The Broadbent Blog


Luc Turgeon: Reflections on Fair Taxes

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Canadians can sometimes be smug. We pride ourselves on our supposed modesty, but we never miss a chance to stress all the ways in which we are better than our American neighbour. We have a universal public health care system. They don't.  Our public school system performs much better than theirs. And, on a number of indicators, from child mortality to the rate of poverty of the elderly, we appear to be a more just society.

When it comes to income inequality in Canada though, there is nothing to be proud of. Over the last fifteen years, Canada has had one of the greatest increases in inequality amongst OECD countries. Inequality is not just an American problem.

This increase in inequality has many causes, from globalization to the decreasing rate of unionization. Changes to the tax system, though, have played a key role.  The rate of taxation of high-income earners in relation to low-income earners has decreased significantly. Any attempts to reduce inequality must, therefore, include significant reform to our taxation system.

The proposals contained in "Towards a More Equal Canada", are a welcome contribution to a necessary debate on how to reform our country’s tax system.  Tax policy is an essential part of the fight against inequality since taxes provide the state with the necessary resources to improve income transfer programs and investments in education and social services.

While we often turn to economists to judge tax proposals, a growing literature in political science on the relationship between taxation and welfare spending can also help us evaluate the proposals of the Broadbent Institute.

What tax mix is most conducive to the creation and maintenance over time of a generous welfare state? There is a debate in political science between those who believe that countries that rely heavily on more “regressive” forms of taxation (such as sales and payroll taxes) are more capable of sustaining high levels of social spending (since such taxes are less visible and are often dedicated to specific welfare spending), and others who believe that such levels can also be achieved through progressive income taxation. Nevertheless, both perspectives agree that a key condition to building and maintaining large welfare states has been moderate capital taxation.

In Scandinavian countries, which have generous welfare spending, only wages (and, in part, above-normal capital income) are subject to progressive taxation, while capital income is taxed at a lower and proportional rate. There are numerous reasons why a lower rate of taxation on capital is central to the creation and maintenance of a generous welfare state. The most important is that it allows for redistribution without a negative impact on saving and investment, which are central to economic growth. As such, the proposal of the Broadbent Institute to tax wages and investment at a similar rate seems inconsistent with developments in countries with generous welfare states.

Rather than taxing all forms of investment gains at the same rate as wages, an alternative measure would be to eliminate the preferential tax treatment of income earned from stock options. Besides not having as negative an impact on saving and investment as the proposal to tax wages and all forms of investment equally, this more targeted measure would be more appropriate considering that much of the recent growth in income inequality has been the product of earning disparities rather than capital income.

Political scientists have also investigated how the taxation system can contribute to welfare and/or tax backlash. They have found that welfare backlash is more likely when progressive forms of taxation are combined with means-tested programs for the poor (for example, income support, child care and public housing) and tax credits for the middle and upper classes (for example, tax deductions linked to child care spending, retirement savings, and in some countries mortgage interest payment). This is the American approach. Since taxpayers tend not to view tax credits as expenditures, which they are, it leads to a feeling among citizens that government programs mostly benefit low-income people who pay little or no tax, and leads to pressures to reduce direct welfare spending.

Over the last two decades, Canada has too often followed a similar approach, with tax expenditures for the middle-class increasingly replacing universal social programs. As such, the proposal of the Broadbent Institute to abolish many of the existing tax credits and to increase the progressivity of the income tax must go hand-in-hand with the type of progressive universalism they propose when it comes to social programs.

Certain taxes are also more likely to contribute to tax backlash, which limits the capacity of the state to raise the necessary revenues to tackle inequality. We know, for example, that steep increases in property taxes, which are highly visible, are especially likely to create tax backlash. This is why in Ontario, where municipalities are called upon to finance social services with such a visible and inelastic tax, the province should solely finance social services.

While there is debate as to whether increasing significantly the progressivity of the income tax system is likely to create tax backlash, the Broadbent Institute is right to point out that it is wise to rely on a number of tax bases, as a steep increase in one type of tax is likely to be highly visible and encourage backlash.

This is especially important as the discourse of many progressives, in both North America and Europe, too often gives the impression that significantly higher income taxes on the wealthy is the solution to rising inequality. It is not. In fact, while we should increase the progressivity of our income tax system and even re-introduce an inheritance tax to apply above some suitably defined minimum amount, as proposed in the Institute's report, we should be wary of policy proposals and a political discourse that overly targets the wealthy.

This is not because the revenues that would be raised are not sufficient to address our current challenges, although this is a legitimate preoccupation, but because this discourse does nothing to challenge the tax phobia that has permeated the political discourse of Anglo-Saxon countries over the last thirty years.

In fact, progressives have often contributed to tax phobia when siding with populist conservatives in opposition to increase in consumption taxes, as seen  recently in British Columbia. While those taxes may be regressive, they ultimately can be used for progressive ends that mostly benefit both low- and middle-income citizens.

Canadians are living on the fumes of the post-war welfare state, telling themselves that they are a caring society while the country continues to slide down in international standings, be it in health or child care.

To be a proud society without being smug means being willing to build and rebuild that society, including by collectively pooling the wealth by paying taxes. 

Luc Turgeon is an Assistant Professor of Political Science at the University of Ottawa.