Pay your taxes on a postcard!

At some point in the not too distant future, one or another of this country’s political leaders is going to campaign for office waving … a postcard. “This,” he or she will proclaim, “is what your tax return will look like under my tax plan. As you can see, it’s only got 10 lines on it. You can fill it out in about five minutes. No receipts to keep, no complicated forms to fill out, no need to hire an accountant. And the rate? Just 15%.” That candidate, I predict, will be swept to power. It won’t even be close. Tax reform bores like me tend to drone on about incentives and revenue neutrality and marginal rates of snzzzzz. But what will light a fire under the average taxpayer, even more than the promise of lower rates, is that postcard....

Mind you, you need some credible authority to provide the theoretical underpinnings, if only to make sure the sums come out right. And you need someone with the media’s ear, an activist or advocacy group, to take up the case, before the politicians will dare. So it is significant to note the release of not one but two major tax reform proposals along these lines in as many weeks. One, from the Fraser Institute, would take us all the way to the postcard in one jump: a 15% flat tax that would mean substantial change to both the personal and corporate tax systems. The other, less sweeping plan, from the Canadian Taxpayers Federation, would get us half way there. Together, they may succeed in putting radical tax reform on the political agenda -- or at least provide some ambitious politician with a platform for a future campaign.

The Fraser plan is the more theoretically ideal, so let’s start there. The principle underlying the flat tax can be stated very simply: tax everything, tax it at the same rate, and tax it only once. That means, first, getting rid of the many credits and exemptions and preferential rates that clutter up the tax code at present. And second, cutting taxes to a single, low rate. The two are sometimes presented as a trade-off, the first paying for the second. But each would be worth doing on its own. The main effect of all those credits and exemptions is to make people do things for tax reasons that they would never dream of doing otherwise: investing in wind power, buying condos and so on. A simpler tax code is a saner one.

Actually, even a flat tax doesn’t tax everything. The Fraser plan would retain the current basic personal and spousal exemptions, on the grounds that taxes are supposed to be based on ability to pay -- that is, on your discretionary income, in excess of what is required for subsistence. This means the flat tax is also, contrary to myth, a progressive tax: the percentage of your income you pay in tax goes up as your income does. Only rather than tax each additional slice of income at higher and higher rates, as at present, it applies the same rate to a larger and larger proportion of your income. Suppose the basic exemption were $10,000. If you earned $20,000, you’d pay tax on half your income. At $100,000, you’d pay tax on nine-tenths of it.

But what was that bit about taxing income “only once”? The reference is to the infamous “double taxation” of income from investment, once on corporate profits, a second time after distribution. The current system tries to take account of this through such tortured measures as the dividend tax credit, but still winds up taxing different types of capital income -- interest, capital gains, and dividends -- at wildly different rates. The Fraser plan solves this at a stroke: business earnings are taxed at the business level, while personal taxes fall only on wages. But of course, it’s people who pay the taxes in either event. It’s just that under a flat tax, they’d only pay once.

In the end, the flat tax is more like a tax on cash flow than such hard-to-measure concepts as income or profit. Businesses would no longer be able to deduct interest payments, for example. But they would be able to deduct the cost of their inputs, since every purchase is somebody else’s sale -- on which tax was paid. That includes capital equipment: expensed in one year, rather than via complex depreciation schedules. Which in turn means no need to exempt savings at the personal level, as with RRSPs: since investment can only be financed out of savings, exempting one amounts to exempting the other.

How does the Taxpayers’ plan differ from this? It steers clear of the corporate and investment income question altogether: the tax treatment of these is left as it is. It also retains several credits that Fraser would eliminate, such as the child tax credit, the age credit and RRSPs. And it allows much higher basic and spousal exemptions: at $15,000 apiece, roughly twice as much as Fraser. The downside: instead of cutting rates all the way to 15%, the Taxpayers’ plan is forced to keep a second, higher rate of 25% on incomes above $80,000.

That’s fine. It would still mean a much simpler, less distortionary system. And politically, it’s more saleable: whereas the Fraser plan would leave many people paying more tax than they do now (those already paying the 15% rate, in particular, who would lose their credits), under the Taxpayers plan everyone gets a tax cut of some kind. Perhaps some hybrid of the two could be devised, with the simplicity and elegance of the Fraser plan, but with two rates, say 10% and 20%. Just so long as we end up paying tax on a postcard.