THE TAX TRAP
Critecs say high taxes are crushing the country's economy—and Canadians need a break
In the end, frustrated and exasperated, Paul Lee reluctantly concluded that the tax system had impeded the growth of the computer games firm that he worked for at every turn. Despite their high salaries, software engineers and graphic artists were slipping out of Vancouver, bound for bigger after-tax pay packets at other companies in the United States. When Lee, a senior vicepresident, tried to recruit employees from the United Kingdom or the United States, they calculated their prospective after-tax incomes—and many scuttled away. So when Electronic Arts Inc. snared the rights to create Formula One video games based on the famous auto races, Lee concluded it would be a difficult scramble to find staff to produce the games at the U.S.-based firm’s development headquarters in Vancouver. Instead, Electronic Arts opted to design them at its office in London, where it is easier to recruit employees who are skilled in game development—and where personal income taxes are lower. And that means 60 to 100 new British jobs over the next few months.
Lee figures that Electronic Arts, the world’s largest developer of video software games, loses more than seven per cent of its 500 Vancouver employees to the United States each year. At least 30 jobs are now unfilled. The firm could have created another 200 jobs in Canada over the last two years—if it could have found the staff. Canadian tax rates are not the only reason for Lee’s problem: skilled computer experts often relish the prospect of lucrative challenges and novel locales. But taxes are “more than 60 per cent” of his dilemma, Lee maintains. “The major input for high tech is people—and when they are taxed at such extraordinarily high rates, you cannot maintain a stable workforce,” he complains. George Hunter, executive director of the B.C. Technology Industries Association, is even blunter. “There is an old adage that applies here: high taxes do not redistribute wealth— they redistribute taxpayers,” he says. “Here in the trenches, people are just pulling their hair out.”
Taxes may be the tithes that bind society together—but they are gripping many Canadians too tightly these days. The total tax burden— which is a dismal tally of everything from income and sales taxes to property taxes in relation to the size of the economy—hit an all-time high in 1996, the most recent year for which figures are available. At 36.8 per cent of the size of the economy, Canada’s tax burden was
almost one full percentage point higher than that of the United Kingdom—and more than eight percentage points higher than in the United States.
Worse, the personal income tax burden is especially onerous. Over the past five years, the federal take from personal income taxes has grown almost twice as fast as gross domestic product—and almost 2Y2 times as fast as wages. Personal income taxes in relation to GDP are almost five percentage points higher than in the United Kingdom and more than three percentage points higher than in the United States. That may not sound like much—but each percentage point represents billions of dollars. Canada has the highest personal income tax levels among the G-7 industrial nations. It is no wonder that Lee is having problems: Vancouver is close to Washington, which has no state income taxes, and beside Alberta, one of the lowest tax jurisdictions in Canada. To add to his woes, British Columbia’s highincome earners are clobbered with steep surtaxes.
The “tax factor” has become a serious consideration for highly skilled workers who are most in demand south of the border. Statistics Canada officials met on March 18 with U.S. immigration officials in a bid to determine how many skilled Canadians are migrating to the United States on temporary visas. Although the 1997 data are unreliable, officials told Maclean’s they suspect that number is now about 20,000 people per year—and they believe it has almost certainly risen over the past five years. (Another 9,770 workers permanently emigrated in 1996.) ‘Taxes, especially personal income taxes, are too high in Canada because the United States is able to attract the best talent south—and that talent has been educated by Canadian taxpayers,” says Donald Johnston, secretary general of the Paris-based Organization for Economic Co-operation and Development. “Canada has to deal with the low U.S. tax rate in order to arrest its brain drain.”
But the price of high taxes is not restricted to the loss of high-
flying, highly educated personnel. Every Canadian responds when their tax rates are raised. People stop working as hard. Investment falters. Marginal tax rates—that is, the steepest tax rate that any individual taxpayer faces—are highest on workers with children who earn about $30,000, largely because that is when Ottawa and the provinces claw back credits such as the National Child Benefit. It sounds almost unbelievable, but more than 60 cents of each extra dollar of income at that level goes to taxes. So there is little incentive to work extra hours. “I have joked that we should have a constitutional amendment that no Canadian should pay a higher marginal rate of tax than [multimillionaire media baron] Ken Thomson,” says economist Thomas Wilson, director of the University of Toronto’s policy and economic analysis program.
The struggle to keep ahead has taken its toll. Canadians saved a paltry four-fifths of one per cent of their personal disposable income in the fourth quarter of last year. That is down from 11.4 per cent in the same period in 1990. By late last year, their debts, including mortgages, were virtually equal to their personal disposable income—up from 80 per cent of their income in 1990.
Halifax resident Ellie Jarrett and her husband, Jim, recently purchased a house—and four months ago they had their first child, Emma. An ophthalmologic assistant, Ellie is on maternity leave until May, receiving $400 every two weeks from Employment Insurance. Jim works as a shipping receiver at a dairy. Their combined
household income now ranges between $42,000 and $45,000. Their child tax benefit payment—the highest is $153 a month for families earnings less than $21,000 with one child under the age of 7—is only $49. ‘Taxes are just crazy,” laments Ellie. “If you work overtime, you might as well work for free.” She pauses. “It just shouldn’t be so hard getting by,” she adds. “It is a lot of stress. There has to be more that governments can do. They give breaks to the rich and to the poor— but we are the ones paying for all the social programs.”
And governments are demanding. According to the Vancouverbased Fraser Institute, the average Canadian family worked almost six months last year—until June 27—just to pay its total tax bill to all levels of government. In 1961, that date was May 3. The institute has also calculated that the total tax bill—everything from income taxes to excise taxes—has gone up 1,286 per cent since 1961—while prices rose by 480 per cent, food by 414 per cent and clothing by 387 per cent. Of course, incomes grew over this period. But there was also a 36.8-per-cent increase in the tax rate. Adjusting for inflation, the family’s tax bill went from $9,719 to $23,218.
Everybody loses when governments gobble too much money. Canadians avoid or evade taxes. The underground
economy flourishes. Worst of all, taxes hit the economy where it hurts most: there is less money available for savings and investments in the clever innovations that are vital for growth.
In 1996, Canadian investments in machinery and equipment were a paltry 6.6 per cent of the size of the economy —compared with 7.6 per cent in Great Britain and 8.3 per cent in the United States.
Those flagging investments undermine Canada’s efforts to boost its overall productivity—that is, the volume of output divided by the capital and labour used to produce it. Although the method of measuring productivity growth is in dispute, Canada has almost certainly trailed behind the United States for much of the past two decades. The OECD predicts that Canada’s standard of living will slip inexorably below the average of its 29 members over the next two decades.
As University of Western Ontario economist Jim Davies warns: ‘With high tax rates, there is less investment in structures and machinery and equipment. And that is part of the reason that our productivity levels have lagged.”
The debate about taxes is obviously part of a wider discussion about the size of government itself: that is, what do Canadians want their governments to do? Ottawa’s budget is now about $156 billion, or about 17 per cent of the size of the economy. Spending is increasing in tandem with economic growth. For the past three years, with conservative cunning, federal Finance Minister Paul Martin has underestimated his revenues—and then spent most of each potential surplus on programs such as health care before the fiscal year ended. Many experts maintain the minister should change that controversial approach: he should set out multiyear targets for tax reduction—so that, at the very least, he cuts taxes with the same careful consideration that he spends money. “The whole process is biased against tax cuts,” argues University of Toronto economist Jack Mintz. “Maybe we had to take care of education and health in the last two budgets. But now we should set up a framework—and we should try for planned cuts of 10 to 15 per cent at the federal level over the next three to four years.”
Melanie and Keith Jollymore run a thriving firm, Jollymore Communications, from their home in Lawrencetown, 40 km east of Halifax. With their 14-month-old son Benjamin, they live as caretakers in a 150-year-old house on an herb farm. They are saving for their own home, their retirements and Benjamin’s education. And they are disturbed by how little they can write off from their taxable income-even though their office is in their home—and by how they must pay almost a third of their income to governments. We are splitting a single job so there is not a whole lot of mad money,” says Melanie, 32. “Most people feel the way we do: they hate to see so much money going into megaprojects and things that are politically motivated. If it went into tax relief, it would have a better effect on people’s lives.”
The problem, of course, is: what is good
spending and what is bad spending? Canadians do receive major benefits from their tax dollars, everything from health care to support for low-income children. Medicare alone accounts for about two percentage points of the difference between the Canadian and U.S. tax burdens. But Canadians have willingly and proudly paid that price.
In effect, citizens accept heftier burdens
when they believe they are getting their money’s worth. “You can get by with a higher level of taxation if you have a high level of public services,” notes David Perry, senior research associate at the Canadian Tax Foundation. “You cannot make generalizations about tax levels: much depends on gut feeling. But it would seem that we overstepped that margin when we increased taxes to reduce deficits.”
Canada’s tax burden also appears heavier because so much revenue must now be diverted to pay the interest costs on the $569-billion federal debt. During thel970s and 1980s, Ottawa and the provinces ran up huge annual deficits: Canadians were living beyond their means. As a result, interest on the federal debt now consumes 27 cents of every revenue dollar—compared with 18 cents in the United States. The party is over—but the guests can’t
The tax burden has become a serious consideration for skilled workers who are in demand south of the border
escape. “In the past, Canadians spent more on themselves than they earned,” says former Toronto tax lawyer William Macdonald, who is now a strategic consultant on public policy issues. ‘Today, they are being forced to earn more than they spend on themselves.”
To add to that discomfort, taxes have been stealthily increasing because of a devilish contrivance called partial deindexation. Prior to 1986, the tax system responded to every move in inflation. If inflation went up three per cent, exemptions went up three per cent. Then, the system changed: everything rose only when inflation exceeded three per cent—and only by the amount that exceeded three per cent. As a result, since 1992, nothing has
budged: basic exemptions, and the levels at which higher rates cut in, are exactly where they were seven years ago.
The effect has been brutal. Between 1986 and 1998, for one, 1.4 million low-income Canadians were forced to pay taxes. Their incomes rose with inflation—but their exemptions did not. Ottawa netted an extra $10 billion between 1986 and 1998 because of this device. (Tax cuts in the last two budgets have taken 600,000 of those 1.4 million low-income taxpayers back out of the system.) Meanwhile, the Ottawa-based Caledon Institute of Social Policy notes that tax reductions in this year’s budget will cut revenues by $1.5 billion in 1999-2000—but partial deindexation will raise revenues by $840 million. So 56 per cent of that $1.5 billion is already taken back. “Partial deindexation is an insidious virus—an arcane change that amounts to a hidden tax increase,” says Caledon president Ken Battle.
It is perhaps no wonder that the nonprofit Canadian Taxpayers Federation scrutinizes government spending, ferreting out the sort of projects that Melanie Jollymore objects to. Last month, with great flourish, federal director Walter Robinson staged a mock awards show to bestow “badges of shame” on governments that squander taxpayer funds. The federal prize went to the public works department that allowed Parliament Hill renovations to skyrocket from $440 million to $1.4 billion. “We are overtaxed because our governments spend too much,” Robinson asserts. “The principle of reallocation should be employed. Take that $1 billion from renovation overruns—and put that into vital priorities like health care or tax cuts.”
Such scrutiny is certainly worth the effort. University of Alberta economist Bev Dahlby estimates that every dollar in federal tax cuts means about $1.38 in additional economic activity—although it may take about five years for those benefits to
appear. “Governments provide us with services that are extremely valuable,” he says. “The question that we have to address is: are the benefits worth the costs?”
Despite the pressure, finance ministers are stalling for time
Vancouver’s Douglas Le Patourel, a commercial real estate agent with a wife and two young children, is exasperated with his tax bill. His income is high: he pays British Columbia’s top marginal tax rate of 52.3 per cent—the second highest in the nation after Newfoundland’s 52.9 per cent. “I spend more money on government than I ever have in my life,” he says.
“It’s way more than I pay for accommodation, for food, for any of the basic things in life. That’s got to be wrong.” When asked if he is about to revolt, Le Patourel can only sigh: ‘Tax revolt? People don’t have the time to revolt. It’s easier to relocate.”
Prior to Ottawa’s Feb. 16 budget, the pressure on the federal government for tax cuts edged, along with health care, into the so-called critical range in the polls. In a survey of 1,600 respondents, Toronto-based pollster Michael Marzolini, chairman of POLLARA Inc., found that 54 per cent of Canadians were “very concerned” about the level of taxation. “People have seen their take-home incomes shrink—and they are concerned about their standard of living,” says Marzolini, who is the Liberals’ pollster. “They want to know that their taxes are on a trend down.”
Despite that pressure, many finance ministers have stalled for time. Although Quebec is the highest tax jurisdiction in North America, it deferred personal income tax cuts to July, 2000—and limited those cuts to a relatively paltry $400 million. Alberta is moving to a flat provincial income tax rate of 11 per cent of taxable income—but it has postponed that reduction until 2002.
Meanwhile, Martin’s 1999-2000 cuts have been relatively small. He spent more than $7 billion on everything from health care to research and development in 1999-2000. But he cut taxes by the relatively modest amount of $1.5 billion. (That does not include an $800million reduction in Employment Insurance premiums.) Next year, he told Maclean’s, taxes will be cut again. But he warned that Canada must “deal with major social deficits such as child poverty, such as the environment.” He added: ‘We have to balance priorities. It’s fine for these single-issue pressure groups to push for cuts—but you can’t be a single-issue government.”
So far, that approach seems to be working. “There is no tax revolt out there now because we do think governments should be there to keep social programs strong,” says pollster Donna Dasko, senior vice-president at Toronto-based Environics Research Group Ltd. Could there be a tax revolt? She answers guardedly: “Maybe. Now that we have increased health-care spending, tax cuts are competing on a more equal basis with other possible priorities.” In other words, the finance minister will need to juggle his spending and his tax cuts far more carefully—next time.
In January, 1995, Bob Scott accepted a corporate move from White Rock, B.C., to Calgary—and he remains enchanted with the change. As a headhunter with a firm that recruits sales personnel, he and his wife, Tracey, and their two youngsters have settled in a roomy home in the suburb of Sundance—“one-and-a-half times more house for two-thirds the price.” Their groceries, gas and car insurance are cheaper. There is no sales tax. Income taxes on his commissions—which are now “quite comfortable”—are far lower. “In British Columbia, I always felt that we were being gouged,” he says. “Here I feel that the money is being put to good use.”
Scott’s acceptance of his tax tab meets at least one of the two economic rules of taxation: equity. In other words, a tax system works if all taxpayers feel that they are treated fairly—and if the funds are
dispersed evenhandedly. The other is efficiency: funds should be collected in a way that creates the fewest economic costs and disruptions. By those standards, personal income taxes should come down more for everyone—but especially for hard-hit middleincome earners. Perhaps Martin could lower tax rates: they are now set at 17 per cent on income up to $29,590; 26 per cent on income between $29,591 and $59,180; and 29 per cent on further income. (Provincial taxes are a percentage of basic federal tax—and both levels of government add surtaxes.)
Then, he could turn to payroll taxes. Canada Pension Plan premiums went up by 30 cents per $100 of employee income this year—while El premiums declined by only 15 cents. That represented a maximum tax increase of $50.85. “At a minimum, payroll taxes should be stabilized,” says Catherine Swift, president of the Canadian Federation of Independent Business.
Finally, many experts argue, he should cut corporate taxes. Canada’s maximum rates ranged from 38.1 to 46.1 per cent in 1997—depending on the industry. That was well above the 35to 42.5-per-cent range in the United States and 31 per cent in the United Kingdom. Worse, Canada’s rates are higher for dynamic service industries such as communications than for manufacturing. ‘We have to set about creating a ‘Canada Advantage,’ ” argues economist Mintz.
Montreal electrical engineer Achour Louni, 35, watched three of his friends leave Quebec for jobs in the United States last year, lured by higher salaries and lower taxes. Louni himself is tempted to follow, uprooting his wife, who is on maternity leave from her nursing job, and his young son. He recently turned down three offers in California—because those salaries were not high enough to cover the cost of private schools and housing. “But if there is a good opportunity, I’ll take it for sure,” Louni says, noting dourly that almost half of his comfortable salary goes to income taxes alone. “I know I could get more elsewhere—especially with the tax advantages.” He pauses. “It’s really the money,” he says finally. And that is a verdict that should send all finance ministers back to their calculators.
With JOHN DeMONT in Halifax, CHRIS WOOD in Vancouver, BRIAN BERGMAN in Calgary and BRENDA BRANSWELL in Montreal