April, writing it down on a single line, subtracting contributions to RRSPs and
pension plans and a few other deductions, and then calculating the income tax
that you owe to federal and provincial governments. The form is just a page and
is so simple that most Canadians don’t need to go to an accountant or spend
money on an electronic program to calculate their returns (1).
Sound like science fiction? Not really. This proposal for a simple
income tax has been made numerous times in the past both in Canada and other
countries. The federal government even took it seriously enough that the Goods
and Services Tax form is a page submitted to Canada Revenue Agency.
The only thing that gets in the way of putting a stake into the heart of
complex and distorting income taxation are voters tolerating special interest
groups pleading for targeted preferences and politicians enacting special
provisions to attract votes. We could devise an income tax that is fair, simple
and pro-growth if voters rose to the occasion and voiced their displeasure over
a tax system that has gone off the rails.
Simplification would be a major disruption, but well worth the effort. Some
people would pay more tax and others less in a tax reform that yields the same
revenue, but the long-run economic benefits will appeal to voters. Only
accountants, lawyers and tax economists like myself will regret a shift to a
simple income tax since the demand for advisory services will drop like a stone
So what would a simple income tax look like? Taxpayers would receive their
usual T4 forms indicating income received from their employers. Those with
self-employed income would need to have their business income calculated
according to accounting principles — but with a twist that I explain below.
Taxpayers can then deduct contributions to registered saving and pension plans
without limits and add withdrawals from these plans to their income. Or they can
put money in Tax-Free Saving Accounts or housing as much as they wish without
limitation. Withdrawals from TFSAs or the sale of a house would not be taxable
as in the current situation. Some other limited deductions could be provided,
but far less than now.
Once the taxable income is calculated, a tax schedule is applied that would
exempt the first tranche of income from tax with higher tax rates applied to
income above various brackets, as in the current system.
So you might be wondering what has happened to other components of income
such as dividends, interest and capital gains, and deductions such as borrowed
finance? Why aren’t they included in income calculations? The beauty of the
simple income tax is that much of the complexity and distortions involved with
the treatment of capital gains/losses, business, property and rental income is
A simple income tax applies to what people consume rather than what they
receive as income from work and investments. Savings are deducted and
withdrawals from savings accounts to consume are added to the tax base.
Alternatively, savings contributed to TFSAs and to consumer durables such as
housing are not deducted from earnings nor are withdrawals taxed.
point is that the return on saving is not taxed (4). The TFSA
system that exempts the return on saving is like the RRSP by exempting
investment returns. The main difference is that a person prepays taxes under the
TFSA since contributions from plans are not deductible. With the RRSP, tax
savings from contributions would be equal to the tax paid on withdrawals, after
taking into account the time value of money.
Under the simple income tax, interest expense and other investment-related
expenses are not deductible either (5). This is far simpler
than the existing income system, which keeps track of all components of capital
income and expenses.
Business income is also simpler to calculate (6). Under the
simple income tax, capital investment is deducted from the tax base, just like
savings contributed to registered plans are deductible. Asset sales would be
fully taxed. No need to figure out depreciation schedules or deductions for
interest and other investment-related expenses since the initial investment
costs are fully deducted (7). Financial income received by the
business is also exempt.
The corporate tax would also be transformed from
today’s complex system into a simple business income tax with investment
expenditures deducted from the tax base but without deductions for depreciation
and borrowing costs. Banks and other financial traders would pay tax on their
net yields (the difference between investment income and expenses), which is the
return for a financial trader’s effort.
Corporate taxation can also be simplified by eliminating special preferences
for small businesses that ultimately discourage growth. All corporations will be
taxed at a single rate. Owners receiving cash dividends from businesses can
claim a tax credit equal to the amount of business level taxes paid according to
their share of ownership.
A simple income tax is also more fair and better for the economy. Under the
existing income tax, savers are more highly taxed than consumers. Consumers pay
tax on earnings, but if the money is spent on goods and services, there is
nothing left over to tax further. Savers, on the other hand, pay taxes on their
earnings as well as any income derived from their savings. In other words, the
existing complicated income tax discriminates against savers.
Taking the onerous tax off saving would be a boon to the economy
(8). Individuals will get a higher yield on their investments
(9). This is especially true today since the existing income
tax applies to income without an adjustment for inflation that erodes the
purchasing power of their savings. Exempting the return on saving allows people
to accumulate faster wealth for retirement purposes and unexpected
contingencies. Most important, it removes the shackles on entrepreneurs to grow
their businesses and improve worker productivity (10). And a
simple income tax won’t discourage risk-taking, which is critical to an
innovative economy (11).
Some might argue that a large portion of savings is in upper income groups
and should therefore be subject to tax in the interest of making the rich pay
more. However, one can still achieve a fair tax system based on consumption with
lower-income households paying less tax than others. This is achieved by
exempting the first $15,000 or so in income with a progressive rate schedule
applied to earnings above the exemption level. As for those who accumulate large
estates to pass onto heirs (which is a form of personal consumption), unsold
assets at time of death could be subject to deemed realization and taxed,
similar to the current treatment of capital gains and RRSP assets, except more
Voters should demand their federal and provincial governments quit using the
tax system to engineer society. The current income tax provides deductions or
credits for a host of expenditures, many of which are unnecessary, including the
lifetime capital gains exemption, transit passes, child fitness credits,
investment tax credits, flow-through share credits, etc. With fewer special
deductions and credits, less work for auditors and taxpayers is needed to
determine eligibility (12).
Of course, getting rid of all deductions is not necessarily desirable. A
deduction for education costs is like investing in one’s human capital (student
loan interest should not be deducted since tuition fees and other education
costs are expensed (13) ). Also, some expenses are incurred to
earn a living, such as child care and disability costs, which would be
maintained to achieve fairness (14). Other tax credits or
deductions are more controversial. Charitable contributions might be viewed as
another form of consumption and, therefore, inappropriately deducted from income
tax payments as a credit. Others might view that governments should share the
cost of charitable contributions given by donors to support the public good.
Research and development credits may be continued as an alternative to grant
support to make sure that innovators take into account their profitability and
the gains made by the rest of society from their inventions. Nonetheless, it is
far from clear whether the grant or tax system need be used for
The tax system has been used to provide refundable credits such
as for child support and to make the GST/HST more equitable for lower-income
Canadians. Canada has been particularly adept in shifting income support from
public welfare spending to refundable tax credits to make it easier to determine
income qualifications. This could continue under a simple income tax system.
Except for a few cases, however, most existing credits and targeted
preferences can be eliminated to keep the tax system simple and less distorting
on economic decisions. Fewer targeted preferences allow governments to keep tax
rates as low as possible (15). And what about the unit of
taxation: would it be the family or individual? Just like it is fair to make
sure that people of different types are taxed similarly, a good tax system would
ensure families of different types (singles, couples with both or only one
person working, families with children) bear similar tax burdens after
accounting for living costs. The burden of taxation should not fall more heavily
on some families such as single earners with kids compared to others. Family
taxation would simplify the tax system by reducing rules to prevent income
splitting and relying on other provisions to apply family taxation on an ad hoc
The existing Canadian system is a hodgepodge: taxpayers file as individuals
but family relationships are used to determine taxes. We allow exemptions to be
transferred between spouses. We determine eligibility of refundable tax credits
based on family income. We also provide income splitting for pensions, CPP
benefits and RRSP contributions.Despite various rules to limit income splitting,
high-income taxpayers have certain opportunities to split income with spouses
when non-employment income is involved. And the Conservatives are considering
broadening income splitting to include couples with children, which is another
piecemeal approach to family taxation.
A simpler approach is to move towards a full system of family taxation such
as they have in France. Income earned by members of a family (spouses and
children) would be aggregated. The amount would be divided by a quotient
reflecting the number of people in a household (for example, one for each adult
and 0.5 for each child). Once the per capita income is determined using the rate
schedule, per capita tax is calculated and then multiplied by the quotient to
determine the family’s total tax payment. Some of this may seem complicated, but
the simple income tax being proposed here is far better than the current system
and less distorting. Some parts of a simple income tax will continue to be
complex because the world is complex, particularly with respect to business
taxation. Complicated rules involving business income would remain, such as
rules around derivatives and international transactions, even if financial
income and expenses were excluded from the tax base (17). For a
majority of taxpayers, these rules will not be important.
Of course, the simple income tax is only one tax to be paid. Other taxes such
as payroll contributions for CPP and Employment Insurance will continue. The
GST/HST, various excise taxes and property taxes will also continue to be paid.
Other taxes add to complexity, but it is difficult to raise income tax rates to
make up for tax reduction in other areas. Besides, if some taxpayers try to
evade the simple income tax, they will have to pay others.
If Canadians want lower taxes, then spending must be curtailed so that
governments won’t need so much money. The next time you hear a politician
promise another tax break for some special group of taxpayers, think how much
that hurts the economy and you as a taxpayer. It’s time to simplify the system
and reduce its onerous impact that undermines economic growth.
Jack Mintz www.FinancialPost.com
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