Current tax system won’t pay for COVID recovery

by Alex Himelfarb, Andrew Jackson, Brian Topp. Originally published on Policy Options
October 5, 2020

COVID-19 has imposed a global economic shock the like of which hasn’t been seen since the Great Depression. Pre-COVID, the world was just starting to come to terms with the extent of change needed to avoid widespread ecosystem collapse due to climate change.

Now, the pandemic has provided a sobering appraisal of the deep cracks in our systems, from education and health to employment standards and income supports. We have been forced to face up to longstanding social and economic injustices that women, Indigenous people, Black people, people with disabilities and other marginalized groups have borne most heavily.

A recent Financial Times editorial appraised the situation and surmised that “[R]adical reforms – reversing the prevailing policy direction of the last four decades – will need to be put on the table. Governments will have to accept a more active role in the economy. They must see public services as investments rather than liabilities, and look for ways to make labour markets less insecure.”

The rock-bottom cost of debt for the federal government means that at least for the next few years, government spending can be dictated by what people need in order to weather this storm and to rebuild smartly and justly to counteract two other calamities on our doorstep: inequality and climate change.

But a transformation of this size also requires a permanent increase in public-sector supports and programs, and these cannot be funded indefinitely through deficit spending. A well-balanced, well-designed and fair tax system can support a society that is also well-balanced, smart and fair, but our current tax system misses the mark.

Since 1980, the tax rate on the top income bracket has dropped from 43 percent to 33 percent, and corporate taxes are down from 36 percent to a staggeringly low 15 percent. Tax breaks on income from investments have also become more generous over time.

All of these shifts in the system have overwhelmingly benefited the rich. Today, the top one percent collect some 15 percent of all income, up from eight percent in the early 1980s, and now own fully one-quarter of all wealth.

The Organization for Economic Cooperation and Development (OECD)  calculates that tax revenue in Canada fell from 34.7 percent of GDP in 2000 to 33 percent in 2019 (well below the OECD average of 34.3 percent). That translates into lost annual tax revenues of almost $50 billion.

We have also squandered our resource wealth, a painful and fateful mistake for a resource economy. The example of Norway haunts Canada. That country has converted three decades of natural resource development into over $1.18 trillion in public investment capital – ample to fund Norway’s diversification away from fossil fuels and to a sustainable and prosperous full-employment economy. In Canada, the tax cuts outlined above were in good part financed with one-time resource revenues – the classic mistake of buying groceries with the family silver.

Meanwhile, public services have been squeezed for decades, and now we are all paying for it as the COVID-induced recession has had more severe and even catastrophic consequences due to the lack of adequate social safety nets including adequate health care and public education.

We do, however, have choices – affordable choices. The goal of the post-pandemic recovery is not to return to the flawed “normal” of old but rather to transform Canada into a more socially equal, sustainable and productive country that plays its part in a better world.

Macroeconomic policy and fair taxes

It is widely agreed that the increased public debt will be manageable in the short- to medium-term as long as the Bank of Canada keeps interest rates at very low levels and continues to buy Government of Canada and provincial bonds to fund most of the new spending. For these reasons, it also makes the most sense for borrowing to happen at the federal level.

Fiscal austerity, by cutting government spending, is not the way to reduce higher public debt, either in human terms or in economic terms. Government spending in many areas is the best solution because it not only saves and creates jobs today but also boosts productivity and economic prosperity. Key examples include high-quality child care and health care, public infrastructure and education.

However, we cannot expect debt to do all of the work. A sustained increase in tax revenues as a share of the economy will be needed to underpin a sustained increase in public spending. We need to create a tax system which can provide the foundation of an economy that serves the many rather than the powerful few. This ensures that those who have benefited most from earlier taxation structures pay the greatest share to build the Canada we want.

We propose five areas of focus to increase federal revenues:

1. A graduated wealth tax should be applied to extreme wealth.

A recent Broadbent Institute report on wealth taxes has shown that even a modest wealth tax on all financial and non-financial assets can raise significant revenues to help with recovery while countering growing inequality. Many options have been presented for a wealth tax in Canada and the United States. The Parliamentary Budget Office recently estimated that a mere one percent tax on wealth over $20 million would net approximately $70 billion over 10 years, even with a realistic level of tax avoidance factored into the calculations.

2. Federal income taxes should be more progressive.

While the Canadian tax-rate structure is moderately progressive over most of the income spectrum, taxes on the top one percent are significantly lowered by the preferential treatment of certain types of income more prevalent among the wealthy.

For example, only one-half of capital gains and stock options are subject to tax, while wages are 100 percent subject to tax. The dividend tax credit also lowers effective taxes for the very few Canadians who earn significant investment income outside pension plans and RRSPs. These tax breaks should end. The top income tax rate in Canada is also lower than in many other jurisdictions. Income-tax reform should target increases at the top one percent (who have incomes above approximately $250,000), with the possibility of top end of that range, the 0.1 percent, (with annual incomes over half a million), paying a much higher rate.

Tax avoidance by the very rich, through the use of offshore tax shelters. should also be countered with much more intensive audits and stringent penalties and by ending tax agreements with countries used as tax havens.

3. End corporate welfare.

Since the 1980s, the corporate income tax rate has been steadily lowered, and corporate tax revenues have fallen as a share of all taxes in relation to GDP. While various federal and provincial governments have justified these lower tax rates as a means of boosting business investment, this investment rate has, in fact, fallen.

After the pandemic has subsided or been reduced to much lower-risk levels, an excess-profits tax will need to be introduced in recognition of the fact that while many at the bottom of the income-scale paid a huge price as a result of COVID-19, some companies were making enormous profits during the crisis (and in some cases, because of the crisis). In cases where Canadian governments do invest in private corporations, the public should always benefit from these public investments through public policy that requires the government to take equity or earn interest at rates that match the risk being assumed.

4. As finances permit, revenues from resource development should be pooled in a sovereign wealth fund, to be invested in a green economic recovery.

The Government of Canada and the fossil-fuel-producing provinces may have missed their once-in-history opportunity to turn the petrochemical boom of the past 40 years into transformative capital. However, some revenues could be salvaged. The federal government for example, could direct any future one-time resource revenues to a sovereign wealth fund that would invest only in sustainable economic diversification and decarbonization projects.

As their finances permit, provincial governments could undertake their own salvage efforts. Alberta, for example, could implement a provincial sales tax comparable to those of other provinces, balance its budget in one year, and begin to accumulate a provincial wealth fund.

5. Increase consumption (sales) taxes and social-security premiums.

Consumption taxes can be progressive if well designed with compensating payments to citizens living on low incomes. That is why most industrial democracies rely on them. However, in Canada, governments are extremely dependent on income taxes and resource revenues.

While these taxes are often seen as regressive, even flat taxes benefit lower-income groups the most if the proceeds are spent on robust progressive, universal, and needs-based programs. In fact, the great majority of the citizens of this country receive much more value from social-security programs and other public services than they pay for in the taxes that fund them. However, it would be unwise to raise consumption taxes during this time of economic recession. Though they are a necessary part of our fiscal tool kit, these taxes should be increased only in the context of fundamental tax reform.

As Canadians, most of us are proud of the progress we’ve made together in creating some key elements of a fair and caring society. Our public health and education systems are strongly supported and widely viewed as fundamental to our way of life. However, the pandemic and the twin crises of inequality and climate change that were already upon us pre-COVID have demonstrated with stark clarity that we have much more work to do.

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We need to respond by borrowing and investing wisely, and building a tax system that establishes the foundation of an economy and a society that serves the many rather than the powerful few. We must also encourage behaviour that supports equality and sustainability and discourages behaviour that threatens those values. Finally, we must ensure that those who have benefited most from the way things were will pay the greatest share in building the Canada we want.

Katrina Miller was a contributor to this article, which is an edited excerpt from the paper, “Paying for the Recovery We Want,” published by the Broadbent Institute.

Photo: Shutterstock/By O.V.D.

This article first appeared on Policy Options and is republished here under a Creative Commons license.