Finance Committee on March 31st, 2008

[John McCallum, Liberal, Markham—Unionville, ON]

I'll share my time with Mr. Turner.

As a former practitioner of economics, I welcome both of you.

I might just mention to Mr. Wallace that one way of raising the threshold at the highest income tax is that you reduce every income tax rate and at the same time raise the threshold, which is exactly what we did in 2005 in the fiscal debate that was defeated.

I'd like to ask a general question. I had to be out of the room for a little while, and it might have been raised, but I haven't heard much talk about a general trade-off between efficiency and equity or progressivity. It would seem to me that a flat tax, while progressive for the reasons given, is a whole lot less progressive than the current system.

For example, I think Jon Kesselman's point number seven said a deduction is better than a credit but a reduction is also more regressive than a credit. I'd like to ask each of you how, in general, you balance the classic question of fairness versus efficiency in making these recommendations.

[The Chair, Conservative, Rob Merrifield]

Who would like to start?

[Prof. Jon Kesselman]

I'll be glad to start.

[The Chair, Conservative, Rob Merrifield]

Mr. Kesselman, then we'll go to Mr. Davies quickly.

[Prof. Jon Kesselman]

That balance or trade-off is not one that can be made as a social scientist or an economist. That obviously involves personal values, or from the political side of the table, it involves constituencies, but—

[John McCallum, Liberal, Markham—Unionville, ON]

Let me interrupt you there, if I may. I know that, but it means since we are the politicians, when we hear these presentations it would be nice for you as social scientists to tell us, if we're gaining something in efficiency, how much we are losing in progressivity.

[Prof. Jon Kesselman]

I will briefly address that. I will differ from Mr. Davies on the flat tax. I think it involves a large compromise in vertical equity. Most studies of the flat tax find that, yes, it would be a large tax relief for the very high income, it could be designed to avoid any tax increase on the very low income, but it would be a shift of tax burden onto a fairly broad range of middle income. In my values, I don't particularly think that's good. Politicians would have to make their own judgments.

Yes, many of the other kinds of proposals both of us have made today do have equity dimensions, both horizontal—that is, across people with the same ability to pay tax—and across income classes.

This will be my last bit on it. For example, my recommendation that we revert to deductibility for employee contributions for the social insurance plans and for medical expenses would be less progressive than the system now, but would try to restore an appropriate measure of horizontal equity—in other words, assessing people's relative ability to pay tax. Someone might have very high medical expenses, which are not part of their ordinary consumption; therefore they should not be part of their taxable base. They should be deductible.

[The Chair, Conservative, Rob Merrifield]

Mr. Davies.

[Prof. Jim Davies]

I think, really, to answer your question about how much vertical equity you are giving up if you gain more efficiency, you need a good model that incorporates these things. We'd have to crunch some numbers, and clearly we don't have those numbers here today.

On the flat tax thing, I was making the point that you need to consider the marginal tax rates that are coming from other taxes in addition to the personal income tax. If we took the personal income tax and just replaced it with a flat tax and ignored what the other elements of the tax system were doing, we'd have a bad system, which I think is in agreement with what Professor Kesselman is saying.

On the deductions, I think there's a bit of a problem in Canada: we have too much of a tendency to leap to the vertical equity question and to overlook the horizontal equity question. When we switched all of the deductions over to non-refundable credits, that was a bit of a symptom of that.

For example, on the family stuff, it's more appropriate to have a deduction for dependents than it is to have a credit. The argument is that you should tax people according to their ability to pay, and kids cost something. Part of my income morally belongs to my kids, not to me, so that ought to be deducted from my taxable income.

Sometimes we should think about horizontal equity first and vertical equity second.

[The Chair, Conservative, Rob Merrifield]

Thank you.

Actually, all of his time has gone, but I'm going to give Mr. Turner five minutes, because we have a little extra time.

You have a full five minutes, Mr. Turner. Go ahead. Then we'll close it off with Mr. Del Mastro.

[Garth Turner, Liberal, Halton, ON]

Thank you, Chair. What a sweetie.

[An hon. member]

Don't blow it, Garth.

[Garth Turner, Liberal, Halton, ON]

Yes, indeed.

Mr. Kesselman, a couple of years ago, when I was still delusionally a Conservative, we had a conversation one night, if you recall, about capital gains. We talked about the proposal that the Conservatives—Mr. Harper, as a campaigner—had brought forward about a capital gains rollover, and I asked you what your opinion was of that.

The government has not proceeded with the capital gains rollover to date. Do you think that's been a wise decision on their part? Can you articulate a little of what you see the costs involved would have been, in the program as proposed?

[Prof. Jon Kesselman]

I do recall a conversation, and in my opening presentation I stated that the “rollover of capital gains” proposal was not a good one. I even said that the government was wise not to proceed with it. I gave several reasons for it.

Just to recap them, it is a big tax windfall for disproportionately a very high-income group, a windfall in the sense that it's a reward for things that have happened in the past, not a use of tax revenues to provide incentive for future savings or future behaviour; it would have been a complex bit of legislation to draft and to enforce, which is perhaps one reason the government did not act on it earlier; and there are other, superior ways of shifting our personal tax system more toward an efficient, consumption-based system, which both Professor Davies and I have outlined here. These are things that previous governments and this government have done; that is, raising contribution limits to the RRSPs and registered pension plans, and the recent introduction of the tax-free savings account, which was under study by Finance Canada even before this government came in.

[Garth Turner, Liberal, Halton, ON]

Let me jump in there, because I see a bit of an inconsistency in some of the things you're arguing.

Certainly, arguing for larger deductions or contribution limits for RRSPs clearly favours higher-income earners. Today, I believe, 93% of all RRSP contributions go unmade; we have only 7% of contributions that are made. That seems to be a very blunt instrument of taxation policy that is not accomplishing, really, any goal right now. So I see an inconsistency there in your argument.

But I wanted to ask you as well about RESPs. We've had a big debate here in Parliament about whether RESP contributions should be tax-deductible or not. Can you give us an academic viewpoint on your position on this?

Perhaps, Professor Davies, you could chime in as well.

[Prof. Jon Kesselman]

Okay. I think the proposal that was brewing in Parliament to make contributions to RESPs tax-deductible was a bad one from the perspective of tax policy.

The reason is that the deductions would be tax-deductible, but typically the withdrawals from an RESP go into the hands of the student, are taxable in the hands of the student, and typically bear little or no tax. So there would be no tax going in and no tax coming out.

This is contrary to consumption tax principles. It is something that would have been very tilted toward high-income families in terms of what we know about how RESP contributions are done now. And they would have become even more relatively attractive to high-income earners if they were tax-deductible. So I think that was not a good way to proceed, and I'm glad the political process is not proceeding with that.

[The Chair, Conservative, Rob Merrifield]

Thank you very much.

Mr. Del Mastro.

[Dean Del Mastro, Conservative, Peterborough, ON]

Thank you, Mr. Chairman.

Mr. Kesselman, I have another question I wanted to get to, but I did want to talk a bit about the capital gains comment you made. I just want to ask you how you would suggest we put incentives in place so that stagnation of capital doesn't occur. Certainly one could argue that the current capital gains laws actually cause stagnation of capital. We have investors who stay in high-risk portfolios because they don't want to pull their money out, to be subject to tax, and that's not good for employment. It's not good for investment into new economies, into new business.

If we aren't going to contemplate changes to capital gains tax to do what you're saying, to assist people to avoid past decisions, how are we going to approach this stagnation of capital? How could we better approach it?

[Prof. Jon Kesselman]

First of all, for 95% to 98% of Canadians, they can do their savings through their pension plan, through their RRSP, and there is no penalty for selling appreciated assets in those. So this is mainly an issue for the top maybe 2% or 3% of taxpayers and a small number of other taxpayers who are unusually high savers for their income class.

You also have to keep in mind, I think, that the capital gains tax rate is half of the normal rate, so even if you're in the top bracket in a relatively high-tax province, you're paying 22%, 23%, or maybe 24% of the gain. These are not extremely high rates compared with what ordinary earners face. A person has to make their choice of whether to sell an asset or not, but even if they don't sell, on most of these we would be talking about appreciation on gains in common shares, equities. Capital is not stagnant. These are just reflecting the value of traded pieces of paper. They don't reflect the actual books and balances and cashflows of those corporations.

So I think the notion that capital is stagnant because of people being locked in due to capital gains tax is perhaps exaggerated—perhaps a phantom, even.

[Dean Del Mastro, Conservative, Peterborough, ON]

Really? Well, I'd point to the fact that I am approached by literally hundreds of seniors in my riding, and I know there are thousands across Ontario who own things like cottages. And they'd like to sell the cottage but they're going to pay a tax penalty to sell the cottage so they are holding on, waiting to see if anything will ever be done, because a lot of these cottages have gone up in value. It's not a bad thing that they would change hands, in fact, and that the seniors might reinvest into something that would more suit their current lifestyle.

I would point that out as an example of where we do see stagnation. They're still paying property taxes and they're paying expenses maybe they can't afford because they don't want to pay a tax on the sale.

So I think we do need to get our heads around it, and I'm not exactly sure what the solution is. I don't think we can rule it out of hand that it doesn't exist.

I do want to ask one more question and I'm going to run out of time if I don't. In government, I think, we're often guilty of forgetting that there is only one taxpayer. There are three levels of government but there is really only one taxpayer.

You talked a bit about property taxes. It doesn't matter if they're profitable or what have you: property taxes on businesses are very high. You talked about levelling property taxes between residential and corporate entities as being politically not popular.

On the increase we've seen recently on property taxes, are we seeing any evidence that this is actually discouraging investment in places in Canada—in Ontario, for example? Are these high property taxes affecting business decisions?

[Prof. Jon Kesselman]

Certainly property taxes enter into the total tax burden on new investment, on capital. I can't speak to Ontario, but certainly there have been a number of studies showing that high property taxes do tend to divert businesses, at least within large metropolitan areas that have different taxing municipalities. They are probably not at the top of the list of where businesses choose to locate and expand across provinces or within or outside of Canada. More important are the costs of labour, the availability of skilled labour, land costs, rental costs. On a small list, perhaps property taxes would be around fifth or sixth on that list, and they are a concern.

[Dean Del Mastro, Conservative, Peterborough, ON]

Is that time?

[The Chair, Conservative, Rob Merrifield]

Your time has gone.

[Dean Del Mastro, Conservative, Peterborough, ON]

Thank you very much.

[The Chair, Conservative, Rob Merrifield]

We'll ask Mr. Pacetti to give his final quick question--we'll allow that--and then we'll move on to the other business of the committee.