which with the agreement of the provinces could be used to finance a decent basic income guarantee. This would replace and augment existing welfare and disability systems with little or no additional tax revenue needed, and would avoid the stigmatization and inadequacy of the latter. And, it would improve health and education outcomes, and encourage engagement with the labour force.

At the same time, opportunities for wealthier persons to accumulate wealth through windfall gains and tax planning could be moderated by fully taxing capital gains and by reducing or eliminating the dividend tax credit. These are intended to compensate shareholders for corporate taxes that had been paid on their behalf, but this rationale has been questioned in light of evidence that the corporate tax is largely shifted to wages through international competitive forces. Eliminating the preferential taxation of capital gains will remove the main source of complexity and tax planning opportunities in the tax system as well as enhancing the fairness of the tax system per se.

These measures would broaden the tax base faced by higher-income taxpayers, but would not affect their marginal tax rates. At the same time, they would have limited effect on middle- and lower-income taxpayers. Most of their capital income can now be fully sheltered from personal tax by vehicles such as RRSPs, RPPs, TFSAs and housing.

Some other tax measures could be considered in the longer term. One concerns housing. At the moment, all imputed income from primary-residence housing, including capital gains, is tax-exempt, unlike sheltered savings in TFSAs and RRSPs which face upper limits. A strong case can be made for capping the exemption of capital gains on primary residences, although the implementation details would have to be worked out.

An even stronger case can be made for re-visiting inheritance taxation in Canada. Many other OECD countries deploy inheritance taxes with varying degrees of effectiveness. Given evidence that wealth inequality is increasing and that rates of return on wealth increase with the amount of wealth, an inheritance tax with a reasonable exemption level would both be fair and would enhance equality of opportunity.

An even longer term issue to be considered in light of upcoming pressures for trade reform is the balancing of resource and non-resource sectors in the economy. This is a challenging policy issue given that the provinces are the stewards of natural resource development and taxation. Provincial resource policies have implications for the national economy, but are undertaken with provincial interests first in mind. They have strong incentives for encouraging resource exploitation within their jurisdictions.

Arguably provincial policies have magnified the consequences of resource booms and busts, and federal policies have in some cases abetted them. Provinces have not been fully effective at taxing resource rents, and those they have taxed have not been saved. Rather, the tendency of the provinces is to use their resource rents for province-building purposes.

The federal government tax policies have also favoured resource industries. Without evoking the spectre of industrial policy, it would be useful to have a good hard look at the reliance on natural resource development as a driver of Canada’s economic development. Pro-active decisions about infrastructure and its role in influencing industrial structure, including transportation of natural resources across provincial borders, would be helpful rather than reacting to the imperatives of international trade.

Robin Boadway is an Economist at Queen’s University
boadwayr@econ.queensu.ca

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