Canadians spend billions complying with complex personal income tax system
With the tax-filing deadline just around the corner, it’s worth reflecting on how much the personal income tax (PIT) has changed since it was first introduced 100 years ago. For example, Ottawa now collects more than $150 billion from the PIT, comprising approximately half of its total revenue, up from just 3 per cent a century ago.
But beyond the tax dollars extracted by government, Canadians pay a significant cost to comply with the tax code. Some Canadians directly pay tax preparers, accountants and lawyers to assist with tax preparation and tax planning. Others purchase computer software to help them wade through the tax code. Canadians also incur indirect costs, namely the financial value of the time it takes to understand the tax rules, compile the relevant materials, and complete the tax forms.
All told, the latest available estimates suggest Canadians spent nearly $7 billion complying with the personal income tax system in 2012. This represents about $500 per Canadian household.
These compliance costs do not improve our lives by increasing our incomes. In fact, the cost of complying with the tax code means Canadians have less money and time available to spend on leisure and with family and friends.
Often overlooked is the fact that the relative burden of the value of these compliance costs falls disproportionately on lower-income Canadians since the costs represent a larger share of their income compared to higher-income Canadians.
It is the complexity of the PIT system that partly drives compliance costs. Consider the evolution of the Income Tax Act, the legislation governing personal and corporate income taxes. Since it was introduced 100 years ago, the Act has grown longer and denser.
When established in 1917, it contained 3,999 words compared to 1,029,042 words today. Put differently, after standardizing the font, margins, and page size, the Act’s page count has grown from just six pages in 1917 to 1,412 pages today.
And the number of lines in the federal income tax form, a key administrative document, has increased from 23 in 1917 to 328 in 2015—that’s 305 more lines since the PIT was first introduced, which is a 14-fold increase.
A key source of complexity is the number of tax credits, deductions and other special preferences (whose importance is measured as “tax expenditures”). For instance, the number of federal tax expenditures in only the personal income tax system (excluding corporate and sales taxes) is now well over 100 and covers a wide range of activities such as donating to a political party and volunteering as a firefighter. And this is an increasing source of complexity; from 1996 to 2014, the federal government added 27 personal tax expenditures for a total of 128.
Claiming a tax credit or deduction typically requires a tax-filer to acquire/keep receipts, fill out additional forms and carry out various calculations. Sometimes it leads people to hire tax professionals so they don’t miss any possible tax benefits. All of this can drive tax compliance costs higher.
And there are other factors that add to the tax system’s complexity including the number of tax rates and differing treatment for different types of income. But regardless of the specific indicator, Canada’s PIT system is now much more complicated than it was 100 years ago.
So what can be done? To lower compliance costs, Canadian governments could reform tax policies that increase complexity to the personal income tax system. Getting rid of ineffective credits, deductions and other special tax provisions would not only simplify the system, it would create room to broadly lower personal income tax rates. Such a recommendation could be put in place as part of the ongoing federal review of tax expenditures.
In the absence of reform, however, Canadians will continue to bear high costs to comply with our personal income tax system.