Cost of Inequitable Tax Loopholes Increases

Finance Canada published its annual Tax Expenditure Report for 2011 and it shows that the cost of some of the most inequitable tax preferences and loopholes continues to rise.

For instance the stock option deduction, which allows CEOs and executives to pay tax at half the rate of ordinary working income, is estimated to cost the federal government $725 million last year.

I’d written about this major problems with this tax preference a number of times before.  Not only is it highly inequitable, but it also fuels speculative behaviour and short-term behaviour.

Now even Roger Martin, dean of U of T’s Rotman School of Management, says they should be eliminated, while well-known McGill business prof Henry Mintzberg wrote in the Wall Street Journal that they ” represent the most prominent form of legal corruption that has been undermining our large corporations and bringing down the global economy.”


Hugh Mackenzie’s annual report on CEO incomes for the CCPA shows just how much stock options provide as part of total compensation for CEOs.  Even the Globe and Mail’s conservative columnist Margaret Wente has argued that they should be eliminated.

Analysis of the CRA’s income tax statistics for 2009 shows that over 95% of the value of this tax preference went to the 2% of taxfilers with incomes of over $150,000 and close to 90% went to the less than 1% of taxfilers with incomes of over $250,000.

The cost of related tax preferences for capital gains also continued to increase.   The half tax rate for capital gains in relation to personal income was estimated to cost $3.6 billion last year while the similar half tax rate for capital gains from corporate income is estimated to cost the federal government $3.9 billion last year.    In total, the stock option deduction and preferential rates for capital gains cost the federal government over $8 billion a year.   These tax preferences also cost provincial governments billions as they generally use the same tax base.

These tax preferences for stock options and capital gains were largely rationalized because it was argued that  they would boost investment and thereby productivity and economic growth in the economy, as supply-side economist Herb Grubel argued a decade ago when the inclusion rate was reduced from 75% to 50%.

That clearly hasn’t happened.   It’s time that the stock option deduction is completely eliminated and that capital gains are taxed at the full rate, after adjusting for inflation, as the CCPA’s Alternative Federal Budget has argued for many years.

If the federal government followed the advice of AFB and these esteemed business professors, it would be many billions better off — and we’d have a more equitable, stable and productive economy.

9 comments

  • A fine piece of work. Had wealthy and the business community not influenced the govt in 1971 to adopt the Carter Commission recommendation for taxing 100% of captital gains this problem might not have arisen.

    Had the progressive income tax rates on higher incomes of 1969 been retained we would have had a minimal problem.

    The use of stock options as a measure of performance in the private sector is so primitive compared with government achievements in developing measurements for their program performance. The former are incredibly short term while the latter are far longer term.

    In any event we should be lobbying for the elimination of this immediately to fund govt infrastructure. This would fit right in with Stiglitz article listed below on tax and spend. The tax will hardly detract from aggregate demand in the economy because these CEOs will probably never spend their wealth – even if they lived to be 200 years old. It may have the added advantage of reducing their gambling in hedge funds and other illusory short-term investments non of which adds very little value to the economy.

    Again great work.

  • Toby, you’re going after the small-fry. According to pages 16-19 of the Tax Expenditure Report, if you add up the Quebec Abatement, the transfer of tax points to provinces, tax assistance to registered pension plans, CPP, EI, and the Basic Personal Amount, it adds up to over 78 billion dollars. Clearly these are the items we should be the most concerned about.

  • You’re funny, rcp. Basic personal amount… LOL!

  • Darwin, the fun (if any) is at the Ministry of Finance. Look at page 19 of the report: Basic Personal Amount is there, with a price tag of $29.5 billion. Presumably they’re serious.

    The lesson, of course, is that labelling something as a tax expenditure doesn’t automatically make it bad. However, Toby’s piece relies heavily on that false premise, since his big-ticket item is the 50% capital gains inclusion rate (the stock option treatment is just a narrative hook). He does not note that the 50% inclusion rate is the original treatment and that the change to 50% in 2000 was just restoring the original treatment.

    As it says on page 9 of the report:

    “The tax system can also be used directly to achieve public policy objectives through the application of special measures such as low tax rates, exemptions, deductions, deferrals and credits. These measures are often described as “tax expenditures” because they achieve policy objectives at the cost of lower tax revenue”

  • “The lesson, of course, is that labelling something as a tax expenditure doesn’t automatically make it bad.”

    I think the article presents clear arguments to why it is bad, because it fails to achieve its goal of promoting beneficial investment and is it promotes inequity.

    The basic personal amount does a good job of reducing inequity and reducing poverty.

  • Thanks for the comments. Yes, there are of course more expensive tax expenditures, but the topic and title of the blog is about “inequitable” tax preferences.

    Other major taxes — sales, payroll, propery taxes — are regressive, so it is especially incumbent on the PIT system to be progressive. This was a point that I believe the Carter Commission emphasized.

    rcp is correct that the original inclusion ratefor capital gains was 50% when capital gains taxes were first separately introduced in canada in the early 1970s. Following that they were increased to 75% before being cut again in 2000.

    However, as Peter Venton suggests, my understanding is that the Carter comm report recommended a 100% inclusion rate for capital gains.

    I haven’t yet been able to read the actual Carter commission report, the subsequent White paper and legislation, but it also appears from the secondary sources I’ve read on this that the Carter commission proposed a 100% inclusion rate: a buck is a buck–and also struggled with the issue of accrued capital gains. The white paper and legislation then proposed 50% which very signifciantly reduced the hostility from the owners of capital to these proposals.

    Before these changes, were capital gains were taxed at the same rate of personal income?

    Can others confirm this?

    Thanks

  • Toby, before the 1972 changes, capital gains weren’t taxed at all in Canada. On the other hand, the provinces had previously levied estate taxes (“death duties”), and they dropped those when capital gains tax was introduced, since it included a “deemed disposition on death” – when you die, the government pretends you sold all your capital assets and levies capital gains tax as if you did.

  • Yes, I know about the changes to inheritance taxes and deemed disposition and that there wasn’t a capital gains tax, but some papers I’ve read have suggested that realized capital gains had in some cases been taxed as normal income previous to 1972.

  • Toby, I think you might be right that in some special cases (e.g. operations of securities dealers) capital gains and losses could be treated as ordinary income, but that wasn’t the general rule.

    See (http://www.cra-arc.gc.ca/E/pub/tp/it173r2sr/it173r2sr-e.txt) and search for “V-day” to get the right paragraph: at the beginning of the paragraph you find:

    “For purposes of determining the amount of the capital gain that is otherwise liable to tax in Canada, one should keep in mind that under the Canadian
    income tax system, any portion of a capital gain that accrued up to the end of 1971 is essentially not liable to tax in Canada.”

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