Spending by stealth through tax expenditures in Canada
Hardly anyone noticed when the federal government appointed a committee of economists, accountants and lawyers to advise it on tax expenditures. This is not surprising because few people understand or even care about them. But they should. Tax expenditures are effectively government spending in disguise.
Stanley Surrey, a tax attorney working for the U.S. government, coined the term “tax expenditure” in the 1960s to refer to governments’ use of the tax system to achieve public policy objectives. The term includes tax breaks through preferential tax rates, exemptions, deductions, deferrals and tax credits. They can be found under the personal income tax (PIT), the corporate income tax (CIT) or the GST.
The concept of tax expenditures itself is arbitrary. Only concessions that have been incorporated into the tax code are treated as tax expenditures, leaving others out. The capital gains exemption on principal residences, for example, is treated as a tax expenditure whereas the exclusion of the benefits of home ownership, a much larger sum, is not. Indeed the tax codes of countries such as the Netherlands and Switzerland treat this “implicit rent” as part of taxable income. For them, it would be a tax expenditure. Its exclusion from our tax code seems to reflect administrative convenience rather than any question of principle.
While tax expenditures might be overlooked if they were few and had minor costs, they are many and some are large. The federal government reports more than 220 tax expenditures, approximately 130 under PIT, 65 under CIT and 35 under the GST.
Amazingly the federal government offers no cost estimates of more than 90 of the listed tax expenditures. While it provides no estimate of the total value of all its tax expenditures, the OECD, however, estimated total tax expenditures for all levels of government in Canada to be almost 11 per cent of GDP for 2009, the equivalent of $140 billion for 2016.
Among the largest tax expenditures at the federal level are the treatment of registered pension plans ($26 billion) and RRSPs ($15 billion) under the personal income tax. Others include the zero rating of basic groceries under the GST ($4.3 billion), partial inclusion of capital gains under both the PIT ($5.8 billion) and the CIT ($6.3 billion), non- taxation of capital gains on principal residences ($5.3 billion) and the preferential tax rate for small businesses ($3.6 billion).
Tax expenditures are also used by provinces and municipalities. One province, British Columbia, lists a further 49 under its own provisions. The sales tax exemption for food ($1.1 billion), the home owner grant ($806 million) and film and television tax credits ($491 million) are the largest.
Tax expenditures are based on people’s tax filing and are seen by some to offer some administrative advantages over spending. Any such advantage is overshadowed, however, by their drawbacks. Tax expenditures are less accountable than government spending. Spending is open to debate when first added as a line item to the budget and could be again when included in subsequent budgets. Tax expenditures, in contrast, show up as modifications to the tax code. They may be debated when added to the code yet are less likely to be debated later on.
Tax expenditures are also less transparent because the public may not view them the same as spending. Even though people may not question the Scientific Research and Experimental Development Investment Tax Credit when presented as a tax expenditure, they might view differently if they knew it cost the government $1.5 billion in lost revenues.
Finally, the role of government in the economy will be understated by traditional estimates that use only government spending. Munir Sheikh, former head of Statistics Canada, finds that adding tax expenditures to spending increases the federal government’s share of GDP from 16 per cent to over 23 per cent. When he considers all governments, the share rises from 44 per cent to 54 per cent of GDP.
Though lower taxes may be a laudable goal as are many objectives of tax expenditures, the piecemeal introduction of tax expenditures by stealth is a poor way to achieve these ends. A simpler tax system with fewer tax expenditures would be more upfront. It would also allow lower tax rates, reduce the costs of tax compliance for Canadians, and reduce administrative costs for governments. Since it’s unlikely that governments will wean themselves from tax expenditures any time soon, they need to recognize that tax expenditures require the same scrutiny as government spending.
A first step would be to require that all new proposals for tax expenditures include cost estimates. In the same vein, existing tax expenditures that lack cost estimates should expire unless governments provide these estimates. Finally, estimates of tax expenditures should not be tucked away in appendices to government budgets: they should be treated as line items in just the same way as spending.