It’s tax time again, so discussions about the tax system are bound to pop up, indeed, here’s a thread on CMF. This time last year I covered the big problem with the flat tax system: that it severely compromised progressivity/fairness for simplicity, and that unless it also dealt with the other bits of the tax system, it wouldn’t really help the complexity issue. But, the people who espouse the flat tax idea do generally share a desire to simplify* the tax system, which I can get behind.
Indeed, I think three guiding principles for our tax system should be: effectiveness, fairness, and simplicity. Simplicity, in my opinion, should come last: it’s nice to have, and helps ensure fairness if people can actually wrap their heads around how it all works, but we should only try to make it as simple as possible and no simpler.
Where to start? Well, first off, look at the problem. As I’ve said, the problem is not that we have tax brackets.
My tax return is 29 pages, and most of that is just focused on figuring out what my “taxable income” is to begin with — later splitting that up into brackets is trivial. And the fairness it adds is certainly worth the tiny complexity there. But the length on the page belies some of the more complex issues, for example, Wayfare bought a computer for her self-employment business, and there are at least four different categories for claiming depreciation for a computer. There are two different ways to enter rent as an expense, depending on whether you rent an office/commercial space for your business, or are claiming a portion of your home rent. Do these fine distinctions really matter that much in the end? Then there are smaller issues that add to the complexity needlessly: as a student, I get a T2202A form from my university, and enter in the amount of “eligible” tuition I paid from there and the number of months I was enrolled, and then do two more calculations: multiply the number of months by $400 for the “education amount” and again by $65 for the “textbook amount”. They’re not hard calculations, but a) why couldn’t I just multiply once by $465, and b) why couldn’t the university do that and put it on the T2202A so I just have to put in one number to the return itself? I don’t actually mind, since the computer does the heavy lifting these days anyway, but it does go to show that the tax return was not designed or closely reviewed with simplicity of completion in mind.
Plus the government seems to like making the return more complicated by needlessly throwing things on there that they could be funding directly. Like the transit pass tax credit: wouldn’t it be just as easy to directly subsidize the transit systems? This ties into some general psychology and misunderstandings out there: I know a lot of people who have a bizarre hatred of taxes. That desire to save on taxes can help drive behaviour far beyond the economic incentive of the dollar-value saved. Look at the home renovation tax credit last year: how many people scrambled to get work done to take advantage of the tax credit? How many people would have done the same if the government had directly subsidized things by <13%? Or better yet: how many people happily engage in money-losing activities for a tax break? I’ve even seen “gurus” on TV recommend buying a money-losing “investment” condo because the money lost gives you a tax deduction! So despite the complexity, it appears as though our array of tax credits does create behaviour-changing incentives that cost the government less than direct spending might.
So, we have many different issues leading to complex/difficult tax returns:
1. Inefficient form design (of the form multiply X by 400, then, multiply X by 65, then, add those two). Very easily fixed with computerization (letting the tax program handle the multiple steps), or shifting some of the burden around to providers of forms, or just fixing the tax return design in the first place.
2. Inefficient/confusing segmentation of expense classes, often for arbitrary reasons (computer equipment purchased on certain dates are treated differently, “network equipment” is different again from computers, cars over $30k are different from cars under $30k, buildings purchased before 1987 are treated differently from those purchased after, which are again a different beast if made of frame or stucco-on-frame or corrugated metal… expensing a portion of the rent you pay for your home to have a home office is different than expensing rent for an office office).
3. Confusing wording (”Include general purpose electronic data processing equipment (commonly called computer hardware)” vs “computers and electronic equipment”). This may go away if expense classes go down to 2-3-4 (in my mind, buildings vs all other equipment — I don’t really see how it matters that much whether your filing cabinet or car or computer are depreciated on different timescales, just pick a few increments of years, like 3, 5, 7, 10, 50 and run with it).
4. Different treatment of income from different sources. I understand why dividends are taxed more favourably than regular income, and I agree with it, but it does add complexity — especially with “eligible” and “ineligible” dividends and the whole gross-up plus credit issue. Same for capital gains - tracking ACB (especially with RoC distributions) and carry-forward losses can get tough over the years; though making capital gains tax free would blow the Fraser Institute’s minds.
5. Special deductions: everything from transit passes to your kid’s fitness programs or your home renovation gets a tax credit these days, and each comes with receipts to keep. Perhaps some of these aren’t worth bothering with.
6. Special treatment for sectors: I said two posts ago that “drilling for oil and gas is its own reward”, yet there are special (and confusing) tax breaks for flow-through shares and other activity. Likewise, farming, forestry, fishing, and I believe “Quebec” have their own set of rules and forms, expenses and incentives.
7. Stuff for low income people. There are a lot of different social programs out there to support low-income Canadians, and even more for seniors. GST/HST rebates, property tax rebates (though that’s provincial), GIS for seniors, OAS for seniors, age credits… can this be streamlined?
8. RRSPs. I’m a huge fan of the TFSA - it makes everything so much simpler, there’s much less tracking to do, etc. I think we could just bump up the TFSA room to $20k/yr and do away with RRSPs entirely going forward. No more trying to figure out your tax brackets and deduction/refund, no more losing contribution room when you need to withdraw, no more pesky HBP or LLP, no more confusion over the difference between tax liability and tax withheld on withdrawal. The RRSP is a huge cause of complexity in the average Canadian’s tax return (for those that don’t invest outside of a tax shelter or have self-employment income, it’s pretty much the only amount they have to track year-to-year and carry-forward). But because they’re stricter for long-term savings, they’re better for encouraging average Canadians to save (and also because they come with a refund which people like beyond all rationality). I don’t seriously expect anyone to say we should scrap the RRSP to simplify the system, because there are many people who might not save for the future at all, were it not for the structures of this device. But it does serve as an excellent example of the trade-off between policy and simplicity: it’s complicated, but we can’t very well get rid of it.
9. Labour-sponsored funds. I don’t even really understand fully what they are, but everything I’ve read about them suggests that maybe they shouldn’t exist at all.
10. Carrying expenses. A lot of column space is spent on people discussing how to structure their borrowings so that they become tax deductible (google “Smith Manoeuvre/Maneuver” for example). But why is interest an expense for borrowings at all? Yes, it’s a legitimate cost of making money with leveraged investments, but making it so encourages leverage. After the financial crisis, perhaps the government should be asking itself if that is something it wants to create incentives for. High amounts of leverage lead to wild booms and perverse risk avoidance — find a “safe” thing to invest in, then lever the hell out of it until it yields like a risky investment… but that process invariably turns the safe thing into a risky thing (see: real estate, ABCP, etc). Getting rid of interest/carrying cost deductions would also help simplify the tax return. Though it would create a disconnect between people and corporations, since it would be pretty much impossible to get rid of leverage in the corporate world. Perhaps another example of irreducible complexity.
11. Donations, especially political.
Of course before getting into simplification we need to consider the other guiding principles for a tax system:
Effective: Is enough money raised? If the tax system is used for policy (e.g.: targeted tax credits/deductions), are these effective at what they do (and worth the hit to simplicity)? Is the system actually collecting taxes, or is evasion too easy (cf. Toronto’s vehicle registration tax)?
Fairness: is it fair? Does it meet with the Canadian sensibility of progressiveness, the notion that the poor should pay less and the rich pay more (within limits) because of their means? Does it otherwise tax everyone fairly?
The way I like to think of that one wrt progressivity is that life taxes you on the first bit of income: just meeting your basic needs like food, shelter, etc. The government, which explicitly provides these basic considerations for those in need, shouldn’t be taxing income that would go there. As you get more income, more of it can be spent on wants (including upgrades to shelter/food/security needs) and savings for the future, which means that income is more able to be taxed.
Anyway, simplification is, somewhat ironically, not a simple topic: the tax system is in part as complicated as it is because of all the different competing interests it has to serve.
* - some of them just don’t like the idea of a progressive tax system where the rich pay proportionately more than the poor, so the flat tax is as much about ideology and their idea of what’s fair as it is about eliminating complexity. To some extent, this fits in with the biblical notion of tithing — 10%, no matter what you make. That of course raises many debates from those of us who think about taxes in a progressive way, since at some point (e.g., when you’re trying to feed yourself on a buck a meal or less) you should probably become a recipient of the church/state’s largess, rather than paying into it.