Simpler measures, better outcomes: It’s time to rethink tax expenditures

Rebuilding a better, fairer Canada is the federal government’s stated goal, and many of its plans depend on tax policy and administration to meet its objectives.

By our count, the current government has more than 30 election campaign promises to fulfill where tax policy is concerned. Some proposals would introduce new targeted personal tax credits or enhance existing ones. Time and again, election promises like these made by political parties of all stripes have ended up adding more complexity to the tax system — but without always leading to the intended outcomes.

At this time of renewal for Canada’s government and economy alike, we believe now is the time to step back and consider the bigger picture. Before making the tax system more complex and inefficient for Canadians and businesses, we believe the government should assess the best ways to use the tax system to deliver policy choices in the public interest. This includes examining whether tax expenditures are the right approach to achieve the government’s aims efficiently and effectively.

In this brief, we explore why adding new tax expenditures requires careful reconsideration and why current tax expenditures need more scrutiny. In particular, we make the case for the government to:

• reverse the slide in Canada’s global tax competitiveness
• evaluate tax expenditures by the right criteria
• reconsider proposed tax expenditures
• take stock of past experiences
• relaunch a tax expenditure review
• take a wise approach to tax

Reverse the slide in Canada’s global tax competitiveness

Canada’s tax system is a key lever for ensuring that our business environment remains competitive, for attracting talent, businesses and investment from around the world, and for achieving sustained economic growth and prosperity for all Canadians.

But, global benchmarks tell us Canada’s tax system is not as efficient or competitive as it could be. For example:

• In the 2021 International Tax Competitiveness Index, Canada scored 20^th overall among 37 OECD countries, which is two spots worse than 2019, and 27^th in the complexity of its individual tax system, falling from 16^th in 2019.
• For 2020, the Global MNC Tax Complexity Project ranked Canada’s corporate income tax system as having the 27^th highest tax complexity among 69 countries, and 39^th when the tax code alone is considered.

Canadians spend $7 billion complying with the personal income tax system each year, amounting to $500 per household, according to the latest available estimates. A 2018 article highlights the additional real costs that tax complexity in the personal tax system imposes on Canadians — including hiring professional tax or legal advice and buying more sophisticated tax preparation software. In 2019, Canadian businesses spent 131 hours on average to prepare and file taxes according to a World Bank study.

With Canadians bearing compliance costs at home and sinking competitiveness abroad, it really is time to reconsider any additions of tax expenditures to an already complex tax system for Canadians and businesses.

Evaluate tax expenditures by the right criteria

A “tax expenditure” is any tax measure that aims to achieve a policy objective at the cost of lower tax revenues, according to the Department of Finance Canada’s tax expenditure report for 2021. This includes tax credits, deferrals, deductions, exemptions and preferential tax rates. Finance Canada’s annual reports set out a number of criteria for analyzing tax expenditures, including the need for government intervention, efficiency, effectiveness and equity.

The Auditor General of Canada found in 2015, however, that Finance Canada did not systematically evaluate all tax-based expenditures and generally did not publish the results of the evaluations that were conducted. The Auditor General’s report recommended subjecting all tax expenditures to systematic evaluations of their ongoing relevance and performance, and communicating these results to parliamentarians and the public.

In step with the Auditor General’s recommendation, we believe all tax expenditures should be measured against at least three key criteria:

1. Is it effective? Is the tax expenditure reaching its intended goals?
2. Is it efficient? Are these goals being met at a reasonable cost? Do the benefits outweigh costs? Can its delivery be easily automated?
3. Does it add needless complexity to the tax system? What is the impact on taxpayers, tax practitioners and tax administrators such as the CRA? Are there simpler ways of achieving these ends through other means (e.g., direct grants, other spending programs)?

Depending on the expenditure, other criteria may be important, such as fairness across different types of income and recipients. For example, targeted personal tax credits tend to favour one group of recipients over others, creating winners and losers while increasing the amount of tax paid by taxpayers overall (assuming that government revenue lost due to targeted tax measures must be made up by higher taxes generally). In addition, taxpayer windfalls should be minimized; that is, taxpayers should not gain a tax saving from taking an action they would have taken anyway for their own personal or business reasons.

In terms of efficiency, tax expenditures are a barrier to tax return automation, which is in place today in countries like New Zealand and the U.K, with personal tax systems that are much simpler than Canada’s.

Here in Canada, the CRA already has most income-related information needed to prepare returns reported to it from employers, banks, and other sources (apart from business and rental income). However, many tax expenditure claims require receipts and other information not available to CRA.

Before tax filing can be fully automated, the government would need to reduce the tax preferences where a claimant must determine whether they qualify and then supply the supporting information.

Reconsider proposed tax expenditures

During the 2021 election campaign, the Liberal Party of Canada laid out some 30 potential tax-related measures that could be put in place in Budget 2022 or after. Newly promised tax expenditures on the agenda include:

• A new, one-time income tax deduction for health care professionals of up to $15,000 over their first three years of practice to help with their costs of setting up a practice
• A potential new savings account to allow Canadians under 40 to save up to $40,000 and withdraw it tax-free to use for their first home purchase, with no requirement to repay
• A tax credit of up to $1,650 for individuals aged 65 and over who want to stay in the workforce and earn working income of $5,000 or more
• A number of new, targeted tax credits at 15 per cent of qualifying amounts for, among other things:
  • the relocation expenses of workers in the construction and building trades (for a maximum credit of $600)
  • costs of renovating a family home to add secondary units for an extended family member (maximum $7,500)
  • the costs of hiring home appliance repair technicians (maximum $75)

We encourage the government to evaluate these tax expenditures before implementing them to gauge their potential efficiency, effectiveness and added complexity.

For example, it seems questionable that a $15,000 tax deduction spread over three years would be enough to spur a healthcare professional to set up a new practice, though it would be a boon to those already planning to do so, creating an inappropriate taxpayer windfall.

The same may be true for unemployed construction workers, who would not receive the credit until they file their tax return in the following year.

The $75 maximum tax credit for appliance repairs also seems too low to make any difference in people’s choices. As with the previous credits for children’s fitness, children’s art and public transit, claiming the amount may not be worth the effort due to the complexity involved for taxpayers in keeping receipts and filing claims, casting its potential effectiveness in doubt.

At first glance, the career extension credit for working seniors seems to have some features of an efficient and effective tax expenditure. It might be simple to administer through current income tracking and reporting requirements, easy to automate, and provide an equivalent benefit to those who qualify, regardless of their level of income. Tax educators Evelyn Jacks and Walter Harder have written that the credit will help offset the rising costs of Canada Pension Plan (CPP) premiums for working seniors not yet collecting CPP benefits. Jacks and Harder conclude: “If the incentive is to keep seniors working, it may make a difference to some.”

However, like the existing Quebec credit that it is modelled on, the $5,000 minimum income threshold means many working seniors will not qualify. Further, Jacks and Harder observe that the credit adds significant complexity due to its interaction with the Age Amount, possibly leading to a double clawback of both credits for working seniors at certain income levels.

This example shows that even a potentially effective and efficient credit should be evaluated. Analyzing the success of the provincial credit in Quebec may be a good starting point.

We believe that, at a minimum, Finance Canada should properly assess tax expenditures with the key criteria in mind (effectiveness, efficiency and complexity) before modifying or enhancing them.

Take stock of past experiences

Federal tax expenditures that have been evaluated in the past and found wanting include the federal public transit credit and the investment tax credit for childcare spaces. Both credits were unduly complex, which led to low take-up, and neither credit proved effective in encouraging the desired changes in behaviour (i.e., attracting more people to use transit, rewarding investments in daycare). Both were cancelled and replaced in Budget 2017 with direct spending commitments for improving public transportation infrastructure and creating affordable daycare spaces.

In 2017, Finance Canada undertook a review of the children’s fitness tax credit and the children’s arts tax credit, two tax expenditures with the policy goal of encouraging children to take part in physical, artistic, cultural and recreational activities. The review led the government to cancel these credits because they fell short when evaluated against the criteria of effectiveness, equity and efficiency for several reasons:

• The average tax savings per child — $64 in 2017 — were relatively small and unlikely to drive significant behavioural responses, especially since family decisions about children’s participation in activities are not particularly sensitive to price.
• Both credits were primarily used by high-income families.
• The credits resulted in windfalls for families that would have signed up their children with or without the credit.

On eliminating these credits, the government said its intention was to simplify the tax code and better target support for families with children.

Also in 2017, Finance Canada reviewed the Goods and Services Tax (GST) credit against the same criteria. Finance Canada found that this tax expenditure met its goal of improving fairness by reducing the burden of this tax on low- or modest-income Canadians who have to bear the same tax rate regardless of their income.

This evaluation showed the GST credit actually benefits its target populations, and likely achieves its goal more efficiently than tax exemptions, multiple tax rates and other alternatives.

The Auditor General determined that both reviews had been conducted appropriately against the stated criteria. However, the Auditor General also noted that not all tax expenditures are similarly evaluated and that when evaluations are done, the results are generally not published. The Auditor General recommended that tax expenditures be subject to the same systematic evaluations that other government departments are required to do for direct program spending.

The cost of tax credits and other tax expenditures should also be reviewed in total. Unchecked, the accumulation of new tax credits adopted over time can lead to significant costs and distortion. For example, in reference to its review of provincial tax benefits, deductions, rebates and exemptions, the Manitoba government stated the following in its 2017 budget:

Manitoba’s tax credit system is among the most diversified and complex in Canada, and currently accounts for an annual fiscal outlay of approximately $600 million. This is equal to approximately 15% of total income tax revenue, spread out across more than 30 provincial tax credits. These credits add to Manitobans’ compliance costs and increase the administration fees paid by the province to the federal government.

Relaunch a tax expenditure review

CPA Canada — and many other national organizations, parliamentary committees and leading economists — has long maintained that the tax system needs a top-to-bottom overhaul. In a series of reports making the case for a comprehensive tax system review in Canada, we highlighted tax expenditures as deserving special attention due to the complications they bring for taxpayers, their advisors and the CRA.

While this broad review should remain high on the agenda in the long run, current conditions clearly require the government to focus on the more immediate needs of Canadians and businesses, and ensuring Canada’s economic recovery is on track.

In the meantime, we recommend the government revisit its 2019 pledge to undertake a tax expenditure review. Such a review would have strong support among CPAs. In response to a 2018 survey of CPAs in the tax field about their experiences with the tax system, 71 per cent said that Canada’s system of tax expenditures is too complicated and needs major reform.

While the proposed expenditure review’s stated scope was limited to eliminating tax breaks for the wealthy, we believe the government should use the opportunity for a broader evaluation aimed at streamlining tax credits and deductions, eliminating inefficient or poorly targeted tax preferences, and enabling more tax system automation.

Ideally this review would be conducted before any tax expenditures are introduced or enhanced, and existing or new expenditures would be reviewed against the same criteria. With layer upon layer of complexity added to the tax system over the years as more tax expenditures have been adopted, it’s important to assess that tax expenditures are meeting their goals.

A recent report from the Centre for Economic Policy Research states the importance of evaluation in the current context of economic recovery:

As governments worldwide face growing funding needs to respond to the pandemic, they cannot afford to lose revenues to ill-designed tax breaks. Comprehensively assessing tax expenditures is crucial, and estimating and reporting their fiscal cost is a vital first step.

In the Canadian context, a paper by law professor Neil Brooks suggests that “…all tax expenditures should be subjected to analysis by a commission of public policy experts, to rationalize the spending done through the tax system. This process would increase the integrity of the Canadian tax system, the efficiency and equity of government spending programs, and the transparency and vibrancy of Canadian democracy.”

Take a wise approach to tax

If work begins on how to implement these latest measures, we encourage the federal government to follow the wise approach to tax that we recommend for all new tax measures by:

• keeping tax rules simple
• approaching any potential tax increase with discipline
• applying a principled decision-making framework to proposed tax changes 

By this approach, all tax proposals on the table would be carefully reviewed to ensure they would support the economy, operate effectively, and minimize disruption for Canadian taxpayers and businesses. New measures would be supported by evidence and properly targeted. Their design would consider how they interact with other tax measures and the tax system as a whole. Early public consultation would help avoid unintended results and unneeded complexity while producing better outcomes. Post-implementation reviews would occur regularly to keep the tax system clutter-free, up-to-date, and in tune with economic and societal changes.

We encourage the government to adopt this approach as it makes good on its election pledges. We look forward to contributing our tax expertise and insights as implementation proceeds.