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Want to change the tax system? Just ask

Calvin Coolidge was U.S.

Calvin Coolidge was U.S. president in the 1920s and a genuine conservative, unlike many of the politicians who try to pass themselves off as such these days, He reportedly said that nine-tenths of his visitors at the White House “want something they ought not to have.”

He liked to keep dead still as they talked and watch them run down in three or four minutes.

If more politicians were like Coolidge we might not have seen the recent uproar over federal proposals to take away some tax advantages enjoyed by private corporations.

Some of the advantages may have made sense at one point. Perhaps some still do. Others should never have been granted. Some were granted not by the federal government but by Alberta politicians eager to hand out thousands of dollars just because someone asked.

A major handout took place in November 2009. You probably never heard about it because the media weren't interested.

Alberta law was changed to allow certain family members to buy non-voting shares in professional corporations. The resulting income splitting was estimated to generate a tax advantage topping out at about $12,000 a year for the people able to use it.

Best of all, from the government's point of view, while the change was expected to cost the province about $1 million a year and rising, it would cost the federal government more, because Ottawa has a bigger share of income-tax revenue. But Ottawa had no say in the matter.

Strangely, there was no rationale for the move except that it would match tax rules already adopted in Ontario, B.C. and Saskatchewan. It didn't matter that professionals already were paying much lower taxes in Alberta than in any other province.

The whole business began with an Ontario decision in 2004 to give physicians a tax advantage instead of higher fees. Higher fees would have shown up as spending while tax breaks would not.

By the time the changes rolled around to Alberta, others were getting the same deal. The 2009 amendment to Alberta corporation law also enabled income splitting for lawyers and accountants — yup, the same lawyers and accountants who have been fomenting resistance to the federal tax changes, and who get more advisory business every time any tax break is written into the rules.

Deals like this were only part of what persuaded the federal government to look at tightening the rules on income splitting — and at ways of sheltering income from taxes by keeping it inside private corporations rather than paying it out as income.

The government did a poor job of explaining. It should have allowed more than two months for consultation, since some consequences may not have been obvious. It possibly should have avoided or delayed changes in areas such as tax rules affecting inheritance of family farms. And it should have been more careful about language that sounded like “soak the rich.”

But none of the critics refuted some basic numbers behind the federal plans.

Canada's small-business corporate income tax rate is the lowest of any major industrialized country. The federal small-business tax rate has dropped by about 20 per cent since 2000, and the amount of income eligible for the small-business rate rose from $200,000 to $500,000.

The number of Canadian-controlled private corporations rose from 1.2 million in 2001 to 1.8 million in 2014, with growth particularly high among professional corporations. The amount of investment income generating tax advantages by being kept inside these small corporations rather than being paid out as income more than tripled in 13 years to $26.8 billion in 2015.

Those types of numbers were going to encourage federal action no matter who was running the government. Anyone who thinks otherwise has forgot the lesson of income trusts. Former federal finance minister Jim Flaherty was all for letting the trusts continue, despite their rapidly increasing tax-sheltered income, until one day he was not. He sprang the surprise “Halloween Massacre” on investors in 2006.

Flaherty's move wiped out $20 billion in share value in two weeks. The government won the next election anyway. Many trusts converted to regular payment of corporate dividends and survived quite nicely.

Short-term political pain can be smoothed over if inflicting it makes long-term sense.

However, two other principles apply.

First, tax situations always change. If a government hands out a tax break, it can be sure that many more people than expected will exploit that break. And people will look for ways to make it more costly — think of how many lawyers and accountants are pushing now to make withdrawals from RRSPs tax-free, even though the deal always was that an RRSP would merely defer income tax, not eliminate it.

Second, taking things away from people always causes howls of outrage, whether doing so makes sense or not. People don't want to give up anything. That's why every government should always think carefully about handing out benefits in the first place, especially when some of those benefits may be things that people “ought not to have.”

Mark Lisac

About the Author: Mark Lisac

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