Lighten the load: It's time to unleash the Canadian
tiger by reforming confiscatory tax policies that discourage saving and
investment
National Post
Wed 21 Sep 2005

Page: FP23
Section: Financial Post: Comment
Byline: Finn Poschmann

Source: Financial Post

In the past decade, many countries around the world awoke
to the link between business investment and job and wage growth, and began to
lighten the tax load on capital investment. Now Canada and most other G7
countries nest atop an unhappy pile of high-tax jurisdictions that need a dose
of pro-growth tax reform to give themselves -- and their trading partners -- a
healthy economic boost.

Smart Canadian policymakers should not simply react to changes in tax policy
abroad. They should take the initiative and adopt measures to unleash the
Canadian tiger by making this country, quite simply, the best in which to work
and invest. And given the competitive and demographic challenges facing Canada,
tax reform is increasingly urgent. Other countries are not standing still -- as
in the United States, where President George W. Bush's reform initiative will
soon spark a major debate on the advantages of reorienting the tax base from
income toward consumption.

Federal and provincial governments have their work cut out for them. Heavy
taxes on investment have discouraged businesses from buying the new-vintage
capital and latest technologies that would improve labour productivity. In the
absence of such modernization, production processes age, businesses fall behind
and they have difficulty increasing their employees' incomes. Annual business
investment per worker has dropped in Canada by nearly a fifth in recent years
and productivity and wage growth have languished for longer.

Canadian governments need to develop multi-year plans to make Canada
friendlier to investment and to remove tax barriers to work and saving so that
workers keep more of the fruits of their labour. Canada needs low rates, broad
tax bases and a shift in the tax mix: We need to move toward greater reliance on
taxes on consumption rather than on savings and investments.

Here is why. With an ageing population and savings rates at historical lows,
the economy's capacity to fund future public benefits at reasonable tax rates is
threatened. But even if savings rates are unaffected by current taxes, as a few
economists believe, Canadians are unable to build wealth for future needs when
taxes take a confiscatory bite. Consider a five-year bond yielding 4%: A
representative 40% statutory tax rate produces a 2.4% after-tax yield. With
inflation running at 2%, the inflation-adjusted real rate of return is a
thoroughly discouraging 0.4%. Hence, on an inflation-adjusted basis, the
effective tax rate on savings in taxable bonds is more like 80% than the
statutory 40%, and that needs fixing.

Taxes on saving should in principle be eliminated so that taxpayers pay the
same tax regardless of whether they consume their earnings today or in the
future. The shift can be smoothly accomplished by, for example, increasing
allowable deductions for pension and registered retirement contributions and by
relying more on sales, excise and user-pay fees.

Meanwhile, the current high marginal tax rates on employment earnings and
investment income are especially damaging to people with modest incomes.
Reductions in overall tax rates are needed, especially the clawback rates for
income-tested programs and taxes on investment earnings. Federal and provincial
governments should co-ordinate their income-testing policies to avoid the
stacking of clawback rates and re-evaluate how seniors are taxed.

Moreover, it is time for Tax-Prepaid Savings Plans. TPSPs would allow
individuals to save after-tax earnings in registered accounts, and, as a mirror
to RRSPs, accrued earnings and withdrawals would not face future taxation. This
would allow Canadians to even out their tax base over time and provide choice
for low-wealth seniors for whom RRSP saving would be financially backward.

Other savings changes would make sense: 10 years ago the maximum age for RRSP
contributions was lowered from 71 years to 69. Recognizing that Canadians now
live and work longer, the age limit (if there must be one), should be raised to
73. And if taxpayers withdraw their RRSP savings for contingencies, they should
be able to increase their lifetime contribution room by the same amount.

Not all smart changes need be tax cuts. The current $500,000 lifetime capital
gains exemption for owners of farm property and shares of Canadian-controlled
private corporations should be replaced by a rollover provision that allows the
proceeds of sales to be folded into an enhanced farmers' and small business
owners' RRSP.

Now, the dividend tax credit: Dividends usually face heavier taxes than other
forms of income, because the personal and corporation income taxes are
imperfectly integrated. As recently noted by Finance Minister Ralph Goodale,
this puts pressure on business to choose corporate forms that, while minimizing
governments' tax take, may not be well suited to an economy that needs
continuing business reinvestment in productivity-enhanced plants and processes.
Fixing the dividend tax gross-up and credit system is the solution staring us in
the face.

With lower taxes on saving and dividend income, other incentives to save
would be less necessary. The federal and provincial labour-sponsored venture
capital fund credits are dubious measures, as labour funds' economic return to
investors is typically low or negative: The median five-year return for labour
funds in existence as of August, 2005, was -9.8% annually; Ottawa and other
provinces should follow Ontario's lead by ceasing to register new funds and by
winding down the credit for investment in labour-sponsored funds.

Employment Insurance operates with a big and persistent surplus, even though
its legislation says premiums and benefits should balance over the business
cycle. That means premiums are too high and, given that contributions are
limited to the first $39,000 in employment income, a heavier burden for
low-income workers than high. Further, EI premiums are unfairly and
inefficiently levied because they are unrelated to the layoff experience of a
business. Employers who take advantage of the Employment Insurance program by
routinely laying off workers are permitted to do so without facing higher
premiums. As part of a premium reduction package, the federal government should
adopt partial experience-rating at the business level so that employers who tend
to lay off workers pay a higher premium, and establishments with good employment
records pay lower rates.

On the corporate income tax side, the place to start is redressing the high
taxes on business investment, with the aim of building labour productivity and
offsetting some of the impact of work-force ageing. Policy initiatives for
Canada to create a distinct advantage for itself include lowering the combined
federal-provincial corporate income tax rate to 25%.

As things stand, Canada's effective tax rates on investment are
second-highest among the 36 developed and leading developing nations we
surveyed, and that can be fixed. Further, a one-point reduction in the corporate
income tax rate enlarges the tax base by 4% to 8%, as businesses shift income
into lower-tax jurisdictions, and that suggests that additional taxes paid by
large companies may offset some or all of the revenue impact of the rate cut.

There is much more to address, such as provincial capital taxes and
withholding taxes that inhibit foreign investment in projects here. Canada's
federal and provincial governments have plenty of work to do, and Canadian
workers can only benefit by unleashing our productive capacity.

Illustration:
• Chart/Graph: Finn Poschmann Via
Statistics Canada's Social Policy Simulation Database and Model, Release 10.2,
C.D. Howe Institute /
INVESTMENT TAX GRAB: Average and marginal effective tax rates for a senior with
interest income. All province average, 2005: (See print copy for complete
chart/graph.)

Edition: National
Story Type: Business; Opinion

Note: Finn Poschmann is associate director of research at the
C.D. Howe Institute.; "The
2005 Tax Competitiveness Report" is available at www.cdhowe.org.
Length: 1176 words