By: Larry MacDonald
The kerfuffle over recently proposed TFSA changes raises once again the question of whether or not our tax system is way too complicated with its plethora of differential tax rates and exemptions. Concerns include:
1) It leads to sub-optimal investment decisions. People, lured by the tax breaks, take their eyes off sound investing practices and make riverboat gambles with their money. A prime example is Labor Sponsored Investment Funds, where thousands of persons poured money into vehicles that went nowhere. A more recent example comes from blogger Michael James, who drew attention to the incentive thrown up by the TFSA to engage in speculation– i.e. people over-contributing to the plan and investing in risky securities in hopes of beating the 1% a month penalty on over-contributions.
2) It’s antithetical to low-cost investing. All the registered plans, exemptions, etc. create a demand for financial advisors to explain them. Being able to show us how to navigate through the labyrinth and reduce taxes, advisors get a foot in the door to sell a panoply of mutual funds and other financial products with embedded fees. If you’ve cast your lot with John Bogle, David Swenson, Larry Swedroe and other proponents of low-cost investing, it seems to me you have to take a stand against this absurd complexity in our tax system.
3) Look at the huge waste of productive resources that go into tax-planning strategies, the legions of tax lawyers, chartered accounts and other specialists. For a clue of what the costs amount to, look to economist James Payne, an authority on the costs of the American tax system: “he estimates that, for every dollar his government collects and spends, individuals and businesses spend another 65 cents in collection and compliance costs,” noted analyst Peter Holle. Wouldn’t our economy be better off if these people were instead employed in more productive pursuits?
4) And don’t forget the time and effort adult Canadians have to spend on comprehending and complying with the tax system – often arriving at misunderstandings that harm them and their savings. Then there are those with the smarts, or the money to hire the talent, to find loopholes and implement tax planning strategies that make the incidence of taxes more regressive at the aggregate level. As a reader noted: “Right now, there are office buildings where the cleaning staff pay more tax than the CEO & CFO…. The cleaning staff have little or no tax dodges & loopholes.”
Don’t we need a tax system that’s infinitely simpler? I’m no expert in how to get there, but from my limited musings, things like a flat tax look worth considering. To be continued….
10 Responses to “ Unbearable heaviness of the tax system ”
Is it the progressive nature of tax system that is really the source of all this complexity? I’m pretty sure if all I had to worry about was tax brackets, I could do without tax advice.
By Patrick on Oct 26, 2009
Patrick
As mentioned in the post, there is also the array of exemptions and registered plans etc. There are also differential tax rates on various forms of income such as corporate, investment, etc. And it keeps changing from year to year too — it’s hard enough to get up to speed on what exists let alone what changes.
By Larry MacDonald on Oct 26, 2009
Larry you seem to be planning a flat tax feature soon, and I am very much in favour of that for many reasons, but I fear the lobby in favour of the status quo will crush it like a bug underfoot. Lobbyists representing accountants and tax firms will mount such an anti flat tax campaign that it might take years for parliament hill to recover. It would, however, be nice to dream about a flat tax system for personal taxation in Canada.
Think about all the time currently wasted by millions of Canadians wading through the annual tax time drudgery. And what about the unbelievable amount of money ordinary Canadians pay to tax accounting organizations in order to avoid the pain of filling out those wretched forms each year. The fact that the Canada Revenue Agency (CRA) has created such a complicated monster is reason enough to adopt a flat tax system.
A flat tax would bring a sudden halt to all the pain involved in trying to understand the special kind of geek speak found only on Canadian tax forms. A flat tax system would probably reduce, by a significant number, the depression patients seen by doctors at tax time. Canadians would easily be able to figure out what 18%, for example, of their taxable income is. In fact, I can use my desktop calculator to figure out that problem in just under two seconds. Think of the joy involved in doing your taxes under those circumstances. It’s especially gratifying when you compound that pleasure with the fact that you would also save the money normally spent employing a tax expert to relieve you of the anxiety formerly imposed by the CRA by virtue of their nauseating volumes of tax regulations.
CRA could still provide necessary exemptions to protect low income Canadians, but high income Canadians would certainly have to pay up, especially if they could no longer wriggle out of paying the flat tax rate applicable to their level of earnings.
Some European counties have switched to a flat tax without any adverse effects on their economies or individuals so it’s not like we would be inventing the process. We probably couldn’t change the tax code as it applies to corporations and small business immediately, so that should keep most of the accountants and tax specialists off the dole. For the few who do find their opportunities diminished I hear the Canadian Forces are still recruiting.
By John Wesson on Oct 26, 2009
Another aberration of our tax system is the denial of income splitting for non-retired spouses. Couples with high disparity in income have to go through hoops to optimize their taxation level (spousal loans, separate accounting betwen high- and low-income spouse, hiring spouse, etc.). It’s completely ridiculous that a divorced couple becomes more tax efficient than it was when married…
By EmperorCoder on Oct 26, 2009
EmperorCoder
Don’t you love the perverse incentives of the tax system such that it’s more tax efficient to divorce than remain married? But for me the best solution is not yet another exemption but to get rid of exemptions per se and go to a lower rate for everybody.
By Larry MacDonald on Oct 27, 2009
John
No doubt many of the tax advisors have considerable pull with legislatures and the common good will be sacrificed to a sectional interest — unless enough people can get behind simplication of the tax system to form a voting bloc that politicians would respect. And maybe if more people realized they could be freed of the time/effort/money expended on completing tax returns ….
By Larry MacDonald on Oct 27, 2009
I am in the 2nd highest tax bracket and superficially would LOVE a flat tax. Since I make significantly more than the average Canadian, my taxes would drop significantly under flat tax rate.
However, flat taxes just don’t work. The government has a certain budget (Planned spending) and must collect that. Under a flat tax system, that spending would be paid by Canadians at a single rate.
Let’s say that rate is 25%. Canadians who currently pay much more than 25% average tax rate will pay less, and Canadians who pay less than 25% will pay more.
In actuality, the rate needs to be set to whatever is required to collect the total taxes required to fund the spending budget.
Our taxes provide us with many services, but these services are typically used most heavily by low-income earners. The high taxed wealthy pay heavily for services they do not use or could easily afford to obtain privately if not provided publicly, hence they get poor value for what they pay.
In other words, the wealthy, high-taxed earners are heavily sub-subsidizing the people in the low-income brackets.
A flat tax would shift the burden from the wealthy to the poor by enforcing a tax rate they simply cannot afford. Setting the flat rate to something all Canadians can afford would not collect enough to pay for our services.
The status quo is the rich get far less return and value out of the services they pay for versus low-income earners. While this certainly is not fair (to the rich) is is the only system that can be stable. One could also argue that the rich are in a position to subsidize the poor, and therefore they have a moral obligation to do so.
By Steve on Oct 27, 2009
The problem is agreeing on a simpler system of taxation. You propose a flat tax, but – as has been pointed out – it’s not the progressive nature that makes taxes complicated, and progressivity gives us the ability to fund the government without tapping too much from people who can’t afford it. The complexity comes from the plethora of possible deductions.
We could simply do away with personal deductions. You earn what you earn and you pay taxes on it no matter how you spend it. But we need business deductions for the self-employed, or they can’t compete with corporations (having to pay taxes on gross revenue rather than net income). So people will work hard to classify personal expenses as business expenses.
And don’t deductions have a role in shaping individual behaviour. Charitable giving is laudable, and losing that deduction would hurt a lot of charities. People are already having difficulty saving for retirement, something I don’t think losing the ability to defer taxes would help with.
So in the end, you can take issues with individual deductions (too easy to abuse, doesn’t encourage outcomes that benefit society, doesn’t benefit me…) but it’s hard to imagine a tax system that could better accomplish its goals.
By Neil on Oct 27, 2009
Most of the complexity in the tax system is due to high general tax rates, as well as to reduced tax rates for capital gains (whch means taxpaters are constantly trying to convert ordinary income into capital gains). How did we end up with this mess?
Full capital gains taxation was recommended by a Royal Commission headed by Ken Carter in the 1960’s and the government, in response to agressive lobbying from corporate canada, reduced the proposed capital gains inclusion from 100 to 50%. This was a major error for at least three reasons: 1) Full capital gains taxation was supposed to be the quid pro quo for repeal of the federal Estate tax (as it played out, the wealthy got the estate tax repeal, while avoiding full capital gains taxation); ii)one of the objectives of the recommended full capital gains taxation was to reduce the complexity; and iii) full capital gains tax inclusion would have permitted a substantial lowering in the general tax rate, which would also have helped reduce complexity.
Until we reduce income tax rates generally and also remove special capital gains treatment we can forget simplification.
Marc Ryan
IndependentInvestor.info
By Marc Ryan on Oct 31, 2009