Aldyen Donnelly: Carbon taxes: helping to shift the tax burden from the rich to the poor

Canadian newspapers repeatedly report that "most" Canadian economists favour GST increases and carbon taxation to finance new income tax cuts.

It is true that "most economists" feel that increasing the GST and/or taxing carbon emissions and using the new revenues to cut income taxes is an appropriate modification of Canada’s tax system. The problem is that they are wrong.

These are the same economists who forecast that if Canada taxes carbon, investors will respond with a wave of new capital investment to modify Canadian manufacturing operations to avoid the carbon tax. In their models, capital never flees in response to new taxes–instead, they believe, it floods into the higher tax environment. If the economists’ theory is correct, of course, then we should never have bailed out Ontario’s auto sector.  All we really needed to do to rejuvenate our auto sector was to hike taxes on aluminum, iron, steel, plastic and glass–key inputs in auto manufacturing. 

You see, according to the theory espoused by our economists, taxing inputs to prohibitive price levels makes new investment flow into Canada. Of course, this is obviously bunk–consensus economics–but bunk.

In a society that believes in certain basic standards of welfare, to be efficient, the tax regime has to be at least neutral if not progressive. Taxes on the consumption of luxury goods can be progressive. But taxes on the consumption of essential goods and services (including energy) always eat up more of the disposable income of poor families than wealthy ones.

Let’s take energy, for example. The poorest 20% of Canadian families spend over 13% of their disposable income (that is income after GST rebates and income support receipts) on energy. 50% of those families do not own even one car, so do not have the option of driving less to cut energy expenses. 70% of those families rent their homes in buildings in which they have little to no control over appliance, heating and cooling system choices. 

Meantime, the wealthiest 40% of Canadian families spend only 2.5% of their disposable income on energy, even though they operate, on average, 1.65 homes and 2.5 cars per family. Their average annual disposable incomes are 11 times the disposable incomes (including government support payments and GST rebates) for the poorest 20%.

So, by definition, any GST increase and/or carbon tax-subsidized income and corporate tax cuts represent an overall tax burden shift from the rich–who benefit most from the income tax cuts–to poorer families.

Don’t worry, say the leftie pro-GST economists. We can use the new GST and/or carbon tax revenues to cut taxes and increase income support to poor families.

Of course, this is where the inefficiency comes in. First, they say, we should shift tax burden to the poor from the wealthier taxpayers. Then we should administer expensive government programmes to return the recent tax increase in the form of income support, GST and home heating rebates to the very tax-payers to whom we just shifted burden. If it costs 10 cents on the dollar to collect the tax and 20 cents on the dollar to administer the programmes designed to give the tax back to the poor families from whom we just collected it, we have made our overall tax system much less efficient. And unless we only hire low income Canadians to work for CRCA, with 30 cents on each collected dollar going to the employees administering the tax system and rebate programmes, we will never have enough spare cash to adequately mitigate the impact of the tax shift to the poor.

In the late1980s/early 1990s, Great Britain and a number of northern European nations elected to increase the rate and coverage of value-added taxes and introduce environmental/new energy taxes to finance corporate and personal income tax cuts.

In 1996, with a sense that something was not quite right, the then-Conservative government commissioned a study of the impact of the UK tax system on families and households. This study has since been undertaken annually. By 2000, the UK and most EU governments realized that their early-1990s income to consumption tax shifts made their tax systems both more regressive and inefficient.

In Budget 2001, the UK Parliament cut the VAT on non-industrial energy purchases  and other essential commodities to 5% (when the standard VAT on consumption was 17%) and committed to shift the basis of taxation in the UK from consumption back to income over the next 10 years. Many other EU nations also elected to massively discount the VAT rate on non-industrial energy consumption around the same time.

In 2003, the 27 member states of the European Union passed an "energy tax" directive into law that also provides for an 100% exemption from ALL ENERGY TAXES (not just emission taxes) for fuel and electricity consumed by any "energy intensive businesses", where "energy intensive" is any business for which energy costs account for 3% or more of operating costs. A tax shift that is bad for poor families has also proved a shift that is bad for small businesses that never paid much in income tax in the first place, especially energy intensive ones.

While UK Budget 2007 accurately boasts that real energy prices (including taxes) were finally down to historical lows, that budget also acknowledges that other actions required to address the highly regressive nature of the UK tax regime had not progressed.

I find the UK Treasury’s annual report entitled "The effects of taxes and benefits on household income, 200x/0x" most enlightening.

Note especially:

  • Table 3 (page 7), showing that consumption taxes ("indirect taxes") ate up 26.9% of the disposable income of the poorest Brit Families and only 14.3% of the disposable income of the wealthiest 20%. Largely due to the consumption tax bias of the system, total taxes ate up 36.4% of the gross income of the poorest 20%, and only 35.5% of the gross income of the wealthiest 20% of families.

 

  • Bottom line is that the wealthy pay out about 2.5 times more in consumption taxes than the poor, but the wealthy family incomes in the UK are 16 times poor family incomes in the first place (the wealthy to poor family original income ratio is 11 in Canada).

 

  • The inefficiency of such a system is well-illustrated in Figure 4 on page 9 of the report. This figure shows that the bottom 2/3rds of Brit families receive more benefits in kind and cash from government than the value they remit in income and consumption taxes, every year.

Obviously, it would be more efficient for the UK to simply to exempt 2/3 of all families from all forms of consumption tax and to finance any further support low income families need through the income tax system. We should not tie up so much in taxpayer resources paying middle to high income salaries to individuals whose government jobs are essentially no more than recycling tax receipts back to the families from whom those revenues were just collected.

I estimate that the UK might actually find they could cut the marginal income tax rate on the highest Brit income earners after they fully exempted the bottom 2/3 of income earning families from all forms of consumption tax, after realizing operating savings from the termination of the lion’s share of government tax revenue recycling programmes.

But Canada’s leading economists still believe that taking Canada farther down the UK’s tax system path is both effective and efficient–10 years after the UK Parliament realized their income to consumption tax shift was a grave mistake.

I wonder what our economists are reading in their spare time.

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