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New directions in Canadian tax policy.

This article which is adapted from remarks delivered on May 13, 1991, at the 25th Annual Canadian Tax Conference of the Tax Executive Institute in Ottawa, presents some general thoughts on new directions that might be expected in Canadian tax policy through the 1990s. Although this may be an ambitious undertaking in light of the uncertainty that surrounds the current Canadian economic and political condition, certain broad policy directions can perhaps be forecast by examining past policy directions and the non-tax forces at play now and in the future.


It is useful to begin with a brief look at the direction of Canadian tax policy and the evolution of Canadian society over the twenty years since implementation of the major tax reforms of 1971.

Fairness in Canadian

Tax Policy

Perhaps the dominant recurrent theme in Canadian tax policy over this period has been the pursuit of fairness in taxation, not that fairness always means the same thing to all people. It is susceptible to many interpretations and applications. The term is used here only in its most general sense to capture the concept that in any given situation the tax system should not impose unduly greater burdens, or confer unduly greater benefits, on one taxpayer than on another.

Obviously many would argue that the Canadian tax system in not fair in its present form and perhaps never has been. Certainly the recent establishment of the Fair Tax Commission by the Ontario government reflects that view. Nevertheless, greater fairness in a variety of forms was a fundamental goal not only of the 1971 tax reform, but also of much Canadian tax policy adopted since that time.

Fairness has been sought in many ways. Policies have been adopted to ensure that the progressive personal income tax rate structure is fair in the sense of ensuring that taxation is not unfairly burdensome on the poor, and that those who are economically privileged pay back a fair portion of their income to society at large in the form of taxes.

Fairness has also been sought through minimum taxes, capital taxes, the elimination of tax incentives and preferences, and other measures designed to ensure that everyone pays a certain amount of tax. The growing burden of tax on capital gains reflects a continuing perception in some quarters that greater fairness is achieved by taxing income and capital gains to the same extent, on the theory that a dollar represents the same degree of wealth regardless of its income or capital source.

Measures aimed at restricting after-tax financing and loss trading have also been defended on the basis of fairness. The complex system of income integration for Canadian-controlled private corporations and their shareholders reflects a desire to be fair as between incorporated and unincorporated businesses while preventing potential abuses through the accumulation of untaxed, or undertaxed, income at the corporate level. Many would also no doubt characterize the relentless preoccupation with tax avoidance as reflecting the desire to stampt out unfairness resulting from the existence of so-called loopholes in the system.

Fairness in Canadian

Social Policy

It is not surprising that this preoccupation with fair taxation coincided with a general preoccupation with social justice in Canada. The 1970s and early 1980s marked a period of Canadian introspection during which issues of economic nationalism and social justice formed the dominant elements in the list of national preoccupations. During this period Canada came to identify itself largely in terms of its commitment to social justice as embodied in universal medical care, worker protection, old age security and a variety of other mechanisms designed to assist economically disadvantaged individuals and regions.


This vision of Canada is now in a process of change as a result of a variety of external and domestic forces. At least until recently, inflation has been a persistent problem. Continuing government deficits reflect the inability of governments to deliver the desired social programs while maintaining acceptable levels of taxation. Federal transfer payments to the provinces have been among the victims, and there is every reason to believe that these transfers will be under continuing pressure in the future.

The strong Canadian dollar, combined with other external factors, has resulted in an erosion of the traditional strengths of Canadian export industries. Increasingly global markets have favored larger corporations serving larger markets. Low wage countries have been successful in improving their manufacturing capabilities relative to high wage countries like Canada. The recent recession has led to a significant contraction in the manufacturing base in central Canada.

All of this has occurred in the midst of the most serious political uncertainty the country has seen in recent memory. Although the issue of Quebec sovereignty is the most pressing issue on the national political agenda, Canada faces difficult issues in the areas of inter-provincial trade barriers and increasingly divergent provincial policy directions. One need not look as far as the recent Ontario and federal budgets to find governments out of step with each other in terms of economic and fiscal policy.

Canadian Values, Concerns,

and Aspirations

In this context, where are Canadians headed? A number of observations can be made.

* A broad majority of Canadians are at last coming to understand the significance of annual deficits and accumulated debt.

* Canadians are also becoming aware of the importance of international competitiveness on an industry and a national basis.

* The perceived weakening of national institutions and lack of support for the present federal government are contributing to increasing regional preoccupations and loyalties.

* Environmental concerns are greater than ever before and are not likely to diminish.


A number of demographic and other factors are connected with these changes and attitudes.

* The baby boom generation, which has such a profound effect on public opinion, has reached full adulthood.

* Its members think in terms of financial security, quality of life, and the health and well-being of their children.

* Retirement savings and pension protection are becoming increasingly important to them, particularly as government is seen as a less and less reliable source of protection.

* As their parents' generation ages, many will inherit significant wealth in the form of real estate and other assets that appreciated in value during the inflationary 1970s and 1980s.


Against this background one can identify a number of tax policy directions that have already begun to emerge in Canada, and others that can be expected in the coming years.


Although fairness will remain a cornerstone of Canadian public policy, in my view tax policy directions in the 1990s will be distinguished from those of the past two decades by a growing emphasis on competitiveness as a key element in making policy choices. In the long run this may be better characterized as a restoration of this concept to its historic place of importance after a period of neglect.

The recent federal budget, and a number of provincial budgets, have emphasized the vital importance of national competitiveness if Canada is to maintain and enhance its prosperity. Commentators and politicians repeatedly raise this issue in debates on industrial strategy, monetary policy, international trade issues, education and, increasingly, tax policy. It will be pervasive in the 1990s.

In this context the recent Ontario provincial budget may well eventually be shown to have been out of step with the needs of society and the wishes of the electorate. It reflects an overwhelming preoccupation with the effects of current economic conditions on certain segments of society and does not adequately address the potentially serious effects of those conditions and of the government's own policies on the productive sector. If subsequent budgets and other policies do not redress this imbalance and give greater weight to the competitive issues facing Ontario, one would expect the present New Democratic Party government to find itself seriously our of favor.

Income Versus Consumption Taxation

Competitive needs combine with demographic trends to tip the broad policy choices away from increased income taxes and other taxes on income-earners and business, in favor of greater taxes on personal consumption. The first conclusion from this is that we should not expect the goods and services tax to disappers.

Moreover, administrative convenience and interprovincial competitiveness will encourage the provinces to conform their provincial sales tax regimes to the GST. The former Finance Minister's original goal of a national sales tax combining the federal and provincial sales tax systems will be achieved eventually, though the timing will vary depending on the political views of the parties currently in power, the existence or lack of majority governments, the timing of provincial elections, and the actions of neighboring provinces.

Estate Taxes and Succession Duties

With an aging population governments will also be increasingly tempted to re-examine estate taxes and succession duties. This was a plank in the Ontario NDP election platform and tax practitioners in Ontario have spent a lot of time in the last year considering whether, when, and how such taxes on duties might be reintroduced in Ontario. It is an option that will probably be examined in other jurisdictions as well.

The debate on the subject will become increasingly difficult as competitiveness becomes a more important factor, since private wealth represents an important source of investment capital. The need to service large government debt loads while building a competitive economy requires the formation of large capital pools. The mobility of capital and the ease with which such taxes and duties can be avoided will further complicate the issue. No one will want to introduce a tax on a go-it-alone basis if they foresee significant risks of driving capital out the jurisdiction. A further element in the equation will be the effect on the ability of a jurisdiction to attract new immigration, particularly wealthy immigration, where such tax measures have been introduced.

Ultimately the adverse competitive consequences, and the resulting loss in income tax and other revenues, will likely outweigh the temptation of taxing wealth in this fashion. Particularly in Ontario, it would be surprising if such taxes were reintroduced.

Corporate Capital Taxes

Corporate taxes on capital represent a type of corporate wealth tax. In recent years, Canadian governments have generally increased or expanded capital taxes particularly as they apply to financial institutions and so-called large corporations. This capital tax expansion has been counterbalanced to some extent by British Columbia's decision to eliminate its general capital tax.

As governments become increasingly sensitive to the fact that international competitiveness will require large capital investments and increasingly large corporations, there will be growing pressure to restrict or abolish capital taxes. The brewing federal-provincial debate over deductibility of payroll and capital taxes initiated in this year's federal budget will also strike a blow against provincial capital taxes. The proposed restriction on federal income tax deductibility for these taxes will increase their economic cost to corporations operating in capital tax jurisdictions, thereby increasing the existing incentive to move capital-intensive businesses to jurisdiction where such taxes are not imposed.

All capital tax jurisdiction will feel increasing pressure to eliminate these taxes, and one might expect that they will generally be reduced and in some cases repealed over the course of 1990s. This result is not particularly likely, however, in the case of financial institutions, nor is it likely to happen in Ontario under the present NDP government.

Income Tax Rates

Turning to the general rate structure for income taxes, there was a tendency in the 1980s to broaden the tax base and reduce the top marginal rates. This exercise was driven largely by tax reforms in the United States. This philosophy still prevails in Ottawa and one should expect a continuation of tax measures aimed at removing targeted incentives and special provisions in favor of lower tax rates. That having been said, the scope for reducing rates is obviously limited given the size of the accumulated government debt.

The tendency to broaden the base and reduce rates tends to favor the service sector over the capital-intensive resource and manufacturing sectors since tax incentives have usually favored the latter. Investment tax credits, accelerated capital cost allowance, special mining incentives, and a variety of other measures targeted at specific indistries or activities come to mind.

The need to rebuild the capital-intensive industrial base will create a pressure to reintroduce measures targeted at this sector of the economy. For the time being, however, it seems most likely the federal government's main focus in this area will contribute to be on inflation control and interest rate reduction in order to benefit all sectors of the economy without drawing on the public purse.

Capital Gains Taxes

On capital gains, it is worth remembering that 20 years ago the effective rate of tax was zero. At present, the effective combined federal-provincial rate of tax on capital gains in Ontario is on the order of 37 percent, which is 3 percent or 4 percent higher than the effective combined rate on dividends. This is a high rate by international standards and only limited relief is available through the personal capital gains exemption. Although governments will be very reluctant to reduce the 75-percent inclusion rate, competitiveness factors will lead to some scrutiny and adverse criticism of the heavy burden of taxation on capital gains. Such high rates not only erode capital, but have a locking-in effect, by creating a disincentive to dispose of capital investments if to do so would trigger realization of significant accrued capital gains.

One way to mitigate this locking-in effect would be to build on the replacement property or registered retirement savings plan model and allow capital investments to be disposed of free of tax to the extent the proceeds are reinvested in another capital investment. In effect, a rollover could be established for reinvested proceeds, with the adjusted cost base of the original investment carried over to the new investment. The ultimate burden of tax would not be diminished, but the locking-in effect would be eliminated by allowing a deferral to the extent that capital is moved into another qualifying investment. It would not be surprising to see something along these lines debated in the years ahead as the need to attract investment capital becomes increasingly clear.

Environmental Taxes

On the environmental front, there will be growing support for tax incentives to reduce or avoid pollution, and tax disincentives aimed at those who create or increase pollution.

Where pollution is caused or resources are wasted through personal consumption, one should expect new taxes imposed on those who make the choice to behave in such ways. The special Ontario retail sales tax on fuel inefficient vehicles is a move in this direction. In announcing an increase in this tax in his April budget, the Ontario Treasurer said the changes "strenghten the message that fuel efficiency and environmental impact should be important considerations when purchasing a new vehicle." Taxes of this nature will become the new sin taxes of the 1990s, characterized by regular tax increases targeted at those who are perceived to be inefficient users of scarce resources or excessive polluters.

Where these taxes are imposed on business, the adverse competitive implications will soften their impact. Canadians will be faced with the dilemma that many exports are produced at some cost in terms of resources or pollution, and attempts to use taxed to modify productioin processes or recover these costs from the exporters themselves will have to be balanced against the desirability of preserving the geese that lay the golden eggs.

Fiscal Disunity and Changing

Federal-Provincial Relations

Important tax consequences will also flow from the current national debate over federalism and the future of confederation. Whatever the outcome of this debate, there will most likely continue to be a single economic unit comprised of the current members of confederation. On the other hand, it also appears likely there will be an increasing devolution of power and responsibility to the constituent parts.

Some provinces are already showing greater independence in setting their own directions in social, industrial and tax policy. This has already encouraged a review of existing income tax collection arrangements with Ottawa, and a consideration of whether these arrangements should be modified to permit greater independence in setting tax policy appropriate to local needs and conditions. In his most recent Alberta budget, Treasurer Dick Johnston called for adjustments to the federal Income. Tax Act to reduce effective federal tax rates in order to increase the taxing room available to the provinces.

Along with the limits on increases in federal transfer payments, there is evidence of a growing desire on the part of the federal government to reduce its role as the unloved tax collector who delivers funds to provincial governments that in turn reap the political benefits of local spending on schools, hospitals and other provincial services.

Technical Tax Developments

Apart from these general directions, can any more specific tax directions be identified for the decade ahead?

Past trends toward increasing use of accounting and economic concepts in determining income are likely to continue. The Department of Finance review of interest deductibility and the costs of financing will probably result in the replacement of the current rules based on traditional legal concepts of interest, principal and so on, with a framework based on financial concepts of yield and economic cost of capital.

At the same time an attempt may be made to bring swaps and foreign currency transactions into a more orderly and principled state. Our present statutory and judicial framework for coping with these transactions has simply not kept up with the pace of change in the financial markets and the interest and currency risk management products that are now available.

In the area of tax avoidance, we are still awaiting judicial guidance on the general anti-avoidance rule. Despite the absence of such guidance, taxpayers and their advisers have learned to live with GAAR and have reached a modest level of comfort with its likely application. It remains to be seen whether the courts will ultimately see things in the same light as those who work with it regularly. Nevertheless, GAAR continues to exert an inhibiting effect on creative tax planning including some types of planning that would probably be viewed as acceptable by both the Department of Finance and Revenue Canada. In some of these areas taxpayers have been able to take comfort from the advance ruling process, Information Circular IC 88-2, and other public pronouncements from Revenue Canada. Undoubtedly additional "safe harbors" will be identified in this way.


If these observations can be said to have had a theme, it is competitiveness. It is a common thread that will run through most Canadian tax polity debates in the coming years. It will not always win the day, but the demands it imposes will influence policy choices in a significant way across a broad range of issues. The overall result will be not so much a new policy direction, as a return to a more balanced approach to the reconciliation of fair taxation with national and provincial competitive needs.

STEPHEN W. BOWMAN is a partner with McMillan Binch in Toronto, which is a member firm of McMillan Bull Casgrain. Mr. Bowman has practiced in the tax field for 10 years. He has spoken and published widely on issues of Canadian tax policy, cross-border investment, and Revenue Canada collectionThe remedies. He is a frequent contributor to the Current Cases feature of the Canadian Tax Journal and to the Prentice-Hall looseleaf tax service, Income Tax in Canada.
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Author:Bowman, Stephen W.
Publication:Tax Executive
Date:Sep 1, 1991
Previous Article:The tax treatment of independent contractors: where we are, and where we're headed.
Next Article:Comments on proposed tax simplification legislation July 23, 1991, and September 10, 1991.

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