BUSINESS/ECONOMY

A promise of fairer taxes

MARK NICHOLS August 25 1986
BUSINESS/ECONOMY

A promise of fairer taxes

MARK NICHOLS August 25 1986

A promise of fairer taxes

BUSINESSI

ECONOMY

After years of debate, the movement for tax reform in the United States rested in the hands of two men last week. Representative Dan Rostenkowski, an Illinois Democrat, and Senator Robert Packwood, an Oregon Republican, huddled around a felt-covered table in a meeting room in Washington’s Capitol Building. As the leaders of a joint 22-member House of Representatives-Senate conference on tax reform, Rostenkowski and Packwood were struggling to reconcile differing House and Senate tax reform bills before Congress adjourned last Friday for a three-week summer recess. And although the two men had themselves reached a deal by late Thursday, it proved unworkable.

They learned that the plan was $17 billion short of their revenue target. Still, both men were determined to present a tax bill to Congress, giving the United States its first massive tax overhaul in 17 years. On Saturday, Packwood was working toward convincing the Senate conference members that an additional $120 billion would have to be raised from corporate taxes. It also appeared that both sides would agree to a slight increase in individual taxes. Declared Packwood: “This is a chance that won’t come again in 50 years.”

Ever since President Ronald Reagan unveiled his tax reform plan 14 months ago, the U.S. initiative has helped to make the issue a political priority in both Canada and Europe. Reagan’s proposal to lower tax brackets and shift more of the tax burden to corporations and away from individuals represented a stunning reversal of a decades-long shift to higher personal taxes in Western industrialized countries. Some European ex-

perts say that if tax reform succeeds in stimulating the U.S. economy, investment dollars may flood across the Atlantic. Declared John Kay, director of the London-based Institute for Fiscal Studies: “Governments in Europe will face the pressure of, ‘If

the Americans can do it, why not us?’ ” There will be similar pressure on Canadian politicians if personal tax rates fall in the United States but not domestically—the top personal tax rate now stands at 34 per cent in Canada and 50 per cent in the United States. “Talent will go across the border so fast it will make your head swim,” said Conservative MP Donald Blenkarn, chairman of the House of Commons finance committee. He added, “We have got to stay onside—that’s all there is to it.” Reagan’s original proposals called for Congress to close personal and corporate loopholes which cost the federal Treasury billions of dollars annually. The government could then afford to lower tax brackets. Under the deal being worked on last week, the top per-

sonal tax rate is expected to fall to 28 per cent from 50 per cent, while the top corporate tax rate would dip to either 34 or 35 per cent from 46 per cent. Under Reagan’s plan, individual taxes would fall by an average of 5.2 per cent, while the corporate burden would rise

by 23 per cent. Declared Bruce Fisher, research director for the labor-backed reform lobby Citizens for Tax Justice (CTJ): “We are going to achieve, more or less, a tax code that will mean more jobs and less of a sense that people are being ripped off.”

Reagan’s crusade has elicited a popular response from middle-class taxpayers. The unexpected momentum for reform which has developed in Washington this summer has already persuaded Prime Minister Brian Mulroney’s Conservative government to convert its own piecemeal tax reform into a more salable and high-profile package of integrated proposals. As a result, ideas for reforming Canada’s tax system could be unveiled with next February’s budget and will likely form a major

Tory plank in the federal election that is expected in 1988.

There are persuasive political and economic reasons for following the American lead: with the maximum corporate and personal tax rates of 46 per cent and 34 per cent that are currently in effect, Canada could face a drain of businesses and individuals lured away by a reformed U.S. system. As well, the Mulroney government, confronted by dismal opinion poll ratings, stands to gain a needed popularity boost by reducing tax rates and simplifying regulations—in effect, producing a more equitable system. “The game is votes,” said Adrien Boulanger, a principal in the Toronto accounting firm of Laventhol & Horwath.

“And there is a perception out there that the rich don’t pay their fair share of taxes and the lunch buckets do.”

Indeed, studies by The Fraser Institute, a Vancouver-based think tank, confirm that the tax burden for the average Canadian is getting progressively heavier. Each year the institute proclaims one day of the year to be “Tax Freedom Day.”

That is the day during the year on which a Canadian family of four earning $33,500 has finally finished paying off all direct and hidden federal, provincial and municipal taxes that it owes for that year—and actually begins to earn money that it can keep. Direct taxes include income, property and sales taxes, while hidden taxes include custom and excise taxes built into the cost of products—and they have been steadily getting heavier each year. Said Sally Pipes, assistant director of The Fraser Institute: “Several years ago people were not really aware of this thing. Now, people are phoning us from across the country.”

Government officials in Ottawa have become intensely aware that public dissatisfaction is growing over the complexity of the tax system—as well

as over the anomalies and apparent inequities that are as prevalent in the Canadian system as they are in the American one. According to New Democratic Party researchers, roughly

8,000 Canadians with incomes over $50,000 paid no taxes at all last year. The auditor general’s office notes that Canadian corporations —many of which pay no taxes—took advantage of tax breaks last year that cost the federal treasury an estimated $25 billion to $35 billion in forgone revenues.

For their part, finance department officials in Ottawa argue that since the Mulroney government took office two years ago, Finance Minister Mi-

chael Wilson has already implemented significant reform measures—while striving to hold down spending and reduce the $34-billion federal deficit. He has closed loopholes, imposed new taxes and provided breaks for some taxpayers in an effort to update and streamline the tax system. “If you look at the proposals in front of Congress,” declared David Dodge, an assistant deputy finance minister in Ottawa, “they are not making their tax system as broad as ours is already—by miles. The Americans are starting with an act so shot through with tax preferences that it makes ours look like a paragon of virtue.”

But in some ways Wilson’s actions have appeared contradictory. While phasing in a $500,000 lifetime capital gains exemption in his May, 1985, budget, he also allowed the overall level of taxation to rise by imposing fiveand 10-percent surtaxes on high income earners. They were replaced last month with a threeper-cent general surtax.

Until recently, Wilson’s department had been devoting most of its effort to further reform of the corporate side of the tax base— and in particular to the creation of the proposed business transfer tax. But that changed when it became clear that the political mood in Washington was swinging in favor of sweeping reforms. Suddenly, “it became blindingly obvious,” said Dodge, that “it would make sense to move on the personal side” of the tax equation as well and tie together all of Ottawa’s plans into a reform package.

Faced with the prospect of high-profile U.S. tax reform, Wilson proposed an overall reform package of his own at a July meeting in Saskatoon of the Mulroney cabinet’s inner priorities and planning committee—and was instructed to go ahead. Three weeks later Wilson told an Ottawa press conference

that he had asked Finance officials to begin work on “a comprehensive reform of the federal tax system” which would, like the U.S. drive for reform, aim at simplifying the system, spreading the burden more evenly and shifting a larger part of the tax load from individuals to businesses. “I don’t see us having an identical tax system as the United States,” said Wilson. But, he added,

“to the extent that they are following a basebroadening and rate-reduction approach, that’s exactly the direction we’re going.”

But there are concerns that, despite the overriding need to have a tax system that is broadly in step with that of the United States, Wilson’s reform proposals could contain a crucial difference in the form of a controversial new business transfer tax. Designed as a replacement for Ottawa’s outmoded manufacturers’ sales tax, the tax, which was proposed in last February’s budget, could scoop up billions of dollars in revenue by taxing the production of goods and, for the first time, services at each step in the process.

Finance officials now expect that the transfer tax will become a key element of a broader tax reform package. But critics say that the tax is harmfully regressive because the impact is felt most by low-income consumers. “Consumers have been crushed at each turn by a succession of increased sales taxes,” said Robert Kerton, chairman of the Consumers’ Association of Canada’s economic issues committee. “We oppose the business transfer tax as just one more way of taking taxes from the consumer.”

With or without the BTT, some observers question Ottawa’s true interest in making fundamental changes in the tax system. What Canadians have seen in recent years, noted David Perry, a senior research associate at the Toronto-based Canadian Tax Foundation, is “simply a series of ad hoc changes, but without an overall plan as to where we are going.”

But other tax experts say that Wilson is now prepared to move in the

direction of orchestrated change—if only for the political mileage to be gained from such a move. According to Samuel Hughes, president of Executive Consultants Ltd., a prominent Ottawa lobbying firm, a broad tax-change package is “a political winner.” And others say that far-reaching reform measures are the only kind that can

succeed against the powerful lobbying efforts of industry and special interest groups. “A broad brush approach is likely to be much more successful,” said Kerton, because a widely based movement for reform would provide less opportunity for “each vested interest to defend its privilege.”

In the United States, what is most remarkable about the recent push for tax change is that it has proceeded so quickly in a society that has resisted repeated attempts at reform. Reagan announced his plan in May, 1985, after studying a set of treasury department proposals received late in 1984. Last December the House passed a version of Reagan’s reform bill that proposed four tax brackets with a 38-per-cent maximum rate for the well-to-do, and

in June the Senate passed its bill, which taxes corporations less heavily.

Up to that point, Rostenkowski, chairman of the House ways and means committee, and Packwood, who heads the Senate finance committee, had succeeded in keeping Washington’s army of lobbyists out of the process. Said the CTJ’s Fisher: “When Packwood stood at the door of the temple and said ‘Go away,’ they did.”

But when 22 members of the House and Senate began meeting last month to reconcile the two tax bills, the lobbyists went to work with a vengeance. The banking industry, for one, which feared the loss of a provision that permits banks to write off bad debt reserves, hired former senator Howard Baker to defend their interests. As the pressure mounted, Republican Senator John Danforth, for one, argued in favor of retaining tax breaks for weapons contractors—many of whom are based in his home state of Missouri.

Despite some last-minute concessions that were made, the reform thrust has so far survived. Even under the more conservative Senate version of the reform bill, 80 million of the approximately 97 million Americans who file tax returns will pay less tax. Seventeen million others will pay more tax—largely because they will be deprived of the use of tax shelters.

But for corporate America, the impact of closed loopholes will far outweigh the benefit of reduced tax rates. Under both the Senate and House proposals, the key change would come from the elimination of investment tax credits which have allowed companies to escape an estimated $123 billion in taxes over the past five years.

The closing of loopholes would end the disturbing spectacle of rich corporations that pay no taxes at all. According to statistics compiled by Citizens for Tax Justice, half of the 250 largest U.S. corporations paid no taxes in at least one year of the 1982-85 period, while earning $73 billion in pretax profits. Telecommunications giant American Telephone & Telegraph, for one, paid no taxes on $25 billion in profits earned between 1982 and 1985—but received refunds totalling $636 million.

As the Conservative government in Canada continues to move toward tax reform, it will undoubtedly encounter the same resistance from special interest groups as has occurred in the United States. But if what Ronald Reagan has described as the “second American revolution” succeeds, the reverberations are certain to be heard around the world.

-MARK NICHOLS with MARC CLARK in Ottawa, IAN AUSTEN in Washington, ANN SHORTELL in Toronto and PAULETTE ROBERGE in London

MARC CLARK

IAN AUSTEN

ANN SHORTELL

PAULETTE ROBERGE