Through The Looking Glass: Why Tax Systems Are Complex

With tax day fast approaching it behooves us to look at our tax system a little more closely.  Many of us have fat returns that bristle with forms, schedules, receipts, and calculations that are baffling to the best of us.  How has this happened and is it inevitable?

Many years ago as a consultant to the Department of Finance I wrote a paper called, Why Things Get Complicated.  The bottom line of this paper can be summarized as follows:

•           The tax system delivers literally thousands of programs from child care credits to mining credits to scientific credits.  The tax system is a highly effective mechanism for the delivery of these programs.  If you were to deliver these systems through separate government departments the cost of delivery would be in the billions of dollars.  The flip side is that the tax legislation is the donkey that bears the burden of delivering theses systems.  The result is complexity.  Because each of these programs effect other areas of the legislation one program can cause thousands of adjustments to other provisions of the legislation (called consequential adjustments).  A tiny example:  recent reductions in the corporate income tax have resulted in equal reductions in the dividend tax credit. 
•       The tax system is better described in mathematical terms rather than in language.  There is a great deal of precision lost when mathematical formulae and algorithms are translated to English.  French is an even less precise language.  The result is that a number of linguistic errors creep into the legislation.  There are a number of tax forms that treat the legislation as intended rather than as described in text.  In fact, when the budget is published there is a plain English guide published next to the text to explain what the provision “really” means.   
•      Complexity is worst when the forms, rather than the legislation, are complex.  There are instances where a one-line budget provision will produce volumes of forms to give effect to the legislation.  If the forms that accountants and others have to fill out are relatively clear then no one much cares what the legislation says.  When you drive a car the interface is important.  It is not necessary to know what goes on under the hood. 
•      With existing computer technology the whole tax system could be “under the hood”.  An annual audit of the algorithms would assure taxpayers and Parliament that the model functions as intended in the legislation.  The output of the tax system could be as easy as a Turbo Tax questionnaire.
•      Some propose that a flat rate on income simplifies the tax process. It does not.  The problem with the tax system is not rates but in defining the income on which tax is to be levied.  If the definition of income includes the effect of all of the programs that the legislation delivers there will be no reduction complexity.  
•      A much simpler way to tax people is through consumption taxes such as the GST/HST program.  While the system highlights the tax burden every time an item is purchased the system is easy to administrate and difficult to defeat.  The tax is incremental in that each level of trade gets credit for taxes that are paid against taxes that are owing.  Only the highest level of trade pays the ultimate tax.  Keep the income tax to deliver the social programs that it delivers so well.  A reduction in the income tax will have an immediate positive cash effect on wage earners who have tax deducted at source.   For those who don’t earn enough income to pay income tax a credit system can be delivered by the income tax legislation to reimburse less fortunate taxpayers.  If forces everyone to be a registered taxpayer. My guess is that an NDP-Liberal government might implement such a system. 

All that said, happy tax day!

Bernie.