Thank you, Mr. Chairman and committee members, for the opportunity to offer my thoughts on the federal government's proposed tax changes affecting private corporations. I hope you find my comments helpful and informative as you deliberate on this important public policy issue.
I'm the director of fiscal studies at the Fraser Institute, an independent, non-partisan economic policy think tank. The institute's mission is to measure the impact of government policies and to broadly communicate to Canadians how those policies affect their lives and the lives of future generations. My comments today reflect my own opinions and observations. They do not, necessarily, reflect the views of other staff, affiliated researchers, or our board of directors.
Since the committee has already heard much about the technical aspects of the government's proposed changes, I will focus my remarks on points that I think have not received sufficient attention in the public debate.
First, I want to commend the government for undertaking a review of the tax code. Canada's personal income tax system has become increasingly complex and uncompetitive over the years, so the goal of reform is a positive one. In fact, the Fraser Institute has published studies on both the growth in tax complexity and the opportunity for the federal government to dramatically simplify the tax system while fostering economic growth. This was largely a response to the previous government's tax changes, which tended to increase the system's complexity with no material improvement in efficiency. As part of the current review, the government has correctly identified problems with our tax system, including a proliferation of so-called boutique tax credits, which are economically ineffective tax breaks for certain groups and individuals. In addition, it has identified tax planning through the use of private corporations as another problem area.
However, the policies implemented to date by the current federal government, including the elimination of several tax credits, along with the proposed changes to the taxation of private corporations, are best described as a piecemeal approach that falls well short of the type of comprehensive tax reform that Canada now needs. This is a lost opportunity.
A major shortcoming of the government's approach to these tax changes is how it plans to use the expected revenues from eliminating preferential tax measures. The standard approach to tax reform, as was the case with Canada's major personal income tax reform in 1987, is to use the revenues from eliminating preferential tax measures to reduce marginal tax rates broadly. In doing so, the government would eliminate special preferences for certain groups while reducing tax rates for everyone, thus improving the economic environment for workers, business owners, entrepreneurs, and investors. Instead, the federal government plans to retain all the new revenues. This is actually a trend with the current government, as it has eliminated a number of tax credits and other special privileges embedded in the tax system without using the resulting revenues to cut rates broadly by an equivalent value.
When it comes to the proposed tax changes to private corporations, it's important to understand why anybody pursues tax planning through such vehicles in the first place, since doing so comes at a significant cost. Business owners, including professionals, must spend significant amounts of money on accountants and lawyers in order to use these options in the tax code. The reason these expenses make sense is that the costs are less than the benefits they gain by lowering their effective tax rates critically. The tax savings are a result of large gaps between different levels and types of income.
For instance, a professional can shift income to a spouse with lower earnings or perhaps a dependent child with no income. If the professional can do so, the gains from the lower tax rates can be significant. Let's assume a doctor being taxed at the top federal rate of 33% can shift income to a spouse who only works part time and pays income taxes at the lowest federal rate of 15%. That's an over 50% reduction in the marginal tax rate by shifting income from one spouse to another. The gain is even larger if the income is shifted to a dependent child with no income.
These tax differences are the reason why people pursue the strategies in question. If the government reduced the gaps between tax rates, it would reduce the incentives, i.e., the benefits, of such tax planning in the first place. Instead, the current government has made this gap larger by increasing the top federal tax rate from 29% to 33%.
By making the tax gap larger, the federal government, along with several provinces, inadvertently increased the incentive for eligible professionals and business owners to use these strategies. Introducing new rules alone to eliminate or mitigate the use of these strategies, as the federal government now proposes to do, will not solve the underlying problem. They will simply incentivize accountants and lawyers to figure out new ways to get around the new rules for their clients. The solution is to concurrently eliminate, or at least meaningfully reduce, the tax rate differentials that exist in the system. Doing so will reduce the incentive for tax planning in the first place.
I have just two final points.
A risk inherent in the government's proposal is the potential to make the tax system more complicated without solving the fundamental problem. There will remain an incentive for Canadians to incur the cost of hiring accountants to help them tax plan, but the administrative and compliance costs will increase as the Canada Revenue Agency plays a greater role in enforcing the proposed new rules.
Finally, my last point relates to the negative signals the government is sending entrepreneurs and investors in its public communications regarding the proposed changes to small business taxation. For instance, on a nationally televised interview, the finance minister used the phrase “going after” to describe his government's approach to extracting more taxes from incorporated professionals and wealthy people. This language signals to the world that Canada is an unfriendly place to do business, which undermines our country's ability to attract investment, which is a key ingredient for economic growth and innovation. Fortunately, we've seen positive tax reform from past federal Liberal governments, whether that's forging a technical committee on business taxation and implementing many of the committee's recommendations, or expanding RRSP contribution room, or lowering the inclusion rate for capital gains taxation. Indeed, pro-growth tax reform is a non-partisan issue.
Thank you, and that concludes my initial remarks.