Nobody cares about the high cost of compliance for those who conspire to use a loophole, but we should all care about the high cost of compliance for everyone else who must navigate the same laws at great risk. Our priority should be high wages not high compliance costs.
A flat tax that applies to all entities and to all types of income is more efficient, equitable and transparent. Government policy can be implemented through personal refundable credits which payout regardless of income, and therefore do not create loopholes. For example, personal refundable credits could be provided to seniors or those with disabilities. Personal refundable credits could also be used to provide a basic minimum income which could reduce the administration costs of other social programs such as the Canada Pension Plan and Employment Insurance.
A flat tax is often suspiciously viewed as a method to reduce the top marginal rate of the wealthy. But the wealthy are not paying the top marginal rate and they never will as long as we continue to tax some dollars at lower rates than others. When income is very high, the cost of artificially organizing your income into lower tax rates becomes relatively small. Meanwhile, another person could have the same organization for entirely authentic reasons. There is no spirit of the Income Tax Act that can be summoned to decide which organization is authentic and which is a sham. The Income Tax Act was written by many people, each of whom, would elaborate differently.
The opaque complexity of the Income Tax Act has grown with reckless abandon. For example, subsection 125(7) limits certain income eligible for the small business deduction to an amount that the minister will determine without explanation or recourse. You have to expect a culture of corruption when the law is riddled with uncertainty.
In 1969, the Carter Commission boldly stated that "a buck is a buck" and proposed to tax capital gains at the same rate as regular income. The government retreated from implementing this simplification in the face of overwhelming opposition and we have being going in the wrong direction ever since. A flat tax is politically viable when you choose the correct rate and refundable credits, or in the words of George Bernard Shaw, "a government which robs Peter to pay Paul can always depend on the support of Paul."
We cannot implement government policy with income tax incentives because high income can always find a disingenuous way to the incentive. There would be no reason to move income from one entity to another entity, re-characterize that income, or determine intentions if every dollar of income paid the same amount of tax. A loophole works because it copies an otherwise valid structure approved by law. You can only get rid of the loophole by removing the incentive as well, and that is done with a simple flat tax.
Joe Milla, CPA, CA