Archived - Tax Expenditures and Evaluations : 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 two analytical papers:

• "Taxes on Business Investment: An International Comparison of Marginal Effective Tax Rates in the Manufacturing Sector"
• "Investing in Post-Secondary Education: The Impact of the Income Tax System"

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 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 that reflect society’s priorities. The tax system can also be used directly to achieve public policy objectives through the application of special tax rates, exemptions, deductions, rebates, deferrals and credits that affect the level and distribution of tax. These measures are often described as "tax expenditures" because they reduce government revenue.

In order to define 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 defined 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. This includes not only measures that may reasonably be regarded as tax expenditures but also other measures that may be considered part of the benchmark tax system. The latter are listed separately under "memorandum items." For instance, the dividend tax 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 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 a full range of measures.

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 2006 Report

A number of new tax measures have been introduced since last year’s report and others have been modified. These are described below.

Personal Income Tax

Personal Income Tax Rates

The lowest personal income tax rate was reduced to 15 per cent from 16 per cent effective January 1, 2005. The rate is 15.5 per cent effective July 1, 2006. Accordingly, the full-year rate is 15 per cent for 2005, 15.25 per cent for 2006, and 15.5 per cent for the 2007 and subsequent taxation years.

For the 2005 taxation year, the 15-per-cent rate applies to taxable incomes of up to $35,595. For the 2006 taxation year, the 15.25-per-cent rate applies to taxable incomes of up to $36,378. The upper limit for the application of the 15.5-per-cent rate is indexed for taxation years after 2006. These rates will also be generally used to calculate non-refundable tax credits and the alternative minimum tax for the 2005 and subsequent taxation years.

Basic Personal Amount

The basic personal amount was increased by $500 to $8,648 for the 2005 taxation year. For the first half of 2006, it was increased by indexation plus a further $200, for a total of $9,039. The basic personal amount was reduced by $400 to $8,639 on July 1, 2006. For the purpose of calculating personal income taxes for the 2006 taxation year, these two half-year amounts are applied as an annual average of $8,839. For 2007, the $8,639 amount is increased by indexation plus an additional $100. For 2008, it is increased by indexation plus an additional $200.

Personal amounts in respect of a spouse or common-law partner or wholly dependent relative were also adjusted. Specifically, for the 2005 taxation year, these amounts were increased by $425 to $7,344. For the first half of 2006, they were increased by indexation plus a further $170, for a total of $7,675. The amount was reduced by $340 to $7,335 on July 1, 2006. For the purpose of calculating personal income taxes for the 2006 taxation year, these two half-year amounts are applied as an annual average of $7,505. For 2007, the $7,335 amount is increased by indexation plus an additional $85. For 2008, it is increased by indexation plus an additional $170.

Pension Income Credit

Budget 2006 provided greater tax relief to pensioners by increasing to $2,000 from $1,000 the maximum amount of eligible pension income that can be used in calculating the pension income credit. This measure applies to the 2006 and subsequent taxation years.

Pension Income Splitting

Objective: This major positive change in tax policy for pensioners will enhance the incentives to save and invest for family retirement security.

The October 31, 2006, Tax Fairness Plan proposes to allow pension income splitting commencing in 2007. The measure will allow any Canadian resident who receives qualifying pension income to allocate to their resident spouse or common-law partner up to one-half of that income.

Age Credit

The Tax Fairness Plan increased the age credit amount, a credit that provides tax relief to low- and middle-income seniors, by $1,000 from $4,066 to $5,066. This increase is effective for the 2006 and subsequent taxation years. The credit amount will continue to be indexed thereafter.

Canada Child Tax Benefit and Child Disability Benefit

The Canada Child Tax Benefit (CCTB), which includes the CCTB base benefit and the National Child Benefit supplement, as well as the Child Disability Benefit (which was shown separately), are no longer included in this publication, reflecting changes to the presentation of government financial information. Acting on a recommendation by the Auditor General of Canada, the Government now presents its financial statements on a gross basis to more accurately reflect the nature and size of its revenues and expenses. Previously, the CCTB and its components were netted against personal income tax revenues, and were considered a tax expenditure. The CCTB and its components are now reported as government expenses.

Refundable Medical Expense Supplement

Budget 2006 increased the maximum amount of the refundable medical expense supplement to $1,000 from $767 per year, effective 2006.

Textbook Tax Credit

Objective: To encourage Canadians to pursue post-secondary education by providing better tax recognition for the cost of textbooks.

This new measure provides $65 per month for full-time students, and $20 per month for part-time students, in textbook tax credit amounts. Students receive a credit on these amounts, in recognition of the costs of post-secondary textbooks.

Full Exemption for Post-Secondary Scholarships and Bursaries

Budget 2006 introduced a full exemption for post-secondary scholarship, fellowship and bursary income. The conditions that apply to the full exemption are the same as those that applied to the $3,000 exemption: the scholarship, fellowship or bursary must be received by a student in connection with a student’s enrolment in a program for which the student can claim the education tax credit.

Canada Employment Credit

Objective: This new tax credit recognizes work-related expenses incurred by Canadians for items such as home computers, uniforms and supplies.

This new credit, which took effect July 1, 2006, provides tax relief on the lesser of $500 and the individual’s employment income for the year. Because this measure took effect on July 1, 2006, the maximum amount on which the credit is calculated for the 2006 taxation year is $250. For the 2007 and subsequent taxation years, the maximum amount on which the credit is calculated is increased to $1,000. The tax credit for a taxation year is calculated by reference to the lowest personal income tax rate for the taxation year (i.e. 15.25 per cent for 2006 and 15.5 per cent for the 2007 and subsequent taxation years). The amount on which the credit is based is indexed after 2007.

Tradespeople’s Tool Expenses

Objective: To provide tax recognition for the cost of tools that tradespeople must provide as a condition of employment and to encourage apprenticeships.

Budget 2006 allows the total cost of eligible new tools acquired by an employed tradesperson in a taxation year, in excess of $1,000 (indexed after 2007), to be deductible up to a maximum of $500 for that year. For the cost of tools to qualify for the deduction, the employer will have to certify that the employee is required to acquire those tools as a condition of, and for use in, the employment. This measure applies to new tools acquired on or after May 2, 2006.

Children’s Fitness Tax Credit

Objective: To help parents offset some of the costs associated with registration fees for children’s sports, thereby promoting physical fitness and healthy living among children.

Budget 2006 will allow parents to claim a non-refundable tax credit in respect of up to $500 in eligible fees for the enrolment of a child under the age of 16 in an eligible program of physical activity. The measure will apply to the 2007 and subsequent taxation years. The credit will be calculated by reference to the lowest personal income tax rate for the taxation year and can be claimed by either parent for eligible fees incurred during the calendar year.

Mineral Exploration Tax Credit
for Flow-Through Share Investors

In October 2000, a 15-per-cent tax credit was introduced to help moderate the impact of a global downturn in mineral exploration on mining communities by promoting exploration. This tax incentive, available to individuals investing in flow-through shares used to finance exploration, expired on December 31, 2005, after two extensions.

Budget 2006 reintroduced the credit for the period from May 2, 2006 until March 31, 2007. The one-year "look-back" rule will allow funds raised with the benefit of the credit in 2007, for example, to be spent on eligible exploration activity up until the end of 2008.

$500,000 Lifetime Capital Gains Exemption for Qualified Fishing Property

Budget 2006 extended the $500,000 lifetime capital gains exemption available on the transfer of farm property and small business shares to qualified fishers. This measure applies to the disposition of fishing property on or after May 2, 2006.

Eliminating Double Taxation of Large Corporation Dividends

Budget 2006 eliminated the double taxation of dividends from large corporations at the federal level by introducing an enhanced gross-up and dividend tax credit (DTC) for dividends paid after 2005 by large corporations. Specifically, starting in 2006, shareholders will include 145 per cent of the eligible dividend amount in income (that is, a 45-per-cent gross-up), and the federal DTC with respect to eligible dividends will be approximately 19 per cent of that grossed-up amount.

Tax Credit for Public Transit Passes

Objective: The new transit tax credit will make transit more affordable, reduce traffic congestion and lower greenhouse gas emissions.

Budget 2006 allows individuals to claim a non-refundable tax credit for the cost of monthly public transit passes or those passes of a longer duration effective July 1, 2006. Specifically, it will be claimable by the individual, or the individual’s spouse or common-law partner, in respect of eligible transit costs of the individual, the individual’s spouse or common-law partner, and the individual’s dependent children that are under 19 years of age.

Corporate Income Tax

Accelerated Elimination of the Federal Capital Tax

The federal capital tax was eliminated as of January 1, 2006, two years earlier than originally scheduled. The tax was levied at a rate of 0.125 per cent in 2005 on taxable capital in excess of $50 million.

Apprenticeship Job Creation Tax Credit

Objective: To encourage employers to hire new apprentices and to support apprentices in their training, the Government has created a new Apprenticeship Job Creation Tax Credit of up to $2,000 per apprentice.

In order to encourage employers to hire new apprentices, Budget 2006 introduced a new Apprenticeship Job Creation Tax Credit, effective May 2, 2006. Eligible employers will receive a tax credit equal to 10 per cent of the wages paid to qualifying apprentices in the first two years of their contract, to a maximum credit of $2,000 per apprentice per year.

Elimination of the Federal Corporate Surtax

The federal corporate surtax will be eliminated for all corporations in 2008. Its elimination is equivalent to a 1.12-percentage-point reduction in corporate income tax rates.

The corporate surtax applies to all corporations and is calculated at a rate of 4 per cent of federal corporate income tax payable after the 10-per-cent abatement for income earned in a province, but before credits such as the small business deduction and credits for foreign taxes paid.

Increase of the Small Business Deduction

The small business deduction currently reduces the federal corporate income tax rate applied to the first $300,000 of qualifying active business income of a Canadian-controlled private corporation to 12 per cent.

The small business tax rate will be reduced by 1 percentage point by 2009. The tax rate will be reduced to 11.5 per cent in 2008 and then to 11 per cent in 2009 and thereafter. In addition, the annual amount of active business income eligible for the reduced tax rate (generally referred to as the small business limit) will be increased to $400,000 as of 2007.

Reduction of the General Corporate Income Tax Rate

The general corporate income tax rate will be reduced to 19 per cent from 21 per cent by 2010. The rate will be reduced to 20.5 per cent in 2008, to 20 per cent in 2009, and to 19 per cent in 2010 and thereafter.

Goods and Services Tax

Reduction in the Goods and Services Tax Rate

As announced in the 2006 budget, the goods and services tax rate was reduced by 1 percentage point as of July 1, 2006. The tax expenditure projections reflect this reduction.

Elimination of the Visitor Rebate Program

The Visitor Rebate Program is proposed to be eliminated effective April 1, 2007, as part of the package of specific spending restraint measures announced by the Government on September 25, 2006.

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) for the years 2001 to 2008.

Estimates and projections are developed using the methodology set out in Chapter 1 of Tax Expenditures: Notes to the Estimates/Projections.^[1] The economic variables used to develop the projections are based on the average of private sector forecasts presented in the May 2006 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.

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Note:

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

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