Every year the Fraser Institute, a Vancouver-based think-tank, calculates from Jan. 1 the date on which an average Canadian taxpayer has earned enough money to pay all direct, indirect and hidden federal, provincial and municipal taxes. That date has become known as Tax Freedom Day. In 1961 Tax Freedom Day occurred on May 2. By last year it had reached July 8. That change reflects what many business and political observers say is a fundamental structural problem with Canada’s tax system: it has become overly reliant on taxes paid by individuals. Federal Finance Minister Michael Wilson acknowledged that problem last October, when he released a set of guidelines for tax reform. He promised to shift the burden from income to corporate and sales taxes while at the same time reducing many of the tax exemptions now enjoyed by corporations. Last week Wilson reaffirmed the government’s commitment to such a comprehensive overhaul—and he said that he would issue a white paper by the end of June.
But tax reform will test Wilson’s political skill and courage. For months Wilson has faced nervous cabinet colleagues who question the political costs of some proposals, including one to apply sales tax to food. And officials in the Prime Minister’s Office raised similar questions. Members of the PMO said that they were keenly aware of the massive political opposition that erupted in Japan two weeks ago when Prime Minister Yasuhiro Nakasone was forced to drop a proposal that would have introduced a five-per-cent sales tax.
Last week, speaking briefly in the House of Commons, Wilson took aim at the speculation that some cabinet ministers were nervous about his proposals. One of these is the business transfer tax (BTT), a federal levy that would be imposed at each stage from producer to consumer. Ottawa is also likely to tax, for the first time, hundreds of consumer products, including food and clothing, and services ranging from haircuts to legal bills to entertainment. But despite Wilson’s assurances, some private-sector observers
still predict that the reforms will only be phased in, with sales tax changes postponed beyond the next election. Said John Bulloch, president of the Canadian Federation of Independent Business (CFIB): “The Conservatives’ 24-per-cent standing in the polls does not give them the credibility to pull off the sales tax reforms now.”
But many other analysts say that the three pillars of the tax system—personal income tax, corporate income tax and the sales tax—must be overhauled simultaneously. Eric Owen, the Canadian Manufacturers’ Association (CMA) taxation expert, said that reducing personal and corporate income tax rates without a major new sales tax would cause an increase in the deficit. And most business observers share Wilson’s view that Canadian income tax rates must be brought into line with new, lower U.S. rates, introduced last October, to prevent both businesses and individuals from moving to the United States.
Since the early 1960s the tax burden in Canada has gradually shifted from consumption to income. Personal income taxes currently account for 46
per cent of federal revenue, compared with 31 per cent in 1961-1962. The contribution to federal revenue from sales tax slumped to 18 per cent in the early 1980s from a high of 37 per cent in the mid-1960s, largely due to governmentapproved exemptions. Corporate income tax, as a proportion of total revenues, has declined almost steadily to the current 10.5 per cent from 20 per cent in 1961-1962 because of various deductions and writeoffs. The objective of tax reform is to strike a new balance by reducing personal and corporate income tax rates, said Wilson. But the tax base will be broadened by eliminating some corporate tax breaks and by taxing the consumption of a far wider range of goods and services.
The Conservatives have pledged an overhaul for two main reasons, according to Wilson’s tax reform guidelines. For one thing, the system is widely viewed as unfair because it is riddled with selective tax exemptions, writeoffs and deductions, available primarily to corporations and wealthy individuals. For another, Canada’s personal and corporate tax rates have to remain competitive with U.S. rates to attract investment. “We do not want to see our job-creating capacity go down there,” Wilson told Maclean's. “We have to be competitive.”
The finance minister has not yet disclosed the details of how he plans to cut personal tax rates, but the spread between the two countries is significant. David Perry, senior research associate with the Canadian Tax Foundation (CTF), said that top tax rates on high incomes in Canada range from 53 per cent in Alberta to 60 per cent in Manitoba. Pre-reform U.S. federal rates had 15 tax brackets, and the top rate was 50 per cent. Now, the U.S. government takes 15 per cent on taxable incomes up to $39,865 annually and 28 per cent on incomes above that figure. But even if Wilson cuts federal rates, provincial income tax increases could offset the savings. Perry noted that the provinces collect 33 per cent of all income tax in Canada, compared with the 15 per cent that U.S. states collect.
As well, it is unclear exactly how the minister plans to narrow the gap on corporate rates. The CMA’s Owen said that the U.S. rate has been cut to 34 per cent from 46 per cent. The Mulroney government has already begun to cut the income tax rate for manufacturers to 33 per cent from 36 per cent. In addition, manufacturers receive a six-per-cent credit, which will be increased to seven per cent by 1989. That will effectively reduce their rate to 26 per cent.
The long wait for detailed pro-
posals is causing concern for executives at some Canadian companies. Said George Binnie, vice-president and comptroller of Stelco Inc.: “It is hard to direct things when we do not know what will happen. You get a little impatient.” For his part, Jack Cockwell, chief operating officer of Torontobased Brascan Ltd., said that the uncertainty has contributed to foreign takeovers of such prominent Canadian companies as Husky Oil Ltd., Dome Petroleum Ltd. and Carling O’Keefe
Ltd. In particular, potential Canadian buyers were concerned that tax changes might prevent them from deducting interest costs or refinancing huge takeover-related debts through preferred-share issues.
The most controversial part of the reform package could be the BTT, which would replace the federal sales tax. Exemptions have undermined the current sales tax and caused numerous disputes between manufacturers and Ottawa, the CTF’s Perry said. One com-
pany maintained that its granola bars are food, which is exempt, rather than candy, which is not. Another company argued that its shampoo should be considered a medicinal product and exempted because it prevents dandruff. Otherwise, it would be a cosmetic and taxable.
The BTT, which is a variation on the value-added tax (VAT) used by many European countries, would, be applied at every step in the chain from producer to consumer. It would be applied to hundreds of previously untaxed goods and services. For consumers, the BTT would likely mean higher prices on most purchases, and for business it would mean an expanded role as tax collectors. Andrew Friedman, a tax partner with the accounting firfn Peat Marwick, said, “The tax has to be all-encompassing or forget it.”
CFIB president Bulloch said that a survey of his 77,000 members showed that 44 per cent opposed the BTT, 34 per cent were in favor and 22 per cent remained undecided. But Consumers’ Association of Canada officials said that they were concerned about the prospect of a BTT. Declared spokesman Robert Kertoin, a University of Waterloo economics professor: “The reason a government wants to introduce BTT is simply a revenue grab. We worry it will divert attention from real tax reform, which would reward real producers instead of takeover artists.” Still, tax reform is a potentially treacherous area. The last comprehensive overhaul occurred in the late 1960s under Liberal Finance Minister Edgar Benson. The 1971 Tax Reform Act passed only after numerous compromises to accommodate the business community. In 1981 another Liberal finance minister, Allan MacEachen, tried to remove exemptions and cut tax rates. The subsequent controversy forced him to scrap most of the changes. Until now, Wilson has avoided major political damage because most special-interest groups have supported his basic principles. But when he releases detailed proposals in June, and the winners and losers are evident, a storm is almost certain to begin.
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