A RADICAL ANALYSIS OF PERSONAL TAXATION

Harry Hillman Chartrand ©
Compiler Press Review #4, January 2000

Executive Summary

The Final Report and Recommendations of the Saskatchewan Personal Income Tax Review Committee was published in November 1999.  In addition to recommending the Province investigate other issues raised during conduct of the Committee’s work (R#7), it recommended that the Province:

(a) adopt a ‘tax-on-income’ approach to personal income tax allowing the Province to set its own tax brackets, deductions and definitions of taxable income  independently of the federal government (R#1);

(b) reduce income tax on all income classes (R#2, 3, 4, 5 & 8)

(c) reduce the rate but broaden the coverage of the provincial sales tax (R#6); and,

(d) compensate lower income citizens for the regressive impact of the broadened sales tax through increased public spending (R#6). 

          Constrained by its mandate and professional optic, the Committee’s recommendations fail, in my opinion, to address the near revolutionary times faced by public finance in Canada - on both the spending and tax sides of the public finance coin including:

a)  the definition of ‘person’ is changing as:

• the traditional family is complemented by new forms of dependency including single-parent families, same-sex couples, adult children remaining dependent on aging parents and aging parents becoming more dependent on adult children;

•  the corporation becomes more a citizen of the world and less a corporate ‘citizen’ of any given jurisdiction leading to tax competitiveness between jurisdictions; and,

• medical genetics and the insurance industry extend the definition of a flesh-and-blood human being to include clones and cryogenic ‘persons’.

b) the increasing incidence of ‘self-employment’ and a corresponding increase in income tax avoidance and evasion;

c) consumer sales taxes become increasingly important as a source of Government revenue just as they too are likely to decline as e-commerce grows and the Internet remains a ‘tax free zone’’; and,

d) the economy continues its transformation into a global knowledge-based economy in which intellectual property becomes an increasingly important source of both corporate and individual income.

          The shift from a ‘tax-on-tax’ to a ‘tax-on-income’ approach for Saskatchewan personal income tax does, however, offer a significant opportunity for the Province to creatively adapt, adjust and evolve in response to the changing reality of public finance.   Among the adjustment I recommend are:

a) a shift from a personal income tax focused on ‘support of the family’ to one focused on ‘support to dependents’;

b) a shift from a strategy (including tax expenditures) of encouraging a ‘corporate tax haven’ to a ‘creativity haven’ approach designed to attract and retain highly qualified talent in the arts, sciences and humanities by, among other things, exempting income earned from intellectual property rights from individual income taxation; and,

c) a shift from compulsory to voluntary taxes (that is, sin taxes on what are currently treated as punishable ‘victimless crime’) that citizens are eager and willing to pay and which, unlike consumer sales tax, will not decline in response to the growth of e-commerce, self-employment and the globalization of corporations.

0.0 Introduction

0.01   This paper was written in response to the Final Report and Recommendations of the Saskatchewan Personal Income Tax Review Committee (Regina, November 1999).  The paper is composed of four parts. The Introduction places personal income tax within the broader context of public finance that includes public spending (fiscal policy) and taxation (tax policy).

0.02  The second section critiques the Committee’s mandate, constraints and criteria.  It also questions the Committee’s conventional definition of ‘person’.

0.03  The third summarizes the Committee’s recommendations and extends them into the emerging global knowledge-based economy. 

0.04   Finally, Conclusions sum up my observations and opinions regarding ‘personal’ taxation in the future. 

0.05   While the situation of Saskatchewan is specific, my extensions, observations and opinions are generally applicable to any jurisdiction in Canada.  In addition, it is my hope that the paper will induce a broad public debate about personal taxation and the cultural maturity and economic competitiveness of Canada – all the Canadas – North, East, South and West.

Pleasure & Pain of Public Finance

0.06   I begin with five assumptions.  First, there are two sides to the coin of public finance – pleasure and pain.  The pleasure (including relief from pain) flows from spending public monies – fiscal policy.  Pain flows from collecting private monies to pay for public spending – tax policy.  Like carrot and stick, a democratic government-of-the-day uses public finance to adjust, adapt and evolve society and the economy towards its ‘ideological’ goals and objectives.

0.07 Second, the only way to gain more pleasure without more pain is through a growing economy.  In the long run, however, a growing economy can be maintained only if public finance does not “kill the goose that lays the golden egg”.

0.08  Third, rational citizens will do their best – in or out of a growing economy - to minimize their pain and maximize their pleasure through lobbying, protests and voting.

0.09  Fourth, in their annual budgets, federal, provincial and local governments flip the coin seeking a politically workable, socially desirable, balance between the ‘heads-I-win’ and ‘tails-you-lose’ of public finance.

0.10   Fifth, the game of public finance is worth playing, at a minimum, because of ‘market failure’, that is:

(a) there are some goods and services (public goods) essential to modern life that cannot be produced by the private sector, e.g. municipal bridges and roads, compulsory mass education, contagious disease immunization, national defense, etc.; and,

(b) perfect competition is not common in the ‘real world’.  Usually some players in the economy (typically a small group or oligopoly) exercise market power over the price and quantity of goods and services available to consumers. The existence of such ‘market power’ justifies a public response including spending, e.g. funding anti-combines agencies, and, taxation.

Ground Rules

0.11 Beyond the constitutional reality that public finance is conducted in the name of Her Majesty in right of Canada and in Her right of each of the ten Provinces, there are five ‘ground rules’ for this annual coin toss:

(a) the Constitution establishes, in broad terms - subject to varying interpretation:

·  on what federal and provincial governments can spend;

·  by what means they can raise public monies; and,

·  in subordinating local to provincial government;

(b) three legal systems interactively define persons, property and taxation in Canada: 

·  criminal law, the prerogative of the federal government but with administration shared by the Provinces;

·  civil law, essentially the responsibility of the Provinces with Quebec being the extreme case governed by a variation of the European Civil Code rather than Anglo-American Common Law as in other Provinces, e.g. torts (non-contractual damages) based on precedent (Common Law) rather than principle (Civil Code); and,

·  tax law, a shared responsibility of the federal and provincial governments;

(c) the federal government ‘owns’ the coin through the Bank of Canada and influences its value through exclusive control of monetary policy;

(d) the federal government can define and redefine what are legitimate sources of public monies, e.g. income tax introduced during WWI as a ‘temporary’ war measures act, and, the 1970 amendment to the Criminal Code permitting lotteries (gaming in general including ‘video lottery terminals’ or slot machines) to become an increasingly significant source of public monies for the Provinces; and,

(e) the federal government indirectly influences settlement of public finance disputes with citizens and the Provinces through its prerogative of appointment to the Federal (formerly the Exchequer Court) and the Supreme Courts of Canada.

Putting the Question

0.12 Within these ground rules, each senior level of government annually puts the following questions to the people:

·  who or what will enjoy public funding: the poor and needy; the average citizen; the corporate citizen; city or rural dwellers; foreigners, i.e. foreign aid; and/or, abstract policy categories such as education, the environment, health care, protection of persons and property, etc;

·  what pleasures will they enjoy, e.g. direct dollars in the pocket (grants in aid), civil service employment, public infrastructure and essential services, investment and/or loans in support of private and/or semi-private ventures, and/or relief from taxation e.g. tax expenditures including refundable and nonrefundable tax credits;

·  how much pleasure will be allowed, e.g. marginal or significant to the life of citizens – corporate or individual; and,

·  when will the pleasure be provided, e.g. weekly, monthly, quarterly, annually?

0.13  Similarly, each government annually puts the following questions about the pain of public finance - direct and indirect, ‘near’ and ‘voluntary’ taxes - to the people:

·  who will suffer so they and/or others may ultimately enjoy the pleasures of public spending;

·  what forms of pain must citizens endure, e.g. corporate, excise, income, near taxes (e.g. fees-for-service), sales and/or voluntary (e.g. lotteries) taxes;

·  how much pain from any one and/or all taxes - should one person or any ‘class’ of taxpayers bare (tax burden);

·  when and by what means should they suffer, e.g., monthly, point-of-sale, quarterly and/or withholding-at-source; and,

·  at what threshold should the quality and/or quantity of pain change or stop, i.e. what are the tax brackets?

1.0 The Committee and Its Mandate

1.01    The Review Committee received its mandate from the Minister of Finance of the Province of Saskatchewan in May 1999.  It was to investigate the structure of Saskatchewan’s personal income tax and consider alternative strategies.  In this regard, it was specifically asked to review the ‘tax-on-income’ approach to Saskatchewan’s personal income tax.   The Committee issued its final report in November 1999.

1.02   The current Saskatchewan personal income tax is a fixed percentage of federal income tax (currently 48%).  This approach accepts existing federal tax brackets, deductions and definitions of taxable income. The Provinces can then apply special taxes on federal taxable income, e.g. the Saskatchewan flat tax.  Provincial income tax revenue is collected by Revenue Canada (except Quebec) and then redistributed to the Provinces.  This is called the ‘tax-on-tax’ approach. 

1.03   The ‘tax-on-income’ approach would allow the Province to set separate tax brackets, deductions and definitions of taxable income.  Federal income tax would continue to be determined using federal brackets, deductions and definitions.  Revenue Canada would also continue to collect provincial income tax revenues and redistribute them to the Province.  The ‘tax-on-income’ approach was made possible by changes to various tax collection agreements between the Provinces and the federal government.

1.04  Shortly after beginning its efforts, however, the mandate of the Committee was extended to include all ‘personal taxes’ in Saskatchewan, not just income tax.  The expanded mandate encompassed corporate taxes (capital, income and payroll), health insurance premiums (a near tax), and the provincial sales tax.  Only limited reference was granted, however, to review resource revenues, e.g. mining and timber taxes as well as related user fees.

Constraints

1.06   All three members of the Committee were ‘accountants’.  As with all disciplines of thought and practice, accountancy molds practioners to ‘see’ through a shared paradigm or ‘window frame on the world’.  In addition, professional practice required the Committee (like all public commissions) to operate within its Ministerial mandate. 

1.07   From within this conceptual goldfish bowl, the final report proposes (with the notable exception of a move to a tax-on-income approach) incremental variations on existing categories, schedules and themes.  It is not a radical report. 

1.08   This paper, however, offers a ‘radical’ assessment of Saskatchewan’s system of ‘personal’ taxes.  It is radical in that it goes to the root meaning of the terms and concepts used by the Committee including the elemental one: who is a person and therefore who is the ‘source’ of personal taxation? 

1.09   In effect, the Committee accepts two Common Law ‘legal fictions’:

· corporations are ‘persons’ with the same rights (but generally greater means) than a flesh-and-blood human being.  Under the Civil Code, by contrast, there are certain ‘rights’ that only ‘natural’ persons can enjoy and responsibilities that only ‘legal’ persons (corporations as defined under Common Law) must bear as ‘corporate entities’; and,

·  families are ‘persons’.  Traditionally, a family is formed when two consenting adults – male and female - ‘marry’ (legally or under Common Law they become ‘one’) and who may, or may not, have children (by adoption, natural birthing and/or other means) who automatically become ‘minor’ members of the family subject to parental control. 

1.10    The definition of ‘marriage’ is, however, now at issue before the courts and subject to intense political debate at both the federal and provincial levels of government in Canada.  There is even speculation that the ‘not-withstanding clause’ of the Canadian Constitution may be invoked to prohibit widening the legal definition to include ‘same-sex’ couples in Alberta.  This controversy is raging at the same time that the biogenetic revolution is transforming the concept of ‘having children’ and a social revolution is witnessing the ‘single-parent’ family (usually with a female head) becoming more common and accepted as the status of women continues to rise.

1.11 Two other demographic factors are redefining ‘family’.  First, an aging population is leading more adult children to become principal ‘care givers’ and custodians, not only of their children, but also of their aged parents.  In addition, the number of workers, as a percent of the population, is declining meaning fewer and fewer taxpayers will support more and more dependents.

1.12 Second, with declining youth employment more and more adult children are remaining at home longer.  In France, this has led the government to offer tax incentives to parents willing to house and care for dependent adult children.

Criteria

1.13 The Committee applied four criteria in assessing Saskatchewan’s system of personal taxes.  They were, in alphabetic order:

(i) competitiveness;

(ii) fairness;

(iii) simplicity; and,

(iv) support of families.

(i)  Competitiveness

1.14    As used by the Committee, competitiveness refers to ‘tax competitiveness’, i.e. how much pain does Saskatchewan inflict on various categories of taxpayers relative to other Provinces, especially Alberta.  With respect to this criterion, the Committee essentially restricted itself to the corporate income tax rate and capital gains particularly from the sale of family farms.

1.15  The term ‘competitiveness’, however, has been imported from market economics where it has a wider and evolving meaning.  Contemporary usage extends competitiveness beyond traditional price competition to embrace ‘working smarter’ in response to demand for higher quality, more customized goods and services, globalization and technological advance.

1.16  Competitiveness is often expressed in sports metaphors such as that of former federal Finance Minister Michael Wilson’s expression "skating where the puck is going, not where it is”.  This captures the anticipative nature of contemporary economic competitiveness.

1.17   From a public finance perspective, competitiveness means anticipating the industries of tomorrow and encouraging their growth and development by creating a favourable fiscal and tax environment.  Ideally, it involves identifying and encouraging development of critical ‘factors of production’ required by these emerging industries.  A plentiful supply of such factors encourages firms to locate in a jurisdiction leading to increased employment and economic growth.

(ii) Fairness

1.17  ‘Fairness’ as used by the Committee encompasses the three public finance concepts of horizontal and vertical equity and tax burden:

·  horizontal equity refers to ‘like treatment of persons in like situations’.   It is reflected in the Committee’s concern about one- and two-income families earning the same income but a one-income family paying more in personal income tax;

·  vertical equity refers to ‘unlike treatment of persons in unlike situations’.  It is reflected in the Committee’s concern about the ‘progressiveness’ of provincial income tax, i.e. the rich should pay more than the poor; and,

·  tax burden refers to the accumulated tax impact on citizens.  It can be measured objectively as the difference between earned and disposable income, i.e. take-home pay after taxes.  It can also be measured subjectively as a sense that taxes are too high relative to the pleasures of public spending received.  If this sense becomes great enough then tax avoidance and evasion become general - up to and including ‘tax revolts’.

(iii)  Simplicity

1.21  Simplicity, as used by the Committee, refers to the ease with which a taxpayer can pay.  The Committee argues that simpler tax forms are better in that taxpayers can easily understand what and how to pay.  Simplicity, for the Committee, means minimizing the pain of extraction to the taxpayer.  There is, however, another dimension to tax simplicity - tax efficiency. Tax efficiency involves the ease and certainty of collection and tax incidence. 

1.22   A traditional appeal of personal income tax is that it can easily, with great certainty and over a long period (especially for fulltime, long-term employees) be regularly extracted ‘at source’ on behalf of the government by employers.  It is much easier to audit a few employers than many individual taxpayers.  There is similar ‘simplicity’ to sales taxes (retailers doing the collection) and other ‘withholding taxes’.

1.23  With ‘downsizing’ of business and government, self-employment has, however, become an increasing common way of earning a living.  Furthermore, the shift from a goods- to a service- to a knowledge-based economy is making the job of the taxman more difficult, i.e. counting widgets is easier than counting appointments which is easier than counting the value of knowledge. 

1.24  Furthermore, voluntary income tax compliance by the self-employed is declining; tax avoidance and evasion are rising.  A ‘gray market’ for the exchange of goods and services, e.g. a dentist providing services in return for an artwork or home repairs, is also growing.  This trend was one reason for introduction of the federal ‘GST’ in the 1980s.  The shift from income to consumption taxation is now a major trend across North America.  In Europe, income taxation has always been a secondary source of public monies.  Instead, reliance is placed on ‘value added taxes’, i.e. consumption taxes.

1.25   Another dimension of tax simplicity is tax incidence, i.e. is the tax being collected from the intended party or is it being shifted to another?  One tax in particular is subject to controversy concerning incidence – corporate income tax.  While a ‘corporation’ is a ‘legal person’ and is taxed as such, it is also a collection of shareholders and managers each of whom pay ‘personal income tax’ on their earnings from salaries, dividends, stock options, etc.  This is the ‘double incidence’ of corporate income tax.  Furthermore, there is evidence that corporations treat income tax as ‘a cost of doing business’ and simply shift its burden or incidence to consumers in the form of higher prices, i.e. shifting tax incidence.

1.25  The questionable incidence of corporate income taxation is one reason many governments (national, regional and local) willing concede ‘income tax forgiveness’ as an incentive for corporations to set up business in their jurisdiction.  In fact, ‘tax forgiveness’ has become a major tool in ‘tax competitiveness’, as defined by the Committee.

(iv) Support of Families

1.26   As noted above, the demographic, legal and tax definition of family is becoming ever more clouded.  Nonetheless, the Committee chose to use ‘support of families’ as a criterion in its assessment of Saskatchewan’s system of personal taxation. 

1.27   A clearer and more useful criterion, in my opinion, would be ‘support of dependents’.  This criterion can be applied to all situations in which a working adult citizen (male or female) has persons – adults or minors – dependent upon them for the essentials of life.   This embraces, without discrimination, the traditional nuclear family, the single parent family, same-sex couples, adult children dependent on aging parents, as well as aging parents dependent on adult children.