The U.S. government is raising tax rates for the wealthiest two per cent of income earners this year — and while the tax hike is smaller than what U.S. President Barack Obama wanted, the outcry it has caused in Congress and some sectors of American society is an indication of just how hard it is to make even the smallest changes to a country's income tax system.
In a progressive income tax system like Canada's, changes usually take the form of small increases or reductions in the rates applied to each tax bracket or in the creation or elimination of deductions and credits.
However, as people begin to pore over T4s, T1s and other tax forms in lead up to the April 30 filing deadline, they might begin to call out for an entirely new — simpler — system.
For those bold enough to adopt them, there is no shortage of ideas on how to structure the ideal tax system.
One of the most-cited, at least by economists, ideas is to replace income taxes with consumption taxes or at least to rely more heavily on them. Consumption taxes apply to what people spend on goods and services instead of what they earn and include taxes on things like retail sales, fuel, tobacco, manufacturing and carbon emissions. Such plans often also favour eliminating taxes on savings and investments.
'There are far more examples of failed attempts to do sweeping tax reform.'— Lisa Philipps, associate vice-president of research, York University
Another common reform proposal is to change the progressive tax system to one based on a flat rate, where everyone pays the same rate regardless of income. After the collapse of the Soviet Union, Russia and a number of countries in Eastern Europe instituted flat rates.
Some reformers suggest we simplify the income tax system by reducing the number of income tiers and eliminating credits and deductions, also called tax expenditures.
Regardless of which model a country chooses — and there is no shortage of debate about the respective merits and fairness of each — the widespread reform of a country's income tax system is no easy task, experts say.
"There are far more examples of failed attempts to do sweeping tax reform [than successful ones]," says Lisa Philipps, a professor of tax law and associate vice-president of research at York University in Toronto. "It's a real puzzle that tax policy people have studied extensively."
Winners and losers
Jack Mintz, an economist and chair of the School of Public Policy at the University of Calgary who has written and lectured extensively on tax-related issues, agrees that overhauling a country's tax system is no easy task.
"It's quite a challenge, actually, tax reform," he said. "But it doesn't mean that it's not done."
Although the impetus for reform can vary, it is often spurred by one of two situations, Mintz said: either the government —federal or provincial — is facing deficits and accumulating debt, or the economy is doing poorly and there is very little growth.
Before embarking on any project of reform, governments should have a clear idea of the type of tax system they would like to implement, Mintz says.
"What is the best structure that is fair, generates growth and jobs … and at the same time provides the same revenues for the government," he says.
The HST was repealed in B.C. after voters rejected the harmonized sales tax in August 2011. (Darryl Dyck/Canadian Press) It is also important to get all affected groups, including the general public, to buy into the idea of reforming the system by explaining the benefits of the new structure.
"There are always difficulties with tax reform [because] you create winners and losers, and the losers scream and the winners don't say as much, and as a result, you can get a pretty strong reaction," Mintz said.
Mintz cites the implementation of the harmonized sales tax (HST) in Ontario in 2010 as an example of a tax amendment that has been implemented without much of a backlash.
The new tax had the support of a number of business groups and the government made various exemptions as a way of softening the blow on lower-income people.
British Columbia, on the other hand, voted to repeal the HST in August 2011 following widespread public backlash to the tax, with opponents saying it unfairly shifted the tax burden onto the middle class.
Tax reform part of a cycle
Michael Smart, an economics professor at the University of Toronto, says wide-ranging tax reform is often a once-in-a-generation sort of event that is sometimes spurred by complexities within the system that end up harming economic growth.
The harm is often the result of politicians putting in place tax measures or programs that benefit specific groups but over time create less than ideal outcomes.
"We need to look at these things periodically, so I think it is just a natural process," says Smart, who favours incremental over sweeping reform. "The tax system goes through a cycle."
One notable example of wide-ranging reform are the changes introduced in the United States in 1986, when the government of Ronald Reagan lowered tax rates, reduced the number of income tiers and eliminated a number of so-called loopholes in the tax system.
Those changes prompted the Canadian government to examine its own tax system. Tax changes made by one country can be a catalyst for reform in another country — especially when those two nations have close economic ties.
"The last such personal tax reform in Canada was in 1987, [and] that was really prompted by what was happening in the U.S," Smart said. "We knew that [we had to ] move with our biggest trading partner."
During that period of reform in Canada, the number of federal income tax brackets was reduced to just three — although a fourth was added in 2001 — and the top marginal rates were lowered. The government also moved to introduce the goods and services tax in 1991 as part of the reform package.
"Tax reform is hard to do," said Smart. "It is complicated, and the various political forces that have to be aligned in order to make tax reform happen are complex, and I think imperfectly understood. The events, when they have happened in the past, it feels a little bit like a magical process."
'Both sides of the ledger'
One approach to reform that is likely to yield results is to examine individual policy areas instead of looking at the whole tax structure, says Phillips.
She points to a recent review of the federal government's spending on industrial innovation that looked at both tax expenditures and direct spending to determine the best way to achieve the government's goal of promoting research and development.
"Looking at both sides of the ledger" is important, she said, because foregone revenue in the form of credits and money disbursed as grants both cost the government but might not achieve the same policy objectives. They need to be looked at rationally and as a whole.
The same approach can be taken with income tax and the numerous credits and exemptions offered to Canadians.
Philipps says an expert panel could, for example, examine the best way to promote children's fitness by assessing the impact of fitness tax credits — which are offered by the federal government and some provinces — as well as government spending on projects like community centres.
"What are the most effective programs to promote fitness among children of all socio-economic classes, because we know it is a problem, and we want to reduce our long-term health-care costs," said Phillips.
"Let's rationalize and figure out a better way to do this."
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