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With the federal campaign, the Tories are at it again. They’re promising simple, easily understood tax policies, as illustrated by a 2¢ cut to the federal diesel fuel tax — a move that will eventually cost the federal treasury $600 million per year.
Such tax cuts are deceptively attractive to targeted parts of the population, but they are not as powerful as others in generating economic growth. The danger with these tax promises, which together add up to a lot of money, is that they whittle away at opportunities for far more urgent personal income tax reform — reform that is painfully needed in Canada.
The 2006 campaign provides a case in point. The Conservatives promised numerous tax cuts, ranging from credits for children’s sports fees to a two-point reduction in the goods and services tax rate. After winning the election, they moved ahead with the tax agenda, including the GST reduction, which alone costs $10 billion annually.
No question, Canadians welcome tax relief. However, if Canada is to be more competitive, it will need to cull out the worst features of the tax system. Personal income taxes are particularly damaging — they discourage talented individuals from working in Canada, lower-paid workers from staying in the workforce and investors from putting savings into risky activities.
As I have calculated with Duanjie Chen, the federal-provincial marginal tax rate on work effort, averaged across all income groups and sectors, is more than 45%. (That’s once income, employer and employee payroll, and sales taxes are taken into account.) This expropriating tax rate has hardly budged in the past two years, despite the GST reduction. It hardly makes sense for people to work extra-hard when governments take so much off the top.
Put in this light, the diesel tax cut is far less important. Sure, it is a brilliant move by Harper to propose a policy in direct contradiction to the Liberal Green Shift plan, which would lower personal and corporate taxes and broaden the federal fuel excise into a carbon tax. While politically smart, the diesel tax cut is a low priority, compared with other tax reforms that would give a much bigger bang for the buck.
Why is that? The best tax cuts are cuts to high rates. Under the federal fuel excise tax, the gasoline levy is 10¢ a litre — two and a half times higher than the diesel tax. The existing federal fuel tax already encourages people to use diesel rather than gasoline, since the latter is priced higher. I can see no reason why we should have a tax system encouraging diesel over gasoline, other than to help certain auto and truck producers.
A better tax cut would have been a reduction in the federal gas tax by 2¢ a litre, bringing it closer to the diesel tax rate. That would cost slightly more, at $800 million annually, but it would have appealed to a much broader part of the population, given most people drive gasoline-powered cars.
However, while a gas tax reduction would be welcomed bybeleaguered commuters, it is not nearly as good a policy as a personal income tax reduction. Unfortunately, personal tax cuts are pretty expensive. If the federal government does not put the kibosh on spending and less meaningful tax cuts, it will not be able to cut personal income taxes. But the Conservatives have been big spenders so far, making it very difficult to make room for a large personal tax reduction.
Of course, the other option is to raise taxes from other sources in order to achieve personal income tax reductions. In this respect, the Liberal fiscal plan makes more sense, since it would lower personal income tax rates by one point, except for the low tax bracket where the cut would be 1.5 percentage points. To make up the revenue, the Liberals would broaden the federal fuel excise tax on gasoline into a full carbon tax. This is sensible policy, although the Liberals could have afforded an even bigger personal tax reduction if they did not try to use billions to fund anti-poverty measures as well.
I am sure most Canadians would get excited about a party proposing a really steep reduction in personal income taxes. Looks like we will have to wait for the next election.
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