Archived - Tax Expenditures and Evaluations - 2005: 1

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Preface

Since 2000, the tax expenditure report has been separated into two documents. This document, Tax Expenditures and Evaluations, is published on an annual basis. It provides estimates and projections for broadly defined tax expenditures as well as evaluations and descriptive papers addressing specific tax measures. This year's edition includes a paper entitled "Marginal Effective Tax Rates on Business Investment: Methodology and Estimates for Canadian and US Jurisdictions."

The companion document, Tax Expenditures: Notes to the Estimates/Projections,was published in 2004. It is a reference document for readers who wish to know more about how the estimates and projections are calculated and who want descriptions of or information on the objectives of particular tax expenditures. New tax expenditures, as well as changes to existing tax expenditures, since last year's report are described in the relevant section of this document.

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Part 1  
Tax Expenditures: 
Estimates and Projections

Introduction

The principal function of the tax system is to raise the revenues necessary to fund government expenditures. The amount of revenue raised is determined to a large extent by tax bases and tax rates. It is also a function of a range of measures-special tax rates, exemptions, deductions, rebates, deferrals and credits-that affect the level and distribution of tax. These measures are sometimes called "tax expenditures" because they have an impact on government revenue (i.e. they have a cost) and they reflect the policy choices of the Government.

In order to determine these tax expenditures, it is necessary to establish a "benchmark" tax structure that applies the relevant tax rates to a broadly defined tax base-e.g. personal income, business income or consumption. Tax expenditures are then measured as deviations from this benchmark. Reasonable differences of opinion exist about what should be considered a normal part of the tax system and hence about what should be considered a tax expenditure. For example, a deduction for expenses incurred in earning income is generally considered as part of the benchmark and thus not as a tax expenditure. But, in some cases, the deduction may confer some personal benefit, making its classification ambiguous.

This report takes a broad approach and includes estimates and projections of the revenue loss associated with all but the most fundamental structural elements of the tax system, such as the progressive personal income tax rate structure. As a result, this includes not only measures that may reasonably be regarded as tax expenditures but also other measures that may be considered as part of the benchmark tax system. The latter are listed separately under "memorandum items." For instance, the dividend gross-up and credit is listed under this heading because its purpose is to reduce or eliminate the double taxation of income earned by corporations and distributed to individuals through dividends. Also included under this heading are measures for which there may be some debate over whether they should be considered as tax expenditures or where data limitations do not permit a separation of the tax expenditure and benchmark components of the measure. This approach provides information on as full a range of measures as possible.

Caveats

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

• The estimates and projections are intended to indicate the potential revenue gain that would be realized by removing individual tax measures. They are developed assuming that the underlying tax base would not be affected by removal of the measure. However, this is an assumption that is unlikely to be true in practice as the behaviour of economic agents, overall economic activity and other government policies could change along with the specific tax provision.
• The cost of each tax measure is determined separately, assuming that all other tax provisions remain unchanged. Many of the tax expenditures do, however, interact with each other such that the impact of several tax provisions at once cannot generally be calculated by adding up the estimates and projections for each provision.
• 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 and projections address strictly the federal tax system and federal tax revenue.
• 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.

The tax expenditure estimates and projections presented in this document are developed using the latest available taxation data. Revisions to the underlying data as well as improvements to the methodology can result in substantial changes to the value of a given tax expenditure in successive publications. In addition, estimates and projections for some tax measures, such as the half inclusion rate on capital gains, are particularly sensitive to economic parameters and hence may also differ significantly from one publication to the next.

What's New in the 2005 Report

A number of new tax measures have been proposed or legislated since last year's report and others have been modified. These are described below.

Personal Income Tax

Adoption Expense Tax Credit

Objective: This measure provides tax recognition to parents for costs that are unique to the decision to adopt a child.  (Budget Plan, 2005)

In order to provide tax recognition of the exceptional costs of adoption, Budget 2005 proposed a 16% non-refundable tax credit to recognize specified adoption expenses, up to a maximum of $10,000.

This measure, which applies for the 2005 and subsequent taxation years, allows adoptive parents to claim a range of eligible expenses such as adoption agency fees, legal expenses, and travel and living expenses for the child and the adoptive parents.

Basic Personal Amount

Budget 2005 increased the basic personal amount, the amount that all Canadians may earn without paying federal income tax, to $10,000 by 2009, and made corresponding increases to the amount for a dependent spouse or common-law partner and the equivalent amount for an eligible dependant.

Child Disability Benefit

Budget 2005 increased the maximum annual Child Disability Benefit to $2,000 from $1,681 per child beginning in July 2005.

Disability Supports Deduction

Budget 2005 proposed to expand the list of expenses eligible for the disability supports deduction, introduced in Budget 2004, to include costs such as job coaches, deaf-blind interveners and Braille note-takers.

Disability Tax Credit

Budget 2005 proposed a number of changes to the disability tax credit (DTC), including:

• Extending eligibility for the DTC to individuals who face multiple restrictions that together have a substantial impact on their everyday lives.
• Amending the DTC to ensure that more individuals requiring extensive life-sustaining therapy on an ongoing basis are eligible.

Medical Expense Tax Credit

Budget 2005 proposed to double the maximum amount of medical and disability-related expenses that can be claimed by caregivers to $10,000 from $5,000.

Non-Taxation of Veterans' Income Support Benefit

Objective: The provision recognizes that these benefits provide a basic level of support to veterans.

Beginning in 2006, as part of the modernization package for Canadian Forces veterans and their families, veterans may be eligible to receive the Canadian Forces Income Support Benefit. This tax-free benefit provides income support to those who have completed rehabilitation and are able to work, but who have not yet found employment.

Non-Taxation of the Veterans' Disability Award

Objective: The provision recognizes that these benefits compensate for the non-economic effects of a veteran's service-related disability.

Beginning in 2006, as part of the modernization package for Canadian Forces veterans and their families, veterans may be eligible to receive a tax-free lump-sum Disability Award payment. This compensates Canadian Forces veterans for the non-economic effects of a service-related disability, such as pain and suffering, functional loss, and the loss of enjoyment of life. It will replace the current veterans' Disability Pension for those with new service-related disabilities.

Refundable Medical Expense Supplement

Budget 2005 increased the maximum amount of the refundable medical expense supplement to $750 from $571 per year.

Registered Pension Plan and Registered Retirement Savings Plan Limits

Budget 2005 increased the limits for registered pension plans (RPPs), registered retirement savings plans (RRSPs) and deferred profit sharing plans (DPSPs) as follows:

• The money purchase RPP annual contribution limit will be increased to $19,000 for 2006, $20,000 for 2007, $21,000 for 2008 and $22,000 for 2009. Corresponding increases will be made to the maximum pension limit for defined benefit RPPs, bringing it to $2,111 for 2006, $2,222 for 2007, $2,333 for 2008 and $2,444 for 2009.
• Because RPP limits are based on current year earnings while RRSP limits are based on prior year earnings, the RRSP limits are lagged one year behind the corresponding RPP limits. Accordingly, the RRSP annual contribution limit will be increased to $19,000 for 2007, $20,000 for 2008, $21,000 for 2009 and $22,000 for 2010.
• The DPSP limit will remain at one-half of the money purchase RPP limit.
• The limits will be indexed to average wage growth, starting in 2010 for RPPs and DPSPs, and in 2011 for RRSPs.

Corporate Income Tax

Deferral of Tax on Patronage Dividends Paid by Agricultural Cooperatives

In order to improve the capitalization of agricultural cooperatives, Budget 2005 proposed a measure to allow members of agricultural cooperatives to defer paying tax on patronage dividends they receive in the form of shares until the shares are disposed of.

Objective: Agricultural cooperative corporations play an important role in rural communities. To aid their capitalization, Budget 2005 proposed to allow members of such cooperatives to defer paying tax on patronage dividends paid to them in the form of eligible shares rather than as cash distributions. (Budget Plan, 2005)

Cooperatives can distribute earnings to their members in the form of patronage dividends, which are paid in proportion to the amount of business the member has undertaken with the cooperative. In computing its income, a cooperative may deduct patronage dividends paid to its members. Accordingly, income paid out in the form of patronage dividends is not subject to tax at the cooperative level. Patronage dividends received by a member, other than those received in respect of consumer goods and services, are included in the recipient's income and are taxable in the year they are received.

This measure permits eligible members of eligible agricultural cooperatives to defer the inclusion in income of all or a portion of any patronage dividend received as an eligible share until the disposition (or deemed disposition) of the share. Eligible shares must be issued after 2005 and before 2016.

This measure is considered a tax expenditure because it constitutes a departure from the benchmark system by allowing members of eligible agricultural cooperatives to defer the inclusion in income of patronage dividends received in the form of shares until the disposition (or deemed disposition) while other patronage dividends are usually included in the recipient's income and are taxable in the year they are received.

Goods and Services Tax

Expanded Goods and Services Tax/ Harmonized Sales Tax Health Care Rebate

Public hospitals are entitled to an 83% rebate of the goods and services tax (GST) and the federal portion of the harmonized sales tax (HST) that they pay on purchases used to provide exempt health care services. The 2005 budget announced the extension of the application of the 83% rebate to eligible charities and non-profit organizations in respect of the GST and federal component of the HST paid on purchases related to their health care services that are similar to those traditionally performed in hospitals. Further, eligible entities-including public hospitals-that incur substantially all of their GST/HST on goods and services for use in respect of the supply of health care services now qualify for the 83% rebate on all of their GST and the federal component of the HST that they incur. These measures have been legislated and are effective January 1, 2005.

The Tax Expenditures

Tables 1 to 3 provide tax expenditure values for personal income tax, corporate income tax and the goods and services tax for the years 2000 to 2007.

Estimates and projections are developed using the methodology set out in Chapter 1 of Tax Expenditures: Notes to the Estimates/Projections (2004).^[1] The economic variables used to develop the estimates and projections are based on the private sector average forecast presented in the February 2005 budget.

The 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 and projections are reported in millions of dollars. The letter "S" indicates that the cost is less than $2.5 million, "n.a." signifies that data is not available to support a meaningful estimate/projection, and a dash means that the tax expenditure is not in effect. The inclusion in the report of items for which estimates and projections are not available is warranted given that the report is designed to provide information on measures included in the tax system even if it is not always possible to provide their revenue impacts.

Work is continuing to obtain quantitative estimates and projections where possible. For example, in previous years, data limitations prevented the split between the scientific research and experimental development and Atlantic investment tax credit of investment tax credits claimed in the current year but earned in prior years (carry-forwards) as well as investment tax credits earned in the current year but applied against prior years' taxes (carry-backs). With the availability of new data, it is now possible to provide an estimate of the cost of these carry-forwards and carry-backs. As a result, the total cost of each of these measures can now be provided more accurately.

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Note:

1. Available on the Department of Finance Canada website at www.fin.gc.ca. [Return]

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