Canada: Finance Canada Answers to Frequently-Asked Taxation Questions

On September 17, 1999, the Canadian Department of Finance released questions and answers pertaining to the 1999 federal Budget, taxes, deficit/debt, economy, federal-provincial relations, financial services sector, and international issues. Selected excerpts of the Finance release are reproduced below:

The Department of Finance is the federal department primarily responsible for providing the government with analysis and advice on the broad economic and financial affairs of Canada. Its responsibilities include preparing the federal budget; preparing tax and tariff legislation; managing federal borrowing on financial markets; administering major federal transfers to the provinces and territories; developing regulatory policy for the financial sector; and representing Canada within international financial institutions.

Revenue Canada is responsible for Canadian tax, trade and border administration. Its responsibilities include assessing and collecting taxes, duties and levies; delivering social and economic benefits through the tax system on behalf of the Government of Canada, such as GST credits; administering trade agreements such as the North American Free Trade Agreement; and processing commercial goods and travellers at Canada’s international borders.

What are the government’s financial priorities?

The government’s priorities are investing in key areas such as health and knowledge and innovation, debt reduction and tax reduction.

The 1998 and 1999 budget actions and the EI premium rate reduction for 1999-2000 provide tax relief of $17.3 billion over the next three years. Over three-quarters of the new spending initiatives in the 1998 and 1999 budgets reflect two of the highest priorities of Canadians – increased funding for health care and for access to knowledge and innovation. But the government cannot simply ignore other program areas that need attention. That is why, for example, this government has set aside funding for crime prevention and research.

The government has been implementing a plan to promote productivity growth in order to improve the standard of living and quality of life for all Canadians. The elimination of the deficit and putting the debt-to-GDP ratio on a strong downward track, together with our commitment to low inflation, are key elements of that plan. This has created a healthy environment for business investment, which is crucial for raising productivity. Tax cuts over the next three years (a total of $16.5 billion announced in the 1998 and 1999 budgets) will provide increased rewards for work, saving and investment, and will enhance job creation and productivity. The 1999 budget also contains a number of measures (totalling more than $1.8 billion) that build on the Canadian Opportunities Strategy and support research and innovation.

Given limited resources, the 1998 and 1999 budgets focused on the most pressing problems. The cost of full indexation of the tax system is about $850 million in the first year, rising to over $4 billion annually in the fifth year.

Increasing the amount of income that Canadians can receive without paying taxes is an effective way of offsetting the lack of full indexation for those who need it most – low- and modest-income Canadians. The 1998 budget provided a $500 increase in the amount of income low-income Canadians can receive tax-free, while the 1999 budget increased this amount to $675 and extended this tax relief to all taxpayers. The greatest proportionate benefit of these increases goes to low- and modest-income Canadians – singles with incomes between about $8,000 and $20,000 and families with incomes up to $40,000.

The government is expecting to achieve a balanced budget or better in 1998-99, even after taking into account the $3-billion contingency reserve and $5.7 billion in new initiatives. This estimate is based on 1998-99 financial results to date (April 1998 through March 1999).

Looking ahead, the government’s fiscal plan incorporates prudent assumptions for interest rates and economic growth, as well as a $3-billion contingency reserve, to help ensure that balanced budget targets will be achieved even if economic circumstances turn out to be worse than expected. If economic conditions do not turn out to be as favourable as we have assumed, the buffer built into the prudent economic assumptions will be used. If the contingency reserve is not required, it will be used to pay down the debt.

A significant amount of tax relief has been provided to Canadians in the 1998 and 1999 budgets. Together, these budgets provide tax relief of $3.9 billion in 1999-2000, $6.0 billion in 2000-01 and $6.6 billion in 2001-02, for a total of $16.5 billion over three years. This reflects the government’s balanced strategy, which entails action on maintaining sound economic and fiscal management, investing in key economic and social priorities – such as health care, education and innovation – and providing tax relief and improving tax fairness for Canadians. Larger tax reductions would have jeopardized the government’s ability to address other priorities.

If we were to completely eliminate the GST, we would have to either drastically cut social spending or substantially increase income taxes – neither of which is an option.

With the sales tax harmonization agreements with the participating Atlantic provinces, Quebec's partially harmonized sales tax system and measures introduced to streamline the general operation of the GST/harmonized sales tax system, we have made significant progress towards a fairer, simpler and more efficient national harmonized sales tax system. The door remains open to other provinces to join the harmonized sales tax system when they are ready.

A national harmonized sales tax system is in keeping with the government's objective of promoting economic efficiency, international competitiveness and sustainable social programs through sound tax and fiscal policy.

The HST is a single, harmonized value-added tax that replaced the provincial retail sales taxes and the federal goods and services tax in Nova Scotia, New Brunswick, and Newfoundland and Labrador. Revenue Canada administers the HST, with the federal government and participating provinces jointly deciding on related policy and administrative issues.

A fundamental principle we are following in providing tax relief is to first look after those who need tax reductions the most – low- and middle-income Canadians.

As a result of the elimination of the surtax, middle-income Canadian families (i.e., those in the $30,000 to $60,000 income range) will get, on average, an 8.6-per-cent tax reduction while those in the $60,000 plus range will get a 4.5-per-cent reduction. As a result of the tax relief provided in the 1998 and 1999 budgets, a typical modest-income Canadian one-earner family of four that receives income of $30,000 or less will pay no net federal income tax. Middle-income families with incomes of about $45,000 will have their net federal income taxes reduced by 10 per cent and some will receive much larger reductions. Compare that with a one-earner family of four with an income of $100,000, whose federal income taxes will fall by less than 4 per cent.

A fundamental principle in providing tax relief is to first look after those who need tax reductions the most – low- and middle-income Canadians. This is why the tax reductions introduced in recent budgets reduce taxes proportionately more for low-income families.

The 1998 and 1999 package of tax changes provides $1.5 billion of tax assistance to low-income families, on top of the over $700 million of net assistance they already receive. Low-income Canadians thus pay no net income taxes, and will receive a total of $2.2 billion in tax assistance. A typical family earning $30,000 will enjoy a $500 reduction in federal income tax – that is, it will become a net recipient of federal benefits as a result of the 1998 and 1999 budget actions. In contrast, average middle-income Canadian families (i.e., those in the $30,000 to $60,000 income range) will get an 8.6-per-cent tax reduction, while those in the $60,000 plus range will get a 4.5-per-cent reduction.

The government has taken action and will continue to work to improve the fairness and efficiency of the personal income tax system. The Canadian income tax system is based on ability to pay. In this regard, high-income Canadians not only pay substantial amounts of tax, but also pay a higher proportion of their income in taxes.

While Canadian income tax legislation already limits the number of tax planning opportunities, the need for further measures to improve tax fairness and protect the revenue base is assessed on a continuing basis. For example, the 1999 budget introduced measures to prevent high-income individuals from reducing their taxes by income splitting with minor children. In addition, it proposed measures to increase the fairness of the rules governing investments in foreign investment funds and transfers to non-resident trusts.

Corporate income taxes are linked to corporate profits (just as personal income taxes are linked to an individual's income) and, therefore, they are sensitive to economic conditions. When corporate profits decline, corporate income tax revenues also tend to decline. This pattern was observed during the period from 1988 to 1992, when federal corporate income and capital taxes declined to less than $10 billion annually. When corporate profitability improves, as it has in recent years, corporate income taxes increase. Indeed, over the last few years, corporate income taxes have experienced the fastest rate of growth of all federal revenue sources, rising from less than $10 billion in 1993-94 to $22 billion in 1998-99.

In addition to federal income tax, corporations pay other direct taxes such as provincial income taxes, capital, payroll and property taxes. For example, the large corporations tax, a tax that is based on a corporation's capital employed in Canada, ensures that all large corporations pay taxes every year. In total, corporations paid almost $70 billion in direct taxes to all levels of government in 1997.

Why not raise revenues through an inheritance tax or other wealth tax?

Canada already has a number of elements of wealth taxation including the taxation of capital gains at death and property taxes. Overall, tax revenues from the ownership or transfer of property are substantial and are higher than in any other Group of Seven country.

Another important consideration in assessing a possible introduction of a new tax is the size of the potential revenue compared with expected administrative and compliance costs. Generally speaking, wealth taxes are complex and costly to administer and do not provide substantial revenues. For instance, combined revenues from estate, inheritance and gift taxes are less than one-half of 1 per cent of total government revenues in the Organization for Economic Co-operation and Development countries that operate them.

As part of its continuing effort to strengthen the fairness of the tax system, the government has introduced a number of measures to ensure that high-income Canadians pay their fair share of taxes. Examples include the prevention of income splitting with minors and an improvement in the rules governing the taxation of income earned through investments in foreign-based investment funds and transfers to non-resident trusts.

Lottery ticket sales and gambling proceeds already represent a significant source of income to provincial governments and charitable organizations, given that only half the money collected is returned to ticket buyers in prizes. As a result, there is already a considerable element of taxation to lottery and gambling proceeds.

Provincial lotteries also generate revenues indirectly for the federal government. The federal government has agreed to vacate the lottery field in return for annual payments by the provinces – $50.3 million in 1995-96. The federal government also receives about $70 million in net goods and services tax from provincial lottery corporations.

Reliable estimates of potential revenues from taxing lottery and gambling winnings are difficult to make. The tax expenditure arising from the non-taxation of lottery and gambling winnings is estimated to be in the range of $1.2 billion, but this assumes no other changes in behaviour or in the tax system. A substantial tax bite could affect lottery sales, thereby reducing revenues for lottery corporations, which are channelled back to provincial governments. The revenue potential would also be much lower if a threshold under which prizes would not be taxable were required for administrative reasons.

We must remember that CPP premiums are not taxes. Rather, they represent a contribution towards benefits that will be received in the future. The CPP was reformed in 1997 to ensure the sustainability of this key pillar of Canada’s retirement income system for current and future generations. The federal and provincial governments are joint stewards of the program. Both levels of government agreed on the 1997 reforms. The seventeenth actuarial report on the CPP and the panel of actuaries engaged to review this report reaffirmed that the 1997 changes are sufficient to sustain the CPP over the coming decades.

The federal income tax relief in the 1998 and 1999 budgets is substantial and more than offsets the impact of inflation in the coming years. Together, the 1998 and 1999 budgets provide tax relief of $3.9 billion in 1999-2000, $6.0 billion in 2000-01 and $6.6 billion in 2001-02, for a total of $16.5 billion over three years.

Most of the increase in revenues is attributable to economic developments and the interaction of the tax system with the growth in the economy. Between 1993 and 1998, nominal income, the base for our revenues, increased by $160 billion.

Over 1.6 million more Canadians are now employed compared to 1993 and they are paying taxes. More companies have returned to profitability following the recession of the early 1990s and they are also paying taxes.

Higher consumer spending also means higher sales tax revenues. In fact, policy initiatives since 1993 have had no net impact on budgetary revenues in 1998-99. The 1998 and 1999 budgets provide substantial tax reductions over the next three years. Together, the 1998 and 1999 budgets provide tax relief of $3.9 billion in 1999-2000, $6.0 billion in 2000-01 and $6.6 billion in 2001-02, for a total of $16.5 billion over three years.

The deficit is the amount by which government spending exceeds revenues in any given year. It represents the amount the government must borrow to cover its expenses.

The public debt is the accumulated total of all past annual deficits and surpluses since Confederation.

The debt-to-GDP (gross domestic product) ratio is expected to be 65.3 per cent in 1998-99, and then fall to less than 62 per cent by 2000-01. This compares to 71.2 per cent in 1995-96. So the debt is shrinking in relation to the size of the whole economy.

The cost of paying interest on the debt has dropped from a high of 36 cents of every federal revenue dollar to 27 cents.

Market debt – the portion of the debt outstanding and held by investors – is expected to decline to about $457 billion in 1998-99, down about $20 billion from its peak of $476.9 billion in 1996-97.

Printing money to pay down public debt has been tried in other countries with counterproductive results.

This kind of increase in the money supply fuels inflation. And because inflation diminishes the value of the money that lenders receive for their investments, they demand a premium in the form of higher interest rates.

Higher interest rates, in turn, dampen investment, economic growth and job creation. They also add directly to public debt charges and to more rapidly compounding debt and deficits.

Yes, in 1946 the net public debt in Canada exceeded 100 per cent of GDP, slightly higher than today. Of course, much of that debt had been accumulated to fight World War II. Once the war was over, Canadians were not content to let the debt stay so high. A combination of responsible fiscal policy and favourable economic conditions brought the debt-to-GDP ratio down continuously until the mid-1970s.

One key to reducing the debt ratio was keeping government deficits low or running surpluses. Another key was that early in the post-war period, economic growth was rapid while interest rates were low. Rapid growth meant that GDP grew quickly, while low interest rates slowed the growth of the debt. That made it easier to reduce the ratio of debt to GDP.

Since the mid-1970s, economic growth has slowed on average and, in many years, interest rates have been very high. Now, government spending is set using realistic assumptions about the economic outlook, and with a renewed commitment to fiscal responsibility. These changes will lead to a falling debt-to-GDP ratio, such as we enjoyed in the early post-war period.

When is low inflation going to create jobs and growth?

We are seeing the payoff. Although international economic and financial turbulence contributed to a moderation in growth in 1998, the economy has grown solidly since the middle of 1996. More important, more than 450,000 new jobs were created in 1998, the highest annual total since 1987. Strong job growth has brought the unemployment rate down to its lowest level in more than eight years.

Canadians paid a high price to get inflation down. However, we are beginning to reap the rewards of our low inflation policy. The success we have had in maintaining low inflation, together with the elimination of the deficit and our commitment to sound public finances, has brought interest rates down sharply since early 1995.

No. Past experience in Canada and abroad has taught us that inflation creates uncertainty and instability, and thus has a negative impact on economic growth and job creation. Canadians have paid a high price to get inflation down. Now we must make sure that we enjoy the benefits of low inflation.

Economists who have looked at the choices between alternative exchange rate systems – whether to have a fixed exchange rate, a monetary union or a flexible exchange rate – see that each system has its pros and cons.

The correct choice comes down to particular cases. Some countries will choose a fixed exchange rate or a monetary union, others will not. As for Canada, the majority of economists – both academics and business economists – believe that the arguments against a fixed exchange rate with the U.S. or entering into a monetary union with the U.S. outweigh the arguments in favour. Clearly, giving up a floating exchange rate would mean that Canada would have to give up an independent monetary policy. Specifically, Canadian interest rates would always be the same as U.S. rates. The last several years provide an example of the risks of losing that independence: if Canada had had U.S. interest rates and a currency pegged to the U.S. dollar over the last two years, we would not have experienced the robust growth that we did.

How does the federal government provide financial assistance to the provinces and territories in support of programs and services?

The federal government provides financial support to provincial and territorial governments principally by way of its transfer programs.

Every year the federal government transfers a significant share of its revenues to the provinces and territories. In 1999-2000 alone, provincial and territorial governments will receive an estimated $39.8 billion in federal transfer payments.

The federal government provides 95 per cent of its transfers to provinces and territories through three major transfer programs: the Canada Health and Social Transfer, the Equalization program and Territorial Formula Financing.

The federal government provides support to the provinces and territories specifically for health care – as well as for post-secondary education, social assistance and social services – by way of the Canada Health and Social Transfer (CHST).

The CHST is a block fund. It gives the provinces and territories the flexibility to allocate payments among social programs according to their priorities, while upholding the principles of the Canada Health Act and the condition that there be no period of minimum residency with respect to social assistance.

The 1999 budget announced that an additional $11.5 billion over five years would be transferred to the provinces and territories, to be designated specifically for health care. Provinces and territories have committed to spend this additional money on health.

In 1999-2000, the federal government will transfer $28.4 billion to the provinces and territories under the CHST. Of this amount, $13.9 billion will be in the form of a tax transfer and $14.5 billion in the form of a cash transfer.

A federal tax transfer involves the federal government ceding some of its "tax room" to provincial governments. Specifically, a tax transfer occurs when the federal government reduces its tax rates to allow provinces to raise their tax rates by an equivalent amount.

With a tax transfer, the changes in federal and provincial tax rates offset one another and there is no net financial impact on the taxpayer. However, revenues that would have flowed to the federal government flow instead to provincial governments.

A tax transfer has the same impact on federal and provincial budgets as a cash transfer. It represents forgone revenue to the federal government and additional revenue to provincial governments each and every year the tax transfer remains in effect. Tax transfers represent a growing source of revenue for provinces since they increase in value over time with growth in the economy.

Currently, some provinces receive more CHST per capita than others. This is largely due to previous expenditure restraint measures placed on the Canada Assistance Plan (CAP), one of the CHST’s predecessors. The cap on CAP limited the growth of payments to Ontario, Alberta and British Columbia.

When the CHST was introduced, the initial provincial distribution of payments reflected the shares provinces received of the CHST’s predecessors, including CAP.

The 1996 budget announced measures to reduce per capita CHST disparities among provinces by half in four years’ time. The 1999 budget accelerated this pace to fully restore equal per capita entitlements for all provinces in three years’ time. By 2001-02, all provinces will receive exactly the same amount of CHST per person – $960.

It is only right that all Canadians, regardless of where they live, receive equal federal support for health and other important social services.

The federal government’s Equalization program is specifically designed to provide federal financial support to Canada’s less prosperous provinces.

Equalization enables provincial governments to provide their residents with reasonably comparable levels of public services at reasonably comparable levels of taxation. Payments under the program are unconditional in that receiving provinces are free to spend them on public services according to their own priorities.

Equalization payments are calculated according to a formula set out in federal legislation. Provinces with revenue-raising capacity below a standard amount receive Equalization transfers from the federal government to bring their per capita revenue-raising capacity up to the standard.

In 1999-2000, provinces will receive an estimated $9.3 billion in Equalization payments from the federal government. Currently, seven provinces qualify for Equalization payments: Newfoundland, Prince Edward Island, Nova Scotia, New Brunswick, Quebec, Manitoba and Saskatchewan.

Yes. This program is called Territorial Formula Financing (TFF).

TFF is an annual unconditional transfer from the federal government to territorial governments. It is governed by agreements between the federal and territorial finance ministers and enables the territories to provide a range of public services comparable to those offered by provincial governments.

Although territorial governments have the authority to raise revenues by taxation, rentals and the sale of goods and services, the majority of their financial resources comes from the federal government through the TFF grant.

In 1999-2000, the federal government will transfer close to $1.3 billion to the three territorial governments: $490 million to the Northwest Territories, $500 million to Nunavut and $300 million to the Yukon.

In addition to TFF, the territories also receive funding under the Canada Health and Social Transfer (CHST) for health, post-secondary education, social assistance and social services. Almost $100 million in CHST will be provided to the territories by the federal government in 1999-2000.

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