Compliance costs and complexity in Canada’s personal income tax
It’s clear that much has changed since the personal income tax (PIT) was first introduced in 1917. Governments now rely significantly more on this revenue source than they did then. For instance, the federal government now relies on the PIT for approximately half of its total revenue, up from about 3 per cent in 1918. In 2015/16, the federal government alone collected $145 billion in PIT. This is on top of the over $90 billion in PIT revenue collectively collected by the provinces.
However, the PIT imposes significant costs by beyond the tax dollars extracted by governments. An important cost is that incurred by individuals and families to comply with the tax code. This essay discusses this hidden cost of the PIT and how an increasingly complex tax code can lead to higher compliance costs.
Complying with Canada’s personal income tax system imposes costs on Canadian households. For instance, some Canadians pay directly for services that assist with tax preparation and tax planning (i.e., tax preparers, accountants, and lawyers). Others purchase computer software to help them wade through the tax code.
But in addition to these direct costs, 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 show that Canadians spent nearly $7 billion complying with the personal income tax system in 2012. These costs are not trivial. They represent about $501 per Canadian household. Put differently, each individual tax filer incurs, on average, $217 in total compliance costs.
These costs, which are incurred simply to comply with various tax rules, do not add any productive capacity to the economy. They do not go towards building new factories or purchasing new machinery, nor do they improve our human capital through investments in education or training. And compliance costs certainly do not improve our lives by increasing our incomes. In fact, complying with the tax code means Canadians have less money and time available to spend on the things they care about including leisure, work, and family and friends.
Another related issue that is too often ignored is that the relative burden of compliance costs falls disproportionately on lower-income Canadians. While the average dollar cost of complying with the tax code increases as one’s income increases, the real burden of such costs is measured as a share of one’s income. Using this measure, lower-income Canadians pay the highest share of their income to comply with the tax code.
The complexity of the personal income tax system is partly what drives compliance costs. In recent years, Canada’s tax system has become more complex across a host of different measures.
For evidence of this, there is perhaps no better place to look than 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 become increasingly longer and denser. A growing web of complicated rules has made it more difficult for ordinary Canadians to understand and more costly to comply with.
For instance, when the Act was established in 1917, it contained 3,999 words. A century later, in 2016, the number of words had increased by more than one million to 1,029,042. For every one word in the Act in 1917, there were 257 words 99 years later. Not surprisingly, the Act’s page count has also increased dramatically. After standardizing the font, margins, and page size, the Act has grown from just six pages in 1917 to 1,412 pages in 2016. The extra 1,400 pages is certainly a contributing factor to the significant compliance costs delineated above.
One main source of the tax system’s complexity is the long list of tax credits, deductions, and other special preferences (known as “tax expenditures”), which has grown in recent years. For instance, the number of federal tax expenditures in 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, or volunteering as a firefighter, or buying a home for the first time. From 1996 to 2014, the federal government added 27 personal tax expenditures for a total of 128. That’s a 27 percent increase in the span of just 18 years.
Claiming a tax credit or deduction typically requires a tax filer to maintain receipts or fill out additional forms in order to be eligible. It can require various calculations to sum up different types of spending over the course of the year or income earned in different jurisdictions. Sometimes people feel the need to hire a tax professional so that they don’t miss any possible tax benefits. These are some of the reasons that claiming tax expenditures can contribute to higher tax compliance costs. In fact, a recent analysis found that after controlling for different factors such as age, gender, and income, Canadian tax-filers who used at least one of the 10 tax measures examined spent, on average, 20.3 per cent more on tax compliance than those who didn’t use any of them.
Consider also the growth in complexity that has occurred in the administrative documents associated with the personal income tax system. The total number of lines in tax forms is a reasonable indicator of growing complexity. The number of lines in the federal income tax form has increased from just 23 in 1917, to 328 in 2015. That’s 305 more lines since the PIT was first introduced.
There are, of course, 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, it is clear that Canada’s PIT system is now much more complicated than it was 100 years ago. Each new tax law, credit, line, or rate can add to the complexity of the tax system. And the more complex the system, the more difficult—and often more costly—that system is to navigate.
Simplification is the solution
Broadly speaking, to lower compliance costs, Canadian governments could reduce or eliminate tax policies that add complexity to the personal income tax system. For instance, getting rid of ineffective credits, deductions, and other special tax provisions would not only simplify the personal income tax system, it would create room to broadly lower personal income tax rates. In the absence of reform, Canadians will continue to bear high costs to comply with our personal income tax system.
Unfortunately, while often called for, meaningful tax simplification has yet to occur in Canada.
For more on Canada’s personal income tax, see here.
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