Tax Expenditures and Evaluations: 2001: 1

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Preface

As announced in 2000, the Tax Expenditures report is now separated into two documents. This document, Tax Expenditures and Evaluations, is being published on an annual basis. It provides estimates and projections for broadly defined tax expenditures as well as descriptive papers on tax expenditures.

This year's edition includes a paper entitled "Present-Value Tax Expenditure Estimates of Tax Assistance for Retirement Savings."This analysis was prepared in response to a request from the Auditor General for alternative estimates that would show the lifetime cost to the government of contributions made in a given year to tax-assisted retirement savings (TARS) plans. In contrast, the tax expenditure estimates for TARS plans published in previous editions of this document are measured on a cash-flow basis. These estimates capture the loss of tax revenue in a given year associated with contributions and withdrawals in that year as well as foregone tax revenue on accumulated investment income on all past contributions. The two sets of estimates provide complementary information and both will be presented in this document, starting with this edition.

The companion document, Tax Expenditures: Notes to the Estimates/Projections, was published last year. It should be used as a reference document by readers who wish to know more about how the tax expenditures/projections are calculated or by readers who seek information on the objectives and descriptions of particular tax expenditures. New tax expenditures are described in the relevant section of this document.

Part 1

Tax Expenditures:
Estimates and Projections

Estimates and Projections of Tax Expenditures

While there is agreement on the conceptual definition of tax expenditures, there is no widely accepted operational methodology for estimating them. A range of methodologies exists internationally, some restrictive, others very broad. The broadest of the available options is to estimate tax expenditures as all deviations from a benchmark tax system. Typically, these deviations take the form of exemptions, deductions, rate reductions, rebates, credits, deferrals and carry-overs.

The approach used in this document is to provide as much information as possible to the reader by reporting any deviation from a very basic benchmark system. This allows the reader to decide whether or not a particular item qualifies as a tax expenditure. These deviations from the tax system are reported in two parts: one includes a list of all items that could be considered tax expenditures under a very broad definition; all other deviations from the benchmark tax system are reported as memorandum items.

Caveats

Care must be taken in interpreting the estimates and projections of tax expenditures in the tables for the following reasons.

• Tax expenditures are values of tax revenues forgone to achieve a variety of economic and social objectives. Whether or not the magnitudes of tax expenditures are appropriate depends upon an evaluation of the underlying social and economic policies. The values reported in the tables provide no information to permit such an evaluation.

• The cost of each tax measure is estimated separately, assuming that all other tax provisions remain unchanged. Many of the tax expenditures do, however, interact with each other, so the impact of several tax provisions at once cannot generally be calculated by adding up the estimates for each provision.

• The estimates assume all other factors remain unchanged (i.e., there is no allowance for behavioural changes, consequential government policy changes or changes in aggregate economic activity in response to the change in the tax expenditure).

• In addition to these considerations, the projections are subject to forecast error and are "best efforts" that have the same degree of reliability as the variables that explain them.

• The federal and provincial income tax systems interact with each other to various degrees. As a result, changes to tax expenditures in the federal system may have consequences for provincial tax revenues. In this publication, however, any such provincial effects are not taken into account – that is, the tax expenditure estimates address strictly the federal tax system.

• In the case of the harmonized sales tax in effect in Nova Scotia, New Brunswick, and Newfoundland and Labrador, only the federal cost of the tax expenditures is reported.

It should also be noted that, on occasion, the estimated or projected change in the value of a tax expenditure in this report does not coincide with the fiscal impact of a measure estimated in the budget. For example, this report shows that the cost of the partial inclusion rate for capital gains increased by $1 billion between 2000 and 2001. This increase is due to the reduction in the inclusion rate from three-quarters to two-thirds announced in the 2000 budget and the subsequent reduction to 50 per cent announced in the October 2000 Economic Statement and Budget Update. However, the economic statement estimated that together these two changes would cost only $300 million more for that same period. For a defined set of transactions, the reductions in the capital gains inclusion rate raise tax expenditures and lower budgetary revenues by the same amount. But the lower inclusion rate is expected to induce additional realizations, which increases both revenue and the tax expenditure. In other words, the rate reduction and the additional realizations have offsetting impacts on budgetary revenues (estimated in the budget) while they both raise the tax expenditure estimate (reported in this document).

A second example is the change in the partial exemption of scholarship, fellowship and bursary income that was also announced in the 2000 budget. The cost of this change was estimated at $30 million for the 2000 tax year. In contrast, the associated tax expenditure provided in this document shows an increase of only $21 million in 2000 compared to the previous year (to $27 million from $6 million). In this case, the apparent disparity is largely a matter of presentation. The total cost of this measure shown in the budget is spread over two or more categories in the Tax Expenditures report. The 2000 budget estimate of $30 million consists of the additional $21 million that will be claimed by students and a further $9 million that will either be carried forward or transferred to parents and claimed by them. These amounts are shown separately in the Tax Expenditures report.

What’s New in the 2001 Report

The October 2000 Economic Statement and Budget Update, as well as other announcements during the past year, made a number of changes which affect the value of tax expenditures. Of particular note are the changes in both personal and corporate tax rates that determine the benchmark against which tax expenditures are measured. These rate changes, therefore, affect a large number of tax expenditures. A tax-rate reduction lowers the value of tax expenditures in the year the change is introduced but this is generally followed by growth in their value over time in line with increases in the size of incomes. These changes, together with others that affect specific tax expenditures, are described below.

Personal Income Tax

Reduction of personal income tax rates effective January 1, 2001

• The 17-per-cent rate was reduced to 16 per cent.

• The 24-per-cent middle tax rate – reduced from 26 per cent in the 2000 budget – was reduced further to 22 per cent.

• The 29-per-cent top tax rate was reduced to 26 per cent on incomes between about $60,000 and $100,000.

• The top tax rate of 29 per cent applies to incomes in excess of $100,000.

• The deficit-reduction surtax was eliminated.

Increased assistance for those who need it most

• Effective July 2001, the Canada Child Tax Benefit for low- and middle-income Canadians increased by an additional $100 per child over the $200-per-child increase in the 2000 budget. Combined with indexation, these increases will bring the maximum benefits for the first child to more than $2,500 by 2004.

• Effective January 2001, the disability tax credit amount was raised to $6,000 from $4,293.

• Effective January 2001, the credit amount for caregivers of dependent relatives who are elderly, infirm or disabled was raised to $3,500 from $2,386.

Enhancement of measures to reward entrepreneurship and innovation

• The capital gains inclusion rate reduced from three-quarters to two-thirds on February 28, 2000 – was cut further to one-half on October 18, 2000. Consistent with this change, the deduction for employee stock options was increased from one-third to one-half.

• Tax-free rollovers were expanded and made available to more businesses. The size of eligible investment increased to $2 million from $500,000 and the size of businesses eligible for the rollover increased to $50 million in assets from $10 million.

Increased assistance to students

• Effective January 1, 2001, the education amount on which the education credit is based doubled from $200 to $400 per month for eligible full-time students and from $60 to $120 per month for eligible part-time students.

New measures to encourage growth and job creation

• Effective January 1, 2001, self-employed individuals may deduct the portion of Canada Pension Plan (CPP) and Quebec Pension Plan (QPP) contributions that represents the employer’s share (measure described in detail below).

• A temporary investment tax credit is provided at a rate of 15 per cent for specified mineral exploration expenses incurred in Canada pursuant to a flow-through share agreement. The flow-through share investor will be able to use this tax credit to reduce federal tax otherwise payable on eligible expenses incurred prior to 2004 (measure described in detail below).

Political contribution tax credit

• For 2000 and subsequent years, the political contribution tax credit is earned at a rate of 75 per cent on the first $200 contributed (previously $100), 50 per cent on the next $350 (previously $450) and 33 1/3 per cent on the next $525 (previously $600). The maximum credit is $500 and is available when the taxpayer has contributed $1,075.

Business Income Tax

Legislated timetable for rate reductions

• The October 2000 Economic Statement and Budget Update set out a timetable for fulfilling the government’s commitment to reduce, by 2004, the federal corporate income tax on business income not currently eligible for special tax treatment, from 28 to 21 per cent¹. Specifically, the federal corporate income tax rate, which was reduced by one percentage point from 28 to 27 per cent, effective January 1, 2001, as part of the February 2000 budget, will be further reduced by two points for each of the next three years to 21 per cent in 2004.

Reduced capital gains inclusion rate

• The capital gains inclusion rate – reduced from three-quarters to two-thirds on February 28, 2000 – was cut further to one-half on October 18, 2000.

Political contribution tax credit

• For 2000 and subsequent years, the political contribution tax credit is earned at a rate of 75 per cent on the first $200 contributed (previously $100), 50 per cent on the next $350 (previously $450) and 33 1/3 per cent on the next $525 (previously $600). The maximum credit is $500 and is available when the corporation has contributed $1,075.

Non-deductibility of advertising expenses in foreign media

• Pursuant to the Canada-U.S. agreement of June 3, 1999, expenses for advertisements published in issues of periodicals after May 2000 that contain at least 80 per cent original editorial content are fully deductible, and advertising expenses in other periodicals are 50 per cent deductible. Previously, the deduction of such advertising expenses was precluded to the extent that the expenses were incurred for advertisements directed at the Canadian market in periodicals that did not meet certain Canadian ownership criteria.

Surtax on the profits of tobacco manufacturers

• Tobacco manufacturers are subject to a special surtax on their profits. The surtax rate has been increased from 40 per cent to 50 per cent of the Part I tax on profits from tobacco manufacturing, effective April 6, 2001.

Description of New Tax Expenditures

Two tax provisions have been introduced since the companion document, Tax Expenditures: Notes to the Estimates/Projections, was last published. They are:

Employment

Canada and Quebec pension plan deduction for the self-employed

Objective: This measure ensures that self-employed individuals are not disadvantaged relative to an owner-operator who is also an employee of the corporation. (Economic Statement and Budget Update, October 2000)

Under the Canada Pension Plan and Quebec Pension Plan (C/QPP), self-employed individuals are required to pay both the employer and employee portions of C/QPP contributions. As of January 1, 2001, self-employed individuals are permitted to deduct the portion of C/QPP contributions that represents the employer’s share.

Small Business

Federal tax credit for flow-through share investors

Objective: To promote mineral exploration activity, particularly in rural communities across Canada that depend on mining. (Economic Statement and Budget Update, October 2000)

This temporary investment tax credit is available to individuals (other than trusts) at a rate of 15 per cent of specified surface "grass root" mineral exploration expenses incurred in Canada pursuant to a flow-through share agreement. The flow-through share investor will then be able to use this tax credit to reduce federal tax otherwise payable. This new credit will apply to specified expenses incurred by an individual pursuant to a flow-through share agreement made after October 17, 2000, in respect of expenses incurred by the corporation after that day and before 2004. This non-refundable credit will reduce the cumulative Canadian exploration expense pool for years following the year in which it is claimed.

The Tax Expenditures

Tables 1 to 3 provide tax expenditure values for personal income tax, corporate income tax and the goods and services tax (GST/HST) for the years 1996 to 2003.

Estimates and projections are developed using the methodology set out in Chapter 1 of the companion document, Tax Expenditures: Notes to the Estimates/Projections². In this case, however, the economic variables used to develop the projections are based on the private sector average forecast presented in the May 2001 Economic Update.

Personal income tax expenditures are grouped according to functional categories. This grouping is provided solely for presentational purposes and is not intended to reflect underlying policy considerations.

All estimates are reported in millions of dollars. The letter "S" indicates that the cost is less than $2.5 million while "n.a." signifies that data are not available. The inclusion in the report of items for which estimates are not available is warranted given that the report is designed to provide information on the type of assistance delivered through the tax system even if it is not always possible to provide a quantitative estimate.

Work is continuing to obtain quantitative estimates where possible. For example, in the past, data were not available on the tax expenditure provided to registered charities and non-profit organizations (NPOs), since they did not file a tax return. However, NPOs have been required since January 1, 1993, to submit information returns to the Canada Customs and Revenue Agency (CCRA) if their income exceeds $10,000 or their assets exceed $200,000. With a number of years of data from the NPO returns now available, it has become possible to produce a tax expenditure estimate for NPOs for the first time. As this is not the case for registered charities, the heading "Non-Taxation of Registered Charities and Other Non-Profit Organizations" has now been broken down in the 2001 publication.

A further example is Oil Sands Tax Expenditures. A more detailed examination of this subject has been undertaken and is available in working paper 2001-17, "Oil Sands Tax Expenditures," on the Department of Finance Web site³. The results in this study supplement the analysis reported on pages 75-81 in the 2000 Tax Expenditures: Notes to the Estimates/Projections document.

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^1.This lower rate does not apply to mutual fund corporations, mortgage investment corporations, investment corporations, small business and Canadian manufacturing and processing income, and investment income that benefits from refundable tax provisions. Nor does the reduction apply to income from non-renewable natural resource activities. The government is consulting on options to extend the lower income tax rate to the resource sector while at the same time improving the tax structure.  [Return]

^2. Available on the Department of Finance Web site at http://www.fin.gc.ca.  [Return]

^3. Department of Finance Web site: http://www.fin.gc.ca/activty/wp-dt/2001-17e.html.  [Return]

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