.

Introduction

Generally speaking it is difficult to discern any coherent philosophy of taxation in modern society. Reference is often made to the principle of ability to pay. This principle, however, is violated as much by governments as it is variously and nebulously defined. For example, in Canada the federal government recently implemented a Large Corporations Tax which will be levied on corporate capital employed in Canada in excess of $10 million.[1] The government reasons that this will ensure that all large corporations pay a minimum amount of tax each year. Similarly, the Ontario provincial government recently implemented a "Tire Tax" of $5 on the purchase of each new, pneumatic tire, including each new tire that goes with the purchase of a vehicle.[2]

The increasing prevalence of such arbitrary and discriminatory forms of taxation is indicative of a number of developments. First of all, governments in general are rapidly losing control over fiscal and monetary policy.[3] Secondly, the ability-to-pay principle of taxation in and of itself has a self-negating tendency since its violation of individual property rights and suppression of production causes large-scale tax avoidance and manipulation. This in turn forces governments to focus more and more on taxable events that yield easily collectible revenues. The principle of ability to collect from those who have the least ability to resist taxation thus slowly erodes the ability-to-pay principle. Thirdly, state intervention in the economy, using revenues generated from a system of public finance based on the ability-to-pay principle, is inherently inefficient and counterproductive. More and more revenues are thus required to sustain less and less production and distribution of wealth. Short-term expenditures replace long-term investment. The ability-to-pay principle is an integral part of the growth of government fiscal deficits in North America. In Canada, governments have found it politically more acceptable to increase taxes incrementally than to cut expenditures. Hence the desperate attempts by tax officials and economists to find new sources of revenue.

Our educational institutions have also largely avoided any insightful analysis of the principles of taxation. The result is that politicians, for the most part, are woefully ignorant of the interrelation between tax systems and the functioning of the economy in general. This is rather astounding when one keeps in mind that total government revenues make up over 40% of the gross domestic product of Canada, and a little over 35% in the U.S. Most courses in taxation in the universities of Canada and the U.S. are primarily descriptive analysis of the current system. Indeed most tax research today is of the same character. I am rather pessimistic that genuine tax reform can emerge from this milieu.

It is not clear how far the arbitrary and confiscatory taxation of individuals can be pursued by governments without creating a tax revolt. Furthermore, tax revolts in themselves rarely lead to the formulation of economically rational and equitable tax policies - Proposition 13 in California being a prominent example. Historically, it has been the manner in which taxes are collected that has caused an otherwise sedate citizenry to become incensed. Nevertheless, the chaotic and arbitrary nature of taxation in Canada, plus its increasing incidence on worthwhile economic activity, will probably in the not too distant future bring about a fundamental re-evaluation of tax policy. What I wish to do in this paper is to give an overview of the philosophical direction that the reformation of tax policy ought to take in North America.

The principles of taxation

It is generally accepted that there are two principles of taxation - ability-to-pay and cost-benefit. The latter principle has usually been dismissed as theoretically deficient in twentieth century literature.[4] This is one reason why there has been a oneside emphasis on the ability-to-pay principle in contemporary philosophies of taxation. Genuine tax reform will, however, only be possible if we re-appraise the cost-benefit principle of taxation as a necessary aspect of a philosophy of taxation that promotes equity, economic efficiency, and ease in administration and compliance. At the same time, the ability-to-pay principle must not be discarded but interrelated with the cost-benefit principle. The unifying centre of a viable philosophy of taxation therefore treats the ability-to-pay and cost-benefit principles as interdependent and not mutually exclusive.

The interdependence of the principles of ability to pay and cost benefit is the great insight of the classical political economists Adam Smith and Henry George. In his much misinterpreted first canon of taxation, Smith advocated a concept of taxation based on ability to pay in proportion to benefits received.[5] The other three canons of taxation, which focus on such matters as certainty, convenience of contribution, and administrative efficiency all flow from this unifying principle. It is also interesting to note that Smith saw commodities taxation as something to which governments turn when it is no longer possible for them to tax people in proportion to their revenue.[6] In the modern history of taxation it has been generally true that governments turn to consumption taxes in time of fiscal crises, which are often engendered by negative forms of taxation. The double taxation of individuals on income, and then on after tax expenditures, represents the single most pervasive confiscation and infringement of individual property rights in modern industrial societies.

Henry George also advocated a system of taxation wherein benefits received are interrelated with ability to pay. The value of land and natural resources reflects benefits received from government expenditures, synergistic spillover, and the general progress of civilization. Community-created land values ought to be taxed back for the public treasury since these values not only indicate an ability to pay taxes but this is a form of taxation that bears the least upon production. The negative effect on production of the overtaxation of individual labour and capital is the chief concern of his first canon of taxation.[7]

George was not only concerned, however, with maximizing the productive capacity of civilization, but also with ensuring that the distribution of wealth is fair and equitable. What the individual creates from his own effort is his absolutely. What is created by nature is the community's absolutely. By focusing on the individual, and advocating a labour theory of value, George hoped to harmonize the interests of the producer and the consumer, which are traditionally put into an antagonistic relationship in economic thinking.[8] By releasing the productive forces of human labour from the bounds of monopolies over nature and from excessive in personam taxation, George saw the inherent harmony of the free individual realization of the potential of one's labour and the distributional justice of equal access to nature. The large-scale recapture for the public treasury of the economic rent of a country must therefore be an ineliminable element of any future philosophy of taxation.

As is well known, George proposed a single tax on land values to cover all the expenses of government. In the twentieth century, however, we have come to accept a greater role for the state in society than many hitherto envisaged. George had an organic theory of the state in which it is seen as primarily an administrative agency for certain necessary monopolies.9 This must be contrasted with the contractarian view of the state that has been prevalent in Anglo-American thinking. The state is now involved to a greater degree in the distribution and consumption of wealth than in assisting in its production. There is widespread recognition that state involvement in production is hopelessly inefficient and wasteful. This awareness is spreading throughout both welfare-capitalist and communist countries.

In the current environment it is necessary to combine both the contractarian and organic views of the state. This means community-created land values should be recaptured for the public treasury, but at the same time additional revenues will have to be raised from individuals and business enterprises in order to fund the services, such as health, education, social assistance and so on, which people expect in a modern day "social contract" with government. Nevertheless the taxation of individuals and business enterprises must be in accordance with the tax principle of ability to pay in proportion to benefits received and with the other canons of taxation laid down by Henry George and Adam Smith.

Application of the principles of taxation

Site Value Taxation

I need not dwell here on the positive effects that would result from the implementation of site value taxation at the local level. Unfortunately, in Canada there has been considerable movement away from the principle of taxing locational property values at the municipal level. Differentiated assessments are no longer done by provincially centralized assessment offices and site value taxation is not given serious or in-depth attention by government bureaucracies or academic researchers.[10]

Some of the reasons for the general intertia with regard to site value taxation in Canada are the same as here in the U.S. With municipal taxes on the market value of total property value, ratepayers are rarely given an opportunity to consider land separately from improvements. They therefore do not usually think it possible or practicable to differentiate between the two values.

Secondly, comprehensive land ownership data and land audits do not exist at the national, provincial, or even municipal levels. We thus have the same lacuna with regard to basic economic intelligence as in the U.S.

Thirdly, most taxpayers are not aware of the degree to which land price inflation factors into the general Consumer Price Index because it is disguised in the form of housing prices in general.

Fourthly, the fiscal crisis of many municipalities has been seemingly alleviated by increases in intergovernmental transfers from more senior levels of government, which rely heavily on progressive income and sales taxes, and by the transference of municipal responsibilities (fiscal, administrative, health, and social services, etc.) to provincial and federal levels of government.

Fifthly, land usage in the twentieth century has increasingly become subject to non-fiscal methods of control.[11] Planning Acts are now the chief regulatory instruments for land utilization, but this has led to pervasive political manipulation and corruption in urban land development.

Finally, most Canadian cities are younger than American cities and have yet to suffer to the same extent the inner city deterioration and inefficient urban sprawl that is the inevitable consequence of the under-taxation of site values and the over-taxation of capital improvements. At present Canadians are sanguine that there is something in our system of government and social ethos which immunes us from American style urban blight. Time, and liberal doses of taxation on improvements, will certainly chisel away at this myth.

It is to be hoped, then, that the movement towards modified forms of site value taxation in the U.S., such as the graded tax levied at the local level in a number of Pennsylvanian towns and cities, will be imitated in Canada. There is considerable underlying ratepayer disaffection with market value assessment on total property values in Ontario. It is, in my view, only a matter of time before this spills over into a more fundamental re-evaluation of taxation at the local level.

Redefining corporate income for tax purposes

The corporate income tax is a misnomer since it is really a tax on profits. Profits belong to individual shareholders and not to the corporation. The taxation of profits is therefore a tax on individuals and not a tax on corporations. In general, this tax has proved to be very unreliable and disappointing to provincial and federal governments in Canada. It now produces revenue that is less than one quarter of the revenue received from personal income taxes and one half that from sales and excise taxes at the federal level.[12] Numerous tax expenditures, especially the accumulated tax deferrals in the capital cost allowance system, and the internationalization of business, have led to the continual erosion of this tax base. This was, however, quite predictable given the error of taxing profits, if one takes the perspective of taxing businesses on the basis of ability to pay in proportion to benefits received.

Businesses benefit from the provision of government services and therefore ought to pay their fair share of the cost of such services. It is, for example, to the benefit of all businesses that the citizens of the country be healthy and well-educated. A tax on business enterprises should be considered as a cost of doing business and this cost ought to be added to the other costs incurred in the production of wealth or value-added, the tax system will not penalize those businesses which are the most efficient in the production of wealth, as does the profits tax.

The taxation of business income expended in the production of wealth, exclusive of goods and services purchased from other companies and of profits, conforms to both the ability-to-pay and cost-benefit principles. The ability to create wealth reflects the ability to pay of a business. It is, however, at the point where a business expends income in the creation of wealth that it benefits most directly from the provision of government services. Under such a business tax profits would thus attain their rightful place as an incentive to produce and costs would no longer be artificially inflated in order to avoid taxes.

The taxation of business income utilized in the production of wealth would restore accuracy and honesty to the accounting and legal professions. At the same time it would provide governments with a stable and reliable source of revenue. It would also be neutral with regard to capital and labour intensive companies. Furthermore, it would help restore the equity markets to their proper role in the financing of companies, which now rely to an inordinate degree on tax-induced debt financing. Like the tax on site values, this tax on business enterprises would be deflationary, job-creating, equitable, economically efficient, and easy to administer and comply with.

Proportional personal income taxation

Excessive reliance by governments on progressive personal income taxes .is confiscatory and an infringement of individual property rights. In recent years there has been a general recognition by governments that high marginal rates on personal income taxes are counterproductive and self-defeating. Technical and administrative tax reforms in Canada and the U.S. have resulted in a reduction in the number of tax brackets and a general lowering of the rates. Such reforms have not been the consequence of a principled reconsideration of the personal income tax system. Rather they have resulted from a view in the professional tax community that distortionary imbalances had entered into the overall public finance picture. Base broadening and rate reduction thus became the chief elements of tax reform.

The levying of taxes on the basis of ability to pay in accordance with benefits received means that personal income taxes must be proportional rather than progressive. Those who rely solely on the ability-to-pay principle see proportional personal income taxes as negating an important function of government, this being the redistribution of purchasing power in the economy of a country. This view is unsustainable, given the historical fact that there has been little equalization of economic opportunity in North America, and indeed wealth has become even more concentrated in recent years.13 There is also empirical evidence which shows that proportional taxation of individual earnings above the poverty line results in more tax revenues from higher income groups than under a progressive system. This is primarily because of the elimination of most tax expenditures, exemptions, deductions, and a reduction in the incentive to avoid taxes.

The ability to pay of individuals is enhanced by benefits received from the government. A low proportional tax on individuals earnings would help do away with the poverty trap in which many welfare recipients find themselves.14 Furthermore, it should be remembered that most nineteenth century political economists and social philosophers saw proportionality as integral to equality in taxation.[15] Since there is a rough correlation between benefits received and income, it follows that the taxation of individual earnings above the poverty line should be proportional.

Conclusion

The Canadian Research Committee on Taxation is of the view that it is necessary to take a global approach to tax reform. By taxing site values at the municipal level, business enterprises on income expended in the production of wealth, and individual earnings at a proportional rate at the provincial and federal level, sufficient revenues will be generated to do away with consumption taxes, and most other forms of counterproductive and arbitrary taxation of productive economic activity. We are advocating a single-rate of taxation on individuals and companies in order to avoid the artificial structuring of business organizations.

With the widespread implementation of site value taxation at the local level, which will promote economic activity and lessen the need for intergovernmental transfers, the rate of taxation on individuals and business enterprises could be kept relatively low. Canada's per capita debt is considerably higher than the U.S. state and federal deficits. The current and proposed sales taxes on goods and services will only add to the inflation rate which in turn will keep interest rates high and thus further exacerbate the problem of servicing the public debt. It is only through positive taxation that integrity will be restored to the systems of public finance in Canada. Only through the harmonization of tax policy with human nature and the entrepreneurial spirit of all individuals will genuine tax reform be achieved.

NOTES

[1] The Budget Speech, (Ottawa, Department of Finance, April 27, 1989), p. 10.

[2] 1989 Ontario Budget (Toronto, Ministry of Treasury and Economics, May 17, 1989), p. 17.

[3] See, for example, Peter F. Drucker, "The Changed World Economy," Foreign Affairs, Spring, 1986, who states that three fundamental changes have occurred in the world economy: i) the primary products economy has come "uncoupled" from the industrial economy, ii) in the industrial economy itself, production has come "uncoupled" from employment, and iii) capital movements rather than trade (in both goods and services) have become the driving force of the world economy.

[4] See, for instance, Report of the Royal Commission on Taxation (Ottawa, Queen's Printer, 1966), Vol. 3, p. 3, and E.R.A. Seligman, Essays in Taxation (London, Macmillan, 1919), pp. 71 et seq.

[5] Adam Smith, The Wealth of Nations (New York, Modern Library, 1937), pp. 777-778.

[6] "The impossibility of taxing the people, in proportion to their revenue, by any capitation, seems to have given occasion to the invention of taxes upon consumable commodities. The state not knowing how to tax, directly and proportionably, the revenue of its subjects, endeavours to tax it indirectly by taxing their expence, which, it is supposed, will in most cases be nearly in proportion to their revenue. Their expence is taxed by taxing the consumable commodities upon which it is laid out." Id. p. 821.

[7] Henry George, Progress and Poverty (New York, Double-day, 1909), p. 406.

[8] Frederic Bastiat, Economic Sophisms, tr. Arthur Goddard (New York, Nostrand, 1964) captures well the antagonism between seller and buyer: The former wants the goods on the market to be scarce, in short supply, and expensive. The latter wants them abundant, in plentiful supply and cheap", p. 14.

[9] Henry George, Open Letter to Pope Leo XIII, Vol. 3 Works (New York, Doubleday, 1906), pp. 81-82. "On the other hand, we who call ourselves single-tax men (a name which expresses merely our practical propositions) see in the social and industrial relations of men not a machine which requires construction, but an organism which needs only to be suffered to grow. We see in the natural social and industrial laws such harmony as we see in the adjustments of the human body, and that as far transcends the power of man's intelligence to order and direct the vital movements of his frame. We see in these social and industrial laws so close a relation to the moral law as must spring from the same Authorship, and that proves the moral law to be the sure guide of man where his intelligence would wander and go astray."

[10] For example, the Assessment Policies and Priorities Branch of the Ontario Ministry of Revenue frequently issues briefs which are completely devoid of any understanding of the concept of site value taxation. Academic research also treats the subject cursorily. For example, H. M. Kitchen's Local Government Finance in Canada (Toronto, Canadian Tax Foundation, 1984) devotes one page to site value taxation in a text of 495 pages, even though he appears to support the concept on the ground of economic efficiency, see p. 217.

[11] See, A. R. Prest, The Taxation of Urban Land (Manchester, Manchester University Press, 1981), p. 29.

[12] See, The Fiscal Plan: Controlling the Public Debt (Ottawa, Department of Finance, April 27, 1989), "Budgetary Revenue's", Table Ill, p. 132.

[13] For example, Statistics Canada in its Surveys of Consumer Finances for, 1984 reports that the lowest 20% of the population had a negative balance in net wealth, in other words they were in debt, while the top 20% had 69% of the net wealth of the country.

[14] The poverty trap is caused by the extremely high rate of taxation implicit in the transition from welfare to work. See Thomas Courchene, Social Policy in the 1990s: Agenda for Reform (C. D. Howe Institute, 1987), p. 83-89.

[15] For example, J. S. Mill, Principles of Political Economy (London, Longmans, 1886), p. 484, "Equality in taxation, therefore, as a maxim of politics, means equality of sacrifice. It means apportioning the contribution of each person towards the expenses of government, so that he shall feel neither more nor less inconvenience from his share of the payment than every other person experiences from his."