Mr. Speaker, it is a pleasure to switch gears a bit and talk in a non-partisan way about some matters which I think are extremely important for the country.
The debate I just witnessed, the shouting, the unpleasantness that took place here and the emptiness of the political rhetoric are the kinds of things that have turned so many people against politics. It is a sad thing to observe, sitting in the Chamber.
I would like to talk about the fact that the underground economy is widely discussed in Canada these days. In these discussions the need for lower taxes and the reform of the taxation system are regularly linked. In my remarks I will expand on these subjects drawing heavily on information which I have obtained as a member of the Standing Committee on Finance on possible changes to the GST and during a recent Fraser Institute conference on the growth of the underground economy in Vancouver.
During the recent hearings of the finance committee many witnesses noted their concern that the GST had been a major cause of the growth of the underground economy, the loss of government revenue, and the precarious state of the government's fiscal condition. These witnesses reflected their own experiences as well as those shared by researchers and the general public. There is widespread agreement that the underground economy was encouraged by the introduction of the GST. This tax induced evasion because it is visible and imposed on every consumer purchase.
Evasion is encouraged additionally by the fact that consumers do not face any penalties for non-payment of the tax. Evasion is particularly high among small firms that supply services with a high labour content. In these industries honest owners are forced by competition from just a few bad apples into operating outside the law.
The GST is not the only determinant of the underground economy. High marginal tax rates on personal income provide incentives that often reinforce the reward of evading the GST. If you are hanged you might as well be hanged for a sheep as for a lamb. Onerous regulations of business and large surcharges on labour costs mandated by the government also encourage firms and workers to operate outside the regular economy.
There are strong incentives for persons receiving unemployment insurance or welfare benefits to work in their own households as well as in the underground economy without reporting their incomes. These social security systems penalize beneficiaries with 100 per cent tax rate on reported income above only a very small amount.
Many people are particularly concerned about the growth of the underground economy because it appears to be accompanied by a change in public attitude about the morality of tax evasion. In a recent survey 71 per cent of Canadians indicated that "most people would cheat on their taxes if they knew they could get away with it". Seventy-nine per cent agreed that people who pay all the taxes they should are fools. Can we believe that? Thirty-two per cent considered acceptable the evasion of the GST by other people.
Some analysts believe that social capital in the form of honesty, which in the past has made Canadians among the most compliant in the world in the voluntary filing of their income taxes, may have been lost irretrievably.
However it is important that the government at least try to get Canadians to return to their traditional honesty by tax reforms that simplify compliance and reduce incentives to cheat by the lowering of both marginal and average tax rates. Unfortunately the lowering of tax rates under any taxation system cannot take place until spending is cut and increased revenue due to economic growth has eliminated the deficit.
Government success in this challenging task is likely to increase further the public's incentive to evade taxes because the level of real government services per dollar of taxes collected will be falling and ultimately reach a rather low level. This phenomenon is due to the fact that in the absence of debt payment a balanced budget provides the people of Canada with a dollar's worth of government services. However in a few years the debt payments of the federal government are likely to be about $50 billion annually.
If by that time program spending remains at its present level of $125 billion and economic growth under the present tax structure yields $175 billion the budget will be balanced. At that time each dollar of taxes will provide for less than 70 cents of traditional government services. Taxpayers will have little trouble rationalizing evasion on the grounds that taxes are not providing value for their money.
During the finance committee hearings and in the public media it is often suggested that the government's financial crisis could be eliminated if only somehow it were possible to tax the underground economy. The validity of this proposition depends decisively on the size of the underground economy and the possibility of forcing it into the open.
The Fraser Institute conference saw some academics present estimates of the underground economy as high as 15 per cent of national income. On the other hand government statisticians and economists suggested that it represent 5 per cent of national income at the most and that it is probably more like 3 per cent. The difference between these two estimates is due to the use of different methods for the estimation of a phenomenon that by its very nature is not known and attempts to remain hidden.
The academics use strong assumptions about the demand for money by the public to finance regular and underground economic business. Some have found the demand for cash is higher, the higher our tax rate. In fact the amount of cash used by the public is much larger than can legitimately be used in the regular economy. The excess amount is believed to be used to finance underground activities.
Analysts in the employ of the government use sophisticated accounting data to check for the growth of discrepancies in balances which if measured completely and accurately should be zero. They also engage in sensitivity analyses of data which show the academic estimates imply phenomena that simply are not observed in the real world by any standard of measurement.
Some part of the observed differences in the estimates are due to definitions of the underground economy. Government estimates focus on the amount of income that goes unreported to the tax collectors on the one hand and is unrecorded by Statistics Canada on the other. The academic estimates include illegal activities which may be as much as 1 per cent to 2 per cent of the national income.
Some academics know of the professional bias of government analysts who prefer not to be reporting that they have done their job poorly and that they tend to make continuous adjustments to their data to avoid the development of the kind of large errors the academics claim to have discovered.
While this criticism is probably unfair, there was the astounding revelation that the U.S. Internal Revenue Service has doubled its official estimate of the amount of tax evasion after a new head had been appointed. He is alleged to have decided that the estimate of 5 per cent evasion, twice that given by his predecessor, would strengthen with congress his case for more tax collectors. The IRS is now investigating its own internal auditors. Some academics noted that official positions on the issue now imply that Canadians are 10 times as honest as Americans in filing their income tax returns.
Dr. Don Drummond, deputy minister of finance for fiscal affairs, put much credence in the maximum of 5 per cent figure for the underground economy. Importantly, he noted that this figure represents a serious problem. It equals about $35 billion and, at $17 of federal revenue per $100 of national income, it amounts to about $6 billion of foregone taxes. This is not
enough to eliminate last year's regular deficit of $42 billion but enough to help significantly the fight for a balanced budget.
However, it is unlikely that the full 5 per cent of the more or less officially admitted maximum underground economy can ever be brought into the open and made taxable. Yet I would argue that the lowering of taxes might make for more tax revenue than the $6 billion suggested by the government representatives.
For one, returns from after tax legal income would rise relative to the returns from illegal activities. More important, there would be reduced incentives to produce in the informal unmeasured household sector. This effect will be enlarged considerably when the economy recovers and the number of persons on welfare and UIC is reduced.
It is believed that persons on social assistance use much of their free time to work in this unmeasured sector which is not included in the official estimates of the underground economy. They would do less of this kind of work, hire others to do it and pay with income from their own formal work. Many economists believe that this tendency would be strengthened even more if the pending redesign of social programs makes it more difficult and less rewarding to remain on social and UIC assistance.
Let me conclude by summarizing my argument. The underground economy in Canada is large and policies that result in shrinking it would result in significant increases in tax revenue. The federal government has the opportunity to achieve this outcome by the lowering of average and marginal tax rates, the elimination and simplification of regulations and the reform of the social programs.
The issues and opportunities are clear. It is time to act on them.
