By Charles Lammam
and Hugh MacIntyre
The Fraser Institute
In its upcoming budget, the Trudeau government is expected to eliminate some of the tax credits, deductions, exemptions and other special treatments that now populate Canada’s tax code. And there are good reasons why some of these tax expenditures, as they are collectively known, should be eliminated.
But rather than just eliminate tax expenditures to grab more revenue and raise taxes on Canadians, the government should at the same time reduce income tax rates broadly, which would help foster economic growth – a key goal of this government.
A recent report from the government’s own finance department highlights some of the problems associated with tax expenditures, which have grown in number over the years. Currently, the department lists 145 tax expenditures in the personal income tax system.
One of the problems with a growing number of tax expenditures is that they make Canada’s tax system more complicated and increase the cost of compliance for Canadians. To claim these tax expenditures, Canadians must keep records, ensure eligibility, and perhaps hire an accountant to check if they’re not missing out on any tax benefits. All of that costs time and money. According to the latest estimates, the cost of complying with the personal income tax system alone is up to $7 billion – or roughly $501 per household each year.
Moreover, these tax expenditures collectively represent $105 billion of foregone revenue for the federal government. That’s more than two-thirds of what the government collects in income taxes ($153 billion). The significant value of foregone revenue means that the government has to keep income tax rates higher to raise the same amount of revenue.
To be clear, some tax expenditures are worthwhile and serve an important economic purpose. For instance, RRSPs encourage retirement savings by allowing Canadians to defer taxes, TFSAs encourage investment by allowing Canadians to shelter investment gains from taxation, and the partial inclusion of capital gains helps support entrepreneurship and innovation.
However, many other tax expenditures have a much weaker or even non-existent economic rationale. While successive governments have claimed that tax expenditures can be used to change behaviour and encourage certain activities, research overwhelmingly finds that they tend to reward people by lowering their taxes for things they would have done anyway.
The finance department’s recent report provides additional evidence. It finds that the now-eliminated children’s fitness tax credit failed to achieve its primary objective of encouraging more physical activity among children. Specifically, the share of children aged 12 to 19 who are physically active dropped slightly from 71.1 per cent in 2005, the year before the tax credit was introduced, to 70.4 per cent in 2014. This is despite the fact that 43.3 per cent of families claimed the children’s fitness or art tax credit in 2014.
The report concludes that the children’s fitness tax credit merely subsidized Canadians who already enrolled their children in physical activity programs. While the credit was eliminated in last year’s budget, there’s an important lesson for other tax expenditures including, for example, the tax credit intended to increase public transit usage but has failed to do so.
So rather than simply eliminating ineffective tax expenditures – which again, will raise taxes on Canadians who use them – a better option is to use the resulting revenue to reduce personal income tax rates broadly in a way that does not affect the government’s fiscal position. This would not only create a much simpler tax system but would also foster economic growth by improving the incentives for Canadians to work, save, invest and undertake entrepreneurial activities.
The upcoming federal budget is an opportunity for the government to pursue tax reform that can improve Canada’s economic prospects in the years to come. Let’s hope the Trudeau government seizes it.
Charles Lammam is director of fiscal studies and Hugh MacIntyre is a policy analyst at the Fraser Institute .