A Better Way to Tax Savings
by Michael Boyd
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We are a country with a low annual growth, a declining rate of personal savings, increasing consumer indebtedness and a growing pool of retirees. Those facing retirement fear that their retirement benefits will prove inadequate. Given this, the very last thing Canada needs is a corporate tax regime that encourages corporate indebtedness. What we need is a tax treatment of dividends advantageous to Canadian savers.
In Canada we treat the interest on corporate debt as a deductible expense before tax but we do not do the same for dividends. Dividends are used to distribute the profits to the shareholders who own the company and are paid out of corporate earnings that have already been taxed, only to be taxed again in the hands of the investor. Our tax structure provides those shareholders receiving dividends with a tax credit, which can be used to reduce tax paid on their other taxable income to provide compensation for the corporate tax already paid. Pension funds, our principal source of retirement savings, have no taxable income. To them, and to the retirees that rely on them, the credit is useless. The saver gets no compensation whatsoever. A tax structure which only taxes the income from equities has to be the single worst way to tax savings. To the saver, inflation is the enemy. Government bonds and corporate debentures do not help in this fight. They will inevitably be redeemed by inflated dollars declining in real value year by year. Today, ten-year Canada bonds pay 1.4% while the rate of inflation is at least 2-1/2%. Ownership is the answer; ownership in the shares of strong, well-managed companies. As corporations prosper, their dividends will increase providing the most effective protection against inflation. And yet interest payments are tax deductible for corporations and tax-exempt for savings plans, while dividends are not. This is seriously bad for the saver. No wonder pension funds are under-performing and many will not be able to provide the retirement benefits expected by their contributors. Most savers don’t even know that their savings portfolios have been indirectly taxed on the whole of the dividend income without any compensation for the corporate tax already paid. They only know that when they need them most, their savings will be taxed as income at their individual rate of income tax. So the saver suffers corporate tax on the dividends entering his savings portfolio and income tax on the capital he withdraws as a retirement benefit. In short, he is taxed twice. A tax that provides no incentive to save but encourages corporate indebtedness cannot be deemed wise. The sensible thing to do would be to equate the tax treatment of dividend income with that of interest on corporate debt. In other words, any taxable dividend paid to a shareholder would be deducted before corporate tax is computed and, when received by the shareholder, taxed as if it were interest payable on a bond. Then a dividend would have the same value for a pension fund as for any other investor, and no tax credits would be needed for anyone. An alternative would be to reduce the rate of taxation the retiree must pay on withdrawals out of his accumulated capital. In the 18th century, Adam Smith, in his famous “Principles of Taxation”, wrote “the tax which each individual is bound to pay ought to be certain and not arbitrary. The time of payment, the manner of payment, the quantity to be paid, ought all to be clear and plain to the contributor and to every other person.” A corporate tax should be a tax on corporate profits, not a clandestine method of taxing pension funds. If the government wants to tax pension funds and savings portfolios for fiscal reasons, then the tax should be a simple direct tax that is clear and plain to the saver and to every other person. This would be a better way to tax savings. The last time taxation was reviewed was over 40 years ago. The government should revisit this matter. We need a logical corporate tax system that has clarity, simplicity and transparency. This is in the interest of all Canadians, who some day may have to rely on their retirement benefits for a comfortable income. |
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