BUSINESS WATCH

The new shape of tax reform

Peter C. Newman June 22 1987
BUSINESS WATCH

The new shape of tax reform

Peter C. Newman June 22 1987

The new shape of tax reform

BUSINESS WATCH

Peter C. Newman

Michael Wilson’s white paper on taxation may not win any votes for the Mulroney government, as detailed measures, being tabled this week, produce a fire storm of protest against lost exemptions. But it will be difficult to argue with its basic thrust. “Tax reform,” the finance minister told me, just as he was finishing the final draft of his long-awaited report, “is something done once in a generation, so there has to be a good deal of screwing up courage, whether this is the right time to do it and whether we have the right package. There are just too many changes taking place worldwide to allow us the luxury of waiting any longer.”

It is not only the U.S. system that has recently been drastically altered, but tax levels in the United Kingdom, Japan, France and West Germany have also been or are being revised. Wilson feels strongly that perpetuating the gap that now exists between Canadian and U.S. tax rates would drive our money and our best brains out of the country unless we follow suit. “When people look at Canada as a place to invest,” he says, “more often than not it’s the United States that is competing for those funds, so we must have competitive tax rates, or we’ll lose jobs and people—and that can happen very fast.”

One of the main problems Wilson will face in trying to get his white paper accepted is that it will be very difficult psychologically for businessmen— particularly investors who have taken such happy advantage of tax shelters for so long—to suddenly have them removed. Although those shelters have been overused and abused, they were put into the Income Tax Act in the first place because the government of the day wanted to channel funds into certain categories: Canadian movies through fast writeoffs, for example, or condominium construction through MURBs and RHOSPs, as well as scientific research through tax credits. “What we’re trying to achieve is a balance,” says Wilson. “The best incentive of all is a lower tax rate, so that Canadians can keep more of what they earn and spend or save it as they see fit. Over time, tax breaks for individuals and corporations have been piled up on top of each other, so that the aggregate impact has provided too much incentive for some industries. Also, the more incentives you put into the system, the

more you have to raise the basic tax rate for everybody. We need a housecleaning, especially to remove those measures put in to resolve problems 15 or 20 years ago.”

What he is really saying is that those taxpayers who have made extensive use of preferences and deductions will end up paying higher effective rates, while everybody else pays less. That’s hard to argue with, except that most taxpayers’ attitudes will be, sure, reform the sys-

tern, but don’t touch my exemptions. “The people who say ‘Don’t touch my exemptions,’ ” Wilson counters, “should also be saying ‘Get my rates down’— and we’ll be doing both. The white paper should be read for its total bottomline impact, instead of for its specific changes. It’s a package, and it must be seen as a package.”

As befitting a Conservative finance minister, Wilson has retreated to the traditional Tory policy of allowing market forces to determine where future

investments will go. That’s a dangerous gamble, because Canadian businessmen have solidly earned their reputation for rushing after profits and taking care of their own rather than the national interest. “While I really do believe that market forces will result in a good allocation of investment capital,” he says, “we will not be taking every incentive out of the system. Some are essential to support broad government objectives. But distortions in the existing Income Tax Act, caused by the layering of individual preferences, have upset the ability of market forces to operate effectively, and we intend to correct that. The higher the tax rate, the greater the incentive to devote more time, money and effort to avoid taxes, legally or otherwise. The public knows who pays for the success of these efforts—the average Canadian taxpayer.”

Any tax system that dramatically reduces its rates must broaden its collection base, or total revenues will take a sudden drop, and Wilson has no intention of allowing that to happen. “What I’ll be trying to do,” he told me, “is to ensure that people who are in similar income brackets bear approximately the same load of taxation. Because some of the existing preferences are no longer effective or necessary, people in similar circumstances have had to carry unequal burdens. So by broadening the base we will be able to reduce the overall rates.”

That benign-sounding statement signals a revolution in Canadian business, which in the past has based much of its planning not on how to create the most jobs or even profits, but on how to pay the least amount of tax. Wilson blames that phenomenon on the rather obvious fact that tax revenues have not kept up with growth of the economy as a whole, and there is no question that corporate taxpayers are going to be hit hard when the white paper is translated into law.

Wilson is determined to break the spiral of higher tax rates leading to more tax preferences, which in turn lead to more tax-motivated transactions, which inevitably lead to higher taxes to recoup the lost revenues.

The good news is that the finance minister regards his white paper as a working draft, not a definitive blueprint. When Michael Wilson rises in the Commons this week, the disruptive and politically treacherous process of tax reform will have only begun.