BUSINESS WATCH

Agenda for a tax revolution

Peter C. Newman September 29 1986
BUSINESS WATCH

Agenda for a tax revolution

Peter C. Newman September 29 1986

Agenda for a tax revolution

BUSINESS WATCH

Peter C. Newman

Last week, when Michael Wilson proclaimed the abandonment of his tough stance on the federal deficit, he was really switching strategies toward his most cherished goal: a fundamental reform of the Canadian tax system. Although the finance minister shied away from detailing his plans on future corporate taxation, Ottawa is known to be working on an approach that would draw clear distinctions between export-oriented industries and businesses that live off imports, with incentives provided for the former and sanctions to be placed against the latter. Real (as opposed to paper) productivity will be encouraged. One major item yet to be considered is how to deal with the exponential increases in corporate concentration.

The target here will almost certainly be the advantage large conglomerates are taking of unlimited interest deductibility—the ability to write off the cost of borrowing money for corporate takeovers. One approach actively being discussed is to differentiate between loans taken out for capital expenditures that create or expand productive capacities and the billions that are borrowed by chief executive officers who buy out other companies mainly to satisfy their egos.

When the details of Wilson’s tax changes finally come down, the finance department’s emphasis on future corporate incentives will shift from large to small and medium-sized businesses. That is where the most dynamic future growth pattern is, and it is the only practical way to encourage increased Canadian ownership of the economy. “Small business,” says John Playfair, a senior tax partner with Clarkson Gordon in Toronto, “could, for example, be allowed to claim an annual basic exemption, like those already applied to personal incomes.”

Wilson’s hope of lowering personal taxes closer to the new American rates will be not only tough but ultimately impractical. Much has been said and written about the reduction of American tax rates, with corporate levels due to drop to 34 per cent (compared to a top Canadian rate of 52 per cent) and maximum personal levels due to decrease to as low as 33 per cent (compared to a high of 60 per cent in Canada). But what’s really important about Washington’s new initiative is that it is designed to transform the funda-

mental philosophy of the tax system. Instead of encouraging taxpayers to make the kinds of decisions that produce tax advantages, the tax system will be neutralized and investments will have to be made mainly for economic reasons.

That is also Wilson’s approach, but his task is made much more difficult because the Canadian tax system does not have nearly so many deductions available for elimination. “Yet,” says

Playfair, “we’re going to have to follow the Americans to some considerable extent because I don’t see how we can remain competitive unless the aftertax results of personal and corporate incomes in the two countries coincide. If they didn’t, we could see well-qualified individuals, who are becoming increasingly mobile, drift to the U.S. and even more industrial activity transferred south of the border.”

An easier objective for Wilson should be simplification of Canadian

taxes. One idea being mooted in Canadian accounting circles is to apply the same lower personal tax rates to companies, on the theory that trusts, corporations and partnerships really aren’t that different from individuals. Once a firm has paid taxes, for example, it is claimed that there would be no need to provide for dividend tax credits.

The powerful Business Council on National Issues recently weighed in with the view that “the tax system is so complex largely because tax policy is used for purposes other than raising revenue. As part of any strategy for comprehensive tax reform, this trend should be reversed.”

The BCNI is one of many groups recommending the adoption of consumption taxes, such as the value-added or business-transfer tax. The idea is that Ottawa would tax people when they spend rather than when they make money. Superficially it sounds like a great idea. It would encourage savings and be a much less visible way of helping reduce the deficit than having to raise tax rates. But it’s not really an equitable tax. It would make an already complex collection system even more convoluted, and might not be worth the trouble in terms of extra revenue. The assumption is that such a new transfer tax would replace federal sales taxes, which already produce more than $10 billion annually for the federal treasury. The only obvious increase in revenues from the transfer tax would flow from the service transactions that are now exempt.

According to Wilson’s own forecasts in his last budget, net public debt as a percentage of gross national product will rise to 57 per cent by 1990 from the current 45 per cent—and that’s after some fairly draconian cost-cutting measures. That means we would be facing a $360-billion federal debt by the end of this decade. Indeed, Wilson confirmed last week that the federal deficit this year will be higher than previously forecast—$32 billion compared to an earlier estimate of $29.5 billion. But he expressed reluctance either to increase taxes or to introduce major spending cuts to reduce the deficit.

The only comfort Michael Wilson— and the rest of us—can hold on to is that tax reform and simplification will spur economic activity enough eventually to lower the deficit. That’s a long shot. But we don’t have any choice.