Believe it or not, there is such a thing as a good tax.
A good tax raises the required government revenue by not only treating equals equally, but also by requiring more from those who will be hurt the least.
However, that is not all: a good tax is also a tax that is administered simply, transparently, and in a “neutral” way.
“Neutral” means it does not cause individuals and corporations to behave differently; in other words, the tax respects the outcomes of the marketplace (unless of course prices do not accurately reflect the true costs and benefits of an activity. In this case the tax might be used to explicitly correct these market failures.)
This confronts Occupiers, and others interested in a more equitable tax system, with a dilemma.
If our starting point is that market outcomes are efficient, then requiring the rich to pay more will surely change incentives. They will try to avoid the tax, and this will compromise the amount of revenue collected. The administrative red tape needs to get thicker, but surely is limited since individuals will eventually feel that working harder or saving more are just not worth it.
Ultimately the tax impacts on economic efficiency: the attempt to divide the pie in a way favourable to the less advantaged ends up making the entire pie smaller, something that is potentially damaging to everyone including the less advantaged.
There was little said during the NDP leadership debate yesterday afternoon that offers a guide for good tax policy to promote equity. So, what are Occupiers to do?
First, there is one thing not to do: don’t pursue equity through changes in value-added taxes like the GST/HST by exempting things -- heating expenses or even food -- perceived to be necessities for the least advantaged. These exemptions narrow the tax base, and imply that the rate would have to be higher to generate the same amount of revenue.
A wider base with a lower rate is preferred because it minimizes incentives to change behaviour: the tax can’t be avoided by changing consumption patterns; lower rates imply weaker inducements to behave differently.
I took this recommendation from a far-reaching article called “ Rethinking Tax-Transfer Policy for 21st Century Canada”. The author, Queen’s University economics professor Robin Boadway, was inspired by major “rethinkings” of the UK, American, and Australian tax systems by a series of noted experts. Prof. Boadway’s carefully written and nuanced article is a blueprint for reforms to the Canadian system.
Occupiers could do no better than to use it as a starting point.
Here is a five-step plan inspired by Prof. Boadway’s thinking and by the recent work of other top economists: U.S.-based research by Peter Diamond and Emmanuel Saez, and an opinion piece by Kenneth Arrow. (Incidental commentary, and certainly any misinterpretations of Boadway’s suggestions, is mine.)
1. Raise the after-tax income received by the least well off.
Do this in a way that promotes work incentives by significantly raising the Working Income Tax Benefit (which is a top-up to the earnings of the working poor). But do it also by expanding refundable tax benefits received by those not fully able to participate in the labour force. In effect, set a minimum guaranteed income for the least advantaged and structure it in a way that removes the huge disincentives to work and red tape embodied in many provincial welfare schemes.
2. Increase taxes on the most advantaged. There are two ways of doing this: do both.
The first is to introduce a higher income tax bracket for top earners. The potential downside of this is that a higher rate on the income earned above some high threshold may lead top earners to work less, or even encourage a brain drain. This is likely not to be that important. As I described in a previous post, top earners in Canada owe their high incomes to a spillover from the U.S. during the 1990s. This downside is not as great because of the economic downturn, and particularly if it turns out that top tax rates are raised in that country. Criticism that a good deal of revenue will not be raised in this way is missing the point: this is a less costly and less hurtful way of raising an additional dollar than the alternatives.
The second thing to do is re-introduce an inheritance tax to apply above some suitably defined minimum amount. This would promote both equity and equality of opportunity. If you don’t tax inheritances, then tax all capital income, maybe at a lower rate than earnings, but include it all in the tax base. This reduces incentives for tax-avoidance in the same manner as minimizing the exemptions in a value-added tax. It also involves taxing the capital gains from selling the principal residence, again only above some threshold.
3. Permit individuals to average their earnings over a period of several years so that a year of very high or very low income does not have important tax implications.
A scheme of averaging will focus the tax system on overall lifetime income, rather than on annual income that could fluctuate significantly from year to year. For example, long-tenure workers laid off from high paying jobs rarely see their earnings rebound. If their life-time earnings fall then the taxes paid in previous years could be rebated. Similarly, some hit the jackpot after years of struggling in low-income, so their tax bill should be adjusted accordingly. There is more income volatility in the globalized economy, and the tax system should recognize this.
4. Heavily tax “rents” in the business sector, and in particular in the natural resources sector.
A “rent” is a return that is pure gravy: a windfall that is beyond the costs needed to bring a resource or service to market. Taxing these pure rents has no impact on the incentives determining how resources are used, and does not therefore influence market outcomes. Our tax system, Prof. Boadway says, “does a relatively poor job of taxing rents, which is a serious drawback in an economy that relies heavily on primary industries.”
5. Save a heck of a lot more revenues from resource taxes for the young and for future generations.
These are non-renewable resources that the current generation should not be spending on its consumption. Let a huge fund develop and invest it in foreign assets so that Canadian dollars are sold on international markets, thereby preventing the appreciation of the currency that has had a negative impact on other industries and jobs.
This five-point plan is about including all sources of income in the tax base, and about targeting tax rate increases where they cause the least pain. It is also about minimizing changes in market-determined outcomes.
These are basic principles that Occupiers and others should follow in putting forward tax proposals; but if they are somewhat uncomfortable about having a mainstream economist as a spokesperson, then they should simply remember the wise words of Horton the Elephant, which, slightly paraphrased, remind us that “a dollar’s a dollar, no matter how large.”
Miles Corak is a professor of economics with the Graduate School of Public and International Affairs at the University of Ottawa. The full version of this post is available at milescorak.com.