The end of April is traditionally the tax filing deadline, and a time when Canadians are frantically organizing their receipts and other documents from the past year to complete their personal income tax returns. This can be a costly and time-consuming process. Yet the cost of completing personal income taxes -- that is, complying with the personal income tax system -- is often ignored when people think about the financial burden of taxation.
The fact is, complying with Canada's personal income tax system imposes a significant cost on Canadian households. These costs come in the form of direct spending on things such as accounting services or computer software, and the financial cost of the time it takes to compile the materials and complete the forms. The consequence is Canadians have less time and money to spend on the things they care about like leisure, work, and time with family and friends.
A new study published by the Fraser Institute seeks to estimate how much it costs Canadians to comply with the personal income tax system each year. The numbers aren't trivial. According to our estimates, altogether Canadian taxfilers incurred nearly $7 billion in tax compliance costs in 2012.
What does this mean for average households and individual taxfilers?
This represents about $501 per Canadian household, or more than the average household's monthly grocery bill. As for individual taxfilers, we estimate that they incurred, on average, $217 in total compliance costs.
And the study finds that these costs are borne disproportionately by low-income Canadians who, as a share of their income, dedicate a greater percentage, 3.3 per cent, than high-income earners, 0.3 per cent, to tax compliance.
One of the main sources of the tax system's complexity is the long list of tax credits, deductions and other special preferences (known as tax expenditures) that has grown over the years. The number of tax expenditures in the personal income tax system (excluding corporate and sales taxes) is now over 100, covering a wide range of activities such as donating to a political party, purchasing textbooks, or volunteering as a firefighter.
Of course there are other factors such as the number of tax rates and differing treatment for different types of income that add to the tax system's complexity. But tax expenditures are certainly a major contributor. Claiming a tax credit or deduction typically requires a taxfiler to maintain receipts or fill out additional forms in order to be eligible. It can require complex calculations to sum up different types of spending over the course of the year or income earned in different jurisdictions. Sometimes people feel the need to hire a tax professional so that they don't miss any possible tax benefits. These are some of the reasons that claiming tax expenditures can contribute to higher tax compliance costs.
Our study seeks to better understand the extent to which these special tax measures increase tax compliance costs. We asked survey respondents whether they had used any tax expenditure from a list of 10 covering a broad cross-section of measures in the tax system such as the Children's Fitness Tax Credit and Public Transit Tax Credit, and then analyzed the results to estimate the effect on tax compliance costs.
After controlling for different factors such as age, gender, and income, we found that taxfilers who used at least one of the 10 tax measures spent, on average, 20.3 per cent more on tax compliance than those who didn't use any of them.
The list of tax expenditures used in our study is illustrative; other tax expenditures may carry higher or lower compliance costs. But our calculations show how tax expenditures add complexity to the personal income tax system and can contribute to higher tax compliance costs for average taxfilers.
What can be done to lower tax compliance costs? Broadly speaking, Canadian governments could reduce or eliminate tax policies that add complexity to the personal income tax system such as tax expenditures. Getting rid of ineffective credits, deductions, and other special tax provisions would not only simplify the personal income tax system, it could create room to lower personal income tax rates for everyone.
In the meantime, Canadians will continue to bear high costs to comply with our personal income tax system.
This piece was co-written by Milagros Palacios, Senior Research Economist, Fraser Institute.
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