Thursday, March 15, 2007

Gong Show: Income Taxes

Okay, today I'm bringing the Canadian Income Tax system to the gong show for you to decide if it gets the gong. Here are the reasons why I think the Income Tax system should get the gong:

1) It is more complicated than necessary
2) It penalizes people for being innovative, for being more productive and for working harder.

I'm not talking about abolishing income taxes here but my biggest gripe is with the fact that our income tax system penalizes people who are trying to improve their family's well being and the general well being of our country. Let us use an example:
Imagine Bill. He owns his own company and he works hard to find new ways to serve his customers through better products and services. Lets pretend that Bill, because he works hard, makes a personal income of $100,000 per year. In BC, under our tax system, ignoring personal deductions, he pays $28,187 in income taxes, leaving him with $71,813 to feed, house, and cloth his family. This seems alright since Bill is a proud Canadian and doesn't mind paying some tax to help run his country and his average tax rate seems reasonable at 28.1%.

Bill is considering implementing a new service in his company and he would earn an extra $100,000 per year if he implemented this new service. His customers would be very well served and this would be a tremendous innovation for his industry. The drawback is that Bill would have to invest a little, risk losing his idea, work longer hours and be away from his family in order to implement this innovation. Bill does some figuring and looks at what he should do since his family could really use the money to pay for braces, education, a family vehicle and a family vacation. Bill figures that if he implemented his new service and worked the extra hours he would earn $100,000 extra per year, bringing his gross income up to $200,000. He also figures that he would go from paying a reasonable $28,187 in income taxes to paying an excessive $71,339 in income taxes and he would go from a net income of $71,813 to a net income of $128,661 - an increase of only $56,848 for all that investment, risk and effort - leaving him with an average tax rate of 35.7%.

Unfortunately, for his customers, Bill decides that the investment, risk, and extra work is not worth $56,848 per year and makes the choice to postpone the implementation of this service until it makes more sense.
This situation is actually all too common in Canada because successful and innovative people like Bill make economic choices everyday based on the net benefit to them, their company, and their family. Our tax system unfairly taxes the people who would likely create new jobs, invest in equipment and provide innovative new services given the right incentives. I'll talk more about our tax system again soon.

Find out your own personal tax rates here.

What do you think? Gong?

6 comments:

Warren said...

Dude, Bill needs to incorporate his business and employ some family members, write off some of his expenses, etc.

In short: Bill needs an accountant. :)

Overall I think the system for "regular employed workers" is a little too confusing and can be expensive at higher income levels. For small business owners I think our system is great.

mohican said...

No doubt Warren! Bill could avoid all of the extra taxation by implementing a few simple steps but I wanted to keep it simple for communication purposes.

There are limits to the amount of write offs and income splitting techniques that one can establish and I have met people in a similar situation to Bill who have exhausted all other tax avoidance measures and they often make the same choice Bill did.

The problem does creep in for high income earners who have the opportunity to do good work that is highly desireable for society. EG - Doctors, dentists, engineers, etc. They often choose to stay home because of 'net benefit' of the extra effort is far less than the 'net benefit' of the previous effort.

mohican said...

vineland said: Would he be better off if his wife joined him and he paid her half would they get taxed less this way (as individuals)?

In short - yes - he would be better off financially. Many people do make that type of choice and sacrifice other things to get ahead financially. As you are alluding, this choice does impact how many children people have.

Unknown said...

I completed my first corporate tax return this year and I am quite jaded by the tax system. Here are the biggest problems with the Canadian tax system IMO:

1) Complexity** (as mentioned) - I read a study that suggest 15% of US gov't revenue goes to pay for the IRS. Probably the same in Canada.

2) Politics - the tax system will never be simplified because there are so many special interest groups the government wants to please with special deductions and tax pass through allowances etc.

3) Zero sum work. Why do we need to calculate GST paid, then GST collected, then remitt $0 to the government? That $0 cost our country 4 hours of my time. Multiply by 10 million tax filers...

4) Structure impacts tax paid. My status as sole proprietor, corporation, salary vs. dividends impacts my total tax paid....why should the formula I use impact my tax paid?

**Complexity example A: if your own units of a mutual fund you have to calculate and track ongoing 'adjusted cost base' in order to calculate capital gains on sales or switches. So, for $100 capital gains this year I spent 2 hours calculating the ACB history for my two mutual funds. Multiply by 10 million mutual fund owners.

Warren said...

guy:
3) Zero sum work. Why do we need to calculate GST paid, then GST collected, then remitt $0 to the government? That $0 cost our country 4 hours of my time. Multiply by 10 million tax filers...

Also related to your complexity point, I heard several years ago that administration of the GST cost nearly half of what the government collected. Now that it has dropped to 6%, it must be around half.

I think I ranted on another thread about consumption taxes being the best and income taxes being the worst.

Guy, I don't know if there is software available, but its certainly made tax returns easier to complete and make sure they are done right for me. I'm a regular wage earner, but with a rental property, RRSPs, some other savings and stocks, etc.

I have recently been considering going out on my own as a consultant, since I'm starting to get punished (like Bill) for doing well as a regular wage earner.

The tools available encourage me to do so, by being able to incorporated. Of course there is risk, but I can't complain too much about the tax rates for small businesses.

Clarke said...

Nobody likes paying taxes, and lots of otherwise smart people are convinced that governments can keep doing everything they do now, with a lot less revenue.

The tax system here is really not that bad on small business people. For wage earners it can be rough. That being said, it tends to be roughest on the people with highest incomes, but regrettably these are the types that can afford to take the hit.