A Tax Proposal That Would Not Fall Flat

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Appeared in the Financial Post

Canadian governments looking for ways to improve the economy would do well to consider Ontario PC leadership candidate, Christine Elliott’s bold plan to implement an 8 per cent “flat tax” should she be elected premier. Ironically, Ms. Elliott’s husband is federal finance minister Jim Flaherty, whose government has favoured reductions in the GST over personal income tax cuts. Indeed, Minister Flaherty’s government should take a page from his wife’s policy playbook. Implementing a “flat tax” would revolutionize Canada’s tax system by removing the current tax penalty on success, and unleash the efforts of hardworking and entrepreneurial Canadians.

It is important to understand that replacing multiple personal income tax rates with a single rate, as proposed by Ms. Elliott, is only one step towards an integrated flat tax. A true flat tax is an integrated approach to taxation which applies a uniform tax rate to all sources of income, personal and business. In addition, an integrated flat tax would dramatically simplify the tax system through the elimination of nearly all deductions, exemptions, and credits that complicate the current tax system.

Currently, the federal and all provincial governments (with the exception of Alberta) maintain graduated or “progressive” personal income tax rates. For example, Ontario has five income tax brackets starting at 6.05 per cent for incomes up to $36,848 and increasing to 17.4 per cent for incomes over $76,442. The federal government maintains four income tax brackets, starting at 15 per cent for incomes up to $38,832 and increasing to 29 per cent for incomes over $126,264.

Graduated income tax rates create strong disincentives for people to work hard, save, invest and engage in entrepreneurial activities. To understand how progressive tax rates act as a disincentive for Canadians to become more successful, it is useful to think of progressive fines used to curb fast driving. Speeding tickets are higher depending on how much above the posted limit we drive, and are meant to discourage excessive speeding. While certainly not the intention, progressive income tax rates have the same effect in that they discourage hard work and success.

When individuals make decisions to increase their incomes through working harder or longer, increasing their savings and investments, or hanging up their own shingle, the marginal tax rate (the tax rate they pay on the next dollar they earn) influences their behaviour. The more of an additional dollar in income that governments take, the less likely people are to engage in efforts to earn more.

An overwhelming consensus in the academic research supports this notion and shows that tax rates that increase as individuals earn more money through hard work and success, act as a disincentive for these activities.

Interestingly, the destructive impact of Canada’s graduated personal income tax rates has not been lost on consecutive federal governments (Liberal and Conservative). In 2005, then-Prime Minister Paul Martin’s economic plan, A Plan for Growth and Prosperity proclaimed that, “Lower personal taxes would also provide greater rewards and incentives for middle- and high-income Canadians to work, save and invest.”

Similarly, current Prime Minister Stephen Harper’s economic plan, Advantage Canada, stressed that, “Canada’s tax burden on highly skilled workers is too high relative to other countries…Canada needs lower personal income tax rates to encourage more Canadians to realize their full potential.”

Unfortunately despite lofty rhetoric, neither the Martin-led Liberals nor Harper-led Conservatives have moved to reduce middle and upper personal income tax rates.

This may have something to do with pressure from social activists who oppose flat taxes because they say it is only fair that the tax system be progressive. Unfortunately, these activists confuse increasing personal income tax rates with progressivity. Progressivity simply means that the share of income one pays in taxes increases as one earns more income. To achieve progressivity, it is not necessary to have increasing personal income tax rates.

Consider Ms. Elliott’s plan, which would result in a single-rate tax of 8 per cent applicable to income over $18,000, her proposed personal basic exemption (the level of income one can earn tax-free). An individual earning $30,000 in Ontario would only be taxed on $12,000 ($30,000 minus the $18,000 exemption) and pay $960 in income tax for an average rate of 3.2 percent. An individual who makes $100,000 would be taxed on $82,000 and pay $6,560 in tax for an average rate of 6.6 per cent. Because the personal exemption constitutes a much higher portion of income for the individual making $30,000, a much smaller portion of their total income is subject to tax.

As a result, the introduction of a single-rate income tax would remove a significant barrier to success and keep the tax system progressive.

Thankfully some provinces are making progress to reduce middle and upper personal income tax rates. Alberta has benefited greatly from its 10 per cent single rate personal income tax. Most recently, New Brunswick enacted a plan to replace its four tax brackets with just two rates of nine per cent on income less than $37,893 and 12 per cent on income above that amount.

Ontario however, is a different story. Shortly after coming into power in 2003, the McGuinty government increased personal income taxes through the introduction of the Ontario Health Premium and cancelled the planned elimination of the personal income surtax.

While the 2009 Ontario budget showed that the McGuinty government has finally realized the harmful effects of high and increasing taxes, it failed to reduce middle and upper personal income tax rates.

Regardless of the outcome of the Ontario PC leadership race, Ontario, and indeed the federal government, should implement a single-rate personal income tax. Doing so would provide true stimulus to wealth creation now and in the future.

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