Kevin Milligan is professor of economics at UBC's Vancouver School of Economics. He served on a panel of external advisers to the tax expenditure review conducted by Finance Canada in the fall of 2016.
Tax credits and deductions for specific items such as buying a new house or a public-transit pass can leave more money in taxpayer pockets and less in government coffers. Sounds good – but there is a cost to these tax expenditures. Our tax system can become bloated with complex measures that cost more to administer than they deliver in benefits, and make the tax system so byzantine that only those with expensive accountants can figure it all out. For this reason, Finance Minister Bill Morneau last fall embarked on a review of all tax expenditures with the aim of improving the fairness, simplicity, and effectiveness of the tax system.
In the budget, the government did make some good moves with the tax measures it tackled, but it did not tackle enough. That is, Mr. Morneau may have grabbed some of the low-hanging fruit, but he left a lot of fruit farther up the tree untouched.
On the fairness of the tax system, the government took a large step forward by committing to review the use of corporate tax shelters by high earners to split their incomes and receive special treatment of investment income.
The government also simplified the tax system by consolidating three complicated tax-relief measures for caregivers into one easier-to-understand package. The new Canada Caregiver Credit will deliver tax relief to those caring for an elderly or infirm family member without the complexity of the old system.
As a third example, the government considered evidence in its choice to end the Public Transit Tax Credit. Definitive research evidence found this tax credit had absolutely no effect on transit ridership, and policy experts were united in the view that other ways of supporting transit are more effective. The budget announced this tax credit will be phased out as of July 1.
So far, so good. But that's the problem – the government didn't actually go so far. Along with the three measures I listed above, I count another dozen small measures tackled in the budget. Adding them all up leads to a total of about $270-million a year, which is well short of the $3-billion-a-year target that the government promised to find through its review. Moreover, beyond the shortfall on dollars, many cluttering tax expenditures remain on the books that cost us all through wasted tax administration and provide unfair tax favours to certain segments of the population.
In my view, the root source of the shortcomings goes beyond the capability of any one finance minister – it is more structural. For every tax expenditure, there is a particular constituency that benefits, while the costs are dispersed across all taxpayers. Firefighters like their volunteer firefighter tax credit; teachers like their teacher school-supply tax credit, and first-time home buyers like their home-buyer tax credit.
Imagine a brave government that tried to remove any of these tax expenditures. The beneficiaries will certainly notice, but the rest of us might not even care. It's all pain, no gain from the government's point of view. This gives a strong structural incentive to keep these narrow tax measures in place – and what's worse, to keep expanding them.
To combat a structural problem requires a structural solution. I have three ideas.
First, rather than put each individual decision on the cabinet table one at a time, they should be handled as a group. An independent committee can be tasked with delivering a bundle of reforms to be accepted or rejected as a whole. The United States has used this method to deal with military base closings – a contentious situation with localized benefits but dispersed costs that is very similar to the politics of tax expenditures. By dealing with a bundle, it is less likely that any one group will feel singled out.
Second, the process should deliver a clear and transparent benefit to all taxpayers. A transparent upside provides a political counterbalance to the political costs of taking away the targeted benefits. For example, if a total of $3.4-billion in tax expenditure reductions could be found, this could pay for a one-percentage-point reduction in the tax rate in the bottom tax bracket.
Third, any new tax measure should by law become subject to a mandatory review for effectiveness after a set number of years. If it doesn't meet the standard expected, it should be cut.
We want a tax system which achieves the goals of fairness, effectiveness, and simplicity. The best way to make more progress toward these goals is to acknowledge the incentives our politicians face. That is, if we want the Finance Minister to reach higher up the tree beyond the low-hanging fruit, we should provide him with a taller ladder.
Kevin Milligan