Making income tax returns simpler is no simple task

Much of the complexity of the Income Tax Act is the result of tax credits, experts say.

Hard to eliminate targeted credits, provisions aimed at ensuring compliance, experts say

Proponents of tax reform say the system is too complex, and it takes too much time and money to complete returns. According to 2010 study by the Fraser Institute, Canadians spend between $4 billion and $5.8 billion each year preparing and filing returns. (iStock)

Although many people say Canada's income tax system is overly complex — a realization often reached as they struggle to compile T4s and calculate federal and provincial credits — coming up with ways to reform it isn't exactly a cakewalk either.

The system has grown over the decades to include a host of provisions, tax avoidance language and credits that provide tax relief for particular groups of Canadians, ranging from parents to volunteer firefighters. Helping people navigate that system has become big business.

According to a study from the Fraser Institute in 2010, Canadians spend between $4 billion and $5.8 billion a year preparing and filing personal income tax returns, the average cost per person being $215.

And only one-third of Canadians actually prepare returns themselves — most either hire a professional or ask a more financially savvy friend or relative.

The cost of doing annual tax returns increases dramatically for businesses. According to figures released by the Canadian Federation of Independent Business, companies spend a total of about $12.6 billion a year meeting their tax obligations. 

The cost per employee, moreover, is higher for small- and medium-size businesses. Very small firms, those with fewer than five workers, pay an average of $3,928 per employee to manage their tax obligations, compared to a per-person average of $212 for large firms that can take advantage of economies of scale.

Hard to eliminate specific tax credits

Calls for tax reform often focus on simplifying the Income Tax Act by reducing the number of income rates and eliminating specific credits for particular individuals or groups. Some would like to see the complete elimination of the current system of graduated rates and the institution of a flat tax system, for example.

According to Gregory Thomas, federal director with the Canadian Taxpayers Federation, the income tax system needs to be simpler and the tax rates themselves need to be both flatter and lower.

He says much of the complexity is a result of targeted tax credits, including the new children's art tax credit and the voluntary firefighter credit introduced by the Conservative government for the 2011 tax year.

However, it is not enough to simply eliminate individual provisions, he says — the whole system needs an overhaul.

"You can’t denounce the tax credit for volunteer firefighters unless it’s part of a plan to eliminate 50 other boutique tax credits and loopholes," he says, "and in the course of doing that drop the actual rate that firefighters, and everyone else, pays."

Not only does the complex nature of the system cost tax filers, Thomas says, it also undercuts government revenue because some are able to game the system by exploiting loopholes. Others end up paying more than they should because they misplace documents or are unaware of certain credits.

"You’re rewarding people who are good at collecting receipts and who have good accountants," he says.

Tax avoidance language creates complexity

While it may be complex, not everyone agrees that the tax system should be flattened.

The complexity of the system is based in part on differences among individuals and businesses — distinctions society as a whole has deemed worthy of exemptions, says Lisa Philipps, associate vice-president of research at York University and a tax law professor at Osgoode Hall.

The tax system is one tool the government uses to redistribute resources. Removing tax credits aimed at helping less fortunate groups in society would require something in its place. But proponents of reform generally say lower rates for all would compensate for any increases in the tax burden shifted onto lower-income earners.

Flat tax debate

One way to simplify the income taxes is to institute a single rate for all taxpayers, regardless of income level. This is also known as a flat tax.

Proponents of a flat tax rate say it is a simple and fair system that provides an incentive for Canadians to work hard so they can invest more money back into the economy, thereby creating jobs and opportunities for others.

However, critics say it would shift the tax burden onto lower- and middle-income earners, and that graduated rates are fairer overall.

"It's not easy to fix," she says. "There are costs to simplification."

Much of the complexity of the 2,950-page Income Tax Act deals with tax avoidance, Philipps says.

This is because courts have generally protected the right of taxpayers to minimize the amount they owe, so the onus is on the government to spell out the specific conditions under which a person or business must pay, she says.

"A simple tax would have a loophole you could drive a truck through, and that people will drive trucks through," Philipps says.

The Certified General Accountants Association of Canada published a report in August of last year calling for an across-the-board simplification of the tax system, noting the high cost of compliance.

It's a move that might sound counter-intuitive, given that such a reform could result in less work for its members, says Carole Pressault, vice-president of regulatory affairs at CGA-Canada. However, she says tax reform is an important issue for her members, most of whom say the system is just too complex. They would rather be involved in growing businesses, not filing taxes, she says.

Pressault says the government should appoint a task force made of independent advisers who can examine the tax system and make recommendations for a tax overhaul.

On the other hand, the House of Commons finance committee called for a review of personal and corporate income taxes in a report published last December, citing the need to "review, modernize and simplify the personal tax system."

"The debate around tax simplification or tax reform is a politically charged debate, of course," she says.

Reasoned public debate on reform needed

It is indeed a charged debate for some. But in Canada, it seems that tax simplification isn't on the agenda of most people outside tax time, says Thomas.

Indeed, much of the debate around taxes in Canada largely centres on raising or lowering taxes, not eliminating specific provisions and how they're determined.

Although simplification is not an easy process, there is room for a discussion on tax reform, according to Philipps. "There is scope for a more informed and reasonable public debate about that," she says, adding that much of the conversation needs to look at "our sensibilities about what fairness constitutes in the realm of taxation."