Taxing the rich continues to dominate the debate on inequality. Some provinces, like Quebec, Ontario, Nova Scotia, and B.C., have already increased taxes at the top. Federally, higher taxes have been suggested at times by former NDP leadership hopeful Brian Topp and, most recently, current Toronto-Centre candidate Linda McQuaig. Would higher tax rates work? And if not, is there anything else we could do?
My largest concern about higher tax rates at the top is the paucity of revenue they would produce. I’ve discussed this here here, and here, while Stephen Gordon contributed here and here. An academic review of evidence is here; direct Canadian evidence is here. In sum, there are serious, evidence-based concerns about raising revenue through higher tax rates on the rich. The concern is less that high income earners would curtail their productive work, but more that they would have a stronger incentive to find ways around paying taxes. People earning at high levels have access to the best financial advice, and I’d be surprised if they ignored that very expensive counsel and simply hand over bigger cheques to the CRA.
The bottom line is that raising the tax rates of the rich, without reforming the rest of the tax system will have little effect other than enriching tax lawyers and accountants.
Accepting these facts is not a resignation to impotence. If modern-day Robin Hoods want to change the tax system in a progressive-but-feasible direction, there are several policy arrows left in the quiver. Here are three things that can help lawmakers actually hit the target.
Keep your eyes on the base
Instead of changing tax rates, we need to pay more attention to how much income is subject to those tax rates—what we call the tax base. High income people can avoid taxes by using legal maneuvers to avoid reporting taxable income. It makes much more sense to direct our policy effort to the base than simply hiking rates and hoping for the best.
The case of Alberta Family Trusts is a good example of where we should focus. Alberta Family Trusts allow high income Canadians to shift income to Alberta in order to take advantage of the province’s lower tax rates. This article from 2010 emphasizes how easy they are to set up and the internet is full of similar advice for the curious high-earner. Increased enforcement and a recent court ruling, however, might have limited this trust loophole. It’s a good start.
Another way high income people can avoid taxes is by making sure their employment compensation is taxed as something else, at lower rates. Lindsay Tedds, Daniel Sandler, and Ryan Compton have argued, for example, that stock options should not receive flexible tax treatment and should be taxed as employment compensation.
We need to pay more attention to practices that allow top earners to lower their taxable income. This is slow, hard, and challenging work—but it is also a much more effective path to making our tax system fairer than trying to pour more water into a leaky bucket.
Examine executive compensation
To a large degree, the story of the top one per cent (and especially the top 0.1 per cent) is about executive compensation. Executives are hired by boards of directors to run organizations. Are boards making astute choices in paying executives such large amounts, or are boards making big mistakes?
Some people wonder if “social norms” have changed so that boards are more comfortable paying large salaries than in the past. Others worry that executives manipulate compensation schemes or board composition. I don’t have the expertise to decisively explain patterns of executive compensation, but if I wanted to get to the source of the increase in top incomes, I might start with a thorough review of Canada’s corporate governance rules to ensure shareholders are getting a good deal from their highly compensated top employees.
Look to Sweden
Finally, if we were interested in a more radical tax reform, we could look to Sweden and other European countries with a “dual income tax.” Under this scheme, employment compensation is taxed on a schedule with progressively higher rates, but all forms of capital income are taxed at the same flat, low rate. The dual income tax model has received expressions of interest from tax economists ranging from Jack Mintz to Robin Boadway.
A dual income tax has the potential to deliver two benefits. First, taxing all capital income at the same low rate could take some of the air out of tax avoidance because there is no longer a gain from shifting income from one type of capital income to another. (Of course, the strongest possible tax fence must be built around employment compensation to prevent leakage.) Second, since employment income is harder for people to shift around, it is easier to tax it at higher rates. This allows a more progressive rate structure than might be possible when capital income is kept in the mix. In short, a progressive tax structure on earned income (which is the source of high-income concentration) for equity, and low flat rates on capital income for efficiency.
It is easy, and worthwhile, to knock poorly conceived policy options off the table. It is a bit harder to come up with feasible alternatives. Here are three suggestions. I hope creative policy analysts can bring some more to the table.