Thanks very much for the opportunity to speak to you about a very important issue.
I would like to take the opportunity to touch on some basic principles of taxation, rather than the specific details of the current system, because I think the time is ripe for some fundamental rethinking about basic taxation in Canada. The nature of the international economy has changed since this issue was last visited, and there have been some major reform initiatives elsewhere in the world.
VAT has been adopted in a vast majority of countries, with the notable exception of the U.S., and accounts for a significant proportion of revenues raised in most.
There have been some major reforms of the personal tax system in many countries, including such things as the dual income tax in western Europe and flat tax systems in some transitional economies.
Some important tax reform studies have been completed or are under way elsewhere, such as the President's commission on tax reform in the U.S., the so-called Mirrlees review in the U.K., and the comprehensive documents on tax reform recently put out by the OECD. Some of these call for some new thinking in the area of personal and business taxation especially, and we should heed them.
The basic objectives of a good tax system are widely accepted. The ideal is to raise revenues fairly, efficiently, and with the least administrative cost to both the taxpayers and the taxing authority. Achieving these objectives in a decentralized federation is a major challenge. In my view, the following priorities are particularly important and necessarily involve some provincial contrivance.
First of all, with respect to sales taxation, by international standards the GST is a very good tax. It's broad-based, well administered, and accompanied by an effective refundable tax credit to achieve fairness. This structure should be protected.
However, there is much work to be done. The federal tax rate is now relatively low, so the share of revenues raised is small compared with that in many countries.
Harmonization with the provinces is a high-priority issue, as I'm sure you've heard before, and a very difficult one in a federation. In my view, the only sensible, workable reform is to adopt an HST type of scheme for Canada as a whole, which amounts to a national GST accompanied by provincial revenue-sharing. This is the system that's used in Australia very effectively, and also in Germany and other countries.
The alternative of allowing provinces to run their own harmonized sales taxes is administratively too cumbersome and has too few benefits. A harmonized GST obviously requires provincial agreement, and that can best be facilitated by federal leadership and the federal government having a significant stake in the outcome. This goal is made more difficult by reductions in the federal GST rate.
The Séguin report recommendation to turn over the sales tax completely to the provinces made little sense for the rest of Canada, in my view. It would, of course, be difficult to replace the Quebec sales tax in Quebec with a harmonized federal sales tax. The best option is therefore to allow the QST to coexist alongside a harmonized GST elsewhere in Canada, rather than trying to replicate the QST elsewhere.
With respect to individual income taxation, we have had a series of piecemeal reforms over the years, some of which go in the right direction, others of which do not. I think it's time to ask the basic question: what kind of personal tax system do we want? Some considerations are the following.
I would not favour a move to a full consumption-based personal tax system. Unlike most other countries, ours does not have an inheritance tax, and that alone means that we need some taxation of asset income.
An option that has attracted a lot of attention is the dual income tax system used in the Scandinavian countries and increasingly taking shape in other European countries—and incidentally, recommended by the President's commission on tax reform in the U.S. This system imposes a progressive rate structure on labour income and a flat tax on personal capital income at the rate corresponding to the lowest tax bracket. The system reduces administrative costs significantly and can be made virtually as fair as our current system.
The main fairness issue with the current system concerns those at the bottom end of the income distribution. The single most important thing that could improve fairness for them and that would remove inconsistencies in the existing tax system would be to make all tax credits refundable, and not just those for the GST and children.
The temptation to use the tax system, whether the income tax or the GST, to achieve social objectives should generally be resisted unless clear and persuasive objectives are at stake. This compromises the simplicity, efficiency, and fairness of the tax system. Examples that one could think of would be to offer tax breaks to homeowners, to induce people to change their spending patterns, to subsidize books, and so on. On the other hand, a clear and persuasive objective that might warrant special treatment and that is kept constitutionally mandated is equality of opportunity. This might justify special measures to ensure that children have equal opportunities and access to education, whether in early childhood or in post-secondary institutions.
Payroll taxation. Payroll taxes are nominally earmarked to social insurance programs, but there is no real connection between taxes paid and benefits received. This is as it should be, given that the programs are social insurance programs. However, it does imply that the contributions are really more like taxes than payments for future transfers. As such, they're highly regressive, even compared with the GST. I would favour relaxing the limits to contributions to correct this, making them more like proportional taxes, with correspondingly lower rates.
Business taxation. There's been much focus on tax rates and far too little on structural aspects of the business tax system, which in my view are the most important. At the outset one must ask, what is the main purpose of the corporate income tax? Traditionally we have thought of the corporate tax basically as a withholding tax against both retained earnings of domestic shareholders and foreign owners. This was the view of the Carter report many, many years ago. However, the tax also plays an important role as a device for collecting rents, particularly in the resource sector, and this orientation had been the focus in tax reports in other countries, especially in Europe. With that in mind, some important issues are as follows.
As documented by the Mintz report, the federal corporate tax system has long favoured the resource sector at the expense especially of services, such as by excessive deductions. This should be corrected, both on the grounds of economic efficiency and on the grounds of the federal government maintaining some access to resource rents. There are various models of efficient rent-collecting taxes--cashflow taxes, allowance for corporate equity taxes, which was recommended by the European Union and is likely to be recommended by the Mirrlees review.
More generally, the use of the federal corporate tax system as a means for the federal government to obtain a share of resource rents is an important one, especially given the federal constitutional commitment to equalization. Traditionally the federal government has obtained a significant share of resource revenues through the income tax system. The tendency to reduce federal corporate tax rates is problematic in this regard. This too reinforces thinking of the corporate taxes, at least partly, as a rent-collecting device and designing it accordingly.
A closely related issue to this is that there is no good rationale, in my view, for the deductibility of royalties from the federal tax. It's largely a transfer of resource revenues from the federal government to resource-producing provinces.
The corporate tax discriminates against small, growing firms and highly risky ones, precisely those that are major sources of productivity growth and employment generation. One measure that would be very helpful here, that would help compensate for financial difficulties faced by new firms, would be to allow for full refundability of tax losses.
On the issue of vertical balance, the federal government collects more in tax revenues than it needs for its own spending, transferring the difference to the provinces. This is as it should be. Federal-provincial transfers play a critical role in our federation, and their size needs to be protected. At the same time, federal dominance in taxation is necessary for maintaining an effective and harmonized tax system. Income tax harmonization through the tax collection agreements relies on the federal government being dominant. In sales tax harmonization, which as I mentioned most reasonably would involve a national sales tax with revenue sharing, would be difficult without a significant federal presence in the GST.
The final category is environmental taxes. Most economists would agree that environmental taxes should be an important part of the program for addressing environmental pollution. Such taxes yield an important double dividend: they provide free revenues to the government as well as correcting the problem of pollution. To exploit that, I would just make two points. The first is that a carbon tax should be contemplated, and if so, if it's used to maintain the competitiveness of Canadian industries, it should also be imposed on the carbon content of imports as well as on domestic-source carbon use.
Finally, revenues from a carbon tax should ideally go into general revenues rather than being earmarked for environmental subsidies. For example, abatement technologies or subsidies to reduce pollution should not be financed by revenues from environmental taxes.
That's it.
