The Reform party gears up to campaign for a fixed-rate levy on incomes
In the beginning, there was only the Income War Tax Act of 1917, an 11-page outline of temporary levies to bankroll Canada’s part in a gruesome conflict. Nearly eight decades later, the war is long over—but the measures linger on. The Income Tax Act now runs to 1,563 pages, with more than 700 additional pages of rules and regulations. Each year, Parliament dutifully adopts hundreds of pages of amendments. More than 36,000 tax challenges are before the courts. With such complexity, it is no wonder that Ottawa accountant Tony Ferrante must keep 10 volumes of tax guides, crammed with more than 10,000 pages of rulings and interpretations and amendments, on his office shelf. Until recently, he subscribed to a $l,300-ayear service that funnelled 100 pages of detailed taxation updates into his mailbox each week. He finally cancelled his subscription because it cost too much to learn too little. “The paperwork is a nightmare,” he says. “Nobody really follows every little change in interpretation by Revenue Canada or every court case. It is impossible.”
When even diligent accountants pronounce such despairing verdicts, it is not surprising that politicians across the United States and Canada have been swept up into the alluring quest for a workable flat tax. On the surface, the idea is simple: a single rate of tax, set at the same level, on both corporate and personal income, with minimal exemptions. In the United States, Republican presidential candidate Steve Forbes has become the main challenger to front-runner Bob Dole, largely on the basis of his advocacy of a flat 17-per-cent tax instead of the present five rates, ranging from 15 per cent to 39.6 per cent, on personal income. In Canada, Reform party delegates appear certain to espouse the principle of a flat tax, instead of the current three rates, at their upcoming con-
vention in Vancouver in June. The party will then adopt a detailed model, outlining the proposed rate, exemptions, spending cuts and tax reductions that it will offer in the next general election. “Riere is a widely held perception that the current income tax system is so complex that the ordinary person can’t understand it and there is a yearning for simplicity,” Reform leader Preston Manning told Maclean’s. ‘There is also a feeling that the so-called fairness of the so-called [current] progressive tax system is a mirage.”
Still, flat tax theory is controversial—and the debate is sure to heat up as the details of individual plans emerge. Flat-tax proponents argue that their system is simpler and fairer because it eliminates loopholes that provide more benefit to the wealthy. They also contend that the flat tax could ignite an economic boom because tax considerations would no longer distort investment decisions. Opponents counter that most flat-tax proposals are unrealistic: if the rate is too low, the deficit will rise; if the rate is high enough to match current revenues, the middle class will be forced to pay more. Worse, businesses could face tax hikes of up to 100 per cent, leading to job losses and bankruptcies.
A flat tax would also limit the ability of governments to use the tax system for social and economic ends. That might mean less government interference in individuals’ lives. But it could also remake the social safety network. Taxpayers could lose such deductions as retirement savings contributions. The working poor could lose income supplements. Small businesses could lose billions of dollars in incentives. “Aflat tax,” says a senior finance department official, “removes the tax system as the vehicle for targeting people in need.”
The debate over the government’s proper role has become more urgent as tax burdens rise—and tax forms proliferate. In the United States, the tax counsellor for a major oil company dragged a six-foot stack of paper before the Republican party’s tax reform commission last year: it was the corporation’s 1993 tax forms. In Canada, taxes on personal income constituted 13.5 per cent of gross domestic product (GDP) in 1993—the highest among the G-7 major industrial nations. Federal personal income taxes are expected to haul in $64.5 billion in 1996-1997, up from $51.1 billion in 1993-1994. Over the same period, federal corporate taxes will rise from $9.8 billion to an estimated $16.3 billion. Reform party MPs delight in quoting nearnonsensical sections of the Income Tax Act, which are simply jumbles of references and notations, to flabbergasted audiences. “I am a businessman,” says MP Jim Silye, one of the drafters of the party’s flat-tax models. “All I know is that the current system is the three Cs: confusing, convoluted and complicated.”
Still, little in life is simple—including the definition of a flat tax. The so-called bible, The Flat Tax, was crafted by two Stanford University taxation experts, Robert E. Hall and Alvin Rabushka. First published in 1985 and updated last year, their model would tax the wages, salaries and pensions of individuals that exceed
such basic exemptions as $9,500 for a single taxpayer.
(Basic exemptions would vary with the size and composition of the household.) There would be no further deductions.
Investment income from capital gains, interest and dividends would be exempt. Businesses would deduct necessary goods and services, wages and benefits and investment purchases from gross revenue. There would be no deductions for dividend or interest payments. The flat rate would be 19 per cent—which the authors calculate would be sufficient to avoid an increase in the federal deficit. The tax burden on lowerand higher-income Americans would decline. The authors add: “The flat tax is a little higher than the current income tax in the range from $30,000 to $90,000.” That is, it would squarely hit the U.S. middle class.
It does not take a genius to see that much of the Hall-Rabushka plan could be political poison. And thus were born the variants. The Canadian pioneer of the flat-tax movement is Toronto Liberal MP Dennis Mills, who has waged a determined, quixotic crusade for a single corporate and personal tax of 20 per cent since the late 1980s. In recognition of current political realities, Mills has enlarged the definition of personal income to include investment earnings. And he has added such key exemptions as deductions for retirement plans and credits for charities, small businesses and employment insurance premiums. As Mills candidly admits, his plan will raise more tax revenue from middle-income households and most corporations. But federal revenues will still drop about $7 billion—because the higher personal tax rates disappear. Despite two fruitless sessions on his proposal with Prime Minister Jean Chrétien, Mills is undeterred: “The [flat-tax] system is not going to go anywhere heading into an
election. But the single biggest way to ignite investment and entrepreneurial spirit in this country is to change the tax act.”
The Reform party has built on Mills’s research with two crucial differences: the party has determined that tax reform must mean tax savings for individual Canadians—and it must not increase the deficit. And that means bigger, faster spending cuts. Manning told Maclean’s that his party has not yet settled on its model. “But what people really want is tax relief,” he said. “If they don’t see more dollars at the end of the day, any kind of tax reform is a hard sell. And that is why tax reform has got to be tied to deficit elimination.”
Still, major tax reform is always a leap in the dark—if only because no one can predict its effects with certainty. Hall and Rabushka offer the “conservative” estimate that their flat tax could add six per cent to the value of the U.S. economy during the first seven years after its implementation. There are no comparable estimates for Canada— although advocates hold out the possibility of unspecified gains. Much of that potential growth stems from the assumption that individuals and industries would no longer make investment decisions based on government incentives. Companies, for example, would locate plants
Tax reform numbers
A Reform party research paper last fall examined the impact of a flat 25-per-cent income tax, with personal and spousal exemptions of $8,200 each and refundable child tax credits. Assuming no other deductions, the model would reduce taxes for lowerand upper-income groups, while raising them slightly for middleincome earners. Examples:
PERCENTAGE CHANGE IN TAX BILL
TWO ADULTS WITH CHILDREN
TWO RETIRED ADULTS
150 and over
where the market dictates: measures such as the Atlantic Canada Investment Tax Credit would be eliminated. Economist Pierre Fortin of the Université du Quebec à Montreal has argued that higher marginal rates discriminate against effort, encourage the growth of tax shelters, undermine international competitiveness and foster tax evasion. “More than an economic problem, our tax quandary has become a moral problem,” he noted in an influential study last year.
Flat-tax opponents counter that the benefits of switching to
"3/9........... a simpler system are overrated.
And the transition costs could be horrendous. Businesses would still have to keep track of expenses and income: the socalled postcard-sized flat-tax form would require plenty of
'3/3........... documentation. And after
decades of concentrated tax planning, corporations could abruptly lose most of their deductions and credits. As a result, even if the federal rate is lowered from its current basic 28 per cent, their tax bills could double overnight—making it far harder to compete internationally.
In addition, because the flat-tax model remains undetermined, no one knows if traditional writeoffs, such as depreciation, would disappear—or if interim arrangements would be made to carry them forward. If interest income is no longer deductible, heavily leveraged firms could sink. Given those brutal possibilities and the sheer scope of the change, University of Toronto taxation professor Jack Mintz warns: “The efficiency arguments can be overestimated. And while I think maybe everybody wants businesses to pay more tax, I do not think that it will be that simple if you tell somebody that you are going to double their tax liability.”
That theme of fairness to companies and individuals rims through the flat-tax debate like a crack in thin ice. And no one can decide what constitutes “fair.” Under the existing federal system, there are three rates: 17 per cent on the first $29,590 of taxable income, 26 per cent on the next $29,590 and 29 per cent on the rest. Flat-tax proponents point out that wealthier individuals have more access to tax advice, more money to put into shelters and more incentive to use them because their rates are higher. A flat-tax would equalize the playing field. Some advocates even cite research that indicates that, whenever top mar-
ginal rates are lowered, the rich actually pay more taxes because they lessen their avid use of tax shelters. In the early 1980s, for example, when top U.S. rates dropped from 70 to 50 per cent, the wealthiest one per cent of taxpayers increased their contribution to government revenues by 23 per cent.
Still, it is virtually certain that most wealthy Canadians would save money if there were no marginal rates whatsoever. That is because the flat rate, whatever its level, will be considerably lower than the top marginal rate. Unless those wealthy taxpayers deploy a formidable battery of exemptions now, they will still save money when they lose those exemptions. That means that the middle class must pay more to raise the same amount of money for government coffers. Notes David Perry, senior research associate at the Canadian Tax Foundation: “If it is revenue-neutral, there are more losers than winners and the losers are all in the middle class. It is difficult to reform taxes if what you really need is a tax reduction.”
If the flat tax raises less money than the current tax, Canadians face further emotional debates about the nature of their nation. Do they want to increase the deficit? If not, they must decide how much more deeply they want to cut into government spending so that the single rate can be set low enough to bring relief to most taxpayers. Then they must decide what few exemptions, if any, they want to preserve in a system in which taxation will no longer be a major instrument of economic and social policy. Do they want to retain the deduction for retirement plans because the population is aging? Do they want to keep the credit for political contributions? Patrick Johnston, president of the Canadian Centre for Philanthropy, says that his centre’s research indicates that Canadians increase the size of their charitable donations because there is a tax incentive. “Governments are cutting expenditures on a host of services delivered by charitable organizations at the same time as there is increasing demand on those organizations,” he argues. “Removal of the credit would be a triple whammy.” Whatever the result of the current debate, it represents the first real protest against the horrendous complications of the tax system. So far, the federal finance department is waiting to see what the United States will do. But if the Reform party adopts a flat tax proposal, it is almost certain that the Liberal government will, at the very least, shred a few forms before the next election. Mintz adds that the flat tax issue has focused attention on the fact that Ottawa taxes savings twice: once, when the taxpayer earns the money; and again, when the taxpayer lives off the income from the money he has saved and invested. “Savings ratios are very low now,” he observes. “Potentially, we have maybe gone too far in one direction in taxing savings. The pressure now is to encourage investment and job creation through the tax system.” If nothing else, that would be a sizable achievement for a feverish debate.
With E. KAYE FULTON in Ottawa
E. KAYE FULTON