Deficits are stretching as far as the fiscal eye can see in federal budgets. Major defence spending commitments are looming. Government needs to spend more, some say, to galvanize economic growth.
The time is right for a tax increase to close that fiscal gap, or so the argument goes. But even a cursory look at fiscal history shows that governments in Canada do not have a revenue problem (although there is a problem with the mix of revenue they collect).
As this first chart shows, the tax bite (from all three levels of government) has been on the rise over the last decade. Sixty years ago, that tax bite – for everything from income taxes to property taxes – was relatively modest, equalling one-quarter of national gross domestic product, according to data from the Organization for Economic Co-operation and Development.
But in the ensuing three decades, that bite grew markedly, as governments’ spending appetite expanded. By 1997, taxes equalled nearly 36 per cent of (a much bigger) GDP. From that high-water mark, however, the tax bite began to shrink relative to the economy.
The Chrétien Liberals fully indexed the personal income tax system while trimming rates and cut corporate taxes, even as they pushed the federal budget into surplus. By the 2010s, the tax bite had fallen toward the 30-per-cent mark.
But the tax bite has risen since 2015, reaching 34.9 per cent (of an even larger GDP) by 2024, the highest proportion since 1999. Those figures encompass all three levels of government, but federal finances track the trend. In fiscal 2014-15, Ottawa’s tax revenues equalled 11.5 per cent of GDP, rising to 13.6 per cent in fiscal 2024-25. (Recent tax reductions will push that number slightly lower in the current fiscal year, to 13.1 per cent.)
So, any proposals for broad tax and fiscal reform must first start from the premise of revenue neutrality (at a minimum). The other premise is: There is not a moment to lose.
Canadian and American flags fly near the Ambassador Bridge, a vital trade route between the countries. Disruption of access to the U.S. caused by punitive tariffs can drag down investment and productivity growth.GEOFF ROBINS/AFP/Getty Images
Canada’s productivity growth is in the doldrums, and trending worse. AI will disrupt the jobs market. Disruption of access to the United States, tariffs and an ageing work force will all drag down investment and productivity growth, without decisive action – or, as a recent CD Howe Institute study calls it, a Big Bang approach that bundles together a sweeping package of tax changes.
“Simply trimming tax rates by a few points here and there will not reverse these trends. Canada needs a more fundamental, growth-oriented reform: one that simplifies the system, broadens the base, and lowers the marginal tax burden where it most constrains productivity,” the study’s authors write.
The prize is big: the study estimates that a Big Bang approach could boost investment by $140-billion, increase GDP by 2.5 per cent, or $79-billion, and increase annual tax revenue by $26-billion.
The Big Bang Theory, Part I
Broadly, the authors of that study argue for deep cuts to personal and corporate income taxes, and increases to consumption taxes – the GST.
Why do they see the need to raise consumption taxes? That would seem to be out of line with a strategy to revitalize the economy and avoid handing tax-hungry governments more revenue on which to gorge. This second chart sheds some light on the question.
The increase in personal income taxes account for nearly all – 93 per cent – of the tax bite since 1965, with that revenue stream more than doubling relative to the economy by 2024. Some of that growth is due to economic success, to be sure. Richer people pay more in taxes, and there is no doubt that the Canadians of 2024 were far wealthier than their 1965 equivalents.
But some of that rise can also be chalked up to higher tax rates, including the insidious effect of de-indexing federal tax brackets between 1986 and 2000.
Whatever the cause, personal income taxes have grown substantially relative to the economy. Corporate income taxes are smaller relative to personal income taxes, but they have increased at a faster pace over the last decade.
And, a point that cannot be stressed enough: The same percentage of GDP in 2024 is worth much more in absolute dollars than in 1965 or 2015, because the economy is so much larger.
In the meantime, sales and excise taxes have actually fallen relative to the size of the Canadian economy. Some, but not all, of that decline is due to policy choices, such as the Harper government’s move two decades ago to reduce the federal GST to 5 per cent from 7 per cent.
Now, combine those two trends and you can see the outsized contribution of personal income taxes and (relatively speaking) the shrinking footprint of sales taxes, as this third chart shows.
In 1965, sales and excise taxes were the biggest category of revenue for governments in Canada. For every dollar in such taxes, just 68 cents was collected in personal income taxes. But by 2024, that ratio had flipped, dramatically. In that year, for every dollar in sales and excise taxes, $1.90 was collected in personal income taxes.
That underscores Canada’s overreliance on personal income taxes. In 2023, personal income taxes in Canada equalled 12.7 per cent of GDP, half again as high as the OECD average of 8.3 per cent.
And to make matters worse, income taxes (both personal and corporate) do more damage to the economy than consumption taxes. In essence, Canadian governments have perversely chosen to grow increasingly dependent on the most painful forms of taxation.
The CD Howe Institute study, among others, aims to rectify that imbalance. The authors propose cuts to personal income tax rates, and a reduction in the number of tax brackets to three from the current five. The top rate would drop to 26 per cent from the current 33 per cent. The authors also propose an opt-in simplified tax credit for individuals, replacing the current welter of deductions.
The authors of the CD Howe Institute study propose cuts to personal income tax rates and reducing the number of tax brackets from the current five to three.Giordano Ciampini/The Canadian Press
Corporate income taxes would also be cut, with one option being to slash the rate to 10 per cent from the current 15 per cent. The authors would at the same time eliminate carve-outs such as the small business rate. Another, more radical proposal is to cut the corporate tax rate to 13 per cent – but apply it only when profits are distributed.
Those changes would boost economic growth, but the study predicts there would still be at least a short-term shortfall in tax revenue: $24.5-billion from the changes to personal income taxes, and up to $15-billion for the changes to corporate taxes. To close that gap, they propose increasing the GST and introducing a new employer-paid payroll tax, notionally to pay for health care costs.
Before increasing any taxes, however, governments need to squeeze their own spending, starting with business subsidies. Some of those handouts would be eliminated as various loopholes are closed. But author Jack Mintz estimated that the federal government could find another $12-billion in business subsidies to eliminate, closing nearly a third of the revenue gap.
The remainder would need to come from somewhere, and the least economically damaging source is the federal sales tax. (A payroll tax is best avoided, particularly one that masquerades as health care funding.) In addition, there would need to be offsets for low-income households.
The economics are sound, but the politics are challenging to say the least, in asking voters to support a higher GST so that corporate taxes can be cut. Which brings us to the next part of the Big Bang theory.
The recent CD Howe Institute study estimates that a "Big Bang" approach to tax reform could boost investment by $140-billion, increase GDP by $79-billion and increase annual tax revenue by $26-billion.Justin Tang/The Canadian Press
The Big Bang Theory, Part II
Frederick the Great, who ruled Prussia in the latter half of the 18th century, espoused a famous axiom of military strategy: He who defends everything, defends nothing. The converse is equally true. It is easier to prevail against a dispersed defence.
The Prussian King’s military axiom is good advice not just for 18th-century infantry formations, but for fiscal reform, too. One of the big problems with any overhaul of taxation is that the voices of those opposing changes often prevail.
The reasons aren’t hard to figure out. Pro-growth tax policies that eliminate special preferences will eventually pay off, with broad economic growth. But those gains are diffuse and will take time to materialize. In the meantime, the pain is immediate, and often concentrated. Small businesses, for instance, would undoubtedly protest the elimination of their preferential tax rate, even though the economic drawbacks of that preference are obvious.
Governments are often tempted to roll out reforms piecemeal, to avoid too much controversy at one time. But, as Frederick could attest, that is a strategic mistake, allowing the opponents of change to concentrate their efforts.
By contrast, a Big Bang approach simply presents too many moving targets. In addition, a comprehensive set of reforms allows government to make the case that while an individual or business may be on the losing end of a particular reform, they will benefit from others.
Stephen Poloz, former Bank of Canada governor, has advocated for ending the practice of giving federal benefits to households who are paying taxes.Ashley Fraser/The Globe and Mail
Far better, then, to bundle those changes together. Former Bank of Canada governor Stephen Poloz made that case earlier this month at a Globe and Mail Intersect event in Calgary, in which he discussed a Big Bang approach to tax and fiscal reform, including cuts to personal and corporate income taxes, and an increase in the GST. (Mr. Poloz also advocated for ending the practice of giving federal benefits to households who are paying taxes. It would make much more sense to simply raise the floor at which taxes kick in, leaving those households no worse off – but lowering administrative costs, he said.)
“You can’t propose any one of those things,” Mr. Poloz told the Calgary audience. “If you said, let’s increase the GST… why, you’d get slaughtered.” The Mulroney government found that out the hard way in the early 1990s when it introduced the GST, he noted. By contrast, New Zealand paired its introduction of a consumption tax in the mid-1980s with substantial income tax cuts.
Mr. Poloz had one other excellent piece of advice on tax reform: Just do it. “So why don’t we just simplify it all, all one night, midnight?” he asked, only partly rhetorically. “And you say, here’s the math, you’re better off. Oh, look at that, everyone’s better off. That’s a day.”
Bang on.