Canada Over-Reliant On Income And Business Taxes, Study Suggests

by Mike Godfrey, Tax-News.com, Washington

11 January 2007

Canadian governments are too reliant on personal income and business taxes and need to rebalance the tax system to make it more efficient through additional use of consumption taxes such as the GST, according to a new study released on Tuesday by the Fraser Institute, the free market think tank.

"Our current tax system is inefficient; it discourages investment and savings, and it's expensive for both taxpayers to comply with and governments to administer," observed Jason Clemens, Director of Fiscal Studies at the Fraser Institute and co-author of 'Tax Efficiency: Not All Taxes Are Created Equal'.

In the study, Clemens and co-authors Niels Veldhuis and Milagros Palacios examine how governments can raise revenue through taxation in the least costly and economically damaging manner in order to improve Canada's economic performance. They also compare Canada's mix of taxes to that of 30 other industrialized nations.

The study found that the costs associated with taxes extend far beyond the direct amount of taxes collected. One of the most important costs associated with taxes is how they affect behaviour and incentives. The study concluded that different taxes imposed greatly varying costs on society depending on how and to what extent they changed incentives. For example, taxes on capital such as corporate income taxes impose much higher costs on society than consumption taxes such as the GST.

"Canada has a great opportunity to improve our economic performance by simply rebalancing our tax system to rely less on capital-based taxes and more on consumption-based taxes," Clemens stated.

The authors also point out that among 30 industrialized countries, Canada has the fourth highest reliance on income and profit taxes, accounting for 46.5% of Canada's total government revenues. By comparison, other OECD (Organization for Economic Co-operation and Development) countries obtain an average of 34.4% of their total revenues from income and profit taxes. These taxes are considered to be more costly to society in terms of their incentive effects and the cost of compliance.

Canada ranks 24th out of 30 OECD countries for its use of taxes on the consumption of goods and services (for example, the GST). Canada relies on consumption taxes for 25.9% of its total revenues compared to an average of 32.3% for other OECD countries. These types of taxes impose much smaller costs on society.

"Canada's over-reliance on high cost taxes such as those on investment income and profit results in a slower rate of economic growth than is possible," Clemens observed. "Since consumption-based taxes impose relatively low costs on a society compared to the inefficient, high-cost capital-based taxes, Canada needs to find a way to rebalance our tax system to maximize efficiency and eliminate this drag on economic growth."

The study makes several recommendations that involve shifting Canada's tax mix: reduce corporate income taxes and eliminate capital taxes; reduce personal income tax rates; harmonize provincial sales taxes with the federal GST; eliminate restrictions on contributions to tax sheltered savings accounts such as RRSPs or pensions and create new prepaid tax savings accounts; and increase the use of consumption-based taxes such as the GST.

"The overall objective for Canadian policy should be to increase prosperity by reducing the use of costly taxes such as taxes on income and profits and replacing the revenues lost through less costly taxes such as consumption taxes. This would not only enhance the incentives for savings and investment, but it would bring our tax system in line with our chief competitors in the industrial world," Clemens concluded.

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