Preface

This book is a summary of the latest results of a Fraser Institute project that began in July, 1975. Its objective was to find out how much tax, in all forms, Canadians pay to federal, provincial, and municipal governments and how the size of this tax bill has changed over the years since 1961. In the interim, nine editions of this book have been published.

The book has been written with two distinct purposes in mind: first, to provide a non-technical do-it-yourself manual so that the average Canadian family can estimate how much tax it pays; and second, to update a statistic, first published in 1976, that we call the Canadian Consumer Tax Index. This index measures how much the tax bill of an average Canadian family has increased since 1961 and by how much it is changing currently. In other words, it measures changes in the price that Canadians pay for government.

This book does not attempt to look at the benefits that Canadians receive from government in return for their taxes. Rather, it looks at the price that is paid for a product-government. It has nothing to say about the quality of the product, how much of it each of us receives, or whether we get our money's worth. These questions are, however, considered in the Institute companion publication, Government Spending Facts 2, published in 1994.

The statistics contained in this book are based on an analysis of the individual circumstances of some 45,000 Canadian families. Prior to 1992, the analysis was done with group average data pre-compiled by Statistics Canada. Because the analysis is now built up from families, it is possible to examine the situation of particular types of taxpayers with a good deal more precision.

The Fraser Institute calculations of tax burden are part of an on-going program of research. In making these results available to the public we seek both to inform and to be informed. Readers who disagree with our methods or conclusions are invited to write to the Institute to convey the nature of their reservations. In this way, our methods and our estimates can be refined and perfected.

-Michael A. Walker


Acknowledgements

We are pleased to acknowledge the assistance of Statistics Canada which provided certain unpublished background data essential to this study. The Canadian Tax Simulator computer programs were originally written by David Gill whose unsparing efforts we are pleased to acknowledge.

The sixth and seventh editions were computed on a set of programs modified to run on a micro-computer system. These modifications were completed by Douglas T. Wills, who has gone on to other ventures.

The eighth and ninth editions of Tax Facts were computed using the SPSS statistical package for which the programming was done by Filip Palda and Isabella Horry.


About the authors

Joel Emes is a research economist at The Fraser Institute. His current areas of research are taxation policy and inter-provincial fiscal performance. He holds a Masters of Arts in Economics from Simon Fraser University where his main areas of study were econometrics and qualitative forecasting.

Isabella D. Horry was a research economist with The Fraser Institute until 1995. She was born in Vancouver, Canada and attended the University of British Columbia. In 1985, she received a Bachelor of Arts, and in 1987, a Master of Arts in Economics. She joined The Fraser Institute in 1988, and co-authored Tax Facts 6 (1988) and Tax Facts 7 (1990) with Sally Pipes and Michael Walker, Government Spending Facts (1991), and Government Spending Facts 2 (1994) with Michael Walker, and Tax Facts 8 (1992) with Filip Palda and Michael Walker.


Filip Palda is a professor of economics at the École Nationale d'Administration Publique in Montreal, and a Senior Fellow of The Fraser Institute. He received a B.A. in 1983, and an M.A. in 1984 from Queen's University. In 1989 received a Ph.D. in Economics from the University of Chicago where he wrote his dissertation under Nobel Laureate Gary S. Becker.

Professor Palda is the author of four books including How Much is Your Vote Worth? The Unfairness of Campaign Spending Limits, published by ICS press in the United States. He has also edited a number of Fraser Institute books including Provincial Trade Wars: Why the Blockade Must End, and L'État Interventionniste: Le gouvernment provinciale et l'économie du Québec.

He has published numerous articles in learned journals on the theory and measurement of political phenomena. He writes a syndicated column for the Sterling chain of newspapers and appears regularly in the media as an economic and political commentator.


Michael Walker, Ph.D., is Executive Director of The Fraser Institute. Since 1974, he has directed the research activities of The Fraser Institute. He has written or edited 40 books on economic topics. His articles on technical economic subjects have appeared in professional journals in Canada, the United States, and Europe. He has been a regular columnist in the Vancouver Province, the Toronto Sun, the Ottawa Citizen, and the Financial Post. He taught at the University of Western Ontario and Carleton University, and was employed at the Bank of Canada and the Federal Department of Finance. He received his B.A. at St. Francis Xavier University and his Ph.D at the University of Western Ontario. He is a director of a number of firms and other enterprises.


Chapter 1:

The Canadian Tax System

Canada in the world of 1996

UNDOUBTEDLY, ONE OF THE MOST unpopular policies in Canadian history was the introduction of the Goods and Services Tax (GST). In part, its political unpopularity was due to the fact that many Canadians thought that this was a new tax that would result in a greater tax burden. But it also reflected a deep-seated concern on the part of citizens about the process of government, and revealed the belief held by many that the government was collecting too many tax dollars to accomplish too little in the way of public services.

The most significant revelation in the reaction to the GST, however, was that the Canadian public has very little real information about their tax system. Very few knew that the GST was replacing a tax already in place, and fewer still realized that the federal government's main ambition was not to raise more revenue, but rather to replace the Manufacturers' Tax. Everyone who had studied the Manufacturers' Tax had concluded that it was a terrible tax which had many unintended, negative economic effects. It was a tax that had to be replaced, but Canadians' ignorance about it was a significant barrier in its removal. While some would say that there is no such thing as a good tax, it is in fact the case that as long as there is a demand for public expenditures, there will have to be taxes to finance them. The task, then, is to design an "efficient" set of taxes: one that does not interfere with the types of decisions people make in the marketplace. We now know that taxes distort people's decisions, leading to behaviour that leaves opportunities for mutually beneficial exchanges unexploited. A tax system that interferes too much with people's decisions can also cripple one nation's ability to compete with another.

In other words, there is something worse than a tax, and that is a badly designed tax which, in addition to taking spending power from the private sector, also distorts everyday decisions in a way that is neither desirable nor necessary. As free international trade becomes a reality, it is increasingly important that governments implement efficient and sensitively designed tax systems. A prerequisite to being able to debate and design such taxes is a base of information about them. The purpose of this book is to provide those who want it with a basic tool kit of knowledge about taxation in Canada in order to enhance the opportunity for rational debate about these issues.

In fact, this book is an important resource for everyone concerned about the extent and relatively rapid growth of taxation in this country. Between 1981 and 1996 the total tax bill from all three levels of government on the average Canadian family increased in real terms by $2,426 in 1996 dollars. Even though the Progressive Conservative Party came to power in 1984 on a platform of government restraint, and managed to some degree to make the tax system more efficient, the federal income taxes of the average Canadian family increased by $1,140 in 1996 dollars between 1985 and 1996. Figure 1.1 charts the progress of taxes for selected years since 1981.

The many faces of the tax collector

What Figure 1.1 shows is that the Canadian tax system is continually changing. To understand the current trends of change it is important to know how the Canadian taxation system has evolved. Under the Canadian constitution, the federal and provincial governments are essentially given unlimited powers of taxation. In the British North America Act, the immediate predecessor of the Canadian constitution, the provinces are limited to collecting taxes that are paid directly by the person being taxed-so-called direct taxes. But because of the broad judicial interpretation of the meaning of the word "direct," the provinces have been able to levy all sorts of taxes, except for import duties and taxes on sales which cross provincial borders. Given this unlimited scope for taxation and the 100 years of ingenuity that have elapsed, it is not surprising that Canada now has a very complicated tax system.[Perrin Lewis' chapter, "The Tangled Tale of Taxes and Transfers," in Michael Walker, ed., Canadian Confederation at the Crossroads, The Fraser Institute, 1979, offers a survey of the Canadian tax system's evolution with emphasis on the sharing of tax revenues between the provinces and the federal government]

To begin to understand some of this complexity, simply note the 13 categories of tax set out in table 1.1. This number has grown over the past few years as new taxes, like those on energy, the airport tax, and the GST have been implemented.

Income taxes predominate

Table 1.1 and figure 1.2 show that personal income taxes are the largest single source of government revenue. During 1995 some $102.5 billion were extracted by federal and provincial income tax-a sum which represented 38.8 percent of the total taxes that Canadians pay. Second in line as a source of federal and provincial revenues was the sales tax-representing 16.0 percent of tax revenue and 42.1 billion tax dollars. Corporate profits taxes, at 6.9 percent of total taxes, accounted for a further $18.2 billion, while property and natural resource taxes accounted for $41.1 billion and 15.6 percent collectively. Together, these five kinds of tax accounted for nearly 77.3 percent of total government revenue during 1995. (Interestingly, both the corporate profits tax and the income tax were implemented in 1916 and 1917 as "temporary" measures to finance World War I.)

Table 1.1 also illustrates how the Canadian tax structure has evolved over the 35 years since 1961. The most obvious change has been the evolution of the personal income tax. While always a prominent feature of the tax system, the income tax has, in recent years, become increasingly important. In 1961 income taxes represented only 22.7 cents out of every tax dollar Canadians paid, but by 1995 income taxes accounted for 38.8 cents-nearly two and a half times the revenue generated by the second-running sales tax.

This increase came about largely through passive interaction between the progressive income tax system and money incomes swollen by inflation.[Douglas Hartle, "An Open Letter to Allen Lambert," The Financial Post, Feb. 11, 1979. Mr. Hartle was a senior civil servant in the federal Treasury Board during the latter period of the income tax explosion] Until the income tax was indexed to the inflation rate in 1974, all income increases were taxed at progressively higher rates in spite of the fact that much of the increased income represented illusory inflation-based gains.

As a consequence of this revenue growth, government was able to rely less on other forms of taxation and to allow the burden of some of these taxes to fall. However, in some important cases-notably sales tax and health and social insurance levies-the rate of tax was increased despite rapidly growing revenues from personal income tax. (Table 1.2 presents the burden of the top nine taxes contributing to government revenue in 1995. The figures in the table are the effective rates of taxation relative to total Gross Domestic Product.)

While revenue from the income tax explosion poured into the federal government's coffers, the provinces were led by their perceived need for tax revenue to gradually boost their sales tax rates (except for the province of Alberta, which has no sales tax, and British Columbia, where the sales tax has been adjusted up and down. In B.C. it was reduced from 7 percent to 5 percent on April 11, 1978, on April 1, 1979 was further reduced to 4 percent. However, on March 10, 1981 it was increased to 6 percent, and in July 1983 to 7 percent. In the 1987 budget, the tax was once again dropped to 6 percent and raised to 7 percent in the 1993 budget, where it remains). The federal government also sought to increase its revenue from indirect sources in the early and mid 1980s by increasing its takings from the Manufacturer's Sales Tax, and starting in 1991 by replacing this tax with the more comprehensive GST. Department of Finance officials hoped to raise an extra $10 billion annually from this new source.

The rise in resource taxation in the 1970s and 1980s resulted primarily from rises in the price of oil and gas, triggered by the oil embargo and subsequent cartelization of oil pricing by the OPEC countries in 1973.[For a complete discussion of oil pricing and taxation, see G.C. Watkins and M.A. Walker, eds., Oil in the Seventies, The Fraser Institute, 1977] In the normal course of events, these price rises in Canada would automatically have meant a sharp rise in the return to Canadian producers. But the reaction of provincial governments was to absorb much of this "windfall," or "rent," as it has been called, in the form of higher taxes or royalties. The federal government, for its part, imposed a further tax on producers who were exporting oil. (This tax, the oil export charge, amounted to the difference between the controlled Canadian price per barrel and the world price.) Proceeds from the federal tax were then used to subsidize imports of foreign oil into the eastern Canadian provinces.

From 1974 to 1984 both the provincial and federal governments escalated their tax effort-but the federal government did so especially. The National Energy Program and the subsequent Energy Agreement allowed the federal government to earn about $4 billion from petroleum during 1984.

The 1985 Federal budget incorporated a number of changes to energy taxes as agreed upon in the Western Accord with the governments of Saskatchewan, Alberta, and British Columbia. Both the oil export charge and petroleum compensation charge were eliminated. Other energy taxes, such as the Petroleum and Gas Revenue Tax, were revised, reduced, and in some cases phased out. These changes, combined with the decline in world oil prices, has resulted in energy related revenues declining in both relative and absolute terms.

The late 1980s and early 1990s saw the federal government trying to make income, corporate, and sales taxes more efficient and less of a burden to Canadians as they attempt to compete in the international marketplace. While corporate and income tax rates fell, many deductions were eliminated in order to expand the tax base. These changes were supposed to lessen the degree to which taxes enter into Canadians' decisions. (If this principle seems strange, consider a flat tax. The rate of such a tax is not related to any economic activity in which the individual may engage. Government simply takes a fixed proportion of total income irrespective of how it is earned. What the government takes may be huge, but since the tax is not related to how much the individual works or spends, it will not directly affect his or her decisions to spend or save, to work or not work, etc. In particular, since the taxation rate is the same regardless of income, there is no particular disincentive to make the effort to move to higher income levels from any given starting income.)

Lowering tax rates, however, did not lead to less tax collection.

In fact, in the past 11 years, federal collections from the average family have risen by $1,140 in 1996 dollars. This rise is due to the expanding tax base. That the federal government has not collected even more taxes is due to its declining commitment to provincial projects such as welfare, education, and health care. In reaction, the provinces have chosen to make up the shortfall not by reducing spending, but by increasing their taxes.

The provinces have been able to raise provincial income taxes less visibly than the federal government because of the "tax-on-tax" system whereby all provinces except Quebec impose a tax upon the federal tax. Table 1.3 shows the combined federal and provincial tax rate in each province for a single taxpayer at three different income levels. Quebec residents must complete both a federal and Quebec tax return.

The federal government collects the tax and returns it to the provinces. In what may have been an effort to disassociate itself from provincial tax collection practices, in 1991 the federal government asked a sample of Canadians outside Quebec how they would feel about filling out two income tax forms: one for Ottawa and one for their province. So far, none of the other provinces have followed Quebec's lead.

Dividing the spoils

Determining which level of government will get how much revenue is one of the important tax questions of the 1990s. Table 1.4 and figure 1.2 provide a breakdown of major taxes by federal, provincial, and municipal levels of government for the years 1961 and 1995. Total taxes collected now amount to 35.2 cents out of every dollar of GDP, a 56.4 percent rise since 1961.

These figures do give a somewhat distorted impression in that some municipal and provincial government revenue comes from other levels of government. For example, in 1961, fully 30 percent of provincial and municipal revenues were derived from other levels of government. (Provinces received transfers from the federal government, while municipalities received transfers from both levels.)

In the case of provincial revenues, the figures for 1961 reflect the tax agreement that was in effect between the federal and provincial governments. Under the agreement, the federal government "rented" the provinces' rights to tax personal incomes. In effect, the provinces relinquished their right to tax personal incomes in return for cash payments from the federal government which collected all the taxes.[These developments are documented in Perrin Lewis, Ibid.] Accordingly, the tax-collection statistics for 1961 do not reflect the division of the revenues produced, but only which level of government actually collected them.

In 1995, the collection figures more closely matched the revenue as it was divided between federal and provincial governments due to the fact that revenue-sharing agreements have been gradually modified to eliminate tax rental arrangements and shared-cost programs. In the years following 1978, the provinces have had, increasingly, to raise their own revenues. As a consequence, tax receipts from different levels of government will more closely reflect the actual sharing of tax revenues. To a considerable degree this evolution reflects the changing attitudes of the partners in Canadian confederation, and the changing tax arrangements are the harbinger of a more decentralized federation. (In Quebec's case, separate tax collection facilities have been in existence for some time.)

The relationship between provincial and municipal government revenues reflects a different process. Municipalities now collect much less of their total revenue in the form of taxes than they did in 1961. And, in fact, fully 44.1 percent of municipal revenue is now accounted for by transfers from federal and provincial governments-mainly the latter. In part, the emerging role of municipalities as dependencies of the provincial government is a result of decreasing reliance on property taxation as a form of finance (see table 1.1). Property taxes accounted for only 12.7 percent of total taxes (of all kinds) in 1995 as opposed to 15.5 percent in 1961 (see figure 1.2).

This trend toward less reliance on property taxation contrasts sharply with the situation in the United States and in California, in particular, where the sudden increase in property taxation touched off what has been called the "Proposition 13" movement. The failure of similar initiatives in Canada, the most recent in Toronto in 1991, may be directly attributable to the different strategy of local government finance pursued in this country.

The fifth column

Hidden taxation

Most people are aware of the fact that they pay income tax, sales tax and property tax, the so-called direct taxes. Many others, appropriately, regard the various social security levies like unemployment insurance contributions and Canada and Quebec Pension Plan payments, as taxes. Similarly, many families know how much of these taxes they pay, either in terms of the rate (in the case of provincial sales taxes) or the total amount (in the case of property and income taxes). There are, however, many taxes of which Canadians, by and large, are unaware. These taxes are built into the price of goods and services but are not identified to the final consumer as a tax cost. For want of a better name, we call these implicit or hidden taxes.

Indirect taxes

There are several different kinds of hidden tax. The most well known of these are the so-called indirect taxes-principally excise taxes on such items as tobacco and alcohol, value added taxes (GST), and import duties. These taxes are paid by some intermediary in the production process and become incorporated in the final price of the product. The most notorious examples are tobacco, liquor, and gasoline taxes. (See figures 1.3 and 1.4 for a breakdown of taxes paid for a litre of gasoline and a bottle of liquor.) In the case of liquor, the federal rate of indirect tax is 132 percent. In addition, alcohol bears a provincial government "mark-up" as well as a provincial sales tax. The final delivered price of alcohol is 577 percent above the price received by the distiller. The tax on tobacco is even more aggressive. The final consumer of both of these products pays the taxes without them having been identified as such. Of course, most people are aware that alcohol and tobacco are highly taxed, even if they do not know the actual rate of tax.

During 1995, total indirect taxes of all kinds amounted to $84.7 billion in Canada. This was 12.7 percent of total Canadian income and accounted for 32.0 percent of total government revenue from taxation. In other words, quite apart from the tax they pay when they receive their incomes, Canadians pay, on average, a further 12.7 percent in indirect taxes when they spend their income. Furthermore, almost one-third of all government revenue is collected in this indirect, hidden form.

The hot potatoes-passing tax forward

Hidden taxes are hard to calculate because people try to pass them on to others. From an individual's point of view, any tax that can be avoided is money in his or her pocket. As a result, people throughout the economy are constantly attempting to avoid situations in which they will have to pay taxes, and seeking to pay as little tax as possible, whatever their situation. The moonlighting tradesperson who engages in "cash only" transactions; the mechanic who fixes his neighbour's truck in return for free cartage; the dentists who fix fellow dentists' families' teeth on a reciprocal basis; the tycoon whose business is "incorporated" in the Grand Cayman Islands: all want to avoid taxes. In the end though, when a tax is levied, somebody ends up paying. Who that somebody is is one of the most difficult and important questions in economics, and is known as the study of "tax incidence."

How employees pass the tax on

To get an idea of the difficulties involved, consider the following: The average Canadian employee measures his welfare in terms of after-tax dollars, and in each new wage bargain aims to get an increase in take-home pay. The fact that an increase in gross terms will imply a smaller increase in after-tax dollars motivates the employee or his union representative to demand a larger gross increase. By doing so, the employee is attempting to get the employer to bear the burden of the additional tax. For an example of this process see the box insert-Figure 1.5.

Expressed slightly differently, the employee who bargains in this manner is attempting to "pass the tax forward." His behaviour is not unique but, on the contrary, is a general characteristic of all employees in the Canadian economy. Corporations attempt to pass their higher profits and payroll taxes forward to the consumer in the form of higher prices (as well as backward on employees in the form of lower wages). Of course, all of these attempts may or may not be successful in any single instance, and they will be accomplished to varying degrees through time.

Who pays the indirect taxes?

It is difficult to know where the burden of these taxes ultimately lies, but not impossible. We simply need to make intelligent assumptions about how each tax is passed on. For example, a general sales tax is collected and remitted to government by retailers. It is clear, however, that in most cases the retailers do not actually bear the tax-they are merely the agents for collecting it. The actual effect of the tax is to increase the price of all goods and services affected by the tax, and to cause a corresponding reduction in the purchasing power of family incomes. Accordingly, to the extent that a general sales tax causes an increase in the general level of prices, the tax is borne not by the collectors, but by income earners in the economy whose incomes now buy less. Indirect or sales taxes therefore burden all income earned in the economy.

Payroll taxes such as Employment Insurance premiums and Canada and Quebec Pension Plan contributions are collected in part from the employer and in part from the employee. And, while no one would dispute the fact that the employee pays the employee portion, in most cases it is true that the employee also pays the so-called employer's portion. This is because the payroll tax paid by the employer reduces the total amount of money the employer has available to pay labour-related costs. In other words, payroll taxes reduce potential wage and salary payments below what they would otherwise have been. Since no corresponding reduction can be expected in the price of the products that the employee will want to purchase, the payroll tax, in effect, burdens the employee.

While both of these arguments have been framed in terms of employees and their wages and salaries, it is clear that taxes burden capital income as well. For example, a general sales tax reduces the purchasing power of all income, not just wage and salary income. As a result, it is appropriate to view the general sales tax burden as falling on all forms of income, including interest income and dividends. All of the tax burden estimates constructed in this study, therefore, allocate the burden of general sales taxes in proportion to all income received by a family. In practical terms, this means that if general sales taxes amount to 6 percent of total Canadian income in a particular year, we add 6 percent of a family's total income to the family's tax bill when we calculate how much tax the family pays.

In computing this general sales tax burden, income that a family receives from government is explicitly ignored. This is because the payments received from government, such as the Old Age Pension and Family Allowance, have historically been and are currently either directly or indirectly indexed to the general level of prices (that is, increased to offset the effects of inflation). As the general price level rises in step with the sales tax, the purchasing power of transfers from government is not permitted to fall. As a consequence, the general sales tax does not have the effect of burdening income in this form, and it would be inappro- priate to allocate any part of the burden of general sales taxes to this sort of income.[This particular distinction is due to the work of Edgar K. Browning and William R. Johnson of the University of Virginia who have completed a study of the burden of taxation in the United States, The Distribution of the Tax Burden, American Enterprise Institute, 1979]

While the burdens of a general sales tax and payroll taxes are relatively straightforward to assign, the assignment of particular excise taxes is a little more elusive. Whereas a general sales tax increases all prices and hence reduces the purchasing power of all incomes, particular taxes on commodities usually affect only the price of that commodity. For example, excise taxes imposed on liquor, motor vehicles, and fuels affect only the prices of those products, in the first instance at least. (Ultimately, of course, they may affect a whole range of prices-fuel taxes affect the price of transportation, as do motor vehicle taxes. These taxes may therefore have an overall effect although levied only on a particular product.)

In light of these considerations, it has been the usual practice when calculating tax burdens to allocate the burden of particular excise taxes according to the consumption of those items. The 1976 tax burden studies published by The Fraser Institute employed this methodology.[These studies, published in 1976 and 1977, respectively, were: Michael Walker, ed., How Much Tax Do You Really Pay? and Sally C. Pipes and S. Star, Income and Taxation in Canada 1961-1975, The Fraser Institute] However, following this methodology gives rise to a variety of problems. First of all, only the first-round effects of the excise tax are incorporated and, hence, the actual distribution of the tax burden may differ substantially from the estimate. Second, this method may not even provide good estimates of the first round effects of the tax. This is so because the relative burden of a particular tax borne by a family is determined not by the family's consumption of the taxed item but by the fraction of the family's income spent on the item relative to the national average.[Edgar K. Browning and William R. Johnson, The Distribution of the Tax Burden, American Enterprise Institute, 1979]

In view of these problems with the traditional approach, and given that the proportions of income spent on different items by various income groups do not vary widely from the average, we decided for the purposes of this study to distribute excise taxes in the same way as general sales taxes. That is to say, this study assumes that excise taxes burden total incomes-excluding government transfers to persons.

So, the answer to the question, "Who pays the indirect taxes?" is a straightforward one. Although indirect taxes appear in a variety of forms, they ultimately burden the income that the family earns.

Other taxes by other names

In addition to "formal" taxes levied by government, there are a variety of other government actions which, while having the same effect as taxes, are not normally identified as such. These activities are becoming an increasingly important feature of the Canadian economic landscape and must receive special mention.

Clothing and textile taxes

In November 1976, the federal government imposed a quota on imported clothing and textiles. Its purpose was to limit the importation of inexpensive clothing and textiles and so protect Canadian markets for Canadian clothing and textile manufacturers. The associated decline in competition for the Canadian consumer's clothing expenditure dollar will undoubtedly have produced a higher price for clothing than would otherwise have existed (particularly since world-wide clothing and textile markets are in a depressed state owing to expanded output from Far Eastern producers).

The difference between the price for clothing that would have prevailed in the absence of the quota and the price that actually prevails is a tax on the consumer. Proceeds from this tax go directly to producers and are, in effect, a producer subsidy. There is no difference in principle between this sort of tax and the other hidden taxes that we have been discussing. Of course, these "clothing taxes" do not show up in government revenue figures, and precise estimates of their size are difficult to make, but we cannot ignore their existence. R.J. and P. Wonnacott in their book, Free Trade Between the United States and Canada, have estimated that the total amount of tax levied in the form of tariff protection or other barriers to international competition may be as high as 10.5 percent of Canada's Gross National Product.[R.J. Wonnacott and P. Wonnacott, Free Trade Between the United States and Canada, Cambridge, Mass.: Harvard University Press, 1967] Currently, this amounts to a tax of over $80.0 billion.

Some of the burden associated with tariffs and quotas will be eliminated as a result of the full implementation of the Free Trade Agreement between Canada and the United States. However, in many cases the principal source of cheaper products is not the United States but less developed countries.

Marketing board taxes

At present, there are dozens of farm product cartels in Canada. These cartels or marketing boards generally have the effect of suppressing competition in the production of the cartelized product, and they consequently cause the price of the product to be higher than it would otherwise have been. As in the case of clothing and textiles, the amount by which the marketing board price exceeds the price that would prevail in its absence-that is, in the open market-is a tax on the consumer. Accordingly, marketing boards ought to be viewed as a device for transferring money from consumers to producers. And this transfer is equivalent to a tax on consumers, the proceeds of which are given to producers.

The increasing power of marketing boards, and the seeming reluctance of government to restrain their growth (the federal Minister of Agriculture actually fosters their growth), suggests that these marketing board taxes will become increasingly important in Canada. Moreover, as restraint in government taxation and spending becomes a reality, it will become increasingly expedient for government to rely on hidden "regulatory" taxation of this sort. Fortunately, offsetting this tendency is the pressure that free trade exerts on the political groups which support these developments.

Regulatory taxation

In general, a government can achieve a given objective either by taxation and subsidization or by regulation; rather than imposing import quotas, the federal government could have assisted Canadian clothing manufacturers by giving them a direct subsidy financed from general tax revenue. That the government chooses to use regulation to convey a subsidy in this fashion should not distract attention from the fact that a subsidy has been provided, and that it is the Canadian consumer who pays for it.

A 1987 study by Moroz and Brown tried to measure the costs of some of the hidden taxes mentioned previously. They estimated the dollar value of protection to Canadian industries in 1979 due to tariffs and non-tariff barriers such as import quotas. The sum of such protection across industries was $34.8 billion in 1996 dollars, or 10.4 percent of the total value of production. Most of the protection went to textiles, agriculture, and forestry. In sum, each Canadian paid $1,432 (in 1996 dollars) in hidden taxes on internationally-traded items in 1979. More up-to-date figures on agricultural protection (OECD, 1995) suggest that farmers received $5.5 billion in protection in 1994. In more recent years, implicit and direct trade taxation has fallen due to multilateral trade agreements in the World Trade Organization and regional agreements like the North American Free Trade Agreement.

Deferred taxation

During his budget statement in November 1978, the Hon. Jean Chrétien, then Federal Minister of Finance, made much of the fact that because the personal income tax structure had been indexed to inflation, there had, in effect, been a reduction in personal income taxation compared to what would have prevailed in the absence of indexing. That is to say, exemptions had been increased by the rate of inflation and tax brackets had been shifted to ensure that incomes swollen by inflation would not be taxed more heavily on that account alone. While this change in the tax structure, first introduced in 1974, was indeed a welcome one, it would be naive to uncritically accept the move as a permanent reduction in the government's propensity to tax.

In fact, the "reduction" in personal income tax revenues was accompanied-starting in 1975-by deficits and shortfalls in the federal government's cash position which were unprecedented in peacetime. Moreover, in 1986, the indexation provisions were modified to only provide coverage for inflation in excess of 3 percent as measured by the Consumer Price Index.

Although this situation is not entirely attributable to the decline in personal income tax revenues, it is clearly the case that continued growth in income taxation would have meant a smaller deficit and a reduction in net cash requirements to be financed by issuing debt. Accordingly, in assessing Canada's current level of taxation, it is appropriate to take into account the extent to which tax collections are merely deferred by current tax "reductions."

In other words, when calculating the total tax burden of all government operations in a given year, it is appropriate to include not only current taxes levied but also future taxes that must be levied to discharge debts acquired by the government in the current year. To the extent that the government finances its operations by deficit financing or by issuing bonds-deferred taxation-there is a hidden tax burden implicit in its operations. Chapter 4 gives the calculated estimates of the total tax burden which includes all of these deferred taxes.

How much tax should Canadians pay?

In 1917 when he first introduced the Personal Income Tax, the Finance Minister of the day, Sir Thomas White, was of the opinion that no Canadian should pay tax on income less than $2,000 if they were single and had no dependents. Married taxpayers, he said, should pay tax on income in excess of $3,000. The tax structure that ultimately evolved provided that single Canadians pay income tax on income in excess of $1,500, while married Canadians were exempted from the tax until their incomes exceeded $3,000. However, in the very next year, this was reduced to $2,000 for a married taxpayer and $1,000 for single Canadians.[House of Commons Debates, July 25, 1917]

While the tax structure has gone through many changes in the intervening years, it is interesting to ask how Canadians would be treated for tax purposes in 1995-96 if this initial view of "ability to pay" had kept pace with developments in people's incomes. To answer this question we have adjusted the original exemption levels by the increase in average wages over the period since 1917. This adjustment yields an exemption level for 1995 of $11,875 for single taxpayers and $23,749 for married taxpayers. But actual personal credits for single and married taxpayers amounted to $6,456 and $12,374 in 1995-in each case less than the level that would have been allowed if the 1917 standard had continued in force.

The reason for the disparity is that over the years from 1917 to 1974 exemption levels were not indexed to the cost of living or the increase in family incomes-in fact, in a few years during the Depression, exemption levels were actually reduced. Since 1974, exemption levels have been indexed to the rate of inflation.


Chapter 2:

Personal Income Taxation in Canada

IN CHAPTER 1 WE ALLUDED to the fact that income taxes are the largest single source of government revenue. It therefore follows that the largest single tax paid by the average Canadian family is the income tax. As we also noted in Chapter 1, this tax came into existence in 1917 as a "temporary" emergency measure to help finance the increasing debt associated with World War I. "Nothing," it is said, "endures like the temporary."

The current income tax structure

Table 2.1 presents the actual income tax rates (both federal and provincial) encountered by the average single individual at various taxable income levels, for 1993 and 1995. As the figures show, the minimum rate of tax is 26.35 percent payable on taxable income of $1.00. The second rate is 40.30 percent payable on taxable income of $29,591. The third rate is 44.95 percent payable at taxable income of $59,181. The maximum rate of 46.40 percent is payable on taxable income of $63,438 and higher. These rates are the marginal rates of tax that a person encounters as he or she moves from one level of taxable income to the next. An equally interesting series of calculations relates to the amount of tax an individual theoretically pays on a given amount of total income (not taxable income). These rates are shown in Table 2.2.

In the case of families, the situation can be slightly different because of credits permitted for the dependent spouse. Support of children also eases somewhat the tax burden on the taxpayer. In perusing tax rates for the average family of four presented in Table 2.3, the reader should bear in mind that this schedule of rates is not directly applicable for many families. In many cases, both adult members of the family declare taxable income. In this case, they each file a separate return, and tax rates for individuals apply. Of course, this is to the advantage of the taxpayers. If, for example, a childless couple who are both working have the same income-say $25,000 per year-they pay total tax of about $8,462 when they file as individuals. If their total income of $50,000 were earned by only one of them, their total tax payable would be about $12,344-a difference of $3,860.

In other words, if their income is earned by one family member, the family pays a gross tax rate of 24.69 percent, but if their income is composed of two salaries, the tax rate is only 16.92 percent. The difference between the two tax rates rises as the family income increases (see Table 2.4). This difference between the single and double income-earner family will continue to haunt the calculations in the remainder of this book. In particular, income tax payments shown in the various composite tax tables in Chapter 3 reflect the fact that, on average, tax payments are made by a mixture of single and double taxpayer families.

Who pays the income tax bill?

While it is possible to calculate tax rates and amounts of tax payable on an "up-to-date" basis, analysis of the income tax system as a whole has to be based on two-year-old statistics. This arises because our conclusions about how much tax the average Canadian family pays is based partly on surveys of taxpayers that Statistics Canada conducts, and partly on data that Revenue Canada collects and that are released with a two-year lag. Accordingly, our analysis of who pays the income tax-and of other related questions-must be based on 1994 data. For the most part, however, the relative magnitudes involved are stable over time and, hence, the conclusions reached are reliable for some time into the future.

In 1994, a total of $88.5 billion was paid by individuals in income taxes and, as Table 2.5 shows, 45 percent of it was paid by individuals with incomes below $50,000. Individuals with incomes below $60,000 paid 58 percent of the total income tax bill. In fact, 40 percent of all income taxes were paid by individuals with yearly incomes in the relatively narrow range of $20,000 to $50,000.

As column 4 of Table 2.5 shows, over half of all taxable returns were filed by individuals with incomes less than $20,000. This proportion reflects the large number of part-time workers, students employed during the summer, and other intermittent workers earning low incomes. These taxpayers generated only 5.5 percent of total tax revenue, while the top 25.7 percent of taxpayers-those declaring income of $35,000 or more-contributed 76.1 percent of the total income tax bill.

An interesting aspect of the information in Table 2.5 is the relationship between taxes paid and income declared. For example, while 23.9 percent of the total income tax bill was paid by individuals with incomes below $35,000, column 6 reveals that this group earned 40.0 percent of all the income declared. So, income earners below $35,000 paid a smaller proportion of the total tax bill than their share of total earned income might suggest. On the other hand, the top 25.7 percent of taxpayers, those who had incomes in excess of $35,000, paid about 76.1 percent of the total tax bill, while receiving only 60.0 percent of total income earned.

The reason for this, of course, is the fact that the income tax structure is "progressive." That is, it takes a larger fraction from high incomes than it does from low incomes, as is clear from the tax rates presented in Table 2.4. Sales taxes also contribute to progressivity because even though they hit everyone at the same rate, there are sales tax rebates which vary inversely with income. Furthermore, many income transfers from the state are indexed to the price of goods, so that as the price rises due to a sales tax, so do the transfers. This eases the burden of sales taxes to the poor. We will come back to this point in the next chapter where we bring sales taxes more fully into the picture.


Chapter 3:

How Much Tax Do You Really Pay?

THE ISSUES DISCUSSED IN CHAPTER 2 focus on the income tax bill that Canadians pay. But income tax represents less than half of the total taxes paid by the average Canadian family. The purpose of this chapter is to expand the analysis of taxation to include all taxes that Canadians pay.

How much income do you really earn?

Cash income

In order to properly calculate how much tax a person (or a group) pays, it is necessary first to determine their income. This is a complex calculation because of the multitude of income sources other than wages and salaries. This section of the chapter, therefore, explains the method for deriving the income figures used in subsequent sections.

The ultimate goal of income calculations is to determine the total income a Canadian citizen would have if there were no taxes of any sort, and other factors remained unchanged. To arrive at such a figure, it is necessary to determine all the income sources a person might have, and all of the taxes that would have been paid on this income before the person received it.

The first layer of income items is easily discovered: wages, salaries, interest from savings bonds, rent from the in-law suite in the basement, or even rent on "the back forty." These sorts of items comprise what in this study is called cash income.

Cash income and underreporting

In its regular surveys of household income, Statistics Canada finds that people typically omit some income items when they estimate their cash income. That is, they underreport their income. The particular items omitted vary from family to family, but, on average, families tend to underestimate their total income by 4 to 12 percent. Items that might be omitted include miscellaneous interest income, income from "moonlighting," and so on. Fortunately, Statistics Canada does have a comprehensive measure of income in the National Accounts framework, and it is therefore possible not only to know that the survey information is incorrect but also to adjust that information to make it more accurate.[Statistics Canada, System of National Accounts, National Income and Expenditure Accounts, catalogue no. 13-201, Supply and Services Canada] Accordingly, cash income estimates used in this study have been adjusted to make them consistent with the comprehensive income figures contained in the National Accounts.

It may be useful at this stage to provide an example based on a fictitious individual. In order to make the example as comprehensive as possible, it is assumed that the individual has income from all of the sources identified in the study-an unlikely circumstance for any real person. The example is presented in table 3.1.

Total income

In addition to cash income, most families also have various forms of non-cash income that must be included in a comprehensive income figure. For example, most wage and salary earners receive fringe benefits as a condition of their employment. Also, part of an employee's income is the investment income accumulated by his or her pension plan and the interest accumulated-though not paid-on his or her insurance policy.

At a higher level of subtlety, a comprehensive income total should also include a number of other income sources. For example, income must be imputed on account of interest-free loans that people make. The interest foregone is in fact implicit income in the form of a gift.

Profits not paid out as dividends by corporations but held in the form of retained earnings are, in fact, income of the shareholders of the corporation, even though they do not receive it in the year in which it is reported. Also, bad debts which are written off by corporations are, in fact, a source of net income to the debtor and are treated as such. Finally, food consumed by farm operators is evaluated at market price and attributed to farm operators as income.

Again, to make the calculation clear, the total income figure is accumulated in Table 3.2 for a fictitious individual who is assumed to have income from all sources.

Total income before tax

Some of the income earned by Canadians is taxed before they receive it. For example, shareholders receive dividends on corporate profits after corporate profit taxes have been paid. In the absence of taxes, the dividends (or retained earnings) of the shareholder would have been higher. Therefore, in order to arrive at a total income before tax, it is necessary to add back the corporate profits collected from corporations. Similarly, if there were no property taxes, net after-tax rental income would be higher than it actually is. Therefore, before-tax income must be augmented by the amount of property taxes paid.

In the discussion of indirect and hidden taxes in Chapter 1, it was noted that these taxes reduce the effective income available to Canadians because they increase the price of items that people buy with their incomes. In effect, income after tax is less, in terms of the things it will buy, than it was before tax. In order to arrive at an estimate of before-tax income it is necessary, therefore, to add back to incomes the reduction brought about by indirect taxes. Payroll taxes levied on firms are, as noted earlier, effectively paid by employees, because the taxes reduce the amount of money available to pay wages and salaries. Accordingly, it is necessary to add back the amount of payroll taxes to employees' incomes to arrive at a before-tax total income estimate.

Table 3.3 presents an example of a complete income calculation for a fictitious individual who is assumed to have income from all of the income sources identified in the study and to have paid all of the identified taxes.

Calculating the total tax bill

Basically, the tax calculation for the average Canadian family consists of adding up the various taxes that the family pays. Hidden taxes such as taxes on tobacco and alcohol are allocated according to the method indicated in Chapter 1. To preserve consistency, the family used for the example of the tax calculation in Table 3.4 is the same family used in the income calculation.

Chapter 4:

The Canadian Consumer Tax Index

Introduction

IT IS ALWAYS SATISFYING TO FIND one number, or index, that neatly summarizes a complicated issue. It is seldom the case that such a number exists. IQ scores do not say everything about an individual's intelligence, and the speed of a computer chip can only give a rough idea of how that computer will perform. The same is true of Canadian taxes. Our system is complex and there is no single number that can give us a complete feel for who pays how much, and how the system changes over time. Some rough guides do exist, however, and we present in this chapter what we think are some of the better guides: the Canadian Consumer Tax Index, and Tax Freedom Day. Both can say a lot about how much tax Canadians pay and how those taxes are changing. But these indexes are not the whole story. If they were, there would be no need for the book you are presently reading.

The Consumer Tax Index

For individual Canadian taxpayers, the most interesting variable is how much tax they actually have to pay. In The Fraser Institute's first tax study, How Much Tax Do You Really Pay? we devised an index which we called the Consumer Tax Index. Its purpose was to provide a summary-at-a-glance indicator of what has been happening to the tax bill faced by the average Canadian family over the years since 1961.

Some readers of that book found the tax index too simple-it failed to take into account how the tax money was spent by governments and, therefore, showed only one side of the ledger.[Don McGillivray, "An Over-Simplified Look At Our Complicated Taxes," Financial Times of Canada, November 8, 1976] On the other hand, the index in that first study and in all subsequent studies has been widely used by financial and consumer affairs columnists across the country to describe how the Canadian tax system has evolved. Moreover, it has been in continuous use ever since its release and has been described as the most up-to-date measure of the extent of Canadian taxation.

During 1988, Statistics Canada approached the Institute to enquire how the Consumer Tax Index is calculated. That interest was motivated by the advent in Canada of the broadly applied Goods and Services Tax and the desire, on the part of the agency, to provide a measure of the impact which the new tax would have on the rate of inflation. In 1990, Statistics Canada indicated that it would not proceed because of methodological problems that would be associated with such a measurement. In view of the high political interest which would attach to such a number, one can appreciate their reluctance.

What is the Canadian Consumer Tax Index?

The Consumer Tax Index (CTI) is an index of the total dollar tax bill paid by the average Canadian family. The average family is the family whose income is average. The consumer in question is the taxpaying family, which can be thought of as consuming government services. In the private market the Consumer Price Index measures the average price that consumers pay for goods and services they buy of their own choice. The Consumer Tax Index measures the price of goods and services that government buys on behalf of its constituents.

The CTI is constructed by calculating the tax bill of an average Canadian family for each of the years included in the index. The index below, therefore, shows the tax bill for a family with an income of $5,000 in 1961, for a family with an income of $8,000 in 1969, and so on. Now, while each of these families was average in an income sense in each year selected, the family is not the same one from year to year. The objective is not to trace the tax experience of a particular family, but rather to plot the experience of a family which was average in each year.

The index thus answers the question, "How has the tax burden of the average family changed since 1961, bearing in mind the fact that the average family has itself changed in that period?" We can note that the average family in 1996 is headed by a younger person, one who is more likely to own a car but less likely to own a house, and has fewer members than the average family in 1961. Most important, the family's earned income increased by 823 percent over the period.

The basis of the tax index is the total tax calculation presented in table 4.1. Income and tax calculations were made for a selection of years beginning in 1961 and culminating in 1996. The tax bill of the average family yielded by this process was then converted to index form. The results are reported in Table 4.2 and Figure 4.1. They show that the tax bill of the average Canadian family has increased by 1,168 percent over the period since 1961, and that the index has a value of 1,268 in 1994.
                     

At least part of that increase reflects the effects of inflation. In order to eliminate the effect of the declining value of the dollar, we have also calculated the tax index in real dollars-that is, dollars of 1996 purchasing power. While this adjustment has the effect of reducing the steepness of the index's path over time, the real-dollar tax index, nevertheless, increased by 124.5 percent over the period (see table 4.3).

What the Consumer Tax Index shows

The dramatic increase in the Consumer Tax Index over the period 1961-1996 was produced by the interaction of a number of factors. First, there was a dramatic increase in incomes over the period, and even with no change in tax rates, the family's tax bill would have increased substantially. In the absence of a change in the tax rate, growth in family income alone would have produced an increase in the tax bill from $1,675 in 1961 to $15,456 in 1996. The second contributing factor was a 37.4 percent increase in the tax rate faced by the average family.

From the mid-1970s to the late 1980s, the rate of increase in the tax bill slowed appreciably, reflecting a decline in the overall rate of taxation and an increase in the extent to which all governments resorted to issuing debt to finance their expenditures. Politicians' affinity for this form of taxation may finally be over as public opinion polls consistently cite the debt and deficit as major concerns, and most provinces have balanced their budgets and some are even paying down their debts. All debt must one day be paid for by taxes. There is simply no getting around this fact. Debts, however, seldom pop up in discussions of what the average Canadian family's tax burden looks like. One way to bring fiscal shortfalls into the picture is to ask how much extra tax the average family would pay if instead of going into debt, the government taxed us to make up the extra it spends. We do this in calculating our balanced budget tax index. This index includes the debt that is being acquired by the various levels of government. We do not include the debt issued by such Crown corporations as electric power authorities in this calculation because this debt shows up as higher electricity rates in the future, not as higher taxes. Comparing our two indices in table 4.4 and figure 4.2 shows that if all governments were to balance their budgets, the tax bill of the average family would be very much higher than it actually is. The difference between the two indices is a measure of the tax burden being hidden from Canadians.

What if we got rid of the debt?

Getting rid of deficits is not the same as getting rid of the debt. A deficit is the amount government must borrow in any given year to finance spending in excess of taxes. Over the years these deficits accumulate. This accumulation is known as the debt. How would the average Canadian family's tax index and tax burden change if all levels of government decided to eliminate their debts by the year 2016-20 years from now? Assuming a very favourable real income growth rate of 4 percent, population growth of 0.8 percent, and no change in government spending per capita, the average Canadian family's tax bill would rise by $4,597 in the first year to pay off the debt within 20 years. The average family's tax rate would jump from 46 percent in 1996 to 56 percent in 1997 and gradually fall to 29 percent in 2016 as seen in figure 4.3.

Taxes versus the necessities of life

While the Consumer Tax Index does show the way in which the average family's tax bill has changed over the past 35 years, that information becomes even more significant when it is compared with other major expenditures of the average Canadian family for shelter, food, and clothing.

Table 4.5 and Figure 4.4 compare the average dollar amount of family cash income, total income before tax, and total taxes paid with family expenditures on other items such as shelter, food, and clothing. It is clear from these figures that taxation has not only become the most significant item that consumers face in their budgets, but also that it is growing more rapidly than any other single item. This is made more evident in Table 4.6 and Figure 4.5, which show the various items as indices based on 1961 values. While incomes rose during the period from 1961 to 1996 by 787 percent (total income before tax), prices rose 465 percent, shelter by 786 percent, food expenditures rose 416 percent, and clothing 421 percent. Meanwhile, the tax bill of the average family grew by 1,168 percent. The balanced budget tax rate grew even more rapidly, rising by 1,322 percent over the same period.

Table 4.7 and Figure 4.6 present the same information expressed as percentages of total income before tax. Total income before tax is a broader measure of income than cash income. As we explained in the previous chapter, it includes non-cash items such as interest accumulated on pension fund income but not cashed by the recipient. In this form, the data reveal some interesting comparisons. For example:

In 1961 the average family had to use 35 percent of its income to provide itself with shelter, food, and clothing. In the same year, 22 percent of the family's income went to government in the form of taxes.

By 1974 the situation had been reversed, and 30 percent of income went to satisfy the tax man, while only 29 percent was required to provide the family with shelter, food and clothing.

By 1996 the situation had worsened significantly. Whereas the proportion of income consumed by taxes continued to increase, the fraction of income spent on necessities (shelter, food, and clothing) dropped dramatically. The average family spent 26 percent of its income on the necessities of life while 32 percent of its income went to taxes.

Tax Freedom Day

The Consumer Tax Index is only one possible angle from which we can view the Canadian tax system. Another simple but revealing measure is the Tax Freedom Day of the average Canadian family. The average Canadian family is the family whose income is the average income of all families with two or more members. Tax Freedom Day (TFD) is that day of the year when the average family has done enough work to pay the total tax bill imposed on it by the federal, provincial, and municipal governments. It is calculated simply by seeing what percentage of income the family pays in tax, and multiplying that percentage by the number of days of the year. If 50 percent of one's income goes to taxes, then one must work half the year for government, and one's TFD falls on June 30. In 1961 TFD fell on May 3rd. Since then it has advanced 53 days, so that by 1996 it fell on June 25th.

The fact that deficits are deferred taxes can also be included in the Tax Freedom Day, just as it was in the Consumer Tax Index. Including deficits, TFD jumps from June 25 in 1996 to July 16th; an advance of 21 days.


Chapter 5:

The Relative Tax Burden

THE FIRST THING PEOPLE WANT TO KNOW about the tax system is "How much do I pay?" Tax Freedom Day and the Consumer Tax index discussed in the last chapter give a rough answer to this query. The next thing people want to know is "How much are others paying? Are some paying less than others?" This is a more complicated question because it calls for a broad view of what the tax system does. It is a question that some reporters and many social activist groups believe has a clear and simple answer: the "rich" pay no taxes and the poor are getting "shafted by the system." In this chapter we suggest that the answers are not so simple. We look at all income groups and how their relative income and tax positions have changed between 1961 and 1996.

A cautious look at these numbers points to a different verdict than the one reached in the media's Star Chamber.

The distribution of income

In order to analyze the relative income and tax positions of Canadians, we have divided all Canadian families into three income groups. The lowest group consists of the bottom three income deciles. The middle group consists of the next four deciles, and the upper group of the top three deciles. An income decile is one of ten groups that result from arranging families according to their total income before tax, from lowest to highest, and then selecting the 10 percent of families with the lowest incomes, the next 10 percent with the second lowest incomes, and so on. The resulting family groupings are presented in Table 5.1 and illustrated in Figure 5.1.

Table 5.1 reveals that the relative shares of the different income groups have been remarkably constant over the period since 1961. In evaluating this result, the reader should bear in mind that the data have a variety of aspects that make them susceptible to misinterpretation. First of all, the data fail to make any allowance for the age of the individuals. This is important, since age is a principal determinant of income. Young people first entering the labour market typically earn wages or salaries considerably below the average, and considerably below what will be their own lifetime average. Similarly, elderly people who have passed the age of retirement are typically in a phase of their life when their incomes are considerably below their lifetime average and when they are spending the savings and pensions accumulated from their working lifetimes.

For example, Table 5.2 displays the "life-cycle average expected wage" for a Canadian male in 1993. Two sources of data on the earnings profile are available-information from Revenue Canada's Tax Statistics, and Statistics Canada's income surveys. While the two sources yield different estimates, they both show the expected age-related movement in wages relative to the average.

Failure to account for the age of income earners can lead to a considerably distorted impression of how income distribution is changing-particularly if there are dramatic changes in the age structure of the population as there have been in Canada. In future years, as the number of people in or near retirement grows, we can expect that the distribution of income will be affected. More of the population will be elderly, and more of the population will have lower incomes as a result. This will not mean that the population is, in any sense, worse off.

A second important warning for those who would draw from these data conclusions about the "equity" of the income distribution is that they ignore income-in-kind that people receive from government. Housing, medical care, education, and other services which are received as direct benefits from government, rather than in the form of cash payments, are not reflected in the income distribution table. And the public provision of these services potentially represents one of the most significant redistributive aspects of Canadian society.

For these reasons it would be inappropriate to infer from the data in Table 5.1 that there had been no change in the effective distribution of income since 1961. The data in their present form are incapable of providing meaningful answers to that question. What the data do provide is a yardstick against which to measure the distribution of taxes. This yardstick will allow us to infer whether, for example, groups of people with low incomes bear a disproportionate share of the tax burden. It will provide an indication of the progressivity or regressivity of the Canadian tax burden. In order to arrive at these results, it is necessary to combine income results with those on tax distribution, which are the subject of the next section.

Tax distribution and tax rates

Our measurements of the distribution of the tax burden provide some interesting and, indeed, puzzling results. Whereas up until the mid-'70s there had been a more or less steady increase in the tax burden borne by the upper third of income groups (that is to say, the top three income deciles), during the interval from 1976 to 1981, the share of the top group fell markedly. As Table 5.3 and Figure 5.2 indicate, during 1976 families in the top three income deciles accounted for fully 66.5 percent of the total tax payments. By 1981 this had fallen to 59.9 percent of the total, a decrease of 6.6 percentage points. The decline in the tax burden borne by the top three income deciles was nearly matched by a corresponding increase in the tax burden faced by those in the middle income deciles. For example, families in the fourth to seventh income deciles, which had borne 27.3 percent of the total tax burden in 1976, by 1981 were bearing 33.3 percent-an increase of 6.0 percentage points. Since 1981 there has been a slight decrease in the tax borne by the lower two income groups, and a rise by the upper income group.

As Table 5.4 shows, there had been a very modest shift in the incidence of the personal income tax system away from the upper income deciles and toward the lower income deciles. The top three income groups accounted for 62.7 percent of total income tax payments in 1981, down from 68.1 percent in 1976. By 1996, the top three income deciles accounted for only 64.9 percent of total income tax payments.

A major factor explaining variations in the share of taxes paid by the top three deciles has been the change in the incidence of the capital-related taxes. These are chiefly property taxes and corporate profit taxes. As table 5.5 reveals, the change in the pattern of these capital-related taxes has been truly astounding. Between 1976 and 1981 the burden of profit taxes for the top three deciles dropped from 72.2 to 66.9 percent. The burden crept up to 71.8 percent in 1985 and fell slightly to 70.4 percent in 1996.

Analysis of the underlying factors reveals that part of the reason for the dramatic shift in the incidence of the capital taxes has been the change in the distribution of capital income amongst Canadians, which is described in Table 5.6. But another reason why capital taxes fell for the upper income deciles in the late '70s and early '80s, then rose in the late '80s is probably due to changes in exemptions. For example, in the early 1980s Canadians took advantage of the tax preferences which the government inserted in the tax system to encourage the development of various sectors of the economy, such as oil exploration, rental housing, and Canadian films. The tax reform of 1987 effectively put an end to much of the tax preference game.

One factor which underlies all of the distribution series is the massive surge in the number of families in the upper income classes. In 1980, for example, only 26.0 percent of families had an income of $35,000 or more. By 1994, 67.4 percent of families enjoyed an income at least as large as that.[Statistics Canada, Household Surveys Division, Income Distribution by Size in Canada 1994, catalogue 13-207, annual, Ottawa, 1995] While inflation has played a role in this development, some of the increase in the number of families in the higher income groups is a result of the fact that an increasing number of families contain two income earners whose joint income pushes the family into the higher bracket. The implication of this for the distribution of taxation amongst families is that the upper income deciles seem to be paying less and less tax because they are composed increasingly of individuals with lower incomes.

As noted in chapter 2, two incomes totalling, say, $30,000 are taxed less in total (by the income tax structure) than one income of $30,000. Since upper income families are increasingly composed of two income earners, this has put downward pressure on the average tax rate in this income range. And, during the 1974-1994 period, the number of two income families included in the top income brackets has increased.

One feature of the developments has been the reversal of trends established in 1976. From then until 1985 the percentage of total income earned by the upper income groups had been steadily decreasing with the middle and lower income groups gaining ground. This is quite clearly reflected in Table 5.1 which shows the distribution of income by decile. Whereas in 1976 nearly 60 percent of all income was earned by those in the top three deciles, this had dropped to 54.7 percent by 1985. However, by 1996, the upper three deciles had rebounded to claim 56.8 percent of income. Whether or not this is the start of a new trend is too early to tell. One further implication of the distribution of total taxes (as opposed to the distribution of income taxes) is interesting to note. Figure 5.2 shows that the flatness in the tax distribution which began to emerge in the late 1970s was reversed in 1985 as a sharper progressivity developed.

A look across the generations

As we emphasized earlier, the tables on income distribution give only a snapshot at a particular point in time of Canadians who fall into various income groups. We must look at these tables with an understanding of what they say well, and what they do not say well. These tables are perfectly adequate for reflecting the fact that our tax system is progressive, and for telling us how much upper income groups pay versus lower income groups. What these tables do not say well is how the tax system treats people of similar ages but different income levels. In other words, these tables do not reflect inequality in taxes and incomes very well. A young person earning a low income now will appear in the ranks of the lower deciles. When she is older she may appear in the upper deciles, and over her life her income may conform to the average Canadian lifetime income. The tables we have presented include in the lower income deciles young, low income earners who will be better off in the future. This makes the incomes and taxes of low income earners look larger than it should if we were to take a longer term perspective. This effect of mixing young and old in a single snapshot is also true for higher income groups.

If we are concerned about equality in the tax system we have to take a longer term perspective, and follow people from the moment they start work to past their retirement. Table 5.7 does this. In it we use survey data to follow the progress of a family that begins its working life in a particular decile.[The families we are talking about here are really "pseudo" families made up of survey data on actual families alive today] The exercise carried out in Table 5.7 involves taking a family today, and following its progress throughout its life. We cannot do this precisely because we cannot predict the future. Nor do we have very extensive surveys which have followed groups of families throughout their lives and looked at their spending and what they get from government. So we have improvised by turning the snapshot Survey of Consumer Finances into a lifetime profile. Our technique was to sample 500 families from each age group. We then fitted the families in each age group into income deciles. We created 500 pseudo-families by taking a family from a given decile in the first age group, and assuming that once it reached the next age group it would have moved up or down in its income ranking according to some random force. We linked this first family to the family corresponding to this new ranking in the second age group. We continued this process for all age groups. This gave a lifetime view of a synthetic family made up of snapshots of many different families in different age groups. We did this for all 500 families in the first age group to give us 500 "lifetime families."[The procedure is similar, though less sophisticated, to the one used by Davies, St. Hillaire, and Whalley in "Some Calculations of Lifetime Tax Incidence," The American Economic Review, vol. 74, no. 4, September 1984] We see that no matter what decile the family starts in, its income first rises, and then falls. The second last row of the table shows the average lifetime tax rate of each group. This is higher, as expected, than the average tax rate we find if we take a snapshot of the Canadian population at a given point in time. The last two rows also show that there is less inequality in average lifetime tax rates between the deciles than if we take the snapshot view.

Who pays the tax bill?

Table 5.3 shows that the largest portion of the tax burden ultimately settles on the higher income groups. In 1996, the top 30 percent of families earned 56.8 of all income in Canada and paid 62.5 percent of all taxes. The bottom 30 percent earned 9.5 percent of all income and paid 5.6 percent of all taxes.

To economists these figures are nothing out of the ordinary. Our tax system is progressive. It is not surprising to find that lower income earners pay less taxes as a proportion of their income than wealthier folk. This result may, however, come as surprise to activists and reporters who claim that the "rich" in Canada pay no taxes. As tables 5.3 and 5.4 show, the rich bear most of Canada's taxation burden. Some critics might counter that the rich in Canada avoid taxes by holding their wealth in corporations and that corporations can better evade taxes than individuals. We address this question in Chapter 7 and bring up results of a study done by the Ontario government's Fair Tax Commission which finds that there is very little dodging of taxes by corporations.

Who belongs to the club of the top 30 percent of Canadian families? A Canadian family is included in the top 30 percent when its cash income exceeds $59,260. The average income in this group is $90,184.

Get it from the rich

It is often said, and more often believed, that the key to "social welfare" or "social justice" is the redistribution of income. That is, take income from those who have much and give it to those who have little. The extreme form of this prescription is the formula "from each according to his ability [to pay] and to each according to his need"-the rule advanced in the Communist Manifesto.[K. Marx and Friedrich Engels, Manifesto of the Communist Party, 1848]

The preceding section's analysis of who pays the income tax reveals that as a country, Canada already engages in significant taxation of those who are relatively well off. However, at least one prominent Canadian economist has suggested that Canada has not been successful in redistributing income from the rich to the poor-that ours is not a "Robin Hood" society.[W.I. Gillespie, In Search of Robin Hood, C.D. Howe Research Institute, Montreal, 1978] It remains interesting, therefore, to ask whether or not we could achieve a more equal distribution of the benefits of the Canadian good life by taxing more of the income of the richest Canadians.

How rich is rich?

The question that immediately arises is "How rich is rich?" At what income level should the government tax away all increases in the interest of "equitable" income distribution? In view of the fact that Members of Parliament earn in excess of $60,000 per year, it is unlikely that "Canadians" would find it equitable to confiscate earnings less than that level. Let us, then, for the sake of illustration, select $60,000 as the maximum income that Canadians should be allowed to earn. Under this rule, all incomes above that level would be subject to a 100 percent rate of income tax, and the proceeds would be distributed to all income earners with incomes less than $60,000.

Counting the rich

In 1993, 1,229,270 persons filed tax returns reporting an income of $60,000 or more. (Note that in this section, individual and not family incomes are the focus of the analysis.) Total income reported by these people was $125.2 billion. If the government had really taxed away all income beyond $60,000, the total tax revenue in 1993 would have been $9.5 billion higher than it actually was. Redistribution of this increased tax revenue to those 18.6 million tax filers with incomes less than $60,000 would yield an average annual payment of $778 for each person submitting a tax return.

Taxing the "rich," not the source of wealth

This calculation is important because it reveals the practical impossibility of "getting it from the rich and redistributing it to the poor." Those who are impatient with the speed at which the economic process improves the condition of the poorest members of society ought to reflect on the fact that the same (or larger) total increase in the incomes of those earning less than $60,000 would be achieved by about 5.6 percent growth in total incomes, even if it were distributed in exactly the same way as it is now.

The rags-to-riches tax burden

In the previous sections we have shown in general terms how our progressive tax system imposes ever increasing burdens on people as they earn more income. What about an individual who had started off in 1961 with meagre earnings and had brought himself up in the ranks? What kind of message does our tax system send to this person? Table 5.8 presents the results of a tax analysis for such an individual. We assume that when he started working in 1961 he was earning $2,750 a year cash income, half the average income, and that his income grew steadily and at such a rate that by 1996 he was earning twice the average, or $92,648 a year.

In 1961, this person's total income before tax of $4,775 attracted a tax bill of $960, or an average tax rate of total income of 20.1 percent. By 1976, the hypothetical income earner had a total income before tax of $17,983 and paid taxes of $4,802, or a tax rate of 26.6 percent. Finally, in 1996, when his cash income was $92,648, his total income before tax was $140,104, and his taxes paid amounted to $50,741. Thus, the average tax rate on total income before tax had risen from 20.1 to 36.2 percent. In each case the tax calculation does not include the amount of debt accumulated by government on behalf of the taxpayer. Including annual provincial and federal deficits, the increase in tax burden is even more dramatic, as Table 5.7 shows.

Over the 35-year period from 1961 to 1996, the hypothetical Horatio Alger experienced a 2,834 percent increase in total income before tax. Over the same period, taxes paid increased by 5,186 percent excluding debt. Taxes including deficits increased 6,827 percent.

Meanwhile, the tax rate faced by this individual increased 80.1 percent. Thus, in improving their circumstances, would-be Canadian Horatios would have earned a total income over the period of $1,519,511 and paid total taxes of $652,030.

Marginal versus average tax rates

Tax rates discourage effort at every point in the income scale. Perversely, this effect is most pronounced for the poor! The reason for this bizarre result is that many social assistance payments stop abruptly once the recipient starts earning income. In effect, the tax rate on the first few dollars of earned income can be large. This tax rate is referred to by economists as the "marginal tax rate" meaning the rate one experiences as one moves up in income. It can differ dramatically from the average tax rate, which is the one we are most accustomed to thinking about. Table 5.9 shows both marginal and average rates for different income levels for Canada. Figure 5.3 illustrates them.

It is this marginal rate which enters into people's decisions about how much to work. When someone decides whether or not to work an extra hour, she asks herself how much extra she will earn, and how much extra tax she will pay. She does not consider how much tax on average she is paying because this does not reflect the true return to any extra effort she may wish to provide. As the table shows, these rates jump considerably as one moves from the second to the third income decile, reflecting that initially it is very costly to work because one rapidly loses social assistance. This effect fades in the middle income brackets but rises again at higher levels of income as the effect of rapidly increasing progressivity starts to be felt.




Chapter 6:

Taxes Across Canada

TAXES ARE THE PRICE YOU PAY for government services. If taxes were the same in all provinces the first five chapters of this book would be a sufficient price guide to government services. But provinces differ in their taxes and so we need to break our analysis down by province. This breakdown may be of interest to Canadians who want an idea of where taxes are lightest and where they are heaviest. It may also be of interest to government officials who understand that it is dangerous for a province's economic health for it to tax much more than do its neighbours.

When it comes to comparing the provinces we must make some adjustment for the fact that family size differs among provinces. The family whose income is average in Newfoundland has more members than its counterpart in Ontario. Put differently, Newfoundland has relatively fewer single-member families than does Ontario. We would not be comparing the same sort of family if we set these averages side by side. To get a more precise comparison, this chapter focuses on families of two or more individuals. However, the appendix also shows many of the results that follow for families and unattached individuals.

Different strokes

Table 6.1 presents the tax situation for the average family by province of residence. In this context, "average family" means a family unit which has an average income in its province of residence. Thus, for example, the average family in Newfoundland has a cash income of $44,176 in 1996, whereas the average family in Ontario has an income of $60,904 in the same year, and so on. It is very interesting to survey the results for each of these families and to see just how the tax bill varies from province to province, and from category to category. It is particularly interesting to see which provinces have the highest propensity to tax in each of the tax categories. Table 6.2 shows that income tax comprises between 34.2 percent and 40.6 percent of the family's tax bill. The highest rate comes from Alberta, where the average family faces a 40.6 percent rate of income tax on cash income. The lowest income tax rate is in Saskatchewan, at 34.2 percent. The sales tax is most heavily relied upon in the Maritimes. For instance, 21.7 cents out of each tax dollar paid in taxes by the average Newfoundland family are collected in sales tax. By comparison, 15.7 cents out of each tax dollar are collected in sales tax from the average Ontario family, while just 8.0 cents per tax dollar are collected from that source from the average Albertan family, as Alberta has no provincial sales tax. Ontario has the highest reliance on property tax, collecting 8.8 percent of taxes in this form, whereas Newfoundland only collects 4.8 percent of its taxes as property tax. Saskatchewan, Alberta and British Columbia have the greatest dependence of all the provinces on natural resource revenues. In Alberta, for example, petroleum related taxes are not collected directly from the tax paying public; rather, they are collected indirectly from the corporations that recover oil and gas from the ground. It is nevertheless the case that the oil and gas in the ground in Alberta belongs to the people of Alberta. It is appropriate, therefore, to regard the taxes which are paid as a result of exploitation of these petroleum resources as the income of Albertans and hence a tax on Albertans.

While this is the appropriate technical treatment of petroleum resource taxes, apportioning it the way we do does confuse somewhat the inter-provincial comparison of tax burdens. If we subtracted from the $26,869 total tax bill that the average Albertan family faces the $1,195 which are collected on their behalf from the petroleum industry, we find that the total tax bill is reduced to $25,674 for the average family. A similar adjustment for natural resource revenues has been made for both Saskatchewan and British Columbia.

In comparing these tax results for the various provinces, it is important to remember that the standard of comparison is the average family. That is to say, the family in each province whose income is average. It is, therefore, the case that the individuals in different provinces will have different incomes since the average income in each province varies considerably. Thus, of course, some of the differences in the tax burdens between the provinces is due to nothing more than the differences in income.

Table 6.4 provides a distribution of taxes by province according to population decile. The great benefit of this table is that it is independent of the incomes within each province, and makes possible a comparison of the provinces according to how the tax burden is spread within each province amongst the various income groups. The outcome of this analysis as reflected in the table is remarkable; there seems to be very little variation amongst the provinces in the extent of the progressivity or regressivity of their various tax systems. That is to say, the upper income groups in all provinces tend to absorb between 60 and 69 percent of the total tax bill.

The similarity of the tax distributions in the provinces is all the more noteworthy when one considers that there is such a different reliance on the different forms of taxation in the various provinces. This fact, which was pointed out above in the discussion of Table 6.1, ought to provide some variation in the tax rates unless, of course, the differences in the progressivity and regressivity of the various tax rates offset one other. From Table 6.3 it appears that the various tax measures do offset one another in their effect on the rate of progressivity of the provincial tax systems.

However, as Table 6.5 shows, there are some important differences between the tax systems in the various provinces. Table 6.5 highlights these differences in the form of the average tax rates which are payable by the various income deciles in each province. Thus, for example, in Newfoundland, the lowest income decile paid a tax rate of 6.2 percent on average, whereas the top decile paid a tax rate of 39.5 percent. In Saskatchewan, on the other hand, the top decile paid 37.1 percent, whereas the bottom decile paid 16.1 percent.

Accounting for the future tax burden

It has become increasingly obvious that the tax comparison between provinces has a major flaw, namely, that those provinces that rely less on taxes and more on borrowing to finance their expenditures, even though their expenditures have not fallen, appear to have a less intrusive taxation system. The reason, as we have discussed in previous chapters, is because deficits force the burden of the taxes needed to finance current expenditures onto future generations of taxpayers. A measure of taxation which ignores this shifting of the tax burden cannot provide an accurate picture of the true fiscal stance of a government. Therefore, we have created a provincial distribution of tax burdens based on the total tax consequences of the current expenditures of government-that is, including the deficits which governments incur. The data are presented in Table 6.6.

Table 6.2 and Figure 6.1 show tax rates by region including deficits. Note that the federal government, along with Ontario, Quebec, British Columbia, and Newfoundland, were the only governments in deficit in 1996. For the remaining six provinces, the increase in the tax rate is entirely due to fiscal mismanagement at the federal level.

Underlying this pattern of taxation is a pattern of government expenditures. That is, the reason for raising revenues is to pay for government spending. Accordingly, an alternative, and perhaps a more direct measure of the level of government activity, is the level of government spending. Table 6.7 presents provincial government spending levels in each of the provinces both in total dollar terms and per capita terms, adjusted for the amount of that spending which is financed by federal transfer payments.

Even though there may be some difficulties with the calculations, they reveal a very interesting pattern of spending, and suggest interesting comparisons with the taxation data. The data reveal that Quebec, Ontario, and British Columbia are among the highest spending and the highest taxing provinces, while the Maritime provinces are among the lowest taxing and lowest spending jurisdictions.

Marginal tax rates and the low income trap

In the previous chapter we mentioned that it is the marginal tax rates that discourage productive efforts. Table 6.8 ranks the provinces on their marginal tax rates in the first four income deciles, and compares those provinces based on Statistics Canada's Low Income Cut-offs (1992 base). There appears to be a strong link. While such broad aggregates cannot "prove" that high tax rates are a cause of poverty, they raise a flag and may be one piece in the puzzle of why many are "trapped" in low incomes.

Appendix

THIS APPENDIX INCLUDES THE TAX CALCULATIONS for all families of two or more and unattached individuals. This alternative average family is also used in chapters 3, 4 and 5.

Table 6.9: Taxes of Families and Unattached Individuals, 1996
Table 6.10: Tax Rates for Families and Unattached Individuals as a Percentage of Cash Income and Total Income Before Tax, 1996


Chapter 7:

Who Pays the Corporate Tax?

Introduction

CORPORATIONS ARE A MAJOR SOURCE of revenue for federal and provincial governments. In 1995 they paid $18.6 billion in taxes, 8.0 percent of all federal and provincial government takings. These statements are factually correct, but misleading. "Corporations" do not really bear these taxes-people do. The purpose of this chapter is to ask "which people?" Even though we are well furnished with data on how much corporations pay and who owns them, answering who pays the corporate tax is not a straightforward exercise. A tax on corporations is a tax on capital. When the tax rises, capital will flee, and this will affect what capital and labour earn and what consumers pay. Who truly ends up bearing the tax depends on these aftershocks. Our calculations suggest that the elderly bear the brunt.

Background

A corporation is a group of people bound by contract to work together and to share the spoils of that work. In its simplest terms it is a joint venture between capitalists and workers. This view is too coarse to be of much help in explaining why corporations exist and the many subtle incentives they respond to, but it is all we need for the present discussion. The corporate tax falls directly on profits. Profits are what is left over after labour and interest on capital as well as materials costs have been paid, and this residual can be thought of as going to capitalists. This is why the corporate tax is a tax on capital. There is often confusion over what the corporate tax rate is because as well as having their profits taxed, corporations may receive special tax breaks which allow them to write off more than their true capital expenses. This means a corporation may pay a high statutory rate on its profits, but at a much lower actual rate because of its deductions.

Statutory rates on capital had risen in the 1970s and '80s but revenue from the corporate tax was unsteady because profits varied, and deductions had increased, thereby "eroding the tax base." It is a general principle of taxation that if you want to raise a certain amount of revenue you distort people's choices less by imposing a low tax on a broad base than a high tax on a narrow base. By the mid 1980s the base had become too narrow and this prompted the first stage of corporate tax reform. In the 1986 budget the federal government started phasing out deductions such as the inventory allowance and the investment tax credit, and announced a leisurely pace at which it would reduce the statutory tax rate by 3 percent on average. However, the U.S. tax reform lowered the corporate rate by 12 percent and this forced Canada to accelerate its own reforms. The danger was that Canada would lose tax revenue to the U.S. because multinationals would report their revenue in the U.S. and their costs in Canada.

In 1987 the Canadian system reduced many exemptions and reduced tax rates to the following levels: 28 percent for large non-manufacturing firms, 23 percent for large manufacturing firms, and 12 percent for small firms. In 1996 the rates are 28 percent for large non-manufacturing firms, 21 percent for large manufacturing firms, and 12 percent for small firms. Most provinces also levy a corporate tax, though at much lower rates. Table 7.1 and the accompanying Figure 7.1 show how federal and provincial corporate taxes have varied in the period between 1967 and 1995.

Why is the corporate tax so popular?

The corporate tax has great political appeal. Ministers of finance argue convincingly that if a corporation makes profits it should pay taxes, just as ordinary working people do. This argument is appealing but hides from Canadians the fact that in the end, ordinary Canadians pay the corporate income tax. We can see this by asking what a corporation is. As we mentioned in the preceding section, a corporation is composed of machinery, contracts, office space, employees, shareholders, and bondholders, to mention just a few. These parts work together to make income for people. Thus, a corporate tax is a tax on people. The corporation itself cannot really pay the tax because it is not the final destination of the income it generates. But, as the next sections show, taxes imposed on the corporation fan out to the general public in an insidious and hard-to-trace fashion. This is why politicians like the corporate tax.

Should it be so popular?

Who are the final payers of the corporate tax? There are, of course, corporations owned by wealthy families and these families bear a significant fraction of the tax. But there are also many ordinary working people who entrust their savings to mutual fund managers. The managers invest their money in corporations and the income of those corporations flows back to these small investors. Money set aside by employers for pensions is also invested in corporations through this roundabout method. For example, OMERS, the Ontario Municipal Employees' Fund, is one of the largest stock owners and traders in Canada.

What is less obvious, but equally true, is that homeowners, farmers, cab drivers and anyone who owns capital in the non-corporate sector of the economy also feels the impact of taxes on the corporate sector. How can this be? The reason lies in the fact that capital is very mobile. If the opportunities for making money in the corporate sector are reduced, investors will look for opportunities abroad and at home in the non-corporate sector. This sector is largely made up of agriculture and real estate. As investors transfer their corporate capital to this sector, capital will become more abundant there, and the returns to capital there will fall. For example, investors in high technology stocks may find the corporate tax gives them too little return for the risks involved and they may decide to invest their money in apartment buildings. This will add to the number of rental apartments, increase the vacancy rate and lower the margins of profit for landlords. Thus the tax in the corporate high-tech sector also is, in effect, a tax on commercial real estate.

This is one of many possible examples that show why measuring who pays the corporate tax is a tricky question. It is also possible that companies will pass it on in the form of higher prices, or that capital will simply leave the country, thereby making labour less productive and reducing wages.

Estimating the Canadian corporate tax

Since none of these assumptions can be dismissed out of hand, there is bound to be controversy over any single estimate of who bears the corporate tax. This is why it is customary to make several sets of calculations, each based on different, but plausible assumptions. The main assumption we use in our calculations is that owners of capital in both corporate and non-corporate sectors bear the corporate tax, but for balance we show what most of our results would look like if labour bore the entire tax or if it were passed on entirely to consumers.

Table 7.2 shows the breakdown of the corporate tax by lower, middle, and upper income groups. As expected, the upper income group bears most of this tax. Income deciles, however, do not tell us anything about the personal characteristics of taxpayers. A relevant question is how much of the tax various age groups pay. Are the elderly inconvenienced? Or do the young and middle-aged bear the greater part? Table 7.3 and Figure 7.2 show how much of all taxes that the government collects are paid by people of different age groups, and compares this to how much corporate tax each age group pays. Even though people above 65 pay little in overall taxes, they bear a disproportionate amount of the corporate tax.

These results are not surprising under our assumption that capital bears the tax. The elderly and retired receive most of their income from capital sources such as retirement funds and rental property. A "sensitivity" analysis here can alert us to some different tax-bearing scenarios. Figure 7.3 shows how much different age groups would pay under the assumptions that: 1) capital bears the entire tax; that 2) capital and labour share the burden equally (that is to say, capital and labour bear the tax in proportion to their shares in national income); and that 3) labour bears the entire burden. As we can see, the results are very different depending on which assumptions we make. How reasonable each assumption is depends on what we believe about the mobility of capital between corporate and non-corporate sectors and between Canada and the rest of the world. The more mobile capital is, the less of the burden of the tax it will bear. There is an active debate over the degree to which capital can pass the tax on to labour-a debate which we cannot resolve here. The point to keep in mind is that it is people who pay the corporate tax. Under two of three possible scenarios (capital bears all, capital and labour bear equally) the elderly pay significantly for a policy which is widely but misleadingly touted as a tax on the profits of corporations.

The myth of the untaxed corporation

By now it should be clear that very little is clear about corporate taxes and that brash claims have to be examined cautiously. One particularly brash claim that consistently receives press attention is that some corporations in Canada are not paying their fair share of taxes. In particular, a labour-sponsored study claimed that 81,462 profitable corporations in Canada paid no taxes on profits of nearly $17.1 billion in 1994, and as a result have forced ordinary Canadians to shoulder a larger responsibility for paying the nation's taxes.[One participant was the BC Federation of Labour. It gave the statistics in its media release, "Corporate Tax Freedom Day," Jan. 28, 1997] A study by the Ontario government's Fair Tax Commission shows a different picture. The Fair Tax Commission analyzed a special 1989 survey of 177,000 corporations in Ontario. Of the profits that were not taxed

· 54 percent were inter-corporate dividends or equity income earned by subsidiaries. That is, profits earned by one branch of the corporation which had been taxed, then transferred to another part of the corporation. Taxing these transfers of money would be like taxing a person for moving his wallet from one pocket to another.

· 11 percent of the profits not subject to tax were earned by firms which in the year before had lost money. The tax system takes the long view of profits and allows firms to carry their losses forward. If Widgets Inc. lost $1 million last year and earned $1 million this year, over two years it has not made any profit and so should not be taxed within this two-year cycle.

· 4 percent of profits were exempt from taxation because of the small business tax holiday (later abolished in Ontario)

· 31 percent of profits were exempt either because these profits went to replace depreciating equipment or because they were "paper gains," that is, assets transferred between members of the same corporate group without any economic gain or loss to the group.

In other words, in the view of the Ontario NDP government of the time, the survey of corporations suggested that there was no overwhelming problem of corporate tax rip-offs.

Another perspective on the popular claim that corporations are not paying their fair share of tax comes from looking at Table 7.4. This table shows that between 1987 and 1990, a time of mostly falling corporate profits, the federal government closed many loopholes and increased the amount of tax paid by corporations from $10.9 billion to $11.7 billion. This meant that federal corporate taxes as a percent of profits went from 19.2 percent to 26.2 percent, a more than 36 percent increase. Between 1990 and 1993 both profits and corporate taxes fell. Nonetheless, between 1987 and 1993, while corporate profits fell, the portion of profits paid in provincial and federal corporate taxes rose from 28.4 percent to 35.3 percent. This is probably not what one would find if it were true that tens of thousands of profitable corporations are paying no tax.

Those advocating reform who claim that corporations are getting an "easy ride" might not be impressed by statistics which show that in recent years, corporations pay significantly more than they did in 1967. Instead these critics might claim that in the last 30 years the share of corporate taxes in total taxes collected by government has fallen. Table 7.5 shows that this is indeed true. There is no disputing that income from labour has become the major source of government revenue. However, Table 7.1 shows that the real dollar amount collected from corporations has risen. In other words, even though governments get a smaller fraction of their revenues from corporations than they did in 1967, this is because of the unprecedented growth in personal taxation, not because corporations are cheating the tax system.

Economist Alan Douglas performed a subtle exercise to get at the reasons why the corporate tax has declined as a share of total government revenue. He found that falling profits were the most significant reason for the decline. In particular, "if the profit rate for 1976 to 1985 had remained at its 1966-1975 average of 11.01 percent . . . average [annual government] revenue would have been $11.31 billion instead of $7.55 billion. An extra $27.6 billion in corporate taxes would have been collected over the decade."[Alan V. Douglas, "Changes in Corporate Tax Revenue," Canadian Tax Journal, vol. 38, no. 1., Jan./Feb. 1990] Douglas also found that the importance of tax breaks, such as accelerated depreciation, had a much smaller effect on reducing revenues. And many of these tax breaks were eliminated in 1987. Put differently, corporations in Canada have known a long slide in profitability. Governments have not "taken it easy" on these corporations. Rather, it is simply that they are a less lucrative source of revenue than individual workers.



Chapter 8:

Canada and the Rest of the World

SO FAR, WE HAVE CONCENTRATED our attention on how much tax Canadians pay and how those taxes have been changing. This is useful information if one wants to compare the Canada of today to the Canada of the past. And it is fine to concentrate on the tax burden within our own country provided one is fairly insulated from the rest of the world. However, new technology is weaving the economies of the world closer together than they have ever been before and stripping away any efforts at insulation. This means that when we consider what our taxes mean to us, we also have to look at what the taxes are in the other countries with which we have close ties.

How do you compare?

We explained in previous chapters that the Canadian tax system is complex and that no single number can summarize it. The same is true when it comes to comparing Canada with the rest of the world. Foreign tax systems are d