Patrick Grady
"Say no to Ontario Tax Separatists,"
Globe and Mail June 20, 2000, p.A17.

Ontario Minister of Finance Ernie Eves proposed tax changes in his budget last month that go far beŽyond what is allowed under the tax-collecŽtion agreement. The real losers from his proposed."Made For Ontario" tax system will be Ontario taxpayers, who will get stuck with 'a separate, unnecessary and 'complicated Ontario tax form to fill out. The Canadian economic union will be anŽother loser, weakened by the decreased harmonization of provincial income taxes.

This issue surfaced from the arcane world of intergovernmental finance at a tax conference held 10 days ago at Queen's University by the Institute of InŽtergovernmental Affairs. Federal and proŽvincial government officials and academics who were there talked of little else, both in the formal sessions and in the hallways.

The long festering controversy goes back to Mr. Eves' 1997 budget when the threat was first made. In response, a Federal Provincial Committee was set up to look into provincial grievances over the Tax Collection Agreement. In October 1998, the Committee issued a report that was accepted by the federal and provincial governments. This opened up the new possibility for provinces to levy their income taxes on taxable income as reported on the tax form and not on basic federal tax as they had in the past.

The new "tax on income" system has many advantages over the old "tax on tax" system that it replaces. It will give provinces more flexibility to pursue their own economic and social priorities through the tax system. It will insulate them from the destabilizing impact on their revenues of federal tax rate changes (there was nothing that provincial finance ministers hated more than to hear the federal minister announce on budget night that provincial taxes will be lower and provincial deficits higher. And it should enable the provinces to simplify the complex web of tax credits and deductions, and flat taxes that has grown up as a result of creative provincial efforts to get around the constraints imposed by "tax on tax." Still Ontario wants more: it not only wants tax on income, it wants to be able to define income so it can pursue its own objectives.

In their 1999 and 2000 budgets, provincial governments have started to gear up for 2001 when "tax on income" will become a reality. All seemed to be going well enough until May 2 when Mr. Eves announced proposals for three seemingly innocuous tax changes. It was only at Queen's that the wide-ranging implications of these changes were revealed and entered the public debate. The problem with these three proposals is that they involve changes in the definition of income and hence went well beyond what is permitted under Tax Collection Agreement even with the new "tax on income" system.

The first of these proposed change would lower the inclusion rate for capital gains to 50 per cent; the second would provide for deductions up to $100,000 per year for capital gains on stock options for research workers; and the third would provide a 30-per-cent bonus deduction on flow through shares for Ontario eligible mining exploration expenses. (With flow-through shares, tax deductions and credits, normally available only to a corporation, are given to the owners of shares.) Ontario's capital gains proposals, in particular, have wide ranging implications for the overall income tax system, extending to individuals, trusts and corporations.

But these proposals are not the end of the story. Ontario Minister of Intergovernmental Affairs Norman Sterling confirmed participants' worst fears when he replied to a question at the Queen's Conference. Mr. Sterling said that the Ontario 2000 budget's changes in the definition of income are only the beginning.

The main argument against allowing the change in the treatment of capital gains - apart from the administrative difficulties resulting from different definitions of income - is that it could be the leading edge of the wedge that will result in the elimination of tax on investment income across the country. If given the chance, investors will find a way to take their capital gains in the lowest tax jurisdiction. This would obviously not be viewed as equitable by Canadians. On the other hand, the main argument in favour of reducing the tax on capital gains is that it is the best way to encourage the growth of the dynamic new economy sectors. This is one of the reasons the federal government itself is moving to reduce the capital gains inclusion rate.

But governments often overestimate the impact on the economy of tax tinkering. And why must Ontario force the pace?

The Federal Government has established the Canadian Customs and Revenue Agency with a mandate to collect revenues for the provinces as well as the federal government. The CCRA will administer new harmonized "taxes on income" for the provinces,generally for free. This is the way the Federal Government subsidizes the preservation of a harmonized tax system. The CCRA can also administer non-harmonized provincial taxes but for the full cost.

The CCRA could thus administer the proposed "Made for Ontario" tax system. but would appropriately'be required by the guidelines to charge Ontario the full cost of administering the entire Ontario income-tax levy. By all accounts this is un-acceptable to Ontario, and could lead Ontario to establish its own system of tax administration. This could cost as much ks $500-million, much more than Ontario taxpayers would save. In either case, a separate Ontario tax form would be required.

If Ontario were to leave the Tax Collection Agreement, it would serve to balkanize the Canadian personal income tax system. Quebec with its separate income tax would become the model of Canada's future. This would further fragment the economic union. And of course there would be the extra income tax form we all don't want to fill out.

If Ontario persists with its proposal for a "Made For Ontario" tax system, the Canadian personal income-tax system will be balkanized. Quebec, with its separate income tax, will become the model for Canada's tax future. The economic union will be further fragmented. And last but not least, there will be the bothersome matter of that extra income-tax form we all don't want to fill out.