Don Cayo: Proposed tax reforms target growing income inequality (with video)

Strategies: Economists suggest removing easy avoidance

VANCOUVER — Never mind that business-friendly tax policies – reforms like the dramatic reductions in federal and provincial corporate taxes over the past decade or so – enhance international competitiveness. This doesn’t impress the electorate when the benefits go mostly to the relative handful of Canadians with the highest incomes.

Just look at B.C.’s ill-fated HST. Economists almost universally options tax than the now-restored agreed it was a far more economically efficient PST and would thus foster

business growth. But it shifted $2 billion of tax burden from companies to individuals, and voters wouldn’t stand for it.

Governments risk a similar backlash if they keep stoking inequality with other policies, warns UBC professor Kevin Milligan in this year’s C.D. Howe Benefactors Lecture.

“For over 30 years, incomes have been growing fastest at the top,” he noted in his lecture Tuesday in Toronto. “At the same time, it has become easier for individuals to respond to higher tax rates with behaviour that lowers reported income.”

The kindest interpretation of Milligan’s figures is that at least the growth of inequality

inequal-has slowed over 30 years, thanks in part to the hit that top earners took during the 2008 recession. Real beforetax income for the lowestearning 90 per cent of Canadians fell seven per cent between 1982 and 1996, then rose 15 per cent in the next 15 years. Yet the comparable figure for the top one per cent grew 35 per cent from 1992 to 1996 and 50 per cent from 1996 to 2011, while increases for the top 0.01 per cent – one in every 10,000 Canadians – were 62 and 59 per cent.

The elite’s gains were driven mainly by sky-high salaries of “super-managers” who run big corporations, not from investments. Indeed, investment income slipped from nearly three-quarters of all money earned by the richest Canadians back in the early days of the postwar era to barely more than one-third today.

Milligan’s concern about growing inequality is echoed in a TD Bank study that was, coincidentally, also released this week.

TD economist Craig Alexander urges public investment in productivity, skills training, family support and early childhood education, as well as tax reforms, to counter the trend, while Milligan focuses on taxes.

“When taxes increase,” he noted, “individuals and firms might respond through changes in their actual consumption, labour, savings, residence or investment choices.

“They also might respond by increasing tax-avoidance activities that shift income across tax bases, to lower-tax jurisdictions, or through time to lower their tax burden.”

Also, it is those very highincome individuals, along with companies, who are most apt to take action to avoid paying more tax.

This puts “an intractable restraint” on options to reverse the trend toward growing inequality, since these kinds of tax-avoidance strategies could mean a higher tax rate will yield less government revenue, not more. His answer? Stop taxing all forms of income at the same rate, and differentiate between money earned through employment and through investment.

Nordic countries have pioneered a dual-tax system – a flat tax rate on investment earnings and a progressive one on employment earnings.

“Such a system allows for progressivity on high employment income – the source of growing income inequality – and accommodates the mobile reality of capital income taxation,” he said.

He warned, however, that increasing the tax rate for the highest employment earners “would not make a substantial difference to public finances.

“To take one example, some have advocated adding a top bracket for income above $250,000 with a tax rate of 35 per cent, or six percentage points above today’s top rate of 29 per cent.

“Assuming no change in the income reported by top earners, such a tax in 2012 would have raised $2.9 billion – a modest addition in the context of the $276 billion of spending in the 2014 federal budget.”

Worse, his analysis predicts that at least a third and maybe the whole amount would be wiped out by tax avoidance.

So he advises that a first step toward reform should be to remove easy avoidance options. This means both taxing stock options as employment compensation and removing unproductive tax breaks that can be used to lower tax bills.

Next would be to simplify and flatten taxation of earnings on capital, much of which is already exempt because it is invested through RRSPs, TFSAs or other tax shelters.

Finally, he advocates increasing the federal tax rates, which now top out at 29 per cent on income over $136,270, on very high income. He cites a suggestion of a new 32-per cent-bracket on income over $250,000, and 35 per cent on more than $400,000.