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| Ten Tax Myths |
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I n fact, Canada’s income tax system is not very progressive any more, which means that high-income people are not being taxed excessively, or even appropriately. After years of regressive tax changes, the income tax system now has just three personal tax brackets — 17%, 26% and 29% (the provinces add between 45-52% of these rates). The highest marginal rate combining both (as well as various surtaxes) is 53.7% in Newfoundland.
This compares to 10 different tax brackets and a top marginal rate of 80% on very high incomes in the 1960s. Tax reform by the Mulroney government raised the lowest rate and decreased the highest rate when it reduced the number of brackets from 10 to three in the mid-1980s.
As noted above, when all taxes (income, GST, payroll, property, sales tax) are taken into account, Canada already has a virtually flat tax system. In other words, everyone pays nearly the same rate of tax, regardless of income. We can illustrate this by looking at some concrete examples.
Let’s take the case of three families of four living in British Columbia. All three families have two income earners. One family earns $30,000, the second $55,000, and the third $90,000. The two-income family with $30,000 is assumed to have each spouse earning $15,000; the family with $55,000 is assumed to have one spouse earning $35,000 and the other $20,000; and the family with $90,000 is assumed to have one spouse earning $50,000 and the other $40,000.
It is further assumed that each family pays CPP and UI premiums, as well as federal and provincial income taxes based on basic personal credits, applicable provincial credits, and typical major deductions at each income level. Each family owns a home and pays property tax amounts based on the Canada Mortgage and Housing Corporation review of property taxes buyers are likely to pay in major cities in each province. Sales and fuel tax estimates (including sales tax on meals, liquor and accommodation) are calculated based on expenditure patterns from Statistics Canada’s 1996 Survey of Family Expenditures. GST estimates are reduced by the GST credit, where applicable. The total tax bill for each family is shown in Table 5.1.
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Table 5.2 presents the taxes paid by the three families as a share of their total income. From this, it can be seen that the personal income tax system is relatively progressive — i.e., that the effective rates at which tax is applied rises along with income. On the other hand, sales and fuel taxes as a share of total income remain the same among all three families, while property taxes and social insurance premiums are clearly regressive. Consequently, when all taxes and premiums are added up, the overall progressivity of the personal income tax system is muted.
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Yet there are proposals in Canada for a completely flat income tax system that would make an already inequitable situation even worse. The Alberta government announced in March, 1999, that it would phase in such a system by the year 2002. It would be the first provincial government to decouple its income tax system from the federal government’s system. Currently, provinces base their tax system on a percentage of the federal income tax.
Alberta’s planned flat tax system would impose a flat provincial rate of 11% on all income earners. Critics have pointed out that middle-income earners, who pay most of the tax revenue, get very little relief, while the wealthiest Albertans gain a great deal. A single person earning $30,000 will get a tax break of $16 a year, whereas a single person earning $250,000 will get a break of over $6,000.
While the Alberta government says the plan will knock 78,000 low-income people off the tax rolls, this could be done without introducing a flat tax. Most of the $600 million in sacrificed revenue from the new tax structure will find its way into the hands of high-income earners[14]. An examination of the arguments put forward by flat-tax promoters shows that none of them stand up to any sustained scrutiny. According to Osgoode Hall Law professor Neil Brooks, flat tax proponents claim to want greater simplicity, but the section of the Income Tax Act that sets out tax rates is “one of the most straightforward: it is scarcely a dozen lines...[O]nce someone’s taxable income is calculated on their tax return, a Grade 3 student can calculate the tax owing, no matter how many rates there are.”[15]
Another argument made in favour of a flat income tax rate is that it would reduce tax evasion. As Brooks points out, this is just a subtle form of blackmail. The rich are in effect saying that, if you force us through the will of the majority to pay taxes we think are too high, we will engage in criminal activity to get our way. Giving in to blackmail is hardly a sound basis for public policy.
Even so, the argument itself is false and implies that a so-called “fairer” flat tax is less likely to be avoided. In fact, it is the GST — a flat 7% tax — that is the most evaded in the country.
The argument flat-taxers use to make their proposal sound progressive is that it will lead to increased economic prosperity for everyone. This is the old “trickle-down” theory that has been thoroughly discredited by both prominent economists and all available evidence. As Brooks points out, the last 50 years have been marked by ever lower taxes on the wealthy and lower rates of economic growth — “a troubling coincidence to those who argue that reducing the top marginal tax rate is the key to spurring economic growth.”
In the 1940s and early 1950s, the top marginal rate was 90% and GDP increased at a yearly rate of 6.2%. In the late 1950s and early 1960s, the top rate was 80% and growth averaged 5.1%. In the 1970s, the top rate was reduced to 60% and growth slipped to 4.2%. Since 1981, the highest rate has been about 50% and growth has averaged just 2.4%.
Brooks points out that these correlations do not imply causation. While the precise relationship between tax rates and economic growth is not clear, there is no evidence that lowering top marginal rates promotes economic growth. If anything, the evidence suggests the opposite — that low taxes retard growth. According to Cornell University economist Robert Frank, “If you only look at the evidence, countries with low taxes on the wealthy — and here the U.K. and U.S. stand out — have slower growth rates than countries in which the tax system is more progressive.
“Countries in which the inequality of reward is lower actually have higher growth rates in productivity. If you look over time, in the U.S., the inequality between rich and poor has grown over the past 25 years, and yet that period has been a period of slower growth than in the past.”[16].
Of the 29 industrialized countries in the OECD, only Canada, New Zealand and Australia have no inheritance tax. These taxes typically kick in at a very high rate and affect only the wealthiest 5-to-10% of the population. The absence of an inheritance tax (also called a wealth transfer tax) in Canada is an enormous advantage to the wealthy, a gift from other taxpayers of $3 billion a year to the richest Canadians.
Nearly half the OECD countries also apply a net wealth tax on their wealthiest citizens, amounting to 1-to-2% of their net worth each year. These taxes, applied to a person’s net assets or net worth, have a very high exemption rate so that they apply only to the wealthiest 5-to-10% of the population. According to Brooks, such a tax in Canada would easily bring in $1 billion in additional revenue.
The effect of not having these two taxes has been a huge and growing gap in wealth — a gap that is far greater even than the income gap in the market part of our economy. The failure to tax wealth contributed to a tripling of the number of millionaires in Canada between 1989 and 1997, to 220,000. Estimates are that this number will triple again by 2005[17]. And, as the Centre for Social Justice documented in its 1999 study The Growing Gap, the gulf between rich and poor is growing at an unprecedented rate, especially since 1993. This growing gap is in part due to the failure of the tax system to moderate the inequities of the market as it used to do, and in part to the erosion of transfer programs.
The tax system, the calls for deep cuts notwithstanding, has clearly not had a negative affect on the investment activities of wealthy Canadians. On the contrary, they are getting increasingly wealthy as a result of that system. In part, this is because capital gains and dividends income from stocks, a major source of income for the wealthy, are still taxed at preferential rates so that income from investing is taxed at a lower rate than income from working. In addition, the interest paid on money borrowed in order to invest is tax deductible.
In any case, there is no evidence for the claim that wealthy people will automatically invest in jobcreating, productive activity if we reduce their taxes. It is not simply the availability of extra savings that determines the level of productive investment. Demand for goods domestically, and demand for Canada’s exports abroad, determine whether or not new plant and equipment come on stream.
In the absence of new demand, investment goes abroad or into speculative activity in the stock market, currency markets, and the like. While individual investors may benefit from this activity, the country as a whole does not.
One of the most popular myths being promoted by business think-tanks such as the C.D Howe Institute and the Fraser Institute, is the notion that our tax system is so out-of-whack with that of the U.S. that it is causing a huge brain drain to that country. Canada’s income tax rate is significantly higher than it is in the U.S. and this is the alleged source of the “exodus” of high-income earners to that country.
This claim, however, is grossly misleading, focusing as it does on a very small part of the picture, in a very short time frame, and intended to create a crisis atmosphere. Once created, the “crisis” can only be dealt with by an immediate and dramatic decrease in taxes.
According to an October 1998 StatsCan study, there has been a net outflow of university-educated people from Canada to the U.S. in the 1990s of approximately 8,500 per year. But, overall, Canada benefits from an enormous brain gain from other countries. During this same period, Canada received 32,800 university educated immigrants — a net gain of 24,300 highly educated workers. This holds true for engineers, computer scientists and natural scientists.
The StatsCan study concluded that, while Canada was losing a small number of skilled workers in key occupations to the U.S., “the numbers are: small in a historical sense, small relative to the stock of workers in these occupations, small relative to the new supply of workers in these disciplines, manifold smaller than the influx of immigrants into these occupations.”
It is not at all clear that even those who are leaving are doing so because of high taxes. The fact is that U.S. universities and some high-tech companies are prepared to pay higher salaries, sometimes much higher, to get skilled labour. The U.S. is 10 times the size of Canada and has that many more opportunities, so it is hardly surprising that some Canadians would be attracted there.
The extent to which there is a small brain drain now has more to do with Canada’s macroeconomic policies than with its tax policy. The Canada-U.S. free trade deal and NAFTA have made it easier for professionals to work in the US. And our disastrous zeroinflation policies of the 1990s were in large part responsible for driving our unemployment rate up nearly twice as high as the rate in the U.S.
Add to that the draconian deficit reduction policies that gutted the civil service, and you have the explanation for the vast majority of the so-called brain drain. Most are not leaving private sector employment; they are unemployables in a public service cut to the bone.
StatsCan figures show that cuts to Medicare, the slashing of university budgets, and the gutting of federally-funded research and development have left thousands of highly educated Canadians with nowhere to work. Tax levels don’t even enter the picture. As much as 40% of the graduating classes of nursing colleges go directly to the U.S. If Canada were serious about reversing the current net outflow of skilled workers to the U.S., it would reverse the severe cuts to post-secondary institutions and research councils, and implement policies explicitly aimed at reducing unemployment.
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The constant whining by high-tech firms about the exodus of highly-skilled workers tells more about the firms themselves than about the tax system. First, they are unwilling to pay as much as their American counterparts. The low Canadian dollar is partly to blame; but Canadian firms could still afford to compete overall because the Canadian corporate income tax system is more generous — 27.4% compared to the U.S. effective rate of 40%.
Labour costs in Canada are also much lower than those in the U.S. in general, in part because our publicly- funded Medicare saves employers millions in medical premiums that U.S. employers are obliged to pay.
As Neil Brooks points out, the arguments about flat taxes — and taxes in general — reflect fundamental differences in definitions about what is a good society. He asks: even if there was a significant exodus of high-income individuals because of our higher taxes, “is the loss so serious...that Canadians ought to yield to the pressure...and refashion their public policy to accommodate them?” According to Brooks, this isn’t just a matter of tinkering with a single tax policy, but goes to the heart of what we as a democratic society wish to do about the unfair distribution of our national wealth.
The brain drain issue, though exaggerated, highlights what anti-free trade activists argued throughout the debates about the FTA and NAFTA: that these agreements would put pressure on Canada to harmonize its policies with the more free-market policies of the U.S. This is exactly what has happened.
Not only are standards of health and education declining toward American standards, but we are now told that we have to harmonize our tax system downwards, as well, to match the U.S. system.
Fortunately, the vast majority of Canadians do not make their decisions exclusively on the basis of how much income they can make or the level of taxes they pay. Most are not attracted to the U.S. because it has a weaker communitarian value system, higher crime rates, and impoverished social programs — particularly with respect to Medicare.
Those who stay regardless of higher pay in the U.S. do so because they value what we have built in Canada. Perhaps the real story is not how many Canadians are enticed to move to the U.S., simply on the basis of economic gain, but how many more choose to stay in Canada.
[14] Edmonton Journal, Mar 16, 1999.
[15] Brooks, CCPA Monitor, July/Aug. 1999.
[16] “Drowning in Stuff”, Part 1 by Jill Eisen, Ideas,
CBC Radio, May 4, 1999.
[17] Survey by Ernst and Young, quoted in the Globe
and Mail, Nov 11, 1997.
| Ten Tax Myths |
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