Finance Committee on March 31st, 2008

[Prof. Jim Davies]

That's an interesting question. Most countries tax husbands and wives independently. In addition to the example of the French system, there's the U.S. system, where most husbands and wives are taxed jointly. For example, when teaching I find that a lot of people are aware that's how it's done in the U.S., and the question arises of whether we should we think of taxing the family unit rather than the individual.

Actually, I had an experience with this back in 1992. I presented a paper at a conference arguing that we should think of doing this, or at least figure out how much inequity we're introducing by taxing people separately rather than as families. There was a very strong negative reaction from people at the conference. There was a very strong feeling, not just from people at the conference, but also from others I spoke to back in the early nineties, that the independence of husbands and wives was too important and too fundamental or central to our outlook at the moment to think of aggregating their income and taxing them as a unit. So I've been discouraged about such initiatives.

[Jean-Yves Laforest, Bloc, Saint-Maurice—Champlain, QC]

Let me stop you there. You talked about women being independent of men. That is exactly what is behind my question.

Does our system really allow men and women to be equal? In the great majority of cases, the man has a higher income. Deductions usually go to the higher income in a family when they could go to the lower income, the woman's. So the woman often loses deductions. She does not benefit from them herself. Contrary to what you are saying, it is not clear that the present system encourages men and women to be independent.

[Prof. Jim Davies]

Yes, I think you're making a good point. It's a complicated issue, because there are downsides as well as upsides.

If you tax a husband and wife together and one of the partners has been out of the labour force and is thinking about perhaps taking a job, their effective marginal tax rate is the marginal tax rate of the family. If the primary earner is earning $70,000 or $80,000, that is a high marginal tax rate; whereas in our system, when the secondary earner thinks of going into the labour force, the first $10,000 approximately is at a zero tax rate. Actually, that's not quite right, but they enter independently, so they enter at the bottom of the tax schedule and there is more incentive for them to enter the labour force, as they're taxed more generously.

Another point to make is that as tax structures are flattened, this becomes a less serious issue. Now, if you actually move to a flat tax, the issue would largely go away. So I would hope that we would continue to flatten the tax structure in the future, and maybe then it won't be so important.

These are good points that you're raising, ones that are well worth examining, I think.

[The Chair, Conservative, Rob Merrifield]

Thank you very much.

We'll now move to Mr. Menzies, for seven minutes.

[Ted Menzies, Conservative, Macleod, AB]

Thank you. We will bear in mind that we only have seven minutes, which I'm going to share with my colleague, Mr. Del Mastro.

Thank you to both of you. Your presentations have certainly stimulated a lot of questions, so we'll try to keep this very tight.

You both raised the issue of the top rate being too low. We've raised the lowest rate and taken a lot of people off the tax rolls completely. I'd like an answer from both of you on whether we should consider reducing the number of tax brackets. Is this the direction we should be going in? Would it be a positive move? Great Britain has moved toward that. Should we be considering this to make it fairer?

[Prof. Jim Davies]

I don't think the number of tax brackets is that crucial, because if we wanted to flatten our structure—which I certainly advocate—we could reduce our 29% rate and our 26% rate.

It's probably a good thing that the bottom rate went down over the years from 17% to 15%, but we still have this 29% top rate. This top rate I would like to see come down—and that will flatten the structure.

Sometimes, in order to achieve flattening, you have to add a bracket. So when we added the middle-income bracket from about $70,000 to $120,000, it actually helped to flatten the structure, because there's a 26% rate there instead of the 29% rate.

So I think there are different ways you can approach this; you don't necessarily have to reduce the number of brackets.

[Prof. Jon Kesselman]

I would concur with Jim that the number of brackets in itself is not a crucial concern for policy. As I said in my presentation, I think that the threshold for the top rate should be higher, but I do not necessarily think that the top rate of 29% is excessive in terms of either incentives or in comparison with other countries.

I think some issues of high marginal tax rates on upper earners really come out of the provinces--Ontario in particular, with its rate schedule and surtaxes labelled as, whatever, a health care tax. The provinces are the places to look for flattening of rate schedules. The progressivity in the federal rate schedule is appropriate. If you want progressivity in a tax system, as many people do, it should be at the federal level much more than at the provincial level.

[The Chair, Conservative, Rob Merrifield]

Mr. Del Mastro.

[Dean Del Mastro, Conservative, Peterborough, ON]

Yes, thank you.

Thank you both for your presentations today. I thought they were well thought out and very comprehensive.

First of all, Mr. Kesselman, you talked about the need to transition retail sales taxes into value-added taxes. I wrote a paper on that very recently. One of the things I agree with you on—and maybe you could touch a little upon this—is you specifically said the way taxes are applied is much more important than the rate. Could you expand on that a little—why where a tax and how a tax is collected is more important than what the rate may be?

[Prof. Jon Kesselman]

The design or structure of a tax affects the kinds of incentives and inefficiencies imposed upon the economy. Some taxes are simply much more inefficient. Let's say most taxes are inefficient, but some are much more inefficient than others, which leads to, I'd say, almost a consensus among tax economists that taxes on capital and investment income and business income are more distorting to the economy than taxes on consumption or labour income, which leads to the preference for consumption-based types of taxes, whether they're done through sales-type taxes, indirect taxes, or through direct personal taxes like what we call our personal income tax.

The evidence for this is cross-national. The countries with some of the highest tax overall burdens in the world are those of Scandinavia, the Nordic countries, the Netherlands. They're still able to perform very well as economies, but they do it through sensible tax structure.

Now, this does not mean that you or I have to favour a very high tax level. That's a matter of choice. But it's saying that whatever level of taxes we want, whether we want big or smaller government, we should pursue a structure that promotes growth and economic efficiency, and that pushing the tax system even further toward consumption-based and labour-income-based is the way to do it.

[Dean Del Mastro, Conservative, Peterborough, ON]

Can I ask you very briefly, because I have one other question I want to get to, whether it's your view that there should be very few instances when products or services may be excluded from value-added taxes? Should it be very uniform in how it's applied? Is that preferable?

[Prof. Jon Kesselman]

As an economist, I think it's preferable that what should be in there are groceries, everything, but you as political experts know that this is not an easy road to follow. Some countries—look at New Zealand and Australia—have in the past decade brought in GSTs of their own with broader bases than Canada, but it is politically tricky and difficult to gain public acceptance for an even more broadly based type of GST.

[Dean Del Mastro, Conservative, Peterborough, ON]

Thank you.

I'd like to ask you both your opinion on a flat tax replacing the current marginal system, and whether you think it would be better, or what have you, than the current system.

[Prof. Jon Kesselman]

Okay, I'll try to do that quickly.

I do not feel a flat tax is appropriate for Canada at the federal level. Alberta has a flat tax. I think it is acceptable at the provincial level because of interprovincial mobility of labour. At the federal level, if we want any progressivity in our overall tax system, given the regressivity of indirect sales taxes, property taxes—all the others—we need significant progressivity in the rate schedule of our federal direct tax.

[Dean Del Mastro, Conservative, Peterborough, ON]

Go ahead, Mr. Davies.

[Prof. Jim Davies]

That's another area in which we differ.

I think a flat tax is a progressive tax as well, because there always is a basic exemption of a certain amount. If you look at Alberta, it's fairly healthy. Normally in flat-tax proposals what people put forward is an increase in the amount of basic income that's exempt, so that the proposals normally deliver a benefit to low-income people. They also deliver a benefit to very high-income people—that's inescapable—but if you arrange it so that there's sufficient benefit to the low-income people, then many observers who look at it will say that on distributional grounds it may improve things.

Another point to keep in mind is that the marginal tax structure doesn't just come from the personal income tax system. It also comes from the CPP, EI contributions, and clawbacks. When you add them all together and look at the effective structure of marginal tax rates, actually the marginal tax rates are at the highest for some of the lowest-income people. Beyond that it's a bit jagged if you add the whole thing up, but the marginal tax rate on average is about constant as you go up, because the very high-income people are not making EI and CPP contributions, for example, on their marginal income, and the two things just cancel out.

Some people think one could rationalize this whole system and simplify things by having one constant marginal tax rate for everybody. This would be a very radical reform. It would require a wholesale rethinking of the whole system, but I think if people are thinking about flat-tax ideas, they ought to think in those terms.

[The Chair, Conservative, Rob Merrifield]

Thank you very much.

We'll now move to Mr. Pacetti.

[Massimo Pacetti, Liberal, Saint-Léonard—Saint-Michel, QC]

Thank you to the witnesses for appearing.

Part of the reason that we came up with this study was not to try to see how the government is going to spend the money, but rather how it's going to raise the money to spend later on. I don't know if that's English.

It could be any government, but if we use this government as an example, they've been doing different things. Just in the last two years, they've cut consumption taxes--GST--but they've also cut personal taxes and corporate taxes. For argument's sake, let's say the government needs x number of dollars. If we use a number of $200 billion or $300 billion or whatever, what is the best approach? Would it be to have a consistent approach and just reduce one type of tax, whether it be corporate, consumption, or personal, or is it best to do a bit of sprinkling everywhere? That would be the first question for both Mr. Kesselman and Mr. Davies.

Mr. Kesselman, would you comment?

[Prof. Jon Kesselman]

We can look back at what's been done, or we could ask going forward. Now, going forward, I don't think there's much room in the federal accounts to do significant further cutting in the next year or two, but let's think hypothetically: if there were room to cut taxes, where should they be cut? Should they be spread out, or should they be concentrated anywhere? I believe the move started under the previous governments, which is continuing and being pushed further by the current government, is that to cut corporate tax rates is generally desirable, but whether heading toward a 15% federal corporate rate goes a bit further than we need to is certainly open to debate. I believe--

[Massimo Pacetti, Liberal, Saint-Léonard—Saint-Michel, QC]

I'm sorry, Mr. Kesselman, but we have limited time.

If we decided that corporate tax was the way to go, what would be the result? What's the next step? What will happen if we cut corporate taxes? Will it stimulate the economy? What will it do?

[Prof. Jon Kesselman]

In general, it should be helpful to business investment. It should also be helpful in some offsetting ways to federal revenues, as corporations will tend to shift more of their revenues into Canada, and they'll tend to shift out of Canada to claim as costs such things as interest financing. They'll shift to other jurisdictions where they operate that have higher rates.

[Massimo Pacetti, Liberal, Saint-Léonard—Saint-Michel, QC]

Do we have examples of places where that's had positive results? Would Ireland be one?

[Prof. Jon Kesselman]

Yes, Ireland is the so-called poster boy of the corporate tax cuts.

[Massimo Pacetti, Liberal, Saint-Léonard—Saint-Michel, QC]

What would the Scandinavian countries do? Are their corporate rates low?

[Prof. Jon Kesselman]

The Scandinavian countries have cut corporate rates, and at the personal level they have cut to kind of a flat rate on investment-type incomes, while retaining progressive rates on individuals' labour earnings. I think that is another way to pursue the general goal that I was espousing earlier.