Significant tax reform required in Canada—Fraser Institute recommends a flat tax

Contacts:

Jason Clemens, Director of Fiscal Studies
The Fraser Institute
Telephone: (604) 714-4544
Email: jasonc@fraserinstitute.ca

Joel Emes, Senior Research Economist
The Fraser Institute
Telephone: (604) 714-4546
Email: joele@fraserinstitute.ca

Embargo date: 14 May 2001

VANCOUVER, BC—Reform of Canada’s federal and provincial tax systems should be based on a flat tax, recommends The Fraser Institute. In a study released today, "Flat Tax: Principles and Issues," the Institute says a flat tax is necessary to achieve efficiency, fairness, and simplicity—the traditional measures of successful tax policy.

"The issue of tax cuts has overwhelmed the equally important issue of tax reform in the national debate. Any discussion of tax reform during the 2000 federal election was riddled with misinformation that prevented an open and rational public debate about tax reform, particularly flat tax reform" says Jason Clemens, director of fiscal studies at The Fraser Institute and co-author of the study.

What is a flat tax?

A flat tax is a comprehensive, integrated approach to taxation. It applies a uniform tax rate to all sources of income, whether personal or business. It ensures that all sources of income, regardless of their nature, are taxed once and at one rate. 

Such a system would provide enormous positive incentives for work, savings, and investment. The research suggests that the economic benefits of implementing a flat tax system would include greater rates of economic and income growth, higher levels of capital formation and investment, and greater social welfare," says Clemens.

It is important to recognize that the replacement of multiple tax rates with a single tax rate, as proposed by the Canadian Alliance and implemented by the Government of Alberta, is only one step in the process of broad-based flat tax reform. Flat tax reform represents a much more comprehensive restructuring of the tax system.

Achieving Efficiency, Fairness, and Simplicity

A flat tax would decrease the amount of economic distortions caused by taxation and therefore increase rates of economic growth. A flat tax would also achieve greater fairness in the Canadian tax system. Households with similar income would face similar tax burdens more consistently (horizontal equity). For instance, single income and two-income households are treated much more equally under a flat tax system than under Canada’s current tax regime. In addition, a flat tax ensures that as individuals earn more, they pay more (vertical equity). Finally, a comprehensive flat tax would substantially simplify the current tax system with its multiple rates, exemptions, deductions, and various tax credits.

Progressivity Without Cost

A flat tax achieves progressivity through the inclusion of a personal exemption. Progressivity requires that an individual not only pay more taxes as their income increases but also that a larger percentage of their income is taken in taxes.

"The current system, characterized by high and increasing marginal tax rates, reduces economic growth by creating strong disincentives to hard work, savings, and investment," says Clemens.

Potential Flat Tax Rates

The study presents a series of potential flat tax rates for Canada and the provinces under different scenarios (see Table 1).

The various calculations completed in the study make it clear that any proposed flat tax rate is influenced by the presence and value of exemptions and deductions. The lower the value of such exemptions and deductions, the lower the applicable flat tax rates required to raise a given amount of revenue.

Of equal importance is the recognition that any decrease in the amount of revenue required by government results in a marked decrease in the applicable flat tax rate. For instance, a $13.4 billion reduction in federal revenues allows for a substantial increase in the personal and spousal exemptions, generous child exemptions, and deductibility for RRSPs and pensions with a federal flat tax rate of 19.0 percent. "Interestingly, this would result in a net reduction in income taxes for all income groups," says Clemens.

Taxing Consumption Instead of Income

Another major benefit of a flat tax is that it effectively moves away from taxing income towards taxing consumption, an inherently more efficient manner in which to tax. By including RRSP and pension deductibility, a flat tax effectively becomes a consumption tax.

International Experience

The study also explains the current tax systems in Hong Kong and the Channel Islands which approximate a flat tax. This counters the assertion that flat taxes are completely theoretical in nature and have never been tested.

Income Mobility

The study also concludes that tax reform should be viewed within the context of one’s entire life rather than within a single year. "There are a number of circumstances in which an individual or household may experience a small tax increase for a few years but receive substantial tax reductions in later years which more than offset any marginal tax increase," explains Clemens. 

Conclusion

Tax policy must be based on achieving the traditional measures of tax success: efficiency, fairness, and simplicity. The flat tax model presented here not only achieves these principles but would create an enormous tax advantage for Canada relative to our competitors. It would facilitate greater work effort, savings, and investment, and ultimately lead to higher rates of economic growth.

Table 1: Possible flat tax rates for Canada and the Provinces

Established in 1974, The Fraser Institute is an independent public policy organization based in Vancouver, with offices in Calgary and Toronto.

For further information or for a copy of Flat Tax: Principles and Issues contact:

Suzanne Walters, Director of Communications, The Fraser Institute, (604) 714-4582,
Email: suzannew@fraserinstitute.ca

A pdf version of the publication is also available by email.