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Jack Mintz is President’s Fellow, School of Public Policy, University of Calgary.

Taxing the rich is popular, at least for all those who are not rich, until the reality hits. When François Hollande was elected France’s president in 2012, he promised to impose a 75-per-cent “supertax” on incomes in excess of €1-million. Business leaders worried about the flight of capital. High profile citizens reportedly threatened to move elsewhere, including actor Gérard Depardieu (who left for Belgium) and France’s richest man, Bernard Arnault (who later withdrew his application for Belgian citizenship and pledged to continue paying taxes at home). Highly paid soccer players threatened to strike and investment-banker-turned-politician, Emmanuel Macron, described the tax as ”Cuba without the sun.”

Eventually, France’s Constitutional Council deemed the proposal unconstitutional and unfair. By the start of 2015, the supertax proposal had been dropped altogether. The hapless Mr. Hollande was eventually turfed out to be succeeded by Mr. Macron in 2017. Mr. Macron, wanting to boost France’s stagnant economy, is now pursuing an aggressive tax strategy to lower taxes, including mothballing France’s wealth tax.

Canadian politicians have not been as aggressive as Mr. Hollande, but they have hit the rich with new taxes to support more spending or tax cuts for the middle class. In 2016, the federal Liberals raised the top rate on incomes above $200,000 by four points to 33 per cent. Two provinces also raised their top rates: Alberta by five points (increasing the top rate by almost a quarter with federal increase, the largest in the country) and Newfoundland and Labrador by 2.5 points. To offset the federal tax hike, British Columbia and New Brunswick lowered their top rates in 2016 (although B.C.’s NDP government has recently bumped up the top tax rate to just shy of 50 per cent by 2018).

These large shifts in tax rates in 2016 are a golden opportunity to see whether much higher income-tax rates lead to more revenue. So far little data has been available except for this week’s release of the Canada Revenue Agency preliminary individual income data of 2016. It contained some surprising information: 25,000 (or 8.7 per cent of high-income taxpayers) and 17.9 per cent of their federal and provincial income taxes disappeared like magic.

To understand what this means, a few statistics are in order. Governments need the high-income earners to pay tax since they carry a lion’s share. Those earning income in excess of $250,000 make up 0.9 per cent of all tax filers, but bear a fifth of all income taxes. Let’s call them the 1-per-centers. If they end up paying less tax when rates go up, then governments won’t be able to fulfill their spending promises.

It is clear that tax avoidance was critical in explaining the disappearing taxes paid by the 1-per-centers. Knowing that tax rates were going to rise in 2016, high-income taxpayers paid out more dividends and bonuses from their corporations to themselves and family members the previous year. This is best understood by looking at three years of tax statistics: 2014, 2015 and 2016. One-per-centers saw their income increase from 2014 to 2015 by $25-billion, of which 80 per cent resulted from higher dividends and bonuses. From 2015 to 2016, taxable dividend and employment-income payments collapsed falling by $31-billion. Capital gains were also affected as taxpayers sold of assets in 2015, although the impact on tax revenues was muted.

From this limited CRA data, three other points can be concluded.

First, 1-per-centers certainly pay a large share of the tax load, and their behaviour in face of tax hikes is important to understand. The Department of Finance embarrassingly predicted an additional $2-billion from the federal four-point hike on high-income taxpayers. This clearly did not happen. Instead, federal personal taxes paid by the 1-per-centers dropped by whopping $1.2-billion just from shifting income from future years to 2015 (the actual loss in federal tax payments was $4.2-billion from 2015 to 2016). Whether the tax hike on high-income earners shall raise much revenue in the future is still unclear, since 2016 taxes paid by the rich have simply returned back to 2014 levels despite the increase in federal tax rates.

Second, while the economy lost its lustre after the commodity price bust in late 2014, CRA-collected income tax payments rose by 2.3 per cent from 2014 to 2016 (and by 3 per cent for the 99-per-centers who were not affected by income tax hikes). One cannot blame the decline in high-income tax payments on the economy tanking – it didn’t (although effects differ by region).

Third, while the number of taxpayers in the highest income group dramatically declined in 2016, it retreated to about the same level in 2014. Much of the gain in the number of high-income taxpayers from 2014 to 2015 resulted in some taxpayers jumping into a higher income tax category. One cannot conclude that taxpayers fled the country. At least in 2016.

Unlike timing changes, tax avoidance by restructuring business affairs or changing residence takes some years to plan. A year of data is inadequate to understand these longer-run economic impacts when top rates are increased. There is anecdotal evidence from tax planners about high-net-worth clients moving themselves or capital abroad, but the current data are insufficient to measure these impacts.

For now, it is best to consider lessons learned from economic studies. Canada’s top rate – averaging close to 53 per cent (including provincial tax rates) – is the fifth highest among OECD countries (the highest being Sweden at 60 per cent and the lowest Poland at 22.1 per cent). For small businesses with $10-million in assets, Canada’s effective corporate and personal tax rate on entrepreneurial new investment is 42.5 per cent compared with 32.5 per cent in the United States. Canada is now disadvantaged in attracting entrepreneurial and skilled labour because of its higher personal tax rates – especially compared with the favourable treatment of small and medium business income under the new U.S. tax law.

In principle, taxes reduce the incentive to work, invest and take risks and, if out of line with other countries, encourage skilled and entrepreneurial investors to move to other jurisdictions. Most (but not all) economic studies have found that high marginal personal income-tax rates reduce economic growth. The most recent is a new study published in the Quarterly Journal of Economics finding that tax cuts targeted at the 1-per-centers increase GDP and lowers unemployment rates. There is some beneficial impact for the 99 per cent but inequality rises.

The concerns over inequality led the federal government to raise the top rate by four points to pay for a “middle” income tax cut. However, to the extent that high marginal tax rates hurt economic growth and results in tax avoidance, the pie available to provide health, education and other benefits shrink. Politically, it is difficult for governments to reduce personal taxes since it leads to the usual reaction of favouring the 8 per cent of taxpayers (with incomes more than $100,000) who pay almost half of personal income taxes.

In the past several years, federal and provincial governments have pursued the wrong strategy by pushing up rates above 50 per cent. Instead, a far better approach would have been to broaden tax bases that would have mitigated rather increased the scope for tax avoidance and, at the same time simplify, reduce distortions and improve fairness. The low small-business corporate rate, which favours higher income households, could have been chopped to simplify the tax system resulting in a single corporate income-tax rate and only one dividend tax credit. Capital-gains tax rates could be raised to the top dividend tax rate, eliminating the advantage of passing out income by buying back shares. Ineffective tax incentives such as for venture capital and flow-through shares that have encouraged the financing of projects with low economic returns could have been eliminated instead.

Which gives us a choice: We can keep raising top rates on high-income earners with its negative implications on revenues, growth and competitiveness or we can broaden the tax base and lower the top marginal rates achieving the same distributional goals but create better conditions for economic growth. Other reforms include shifting taxes to consumption from income would also improve growth.

Tax reform is controversial since no one likes getting their ox gored. But it’s time to have a serious effort at reviewing the tax system to grow the economy and make taxes fair. At this point, the system will topple if we think that raising the top rate is the only answer to ensure governments have the means to fund public services.

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