Challenges in Shifting Canadian Taxation toward Consumption

Transcription

1 Challenges in Shifting Canadian Taxation toward Consumption J. Rhys Kesselman, SFU Public Policy (with Peter Spiro; 2014 Cdn. Tax Journal) Jan. 14, 2016, UBC Allard Law School

2 Goals of this paper Review economists conventional wisdom Describe consumption tax methods and how they depart from pure income base Assess critically the evidence used to reach policy conclusions of consensus view Work effort; savings incentives; investment effects; growth & efficiency; tax compliance Examine distributional impacts of tax shift Assess requirements for revenue neutrality and distributional neutrality 2

3 Consensus expert position Consumption-based taxes are more economically efficient, supportive of incentives, and conducive to economic growth than income-based taxes Consumption-based taxes can be indirect (e.g. PST/GST/HST) or direct (e.g. personal income tax (PIT) & deduction for savings or exemption of capital incomes) Shifting the tax system toward consumption would be desirable, either by Shifting the overall mix: less PIT and more GST/HST Shifting the base of PIT further toward consumption Impacts on distribution of tax burden not a major 3 concern for reforms (downplayed or ignored)

4 Consensus view 1: GST rate cuts Economists Dump on Harper s GST-Lowering Plan, CBC News 2005 Western Univ. economist Jim Davies described GST cuts as stupid, stupid, stupid, stupid Globe & Mail 2007: all 20 [surveyed] economists said other tax cuts would be better for the country than trimming another percentage point from the GST It s a remarkable show of unanimity on public policy. Don Drummond, TD Bank, The GST rate cuts don t move that agenda to make Canada s workers and companies competitive forward at all. 4

5 Consensus view 2: Shift tax mix J. Duclos & J. Gingras: tax mix [should] depend more on consumption taxes [less on] income taxes Jack Mintz: sharp increase in sales tax revenues (sales and excise) to reduce income taxes Ken McKenzie: Alberta replace its PIT with sales tax AB sales tax, recent: Mintz, CD Howe Institute Others advocating tax mix shift Bev Dahlby (U of C as are Mintz & McKenzie) Ontario Institute for Competitiveness & Prosperity Fraser Institute Conference Board of Canada CD Howe Institute (PIT rate i 1%, GST rate h 1%) 5

6 Consensus view 3: Shift PIT base Mintz: a major expansion of RRSP and pension limits to allow for greater accumulation of wealth Many others advocating similar: Pierre Fortin, Dahlby, Clemens (Fraser Institute), Bill Robson (CDHI) Herbert Grubel: cut capital gains tax rate to zero Finn Poschmann et al.: support doubling TFSA contribution limits (proposed by CPC in 2011) Kevin Milligan (UBC Economics): proposal for a dual income tax at personal level, with relatively low flat-rate tax on capital income combined with higher progressive rates on top labour incomes 6

7 Consensus view 4: Equity dismissed Dahlby: redistributive policies should be pursued through gov t expenditures rather than taxes because redistributive expenditures are more cost effective than highly progressive taxes Poschmann: the fact that an economically beneficial tax policy choice offers benefits to highincome households as opposed to low, does not disqualify it Grubel: dismisses objection to zero tax rate on capital gains: the income used to classify families includes capital gains and these gains are often a rare event 7

8 Minority Canadian and foreign views Objections to consensus critique of GST rate cuts (Kesselman, Grady) Distributional critique of proposal to double TFSA limits (Yalnizyan, Kesselman) Support progressive personal expenditure tax, lifetime inheritance tax (Robin Boadway) Foreign analysis has paid careful attention to distributional impacts of tax mix shift and PIT base shift (US, UK, Australia, EU) 8

9 PIT base and consumption methods PIT has hybrid income/consumption base, C-based for great majority, 3 methods used 1. Tax deferral method 2. Tax prepayment method 3. Reduced tax method These all relate to the PIT s treatment of savings and capital-source incomes, not labour earnings 9

10 1. Tax deferral method Income = Consumption + Savings Consumption = Income Savings Allowance of tax deduction (subtraction from taxable base) for RRSPs, RPPs; withdrawals from accounts add to base Federal revenue cost $13.2 bn, $21.6 bn Annual ceiling: 18% of earnings, ~$25,000 Equates to annual earnings of ~$140,000 Indirect taxes (PST,GST/HST) this method 10

11 2. Tax prepayment method Income = Labour income + Capital income Tax Labour income, exempt Capital income Capital income is return on savings No upfront deduction, but no subsequent tax Current provisions Tax-Free Savings Accounts, $5,500 annual limit, independent of earnings, carry-forward Lifetime capital gains exemption, $820,000 for small business shares, eligible farm properties Owner-occupied housing (no capital gains tax on sale, imputed rental value also tax-free) 11

12 3. Reduced tax method Further departures from income-based treatment in Canadian PIT Capital gains on most financial and real assets taxed at half rates (also enjoy tax deferral) Dividend tax credits, presumably to offset burden of corporate income tax (fed rev. cost $4.5 bn) Unrestricted deduction of interest costs for leveraged investments (with investment returns deferred and enjoying capital gains treatment and dividend tax credits) 12

13 Effective tax on capital incomes Study based on 1996 data for Canada: only about a quarter of personal investment income is subject to income tax Update to 2012, tax changes, less than 20% taxable Personal savings can also be invested in human capital (formal education, training, skill upgrading) Study based on 2006 data for Canada: considering both tax treatment and public subsidies to PSE, most persons enjoy a small net subsidy on their investment Conclude: PIT and associated policies tax on basis much closer to consumption than income; exception is very high earners & wealth holders 13

14 Consensus reform proposals A. Shift tax mix: less PIT revenue, more GST/HST revenue Overall revenue neutral, but ignore distribution neutral B. Shift PIT base further toward consumption Typically revenue reduction, also ignore distribution Basic economic analysis is similar for both variants of consensus reform proposals Approach here: assess (simplified) each of the claimed economic effects for reform proposals; then turn to proposals distributional issues 14

15 Claim 1: Work incentives Basic economic theory of labour supply is the individual s choice and trade-off between leisure time and income (for purchase of real G&S) Tax imposes a wedge between gross earnings and net earnings that can be spent on G&S Proponents of tax mix shift argue that reduced PIT rates encourage more labour supply But they ignore the higher GST/HST rate, which makes G&S more expensive, thus little change in trade-off Proponents of PIT base reform forget: untaxing K income higher tax rates adverse for work Improved work incentives only if regressive change 15

16 Claim 2: Savings incentives Economic theory: reducing tax on savings raises attraction of future consumption vs. current cons. Complications and reservations relative to theory Income/wealth effect of reduced tax on savings, raises current income, raises current cons., reduces savings Some individuals behave as target savers, so that reduced tax on investment income means they need less savings to reach their target level of Large element of windfall tax savings with no incentive for incremental saving, especially for the wealthy who simply shift taxable assets into tax-sheltered accounts Tax incentives for savings (RRSPs, IRAs): highly mixed empirical findings about actual effects 16

17 Claim 3: Investment effects Even if aggregate personal savings increase from tax policy, will this increase domestic investment? Marginal source of funds for corporate investment is retained earnings, not new stock issuance International capital mobility and business finance for larger firms means that net-of-corporate tax return is determined outside Canada Any additional domestic savings displace foreign funds Important determinant is taxes at the business level Investment by small business: may be affected by personal savings, but sector already inefficiently favoured by current corporate tax system 17

18 Claim 4: Econ. growth & efficiency Theory and empirical studies of tax mix, structure effects on economic growth and efficiency Some findings that cons n taxes better for both Ignore fact that Canadian PIT already heavily cons n Much of gain in theoretical studies stems from lumpsum tax on wealth of older persons thru higher prices Both theoretical models and empirical studies highly sensitive to many assumptions; also role of PIT progressivity in the findings Canada Finance (2004) ignores int l capital mobility assumes 90% of domestic savings invested in Canada Dahlby-Ferede/CD Howe (2011) estimates MCFs of PIT and GST, but not differ with statistical significance 18

19 Claim 5: Tax compliance Tax mix shift: GST/HST less vulnerable than PIT GST/HST also faces many forms of avoidance/evasion Evidence of post-gst increase in aggregate evasion Individuals evading GST consistently also evade PIT PIT base reform: reduces avoidance/evasion on some capital income because no longer taxable If distribution neutral, requires higher PIT rates on upper brackets, which induces avoidance/evasion on both capital income still taxable and on labour income 19

20 Distribution issues: Tax mix shift GST/HST are regressive; exemptions and tax credits offset regressivity only at lowest incomes Given PIT progressivity, shift of tax mix toward GST/HST would be regressive unless Reduction in PIT rates were concentrated in lower PIT brackets, only smaller rate cuts in upper brackets: Top-bracket PIT rate cut < 0.5 x Low-bracket rate cut Need differential PIT rate cuts because: 1) Saving rates rise with income (and GST/HST applies only to spending); 2) PIT rate progressivity means declining share of gross income available for spending 20

21 Distribution issues: PIT base reform PIT is most progressive component of Canada s overall taxation system Reducing its relative role in tax system would reduce progressive and tilt overall system toward regressive Personal investment incomes highly concentrated in upper income brackets (constitute larger % of their total incomes; table on next slide) Reform to reduce taxation of capital incomes (taxdeferred, tax-prepaid, or tax-reduce) would be strongly beneficial to highest earners and wealth holders PIT base reform with offsetting hike in top tax rates: worsen labour disincentives, avoidance 21

22 High concentration of capital incomes Assessed income range $150, tax year, all returns, federal tax TOTAL RETURNS 2.2% TOTAL INCOME ASSESSED 16.6% INTEREST INCOME 24.9% TAXABLE DIVIDENDS 51.4% TAXABLE CAPITAL GAINS 62.9% 22

23 Problems with distributional shift Tax progressivity is a matter of personal values and political process, BUT real-world effects of greater inequality and reduced progressivity Greater inequality undermines public support for proinvestment policies, thus reduces growth Greater inequality shortens duration/sustainability of economic growth cycles Perceived degree of equity in taxation (whether rich pay fair share ) affects taxpayer compliance Countries with more progressive taxation have higher self-reported levels of well-being 23

24 Personal versus business level tax International capital mobility suggests that reducing taxes at business level more effective Cut corporate income tax rates, increase investment tax credits and depreciation rates; econ efficiency Harmonizing provincial sales taxes effective About 40% of retail sales tax burden on business Harmonization is not primarily a tax mix shift; most of business tax savings from harmonization is shifted to consumers via lower prices Rather, harmonization is essentially a tax base reform that makes the sales tax a more pure consumption tax, getting the burden off investment and business inputs 24

25 Distributional AND revenue neutrality These are not merely academic constructs; in real-world policy cannot be taken independently Reforms that are not distributional neutral (with highest earners gaining) are not likely to be revenue neutral either Middle and moderate earners will oppose increases in their own tax burdens, all the more if rich are gainers Thus, distributionally skewed reforms will yield lower total revenues Public expenditures overall very progressive, so that the largest losers will be poor, vulnerable, low earners 25

26 Lessons learned? Expert analysis and views are not always correct, no matter how broadly held and often expressed DUH! Nevertheless, consensus economic (and tax policy) expert views whether right or wrong have powerful impact on real-world policies Policy recommendations impact both levels of public revenues and their distribution and thus the ability to finance public programs needed to address inequalities of opportunity and outcome 26