Challenges in Shifting Canadian Taxation Toward Consumption

Abstract

Tax policy analysts in Canada have widely promoted shifting revenues away from the personal income tax and toward the consumption-based goods and services tax/harmonized sales tax, or shifting the personal tax base further toward consumption. This study challenges the “consensus expert” policy recommendations by critically assessing the theoretical and empirical evidence relating to behaviour in the areas of work effort, saving, investment, economic growth, efficiency, and tax compliance. The study further examines the failure of the consensus view to account adequately for the regressive impacts of the prescribed policy changes. Most of the consensus expert analyses rely heavily on foreign evidence while ignoring the fact that the Canadian direct personal tax is already highly oriented toward a consumption base. Capital incomes that remain subject to the personal tax are concentrated in the highest income groups, and these constitute the largest departure from consumption-tax treatment. Moreover, the consensus expert view often neglects the openness of the Canadian economy and heavy corporate reliance on internal finance — both factors that mute the impact on domestic business investment of any stimulus to personal savings. Scrutiny of the two Canadian empirical studies most cited by these analysts reveals an overstretch from the policy inferences that can properly be drawn. We conclude that the proposed reforms are deficient in their claims of large economic gains via incentives, efficiency, and growth. Most of the asserted economic gains are overstated, controvertible, or non-existent. Careful review of the theoretical and empirical evidence reveals a lack of robustness or vulnerability to key assumptions. Most of the putative economic gains from shifting the tax system further toward consumption diminish or vanish when the reform is constrained to be distribution-neutral. Thus, it is the move toward a more regressive tax system implicit in such reforms rather than moves toward a consumption base per se that generates any such potential gains. Both types of reform would adversely affect the distribution of the tax burden unless accompanied by a steepening of the personal tax rate schedule. This study examines the requisite conditions for making the proposed reforms distribution-neutral as well as revenue-neutral.

Keywords: Tax mix, consumption taxes, income taxes, tax reform, savings

JEL Classification: D31, H2, H22