Some Thoughts on the Carter Report

The most radical recommendations in the report are those in favour of a tax on world-wide capital gains, legacies and gifts at progressive income tax rates, and the substitution of the family for the individual as the tax unit. I shall deal later with the tax on estates and gifts.

Taxes on capital gains, though levied for years in the United Kingdom and United States, have never been introduced in Canada. While I was Minister of Finance I always resisted proposals for such a tax, and I must say that I did not encounter strong pressure in favour thereof. I was of opinion that, whatever justification there may be for such a tax in countries with a capital surplus, like the United States and the United Kingdom, it was quite inappropriate to a capital-importing country like Canada. I genuinely feared that such a tax in Canada would discourage domestic thrift and investment as well as foreign capital, all of which Canada urgently needed. When such a tax was discussed it was always in terms of a special tax on certain defined kinds of capital gain, and always at a special flat rate, usually 25 %. It is a very different kind of tax which the Commission has proposed. Indeed, it is not a new tax at all, but the inclusion of net capital gains of every kind in the tax base to which the high progressive rates of income tax apply. Some considerations would apply to mitigate the rigors of the measure, but in essence it becomes a matter of widening the tax base, not a new kind of tax. The Commission has been guided by a pithily stated principle, "It is what you get, not how you get it, that should count for tax purposes". For my part I am not prepared to commit myself to any such all-pervasive principle.

I am all too well aware of the difficulties in the present law in separating income and capital gains. This border is being constantly fought over in the Tax Appeal Board and the courts. It has often been argued that a tax of 25% on capital gains would not be too great a price for relief from present uncertainties in that respect. I have never shared the view that the introduction of a tax on capital gains would have the effect of satisfying either the courts or the taxgatherers that gains are to be presumed to be of a capital nature. Now the Commission would end all this border warfare by submerging capital gains in the not very refreshing flood-waters of liability to income tax.

The Commission has agreed that the full taxation of capital gains under our present tax systems might be disastrous. It, therefore, proposes certain safeguards against the full weight of this new exaction: the taxation of property gains would not be retroactive; there would be a lifetime exemption of $25,000 on gains from the sale of houses and farms; income-averaging over a period of five years would be allowed; all losses would be deductible in computing income except those on houses and personal-use items; full credit would be allowed for taxes paid by Canadian corporations. But above all, the Commission proposes certain modifications in the progressive rates of taxation applicable to the various strata of income and a ceiling rate of 50%, as opposed to the present 80%. With these alleviations the Commission believes its proposals to be equitable, and asserts that not to tax capital gains would no longer be equitable. It cannot estimate the revenue effects of its proposal.

That inequities exist in the present tax system is undeniable. The tax rates on earned income are so high today that they throw into stark contrast the tax position of those enjoying capital gains.

For my part I would feel less disturbed by this farreaching proposal if 1 could share with complete confidence the Commission's assumption that the top rate of levy on personal income will not exceed 50%. The Commission has repeatedly stated this limit as though it were as final as the laws of the Medes and Persians. I fear that the same political considerations which led to the introduction and maintenance of the present 80% ceiling rate might inhibit the reduction of that ceiling to 50%. Even if the 50% ceiling were enacted who can say that succeeding governments may not lay impious hands upon it if the big spenders continue in control of national policy? How well we know to our cost that there is no permanence in tax rates!

The administrative problems created by taxing capital gains would, in my opinion, be even more formidable than the Commission considers. They would require annual tax returns to include information on all securities and real property owned, with particulars of all property gains and all deductible property losses. Fair market values must be established at the date of introduction of the tax for all property of all kinds then held. The task of establishing fair value for unincorporated businesses and private companies and real estate would be simply baffling in many cases. We have trouble enough in establishing equality in assessing real estate values for municipal tax purposes. The administrative burdens and woes thrown on the tax authorities would contrast with the prosperity of professional appraisers.

I confess that it troubles me to see the base of the income tax, with its high progressive rates, enlarged to a virtually universal extent. Such a proposal would wear the guise of equity only if it were the sole means of securing and maintaining a substantial reduction in the rate of personal income tax. It has, of course, been welcomed by the socialists. It could open the door to their old cherished idea of a capital levy.

On this area of the report I am very much impressed by the minority views of Mr. Grant and Mr. Beauvais. Canada needs capital. Does it make sense to penalize it?

The Commission's zeal for an all-inclusive tax base and the rule of sheer logic has led it into some very doctrinaire proposals. Perhaps, having decided upon a tax on capital gains, the Commission felt that it must take a hard line against even very small non-cash benefits provided by employers in favour of their employees. Perhaps this also is the reason for the proposal to treat bed and board in the home as taxable income even to relatives. Such proposals may be correct in theory, but in not a few cases they appear to be unenforceable. A tax on benefits measured in very small amounts which would cost more to collect than it would yield can hardly be regarded as practicable.

Similarly, the Commission proposes to tax family allowances, old age pension benefits, unemployment insurance benefits, workmen's compensation and all other kinds of social assistance and relief. Old age security payments are already included in taxable income. To tax the others, however, would undoubtedly lead to demands for off-setting increases in the payments. Indeed, the Commission proposes that these payments should in all cases be reviewed to ensure that their inclusion in taxable income does not result in hardships. I can see no merit in taxing these payments just to make a tax system based on a comprehensive tax base logical to the last degree when it would mean simply taking money out of the pocket with one hand and putting it back with the other.

Much attention has been attracted by the proposals of the Commission concerning business entertainment bills and transportation costs on business trips, although it recognizes that the amounts involved are probably relatively small. The Commissioners are not the first persons who have wrestled with this problem. It is one that has disturbed Ministers of Finance for some time. Undoubtedly abuses are practised in this field by some taxpayers. The problem has been to find a means of dealing with the problem which will at the same time be fair and effective and enforceable. In the past rigid scales of allowances for these purposes have been rejected because of the injustices that such rigidity would impose. The Commission now proposes fixed flat dollar limits. They have completely accepted the idea of the rigid scale. I prefer the view of Mr. Beauvais. It seems to me that the Commission's proposal is so rigid as to be unrealistic and that it will result in injustices.

The Commission recommends the repeal of the Estate Tax and Gift Tax in their entirety. This is a bold and arresting proposal. In their place it recommends that gifts and bequests be treated as income in the hands of the recipient and be taxed as such at progressive rates. The major alleviation is that gifts and estates, regardless of size, passing to a spouse or dependent children would to totally exempt. In addition, there would be a $5,000 lifetime exemption on gifts outside this small family unit and a generous provision permitting income-averaging over a ten-year period, five years back and five years forward, with respect to both gifts and bequests. A gift outside the family unit will be deemed to be a disposition at fair market value. Therefore, accrued gains will be taxed to the donor and the fair market value will be taxed as income to the donee. The net result of all these changes would be a very heavy increase in taxes from these sources, rising from the present $140 million to $350 million annually.

This proposal involves a revolutionary departure from concepts hitherto prevailing in Canada. The individual has been the tax unit; now he will be replaced by the inner family. All concepts of estate planning are knocked topsyturvy. Where now the effort has been to avoid the tax consequences of successions, the tax advantage would lie with outright succession from husband to wife and dependent children. To treat all others, including self-supporting children and close relatives as strangers in relation to taxes on succession, and to tax all gifts and bequests outside the family unit as income at high progressive rates, will rudely shatter established concepts.

It is unthinkable that such a radical change would be introduced unless the provinces vacate the succession duty field, and the Commission recommends that they do so. How the provinces can be convinced to vacate and how Quebec in particular can be persuaded to surrender its tax control over succession remain to be seen. In my view the provinces hold the key to the fate of this radical proposal, and I am conditioned by experience to believe that they will not lightly surrender their rights.

It is regrettable that until the fate of this proposal is finally determined the greatest uncertainty will surround all measures of estate planning.

It is interesting that the Commission has made findings and pronouncements on two vexed questions: -

First, does the present weight of federal estate tax and provincial succession duty force sale of family businesses, particularly to non-residents? After an examination of the evidence the Commission finds that no clear conclusion can be drawn from it.

Second, should these taxes be reduced to discourage Canadians from transferring their residence abroad to reduce the tax on their estates? The Commission answers with a firm and resounding "NO".

One of the most interesting and attractive proposals relates to the taxation of corporations. The Commission would enlarge the tax base of corporations by including property gains, gifts, windfalls, etc. while at the same time allowing more generous deductions, such as payments for goodwill and the cost of obtaining certain types of contracts and lists of customers and the cost of issuing securities. To this enlarged base the Commission would apply the present 50% tax rate, eliminating altogether the prevailing reduction to 21 % on the first $35,000 of taxable income. To compensate for this deprivation it would institute a new kind of rapid depreciation allowances designed to assist new and small businesses for a period of ten years. The more generous provisions for carry-forward and carry-back of business losses, and concessions to all qualified businesses, whether or not incorporated, in relation to capital cost allowances will be warmly welcomed.

The most striking proposal, however, concerns integration of the corporation tax with taxes payable by shareholders. For tax purposes the taxable income of the corporation, whether distributed or not, would be deemed to be allocated among the shareholders. Each shareholder would then be given credit for his portion of the tax paid by the corporation and would offset it against his own tax. His tax base would be enlarged by this individual accrual, but except in the case of shareholders paying a personal tax rate of 50% or more, he would receive a tax credit. In effect the individual shareholder's proportion of the corporation's taxable income would be taxed at his personal rate, and there would be no double taxation of income earned by the corporation. The integration scheme would apply only in favour of Canadianresident shareholders. This proposal in its general features will undoubtedly.attract wide support.

It must be pointed out, that while the position of the shareholder as such is likely to be materially benefited, the position of the bondholder as such has in most cases been ignored. Unless some comparable concession can be extended to him the Commission's proposals are likely to distort debt financing by corporations.

In its zeal for simplifying general rules of taxation, the Commission has made specific proposals which will impose serious burdens upon our extractive industries, life insurance companies and banks and some other financial institutions. The proposals for reducing the tax-exempt inner reserves of the chartered banks are too large and involved a subject to be introduced in this address. But I must comment on the other two.

Mines and Petroleum Industries

The Commission recommends the immediate cancellation of the mining and petroleum depletion allowances and a phased withdrawal of the three-year tax exemption for new mines. These special concessions have been accorded by our income tax legislation for many years. They are a recognition of the wasting character of these assets of the extractive industries, and of the risks taken by investors and developers of mineral and petroleum deposits. They have played a very influential role in attracting investment, from both residents and non-residents, for the fruitful development of these natural resources, and their withdrawal will undoubtedly be widely publicized and will be interpreted as a loss of interest in the development of our resources. The Commission's proposals will cost these enterprises $136 million per annum, with most of the burden falling on the mines. These proposals are far too drastic, and I personally would firmly oppose them.

Generally speaking, touay mutual life insurance companies are exempt from federal taxation, and joint stock companies pay a total of only $2 million. Since 1956 Parliament has largely left this industry to be taxed by the provinces, which have levied a premium tax yielding them about $15 million per annum. The Commission appears to suggest that the provinces should give up this revenue. It makes the radical proposal that all life insurance companies, whether resident or foreign, and whether organized as joint stock or mutual companies or as fraternal benefit societies, should be taxed in the same way as other corporations. The federal tax yield would rise from $2 million to $77 million per annum on the basis of the 1964 figures. The Commission acknowledges that there would be less money available for policy reserves, that there could be some reduction in policyholders' dividends, that premiums on policies issued in future would increase, and that life insurance as a form of savings could become relatively less attractive.

I must observe that the life insurance industry has enjoyed favoured federal tax treatment for a very good reason -that it is the soundest kind of social security, and that people should be encouraged to provide for themselves and their families by this means. The Commission admits making an exception on "social security" grounds in the case of . benefits gradually built up by contributions to pension retirement savings and profits. I cannot follow the logic of denying similar tax treatment to life insurance policies. Life insurance attracts 30% of total personal savings of Canadians. It channels those savings beneficially into mortgages, bonds, stocks and buildings. In 1966 the Canadian life companies paid out a billion dollars in benefits, two-thirds to living policyholders and one-third in death benefits. Canadians hold more life insurance per capita than the people of any other country. In proposing that all life insurance companies be taxed like any other industry the Commission has subordinated some very important considerations to a doctrinaire attachment to a dogma. For my part I am firmly opposed to their drastic proposal.

The Commission proposes that charities be taxed on their business income and some of their investment income. I recognize that the present rules in our tax legislation with respect to charities may not be perfect, but in principle I am opposed to taxing charities. For my part I could not accept the view of the Commission on this subject.

The Commission has offered some interesting, but by no means novel, proposals respecting the sales tax. Under the constitution Parliament can raise money by any mode or system of taxation; the provinces are limited to direct taxes. The present federal sales tax is a classic example of an indirect tax. It is levied on the manufacturer or producer. He includes it in the price he charges to the wholesaler. The latter, in turn, includes it in the price he charges to the jobber or retailer. The latter in his turn includes it in the price he charges to the consumer. In every case mark-ups are added on the total price, and while the yield to the government from the tax is confined to the percentage paid by the manufacturer or producer, by the time the goods have reached the consumer several pyramided percentage markups on the tax are included in the end price. The tax is objectionable from several points of view. In the first place, it is hidden. The taxpayer, namely the consumer, is not aware of the amount of the tax he is actually paying. It costs the taxpayer much more than it yields to the government. Many people also object to it because, not only is it not a progressive tax, but in some respects it is regressive; that is to say, it bears no relation to the income or capital wealth of the taxpayer, but is based upon his consumption, which often must be identified with need.

From the government's point of view, however, the federal sales tax has the irresistible virtue that it is the easiest of all taxes to collect. It consists of a simple percentage, and it is levied at a level where it can be most easily collected. It can be raised or lowered with ease, for only a change in the flat percentage is involved. It produces a handsome yield. The sales tax imposed by nine of the provinces (Alberta only excepted) is of a different character. Being a provincial tax, it must be a direct tax. It must not be levied on anyone who will pass the tax on to someone else. Therefore, the tax must be imposed upon the consumer. It cannot even be constitutionally imposed upon the retailer. Therefore, the cumbersome method adopted to meet the problem is to levy the tax on the consumer and to constitute the retailer the government's agent for the purpose of collecting and remitting the tax on behalf of the taxpayer, namely, the consumer. Recently the federal sales tax was advanced to 12%, and three years ago exemptions in favour of building materials and production equipment were withdrawn. These measures have increased popular resistance to the federal sales tax.

The Commission recommends the abolition of the present federal sales tax in its entirety. In its place, however, with some sacrifice of revenue, it proposes a 7 % sales tax to be applied at the retail level to both consumer goods and services. The inclusion of services will greatly widen the tax base, although there are some notable exemptions, for example, raw materials, unfinished goods, production equipment and machinery, goods for export, finished buildings and structures and capital goods used in distribution and services. The proposal to restore the former exemption in favour of production equipment has been welcomed. The Commission also recommends the eventual removal of the sales tax on building materials and this proposal has likewise been warmly received.

The Commission proposes an amendment to the constitution to permit the provinces to levy an indirect sales tax on the retailer, and that where a province has a general sales tax rate of 5% with the same tax base as the proposed federal tax, the provincial governments might undertake the collection of the combined 12% for both governments. As against very great administrative problems which would arise from the change in the level at which the federal tax is imposed, and a sacrifice of $175 million of federal revenue, the proposal to combine the collection of the two taxes offers advantages. The collection at the retail level will assure that the customer is made well aware of the tax he is paying. Moreover, there will be no mark-up on the tax. The adoption of the direct tax at the retail level, however, will give rise to great difficulties in enforcement, and I expect it will be strongly resisted by the federal tax authorities. Sales at the consumer level being far more numerous than those at the manufacturers' or producers' level, the adoption of the indirect retail tax will necessitate enforcement through a multitude of retailers. The problems of enforcement would be greatly multiplied as compared with the present federal tax.

It should be realized that the inclusion of services in the tax base will widen considerably the incidence and irritations of the federal sales tax. The removal of the tax at the manu facturers' or producers' level ought to result in a reduction of prices at that level. Can anyone guarantee that it will?

While its terms of reference made no express mention of federal-provincial fiscal relations, the Commission decided that it was not precluded from examining their effect on the Canadian fiscal system. They, therefore, took account of what they believed to be the objectives in that field and undertook to develop a tax structure consistent with the realization thereof. They refrained from considering the division of tax revenue between federal and provincial governments. Their recommendations offer no tangible relief for either provincial or municipal governments in the fiscal strait-jacket in which they unhappily find themselves.

Briefly, the report opposes any further abatement of the personal and corporation income taxes in favour of the provinces. It looks upon the personal income tax as the federal government's most effective tool for stabilizing the economy. It recommends that the provinces abolish succession duties. It suggests that if Ottawa wishes to give the provinces more tax room it do so by reducing its own rate of sales tax, presumably to allow the provinces to increase theirs beyond the proposed 5%. It notes the necessity for adoption of a uniform income tax base by both federal and provincial governments and hopes that the broad new base it would propose will be as attractive to the provinces as to the federal government.

It appears to me that this report offers but cold comfort to the provinces and municipalities in their genuine fiscal anxieties. For my part I am concerned that in today's cir cumstances the Commission has leaned so heavily in favour of the federal level of government.

Tax administration is a subject of very considerable importance under any circumstances. The commission has recommended a completely new system of Canadian tax administration. It proposes that the functions of the Department of National Revenue be assumed by an independent board of revenue commissioners, reporting directly to Parliament through the Minister of Finance and having somewhat the same relationship to the government as has the Bank of Canada. The Commission also proposes that a new tax board be established to replace the existing Tax Appeal Board and possibly also the judicial functions of the Tariff Board.

The Commission expresses the opinion that by placing tax collection under the proposed new board "impartiality would be assured and any attempt to exert political influence on the collecting authority would be negated". This assertion standing alone would have seemed to suggest that the Commission had found evidence that political considerations were influencing decisions of the Department of National Revenue. If so, knowing the highly competent men who have served the public in the Department of National Revenue, I would have resented it. However, the Commission has emphasized that it is not implying that it has found any disturbing shortcomings in the Department of National Revenue but, on the contrary, that the officials of that Department are "carrying out their duties in a dedicated and conscientious way".

The Commission thinks it is sufficient that responsibility for actual tax policy remain with the government and particularly the Minister of Finance, but that administration can be severed entirely from political responsibility. This is a new doctrine, and in my judgment, an unrealistic one. Administration is a government responsibility. Attempts in the past to separate areas of the public service from the principle of governmental responsibility have created frequent border wars. The public has never yet accepted the idea that there are, or can be, areas of the public service and public enterprise that lie totally outside the realm of government responsibility. What the public demands are governments not with reduced areas of responsibility, but with a higher sense of responsibility.

The Minister of Finance charged with responsibility for tax policy needs the full and intimate assistance of the senior officers of the Department of National Revenue. Relations between the Minister of Finance and an independent board, holding itself responsible only to Parliament and not to government, would be very different, and would, I fear, deny to the Minister of Finance assistance of a kind which he often needs. '

Any proposal for improving and expediting appeals and improving the machinery for tax settlements should be very sympathetically considered.

I am sure that many good people had hoped that it would be possible for the Commission to simplify tax forms, tax procedures and tax legislation. The Commission admits that is can hold out no such hope. Even with the virtually allinclusive new proposed tax base, the Commission has concluded that tax forms are likely to be more complex than in the past. This will be very disappointing news.

I am very pleased that the Commission has expressed its firm opposition to anything which would create the impression that Canada is hostile to foreign investment. On the other hand, it desires that foreign subsidiaries in Canada become more conscious of the Canadian public interest. With this aim I am sure that most of us are in complete agreement. Fiscal measures should not be called upon unduly to sustain government policy in other fields, and we must be on our guard against radical changes of the rules under which foreign investment has been attracted to Canada. We have seen the disastrous effects of punitive applications of fiscal discrimination against foreign investment.

The Commission concluded that Canada's rate of saving is high and it found "no great merit" in providing tax incentives to raise it still further as a means of reducing reliance on foreign capital. It saw no reason to favour personal saving any more than corporate saving or a government surplus. The Commission disclaims any belief that the adoption of its proposals will have a dramatic effect on foreign ownership and control. I should think that on balance they will have a discouraging effect on future foreign investment.

It is evident that the Commission has not considered that our tax system should bear major responsibility for solving Canada's chronic balance of payments problem. It has not, however, overlooked the effect of its proposals on that problem. Its proposals on balance might reduce slightly our balance of payments deficit, and this will be accounted in their favour. Stabilization Policies

The use of fiscal measures for the purpose of regulating the economy is too large a subject to be discussed adequately today. The Commission urges faster and more effective federal action to prevent or check inflations and recessions. This is a laudable goal. The means proposed by the Commission, however, will probably win less unanimous support. The Commission proposes that when either the employment rate or price increases exceed previously defined limits a full-scale debate in the House of Commons should be mandatory and that the government should be required to state what it is doing and what it intends to do about the situation. This is a beautiful theory, but it appears to assume that government can be reformed just like the tax system.

The Commission also proposes that the government should have standby authority to change specific taxes within defined limits subject to later parliamentary approval. There is, of course, a precedent for this proposal in legislation passed several years ago in the United Kingdom. In terms of constitutional usage, this is a radical proposal. It is a soundly established principle since the days of Charles II that taxes can be imposed only by Parliament, and Parliament has been unwilling to legislate to confer upon government power to vary taxes, particularly power to increase them. We have some exceptions in our tariff legislation, but none of consequence with respect to the principal forms of taxation. I doubt if the Canadian Parliament will be disposed to vest very wide powers of this kind in Ministers.

I referred at the outset to the Commission's claim that its proposals should be accepted in their entirety as a package, an integrated programme. On analysis it seems to me that certain of their major proposals do fall in that category: the inclusion of capital gains, gifts and legacies in taxable income subject to progressive tax rates; and the substitution of the inner family as the tax unit. Other important proposals are, in my opinion, severable and can be considered on their individual merits. Such are the retail sales tax, the taxation of life insurance companies, banks, the petroleum and mining industries, charities, expense accounts, etc. Parliament should not be denied its right to consider the individual parts as well as the whole of the proposed new tax system. Moreover, nearly all of the proposals are open to modification in one form or another, as the minority reports recommend in a number of cases.

Perhaps you will concede that our President assigned me a large and intolerably long task. At the outset I stressed that my theme is limited to "Some Thoughts on the Carter Report". I said that at this early stage and in one address I could not hope to offer more than a preliminary review and assessment of the report, confined to some broad considerations and certain of its highlights. I hope that my observations will encourage you to study for yourselves this very valuable, stimulating, challenging and most controversial report. Its importance justifies our attentive study; its contents will fully repay it.

Thanks of the meeting were expressed Mr. Sydney Hermant.