Tax Season·Analysis

5 benefits of a flat-tax system, and why it still isn't likely in Canada

Flat tax proponents say it would encourage investment and entrepreneurial activities, spur job creation and boost government revenue, while critics say it would unfairly shift the tax burden to lower income earners.

Graduated income tiers a disincentive to work, economist says

Opponents of a flat tax say it would shift the tax burden onto lower- and middle-income earners because it would reduce the amount paid by those in the higher marginal rates. (iStock)

A common refrain during tax season is that the whole system of credits and sliding rate scales is just too complex. One of the ideas that has cropped up in recent years is to replace the system with a simple flat tax, but it turns out to be a whole lot more complicated and controversial than it might seem at first glance.

On the plus side, imagine filling out a return that consists of a single sheet of paper or web page. Simply total up taxable earnings and multiply by a single rate that is applicable to all people regardless of income level to determine how much you owe. That, in essence, is a flat tax system.

Proponents say a flat tax system would reduce the time it takes to fill out a return and, for the most part, eliminate the need to consult — and pay — a tax professional like an accountant or lawyer.

A flat tax can come in a number of different forms of varying complexity (as in all matters tax-related, it seems). But one of the mostly commonly advocated versions would see the complete elimination of all credits, exemptions and graduated rates based on income in favour on just one rate, along with an upfront deduction amount.

An incentive to work

People who have been pushing for a flat tax system says it is a simple and fair alternative that, if set up properly, could maintain existing government revenues.

Opponents, on the other hand, say it shifts the tax burden onto lower- and middle-income earners.

For Niels Veldhuis, senior economist with the Fraser Institute, the argument for changing the tax system isn't about burdens but about productivity. He says a flat tax would increase the incentive for Canadians to work, earn more money and, in turn, invest that money back into the economy.

The current system of graduated rates takes a larger percentage of a person’s income the more money they make, and this is a disincentive for hard work, he says.

"You’re sending a signal to young, aggressive Canadians who want to take risks, who want to start businesses, who want to save and invest. And what you’re telling them is the more successful you become, the more and more we’re going to penalize you," Veldhuis says.

Unleashing that entrepreneurial spirit, so the argument goes, will create more investment, jobs and opportunities which will, in turn, increase government tax revenues.

Proponents of the flat tax also say providing a large upfront exemption amount would help lower-income Canadians because they would have to pay little, if any, tax.

Veldhuis points out that an upfront exemption amount also means that the tax system is still progressive because the more you make, the higher the amount you pay.

Simplifying taxes

It seems easy to say that the current Canadian income system is too complex, but reforming the system could prove to be a challenging endeavour, tax experts say.

Much of the complexity comes from "avoidance language" created to eliminate loopholes. It's also difficult to eliminate specific credits that benefit certain groups without overhauling the whole system to compensate for the increased tax burden.

For instance, if there was a personal exemption of $15,000 and a flat rate of 15 per cent, a person who earns $20,000 would pay $750 a year on the $5,000 of taxable income, which works out to 3.75 per cent of their total income.

Under that same system, a person who earns $40,000 would pay $3,750 or 9.38 per cent of their $25,000 in taxable income. However, as total income starts to rise the percentage paid in tax begins to flatten as it approaches 15 per cent.

‘Huge boon for the rich’

For Simon Enoch, director of the Saskatchewan office of the Canadian Centre for Policy Alternatives, the "devils are always in the details" when it comes to a flat tax system. But in general he is opposed to the idea because it would likely shift the tax burden onto lower- and middle-income earners.

"I think by definition it is a huge boon for the rich because, obviously, the top marginal rate would be cut down," he says.

Enoch says a flat tax would also require a complete overhaul of the delivery of social services, because the current the system of graduated rates is used to redistribute income to those whom society has deemed worthy of the credits and exemptions.

The wealthy, moreover, would be unable to earn money if it were not for a whole host of societal benefits paid for by the government, including the regulatory and legal system, Enoch says. The rich need to foot the bill for these institutions that have supported them and their business or investment ventures.

"I think we need to have a discussion about what sort of society do we want, and those people that do succeed, do they have an obligation to sort of pay back the success they've had?"

Tax reform prone to misunderstandings

Much of the tax reform debate seems to revolve around questions of fairness and whether that means higher-income earners pay close to the same as others in terms of a percentage of income or substantially more under a system of graduated rates.

Lisa Philipps, associated vice-president of research at York University and a tax law professor at Osgoode Hall Law School, says there is room for more reasoned debate about the tax regime in Canada.

But the issue is prone to misunderstandings and "demagoguery" as the complexity of the income taxes in general is not reducible to simple election slogans.

A number of countries, including Russia, Czech Republic and Slovakia, have instituted single-rate systems over the past decade or so. The issue has played a role in the U.S. Republican primaries, but it appears to be less of a concern in Canada.

Although the Conservative government has suggested that rates could be flatter and lower, at a party convention in June 2011 a motion in favour of a flat tax system was rejected. So it's unlikely Canadians will see a tax return that takes only minutes to fill out any time soon.