canadian tax journal / revue fiscale canadienne (2012) 60:2, 509 - 28
Current Tax Reading
Co-Editors: Bev Dahlby, Tim Edgar, Jinyan Li, and Alan Macnaughton*
Richard M. Bird, Enid Slack, and Almos Tassonyi, A Tale of Two Taxes:
Property Tax Reform in Ontario (Cambridge, MA: Lincoln Institute of
Land Policy, 2012), 275 pages, ISBN 978-1-55844-225-2
The authors have produced a worthy tribute to Charles Dickens on the 200th anniversary of his birth. A Tale of Two Taxes is a page turner, with an intricate plot and a
surprising and (some may think) heroic conclusion. The two taxes are the residential
and non-residential property taxes in Ontario. The property tax has been called the
most hated tax in the United States. Perhaps this is true in the United States because
the Americans do not have a federal sales tax. In Canada, that distinction clearly
belongs to the goods and services tax/harmonized sales tax and provincial retail sales
taxes, but the property tax is probably the runner-up. Given the significant revenues
that are raised through the property tax in Canada and its key role in financing local
government, it is one of the most important taxes, but also the least studied. A Tale
of Two Taxes starts to fill the research gap and should be read by everyone interested
in local government finances in Canada.
The authors set the stage by recounting the historical development of the property tax in Ontario and its role in financing local government services and education
since 1793, emphasizing the interventions by the provincial government in regulating
the base for local property taxation. This has meant that the property tax has never
been a strictly local tax, especially since the provincial government started to play a
growing role in the financing of education, a process that culminated in its decision
to levy a province-wide property tax earmarked for education.
The book focuses on the changes to the Ontario property tax system that occurred in 1998 and why a seemingly sensible reform—the introduction of a market
value assessment (also known as a current value assessment)—resulted in a series of
other measures that largely offset the intended effects and arguably produced a
more complex and less transparent system of taxation than the preceding system.
The long intervals between reassessments of property values had produced large
inequities in the effective property tax rates across more than 36 different property
* Bev Dahlby is of the Department of Economics, University of Alberta, Edmonton, and fellow,
Institute for Public Economics. Tim Edgar is of Osgoode Hall Law School, York University,
Toronto, and the Faculty of Law, University of Sydney. Jinyan Li is of Osgoode Hall Law
School, York University, Toronto. Alan Macnaughton is of the School of Accounting and
Finance, University of Waterloo. The initials below each review identify the author of the review.
 509
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classifications, and even within given property classes. Particularly problematic
from an economist’s perspective were the relatively high effective tax rates on multi­
residential, commercial, and industrial property compared with residential property,
which resulted in ratios exceeding 5:1 in the city of Toronto and 1.5:1 in most municipalities. Removing the dispersions in the real effective tax rates meant that some
taxpayers gained a rate reduction only at the expense of other taxpayers. Naturally
this created a great deal of resentment, as well as a large number of appeals. Ultimately, the Ontario government backtracked on the reform process by introducing
a series of measures that capped rate increases and regulated relative tax rates on
different classes of property. The authors maintain that the voter backlash that
prompted these amendments was predictable, and the government should have
anticipated the political repercussions of adopting a method of assessment that
made the system more complex and less transparent, and in some cases may have
undone the intended effects of the reform. Although the book is about Ontario’s
attempts at reforming the property tax, it would have been useful to have comparisons
with the responses in other provinces that have also adopted market value assessment
and, like Ontario, have taken over the property tax to (nominally) fund education.
The residential property tax is unpopular because homeowners are confronted
with large tax bills at least once a year, and the linkage between the services that are
funded from the property tax and the payment of the tax to the municipality has
become weaker over time. But another source of unpopularity, which may not be
fully appreciated by most economists, is that the property tax is essentially a presumptive tax. Calculations of market value based on statistical models of sales data
of “similar” properties, or computations based on the potential income generated
by a property, always involve judgments of what is relevant for determining the
“true” value of a property. Differences between the actual sales value of a property
and its assessed value can occur if only because the sale takes place at a different
time in the year from the base date for the assessed value. The complexity of the
assessment process and the lags between the receipt of assessment notices, the setting of tax rates, and the determination of tax bills also contribute to the general
perception that even a well-run assessment system is “unfair.”
A Tale of Two Taxes also addresses the question of the ability of the property tax
to finance local governments in Canada. Large metropolitan governments across
the country have argued that the property tax is not adequate to finance the broad
range of services that modern cities are expected to provide. The authors report on
an econometric study of the tax sensitivity of the residential and non-residential
property tax bases of a group of local governments in the Greater Toronto Area.1
In general, higher tax rates erode tax bases, and consequently revenues do not increase at the same rate as the tax rate. If the elasticity of the tax base with respect to
1 See chapter 8.
current tax reading  n  511
the tax rate is −1.0, then a tax rate increase is completely offset by the reduction in the
tax base and total revenue does not increase. The government will be at the peak of
its Laffer curve or its “revenue hill.” If the elasticity of the tax base is greater than
−1 (say, −0.50), then tax revenues increase with higher tax rates, while if the elasticity is less than −1.0 (say, −1.25), then higher tax rates result in lower tax revenues.
Determining whether local governments are on the upward- or downward-sloping
sections of their property tax Laffer curves will indicate whether the property tax can
be used to finance more spending or whether the property tax has been tapped out
as a source of revenue. (These elasticities can also be used to determine the marginal
cost of raising additional revenues.) Although the study found that the elasticity
estimates vary a good deal across municipalities and with the different statistical
techniques that were employed, the elasticities are generally negative and greater
than −1.0 for both the residential and non-residential tax bases. That is, higher
property tax rates will generate more tax revenue. Of course, that does not mean
that property tax rates should be increased, but only that more revenue could be
generated through higher tax rates.
In the final chapter of the book, the authors propose some reforms to the Ontario
property tax system. They are keenly aware that any reforms must be perceived as
fair and yet must also reduce the current economic distortions caused by the very
high effective property tax rates on commercial and business properties. They propose the equalization of the tax rates on non-residential and residential properties.
To offset the resulting reduction in local tax revenues, they recommend that the
Ontario government eliminate the provincial property tax that is earmarked for
education so that local governments can take up the vacated tax room. Since they
anticipate a backlash against proposals that would shift the balance of the property
tax to homeowners, they suggest that the government consider the introduction of
a business value tax (BVT). A BVT is a tax on the incomes generated by business activity (wages and salaries, the return on equity investment, interest payments on
debt, and pure profits or economic rents) and has been adopted by a number of
countries, including Italy and Japan. A BVT differs from a value-added tax in two
ways. It is a tax on income, not on consumption, and it is an origin-based tax and
not a destination-based tax; that is, it is a tax on the source of the income generated
and not on the residence of the recipient of the income. The introduction of a BVT
would also be controversial because it would increase the cost of hiring labour, and
it might increase the tax burden on labour-intensive debt-financed firms—that is,
the small business sector. But then, as in A Tale of Two Cities, we need a hero to sort
out “the best of taxes from the worst of taxes.”
B.D.
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Canada, Review of Federal Support to Research and Development
Innovation Canada: A Call to Action, Expert Panel, Report of the Expert
Panel (Ottawa: Industry Canada, October 2011) (www.rd-review.ca),
148 pages, ISBN 978-1-100-19384-7
Canada, Secretariat to the Review of Federal Support to Research and
Development Expert Panel, Assessing the Scientific Research and
Experimental Development Tax Credit, Working Document (Ottawa: Review
of Federal Support to Research and Development, Working Paper, 2011)
(www.rd-review.ca), 32 pages
Innovation Canada: A Call to Action is the much-anticipated report of an expert panel
chaired by Tom Jenkins, the executive chair and chief strategy officer of Open Text
Corporation. Consistent with the mandate of the panel, the report provides an accessible review of the patchwork of federal programs supporting business research
and development. The most significant of these programs is the federal tax credit
for qualifying scientific research and experimental development (SR & ED). It is not
surprising, therefore, that the report includes two important recommendations for
improvement of the credit. First, to reduce compliance and administration costs,
the report recommends that the credit for Canadian-controlled private corporations (CCPCs) be based on labour-related costs only, with the credit being enhanced
to recognize the narrower expense base of these corporations. The report suggests
that the government should consider extending the same approach to all firms provided that appropriate compensatory assistance can be granted to large firms with
high non-labour costs. Second, in an effort to encourage the growth and profitability of small and medium-sized enterprises, the report recommends that the amount
of the tax credit be reduced primarily by reducing the amount of the refundable
portion for CCPCs. The report suggests that the savings should be redirected to
provide additional funding for direct grant programs. The report also recommends
that data be provided on the performance of the SR & ED credit on a regular basis to
permit evaluation of its cost effectiveness. The two substantive recommendations
would ideally be introduced on a phased-in basis.
A more detailed discussion of the expert panel’s recommendations on the
SR & ED credit can be found in the background working paper, Assessing the Scientific
Research and Experimental Development Tax Credit, prepared for the panel by Department of Finance officials. There is also much interesting discussion in the working
paper of aspects of the SR & ED credit and possible changes that did not make it into
the expert panel’s report. For example, there is some discussion of proposals to
provide a present value adjustment to the non-refundable credit for large businesses,
as well as the use of flowthrough shares as an alternative policy instrument. Both are
viewed negatively, however, in the working paper. Much the same view is apparent
in the discussion of proposals to extend qualifying activities to include more activities occurring outside Canada and to provide assistance for innovative activities not
currently within the legislative concept of SR & ED. There is also some discussion of
administrative aspects of the program, including the practice of paying contingent
current tax reading  n  513
consultant fees. Finally, the working paper provides some otherwise unavailable
descriptive statistics on program use.
T.E.
Martin A. Sullivan, Corporate Tax Reform: Taxing Profits in the 21st Century
(New York: Springer-Verlag, 2011), 174 pages, ISBN 978-1-4302-3927-7
United States, The President’s Framework for Business Tax Reform: A
Joint Report by the White House and the Department of the Treasury
(Washington, DC: Department of the Treasury, February 2012), 25 pages
Perhaps more than in any other country, corporate income tax reform in the United
States never seems to be far from the political arena. Indeed, at any point in time in the
political cycle, there seem to be any number of proposals from US politicians to reform
the corporate income tax; yet despite the political attention (or perhaps because of it),
nothing much ever gets done. The current fiscal environment may, however, motivate
politicians to turn back the clock and embark on a 1986-style reform effort without
the revenue-neutrality dimension. Corporate Tax Reform: Taxing Profits in the 21st Century is an accessible and non-partisan view of the US corporate income tax in all of its
political and policy dimensions. The President’s Framework for Business Tax Reform is
the latest in a seemingly endless stream of proposals to reform aspects of the tax.
Martin Sullivan is an economist who may be familiar to many readers in his role
as a contributing editor to Tax Analysts, publisher of Tax Notes and Tax Notes International. Corporate Tax Reform is in the nature of a brief primer on the economics and
politics of the US corporate income tax. There is very little in the way of sophisticated
technical or policy analysis, and the book is written in a manner that makes the subject
accessible to readers who are not tax policy makers, academics, or practitioners. Even
so, Sullivan’s account is thoroughly entertaining, and there is much in it that should
be of at least some passing interest to tax experts. The target audience is apparent in
the format, as well as the writing style. The subject is divided into 15 short chapters.
Sullivan avoids the kind of dense prose characteristic of the relevant academic and
technical literature, with secondary sources cited only lightly and very selectively.
Formal citation is avoided, with some sources simply mentioned in the text itself. A
brief appendix entitled “Further Reading” provides citations to selected sources.
Sullivan characterizes his book as “a three-part guide to the economics and politics
of the corporate tax.”2 Part one provides some background information. Chapter 1
surveys very briefly some of the current proposals for reform of the corporate income
tax that are receiving the most political attention. Chapter 2 summarizes statistics
on corporate profits and the corporate income tax. Chapter 3 reviews the familiar
economic arguments against the corporate income tax, which are contrasted in chapter 4 with a review of the political economy factors that make the tax attractive.
2 Corporate Tax Reform, at xii.
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Part two discusses structural features of the corporate income tax that should be
the focus of efforts to reform the tax rather than replace or radically alter it. Sullivan
emphasizes five particular features: (1) the tax base and the corporate tax rate, (2) the
treatment of multinational enterprises, (3) the status of passthrough entities used
predominantly by small and medium-sized businesses, (4) state corporate income
taxes, and (5) complexity. Multiple chapters are devoted to the first two structural
features. Chapter 5 sets out the economic and political imperative to reduce the
federal statutory tax rate. Chapters 6 and 7 survey various corporate income tax expenditures that could be eliminated in an effort to realize that goal. Chapters 8 and
9 are devoted to somewhat cursory discussions of, respectively, the treatment of
foreign-source income of US-based multinational corporations and profit-shifting
through transfer pricing and related techniques. The focus of chapter 8 is the tiresome debate in the United States over an exemption or territorial system of taxation
as opposed to a worldwide system with deferral of foreign-source business income
until repatriation and a credit provided at that time for source-country tax. With
Japan and the United Kingdom recently moving to exemption systems, the United
States remains the sole major capital-exporting country using a deferral with foreign
tax credit system. Chapter 9, on profit shifting, does nothing more than statistically
highlight the magnitude of the problem. No solutions are offered.
Chapter 10 makes the point that a broad range of large businesses benefit from
passthrough treatment available to limited liability corporations (LLCs) and limited
liability partnerships (LLPs) under the US elective approach to entity classification.
Sullivan makes the obvious point that the boundary between large businesses subject to the corporate income tax and small and medium-sized businesses eligible
for passthrough treatment needs to be a focus of any corporate tax reform effort.
Chapters 11 and 12 are conceptually related in that they both address the issue of
complexity, albeit from somewhat different perspectives. In chapter 11, on state
corporate income taxes, Sullivan suggests that these taxes could ideally be eliminated, given the relatively small amounts of revenue raised. In chapter 12, he identifies
three additional, and particularly troublesome, sources of complexity: (1) the alternative corporate minimum tax, (2) the taxation of foreign profits, and (3) the tax credit
for scientific research.
Part three does not add much to the book. Chapters 13 and 14 review various
proposals to replace the corporate income tax with some form of consumption tax,
to integrate the corporate and shareholder income taxes, and to introduce a tax on
market capitalization. The brief treatment is warranted given the politically unrealistic nature of these proposals. The concluding chapter 15 rounds out the book with
a summary of the dire fiscal environment in the United States, which reform proposals must take into account.
Many of the themes emphasized by Sullivan are echoed in The President’s Framework for Business Tax Reform. In particular, the report highlights the imperative to
reduce the federal corporate statutory tax rate from 35 percent to 28 percent in line
with the average reported by the Organisation for Economic Co-operation and
Development (OECD). This would be done by eliminating a number of corporate tax
current tax reading  n  515
expenditures, which, the report claims, currently make the effective marginal tax rate
on corporate investment in the United States similar to that in OECD countries.
The tax expenditures that are singled out for elimination are (1) last-in, first-out
accounting for inventory; (2) the expensing of intangible drilling costs and percentage depletion for oil and gas wells; (3) interest expense deductibility on borrowed
money used to acquire corporate-owned life insurance on officers, directors, or
employees; (4) capital gain treatment of profits on partnership carried interests; and
(5) accelerated depreciation for corporate purchases of non-commercial aircraft. In
the domestic context, the report also suggests that tax depreciation should be
aligned more generally with economic depreciation. Two significant proposals that
are only mentioned and not explored in any detail are generalized limitations on the
deduction of corporate interest expense and the treatment of a broader range of
large LLCs and LLPs as corporations for income tax purposes.
The report includes separate sections devoted to a discussion of reform proposals directed to US manufacturing and the treatment of foreign-source income from
outbound direct investment. With respect to the former, the report proposes to
reduce the corporate rate to 25 percent, while lowering it further for “advanced
manufacturing” through enhancement of the domestic activities deduction. This
clearly politically-motivated proposal is supplemented with a proposed enhancement of the simplified research and experimentation tax credit, which would also be
made permanent. And to top it all off, there is the usual menu of proposals to encourage investment in clean energy.
The section of the report addressing the taxation of foreign-source income of
US-based multinationals contains a now-familiar set of provocative proposals intended to encourage domestic investment. Most importantly, the report proposes
the introduction of a minimum tax on overseas profits applied on a current basis as
earned in a foreign subsidiary, rather than at the point of repatriation, but with a
credit for source-country tax. This proposal would be supplemented by a general
denial of the deductibility of interest expense linked to the earning of foreignsource income until repatriation of the income. As with all of the proposals in the
report, there is no discussion of the critical design features. The policy content of
the report is thus significantly diminished.
T.E.
Steven A. Bank, Anglo-American Corporate Taxation: Tracing the Common
Roots of Divergent Approaches (Cambridge, UK: Cambridge University
Press, 2011), 181 pages, ISBN 978-0-19-532136-4
This book provides a rich historical account of the decidedly different corporate
income tax systems in the United Kingdom and the United States. The author (who
is a tax law professor at the University of California at Los Angeles law school) draws
on much of his earlier work in which he combines history and finance in the study
of the taxation of business entities. This book is particularly ambitious in its attempt
to combine a historical account of the development of the UK and US corporate
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income tax systems with a comparative analysis that searches for cultural, political,
legal, and economic explanations for observed differences.
The corporate income tax systems in the United Kingdom and the United States
have always been notable for their extreme differences. The most prominent and
generalized structural difference is the treatment of equity income. The United
States has always been the most significant country operating a classical system in
which corporate equity income is taxed at the entity level and again on distribution
as a dividend at the shareholder level without any attempt to integrate the two levels
of tax. The United Kingdom has always been characterized by its use of an imputation system in which equity income is exposed to tax at the same two levels but the
corporate-level tax is imputed to shareholders as a credit against dividend taxes.
Interestingly, as Bank describes in his introduction, there have been only passing
comparisons of the two systems, and no attempt has been made to draw out the
potential historical richness of a systematic comparative study. The book clearly fills
this important gap in the literature, given the significance of the two countries in
the development of the western economy.
Part one of the book performs the necessary function of describing separately the
chronological development of the corporate income tax in the United Kingdom and
the United States. Notably, both systems integrated the corporate- and shareholderlevel taxes in the beginning, but the United States began to move to a classical system
around the time of the First World War. Then in 1965, the two countries again
converged with the adoption of a classical system in the United Kingdom. But as
Bank’s chronological account details, these two periods of convergence were brief.
It is only recently that convergence has re-emerged with the introduction by the
Bush administration in 2003 of a low rate of tax on dividend distributions that mitigates, to some extent, the effects of a classical system.
Part two is arguably the richest portion of the book. In this part, Bank attempts
to explain the differences in approach in terms of profits, power, and politics. He
suggests that different views of the legal conception of the corporation and the economic incidence of the corporate tax have little explanatory power. Instead, he
provides some evidence that a move in the early 20th century to a more pronounced
separation of ownership and management in the United States, as well as a greater
reliance on retained earnings, may explain more fully the differences in the two
corporate income tax systems. These explanatory factors may have also been supported, in part, by differences in politics and ideology.
The last part of the book shows that many of the same explanatory factors are
still present in debates over corporate income tax reform in the two countries.
Nonetheless, Bank suggests that external forces, including the influence of the
European Union, the European Court of Justice, international trade organizations,
bilateral tax treaties, and competitive pressures from corporate tax reforms in other
countries, are at work to force an element of convergence of the corporate income
tax systems in the United States and the United Kingdom.
T.E.
current tax reading  n  517
Thomas Piketty, Emmanuel Saez, and Stefanie Stantcheva, Optimal
Taxation of Top Labor Incomes: A Tale of Three Elasticities, NBER
Working Paper no. 17616 (Cambridge, MA: National Bureau of
Economic Research, November 2011), 54 pages
An increase in income inequality, highlighted by a recent OECD report,3 and the low
average tax rates paid by prominent wealthy Americans, such as Mitt Romney and
Warren Buffett, have moved the tax treatment of high income earners to the top of
the US policy agenda. Public concerns in the United States and other countries go
beyond the lack of progressivity in the tax system. As the authors of this study point
out, the Occupy Wall Street protesters feel that the increase in the income share of
the top 1 percent has come at the expense of the remaining 99 percent. One of the
goals of the study is to incorporate the notion that the rich gain at the expense of
the rest into a formal theory of optimal income tax policy.
The paper is divided into two main parts. In the first part, the authors develop a
simple theoretical framework that can be used to derive formulas for the optimal
marginal tax rate in the top tax bracket, based on three elasticities that reflect behavioural responses of taxpayers in that bracket. The first elasticity reflects the
responsiveness of earnings based on changes in hours of work, effort, and occupational choices; the second elasticity measures income shifting to lower-taxed forms
of income; and the third elasticity is the responsiveness of compensation bargaining
to changes in the top marginal tax rate. The authors show that the marginal tax rate
that maximizes the total tax revenue from the individuals in the top tax bracket can
be calculated as a weighted sum of these three elasticities.
The first elasticity is a conventional one. This model predicts that if changes in real
earnings were the only response to higher marginal tax rates, the revenue-maximizing
top marginal tax rate would be in the 50 percent range. The income-shifting elasticity
arises because some forms of income are taxed at low rates (for example, capital gains)
or not taxed at all (for example, corporate fringe benefits such as vacations disguised
as business travel). The authors argue that the optimal tax system would eliminate
the lower rate of taxation on such forms of income, but failing that, income shifting
leads to a somewhat lower revenue-maximizing tax rate. The authors argue that while
income shifting to lower taxed forms of income is an important short-run response
to an increase in the marginal tax rate on earnings, it has not been an important
determinant in the growth of the income share of the top 1 percent of taxpayers in
the United States.
The model of the compensation bargaining response to higher tax rates is a
novel, and controversial, contribution because it allows for the possibility that executive compensation can exceed the value of the individual’s marginal product. In
3 Organisation for Economic Co-operation and Development, Divided We Stand: Why Inequality
Keeps Rising (OECD: Paris, December 5, 2011), reviewed in the Current Tax Reading feature
(2012) vol. 60, no. 1 Canadian Tax Journal 257-74, at 268-69.
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(2012) 60:2
other words, an individual’s gain can come at the expense of someone else’s income.
The authors do not present a formal bargaining model or detail how excessive compensation drives down the wages and salaries of the 99 percent. They simply assert
that such a process is possible. The model suggests that if executives were overpaid,
the optimal marginal tax rate would be considerably higher than the rate in the conventional model, because a higher marginal tax rate would discourage an individual
from bargaining for a higher salary. Indeed, in the authors’ framework, with compensation bargaining and no earnings response or income shifting, the optimal tax
rate would be 100 percent if executives were overpaid.
In the second part of the paper, the authors survey time-series and cross-sectional
data on the share of income received by high income earners, the marginal tax rates
of those earners, and economic growth rates of 18 OECD countries, to try to infer
the values of the three behavioural elasticities. They find a strong negative correlation between the decline in the top marginal tax rates and the increase in the income
share for top earners since 1975 in the United States. The elasticity of the share for
the top income groups with respect to the net-of-tax rate (defined as 1 minus the
marginal tax rate) is around 0.5 but varies significantly across countries. The authors
argue that the increase in the income share for the top earners in the United States
cannot be explained by the tax-avoidance and income substitution effects since
1975. They also point out that there is no correlation between the growth of real
gross domestic product (GDP) per capita and the decline in the top marginal tax rate
in the United States since 1975. This finding is consistent with the compensation
bargaining model, but could also be attributed to other trends such as the rise of oil
and gas prices in the 1970s and globalization and technological changes since the
1980s. If the compensation bargaining elasticity were 0.2 and the earnings elasticity
0.3, with an overall elasticity of 0.5, then the revenue-maximizing top marginal tax
rate would be 83 percent, compared with 57 percent given an earnings elasticity of
0.5 and no bargaining effect.
The theoretical models developed in this paper and the empirical analysis that
the authors use to flesh them out provide a useful framework for a re-examination
of the progressivity of income tax systems in the United States and other OECD
countries. However, the compensation bargaining model is highly controversial and
needs more theoretical and empirical support before it is widely accepted by public
finance economists.
B.D.
Organisation for Economic Co-operation and Development, Corporate
Loss Utilization Through Aggressive Tax Planning (Paris: OECD, 2011),
88 pages, ISBN 978-92-64-11921-5
Although economic theory suggests that losses should be fully refunded for income
tax purposes, budget considerations mean that this policy prescription is impractical. Instead of refundability, countries typically provide taxpayers with the ability
to offset losses from some sources against income from other sources, and where
current tax reading  n  519
losses exceed income, they can be carried over to other taxation years. The ability to
use losses in these ways extends in some countries to members of the same corporate
group through some form of group loss transfer or consolidated reporting. Because
these types of loss relief typically do not extend to unrelated taxpayers, income tax
systems have historically been plagued by transactions intended to transfer losses
for a fee between such taxpayers.
The 2008-9 financial crisis obviously resulted in an increase of supply for the
loss-trading market, which may have been the impetus for the release by Canada’s
Department of Finance of a consultation document indicating an openness to the
introduction of a formal corporate loss relief system.4 The loss overhang created by
the crisis has also placed added pressure on government budgets from increased
loss-trading transactions by unrelated taxpayers. This OECD report emphasizes the
need for tax policy makers to use anti-avoidance rules and advance disclosure regimes to address the budget risk presented by loss trading.
The report focuses on both economic losses and artificial losses generated in
loss-creation transactions. It also focuses on such transactions in a purely domestic
context and in a cross-border context where a loss is transferred from a low-tax to a
high-tax jurisdiction or the same loss is recognized in multiple jurisdictions. Generic
examples of loss-transfer transactions using financial instruments, corporate reorganizations, and transfer-pricing techniques are described for illustrative purposes. The
description of these transactions and the associated general policy recommendations
are preceded by informative overviews of the loss-utilization regimes in member
countries and data on loss carryforwards. The report indicates that the data are
surprisingly fragmented given different data collection practices in member countries. Although it is not possible to break down country data by company size or
industry, the report does highlight some general conclusions, including the obvious
one that the size of loss carryforwards is constantly increasing and is exacerbated
by economic downturns. There are apparently large differences in the size of loss
carry­forwards as a percentage of GDP, which may be attributable to differences in
binding loss constraints as well as measurement issues. Some member countries
report loss carryforwards as high as 25 percent of GDP.
T.E.
4 Canada, Department of Finance, The Taxation of Corporate Groups: Consultation Paper (Ottawa:
Department of Finance, November 2010).
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Michael Keen and Ruud de Mooij, Debt, Taxes, and Banks, IMF Working
Paper WP/12/48 (Washington, DC: International Monetary Fund, February
2012) (www.imf.org/external/pubs/ft/wp/2012/wp1248.pdf ), 32 pages
This paper poses a simple but important question: “Are banks’ capital structures
materially affected by the differentially favorable tax treatment of debt?”5 Perhaps
somewhat surprisingly, there is no systematic empirical evidence bearing on this
question. The paper thus fills an important gap in the literature, particularly given
the role in the 2008-9 financial crisis of excessive leverage in the financial sector.
Keen and de Mooij first construct a simple model of a bank’s capital structure
decisions in the presence of tax incentives to use debt and regulatory requirements
that penalize equity shortfalls relative to risk-weighted assets while allowing the use
of debt-equity hybrids within an upper bound. The regulatory requirements are, of
course, the variables that distinguish the empirical inquiry for banks from that for
non-financial firms (the latter of which is the subject of a large theoretical and empirical literature focused on the effect of taxes on capital structure). The authors
then test the predictions of their model against a panel of 14,377 commercial banks
in 82 countries from 2001 to 2009. The authors find that, in general, the capital
structures of banks are about as responsive to taxes as those of non-financial firms.
This result is attributable primarily to the fact that a large percentage of banks hold
levels of equity above the minimum regulatory requirement, with the size of the
equity buffer being sensitive to tax. The responsiveness of banks to taxes is not,
however, associated with the use of hybrid instruments treated as equity for regulatory purposes and debt for tax purposes. In fact, the use of such hybrids tends to be
insensitive to tax, since they are the preferred form of debt capital in the presence
of a tax incentive for debt and are used first up to the point at which regulatory
limits on their use have an impact. Banks with low levels of equity buffers are insensitive to taxes but sensitive to changes in capital requirements. The largest banks,
holding almost 60 percent of all bank assets, are found to be considerably less responsive to both tax and minimum equity capital requirements.
Assuming a 25 percent corporate income tax rate, the authors suggest that their
empirical findings indicate that reform of the taxation of debt and equity intended
to mute differences in treatment might increase banks’ equity capital in the long run
by, on average, 3.75 percent, which represents a 30 percent increase over current
levels. They caution that the insensitivity to tax of the capital structure of the very
largest banks means that any such reform would have to be significant to have a
marked effect. This note of caution is important given the systemic importance of
these banks.
T.E.
5 At 3.
current tax reading  n  521
United States, Government Accountability Office, Financial Derivatives:
Disparate Tax Treatment and Information Gaps Create Uncertainty and
Potential Abuse, GAO-11-750 (Washington, DC: GAO, September 2011)
(www.gao.gov/products/GAO-11-750), 59 pages
Erika W. Nijenhuis, “New Tax Issues Arising from the Dodd-Frank
Act and Related Changes to Market Practice for Derivatives”
(2011) 2:1 Columbia Journal of Tax Law 1-99
Alex Raskolnikov, “Taxation of Financial Products: Options for
Fundamental Tax Reform” (2011) 133:12 Tax Notes 1549-57
The United States has one of the more legislatively intensive regimes for the income
taxation of derivative financial instruments. The legislation has developed incrementally over the past three decades, and, not surprisingly, there are well-known
weaknesses that have motivated calls for fundamental and comprehensive reform.
The GAO report focuses primarily on the administration and enforcement of the
income tax rules applicable to derivatives. The report finds that, between 1996 and
2010, the Internal Revenue Service (IRS) and the Treasury department did not complete 14 of 53 guidance projects related to the taxation of derivatives. Although this
failure to complete a large number of projects would normally be categorically
condemned, the report acknowledges that unintended consequences of efforts to
provide certainty for taxpayers and the complexity of derivative products present
challenges that are not typically associated with guidance projects and can result in
defensible delays. The report does criticize the IRS, however, for failing to coordinate
more systematically with non-tax agencies, such as the Securities and Exchange
Commission and the Commodity Futures Trading Commission, in identifying new
financial products or new uses in a timely manner. In terms of the relevant substantive law, the report notes the incomplete nature of the US legislative regime, which
leaves gaps and loopholes for the tax-driven use of derivatives. A considerable portion
of the report describes the well-known use of variable prepaid forward contracts
and equity swaps as particular examples.
The article by Nijenhuis provides a thorough account of the tax law effects of the
Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010.6 A principal focus of that legislation is the requirement to trade a range of swaps through an
approved central clearinghouse. One tax law effect of this requirement is that such
swaps become subject to mark-to-market tax accounting rather than realization-based
recognition. Nijenhuis describes in some detail how the exception to this requirement for cleared swaps is underinclusive and requires expansion. The other focus of
the article is the uncertain treatment of upfront payments under cleared credit default swaps as notional loans for income tax purposes under the notional principal
contract regulations.
6 Pub. L. no. 111-203; 124 Stat. 1376.
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(2012) 60:2
The article by Raskolnikov provides an overview of challenges to reform of the
income taxation of derivatives and a brief description of a menu of possible reform
options that are articulated in the academic literature. The article is the text of the
author’s testimony given on December 6, 2011 before a joint hearing of the US
House Committee on Ways and Means and the Senate Committee on Finance. His
discussion of three benchmarks for evaluating reform options and three different
fundamental reform options does nothing more than summarize existing ideas in the
academic literature. He does, however, add a brief account of the possible impact on
the taxation of derivatives of ostensibly unrelated reforms, including corporateshareholder integration. He also issues an important plea for the IRS to make detailed
tax return data available for study of revenue costs and other losses from the taxdriven use of derivatives.
T.E.
Alexandre Laurin and Jonathan Rhys Kesselman, Income Splitting
for Two-Parent Families: Who Gains, Who Doesn’t, and at What Cost?
C.D. Howe Institute Commentary no. 335 (Toronto: C.D. Howe Institute,
October 2011), 20 pages, ISBN 978-0-88806-850-7
During the spring 2011 federal election campaign, the Conservative Party of Canada
proposed to allow spouses with children to split up to $50,000 of investment and/or
labour income.7 Conceptually, the proposal represents a significant extension of the
current provision allowing spouses to split pension income, which was introduced
by the Conservative government in 2006. In this study, Laurin and Kesselman estimate the revenue cost and incidence of the proposal. Their findings include the
following:
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n
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n
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n
two-earner couples would bear the heavier tax burden relative to single-earner
couples on average;
40 percent of the benefit of splitting would accrue to families with incomes
above $125,000;
85 percent of households would receive no benefit;
nearly one-half of couples with children would receive a benefit of $500 or less;
the proposal would cost $2.7 billion annually at the federal level and an additional $1.7 billion provincially, assuming that the provinces adopted the same
proposal; and
expansion of the proposal to spouses without children would more than double
the annual revenue cost ($5.6 billion federally and $3.5 billion provincially).
Given the revenue cost and these regressive features of the proposal, the authors
suggest that alternative policy instruments, such as enhanced transfer payments to
7 Conservative Party of Canada, Here for Canada: Stephen Harper’s Low-Tax Plan for Jobs and
Growth (Ottawa: CPC, 2011), at 26.
current tax reading  n  523
low-income families and/or across-the board personal income tax rate reductions,
are preferable. They conclude that if such a measure is to be adopted, it should be
limited to investment income. Extending income splitting to labour income could
negatively affect the labour market decisions of non-working or lower-income
spouses (primarily women), because splitting income with a spouse would subject
them to a higher marginal tax rate. The authors rationalize acceptance of this more
limited form of splitting on the basis that the income attribution rules intended to
prohibit splitting of investment income are largely ineffective in their application.
T.E.
John B. Burbidge, Kirk A. Collins, James B. Davies, and Lonnie Magee,
“Effective Tax and Subsidy Rates on Human Capital in Canada”
(2012) 45:1 Canadian Journal of Economics 189-219
Human capital is the key input for the knowledge economy. Even though the personal
tax system and public sector subsidies for post-secondary education can influence
individuals’ participation decisions in higher education, the taxes and subsidies for
human capital formation have received much less attention from economists than
the tax treatment of physical capital. This article is a welcome addition to a small
literature since it extends and updates earlier work by Collins and Davies.8 In this
study, the authors compute effective tax rates (ETRs) and effective subsidy rates
(ESRs) for males and females for college, bachelor’s, master’s, and doctoral programs
based on gross earnings, the direct costs of education, and taxation data for 1997,
2000, and 2006. The real earnings profiles for 2000 based on 2001 Canadian census
data are used to isolate the effects of changes in the income tax system and public
funding of education for males and females with each type of degree.
The ETR on human capital is largely determined by the progressivity of the tax
system and the extent to which students can deduct the direct costs of education
from their taxable income. With a progressive tax on personal income, the opportunity cost of acquiring an education—the forgone earnings—is implicitly deducted
at a lower tax rate than the tax rate that applies to post-program earnings. The more
progressive the tax system, the higher the ETR. The ESR is largely determined by
the public subsidies that are provided to higher education institutions. Changes in the
progressivity of the tax system and the expenditures on post-secondary education
drive changes in both ETRs and ESRs.
The authors compute gross and net private rates of return on education acquisition and the public or total rate of return to calculate the ETRs and ESRs. They also
calculate their difference (ESR − ETR), which they refer to as the net subsidy rate; this
measure provides many insights concerning the levels and trends in the tax-subsidy
8 Kirk A. Collins and James B. Davies, “Measuring Effective Tax Rates on Human Capital:
Methodology and an Application to Canada,” in Peter Birch Sørensen, ed., Measuring the Tax
Burden on Capital and Labor (Cambridge, MA: MIT Press, 2004), 171-211.
524  n  canadian tax journal / revue fiscale canadienne
(2012) 60:2
system for funding post-secondary education. Here, only a few key results will be
highlighted.
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The raising of the 29 percent federal tax rate bracket in 2001 to about $100,000
reduced the progressivity of the tax system and contributed to a reduction of
the ETR for median income earners with bachelor’s degrees, from 12.8 percent in 1997 to 8.5 percent in 2006 for males and from 19.9 percent to
12.0 percent for females. Over the same period, the decline in real public sector
spending on post-secondary education resulted in a reduction in the ESR from
15.4 percent to 9.2 percent for males and from 10.6 percent to 6.2 percent for
females. As a result of these changes, the net subsidy rate for graduates with
bachelor’s degrees, while still positive, declined for males and especially for
females.
The net subsidy rate for college graduates increased between 2000 and 2006.
The ETRs and ESRs for master’s and doctoral graduates declined between
2000 and 2006. The net subsidy rate also declined, although at the doctoral
level they were still relatively high, at 22.7 percent for males and 32.2 percent
for females in 2006.
The authors discuss how these changes in the tax-subsidy system and earnings
profiles may be affecting post-secondary education enrolment trends. The registered
education savings plan (RESP) program is one tax measure that was not included in
their analysis, because they felt that most graduates in 2006 would not have benefited
from the enhancement to the program that occurred in 1998, when Canada education savings grants were introduced. Future research on the impact of the enhanced
RESP program on ETRs and ESRs, as well as its distributional effects, would be a
welcome extension of this very important line of empirical public finance research.
B.D.
Michael P. Keane, “Labor Supply and Taxes: A Survey”
(2011) 49:4 Journal of Economic Literature 961-1075
Those of us who work as public finance economists operate at the top of the food
chain with respect to economic research: we rely on economists in other fields, such
as industrial organization, international trade, and labour, to provide us with the
theoretical models and values for key parameters, so that we can conduct our studies
of tax incidence and the excess burden of taxation. We are therefore especially
grateful to Michael Keane for this up-to-date survey of econometric modelling of
the supply of labour. Not only is the survey comprehensive; it is also (for the most
part) comprehensible by non-specialists. And, as a special favour for public finance
economists, Keane emphasizes the implications of the econometric models and
elasticity estimates for the measurement of the excess burden of taxation. Parts of
this survey will provide very useful material for graduate courses in the economics
of taxation.
current tax reading  n  525
The survey focuses on the measurement of the effects of wages and taxes on male
and female labour supply. Since different dimensions of labour supply are important
for males and females—for example, the participation decision has historically been
more important for women than men—Keane surveys the labour supply literature
for the two sexes separately. For males, three basic models are outlined: a standard
static model with a piece-wise linear tax system, a life cycle model with financial
savings, and a life cycle model with both financial savings and investments in human
capital. Among economists, there is a widely held view that the uncompensated
(Marshallian) labour supply elasticity of prime age males is close to zero or perhaps
even negative. But a number of the studies surveyed by Keane have found relatively
large labour supply responses by males, and this is especially true in studies of the
dynamics of labour with human capital accumulation. For the 29 econometric studies that Keane summarizes,9 the average uncompensated labour supply elasticity
for males is 0.06 and the average compensated (Hicksian) labour supply elasticity is
0.31. Keane argues that econometric studies that used the ratio of earnings to hours
as a measure of individuals’ wage rates are subject to a “denominator bias.” In these
regressions, where hours of work is the dependent variable, the estimated coefficient
on the computed wage rate will be biased downward, and these studies generally
produce low labour supply elasticity estimates. For the studies that have used a direct
measure of individuals’ wage rates, the simple average compensated labour supply
elasticity is 0.43. Since measures of the excess burden from taxation depend on the
compensated elasticities, Keane feels that the efficiency losses from taxation of
labour income may be underappreciated.
For women, the estimated labour supply elasticities are generally quite large.
Keane notes that in five studies where fertility, marriage, work experience, and education are allowed to respond to wage changes, the average long-run female labour
supply elasticity is 3.6, indicating a high degree of wage and tax sensitivity. As Keane
points out, one of the major gaps in the literature on female labour supply is that there
are few studies of the joint labour supply decisions of couples. We public finance
economists can only wait until our labour economist colleagues have filled that important gap so that we can have more robust models of the tax treatment of families.
B.D.
Michele Campolieti and Chris Riddell, “Disability Policy and the Labor
Market: Evidence from a Natural Experiment in Canada, 1998-2006”
(2012) 96:3-4 Journal of Public Economics 306 – 16
This study examines the participation and employment effects generated by the
addition, in 2001, of an earnings exemption to the qualification criteria for Canada
Pension Plan disability (CPPD) benefits. Campolieti and Riddell also examine the
effects of the introduction, in 2005, of an automatic reinstatement provision under
9 Table 6, at 1042.
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(2012) 60:2
the CPPD program, whereby former recipients could remain eligible without reapplication and retesting for up to 24 months. The automatic reinstatement provision
reduces the risk that disability beneficiaries face when they attempt to resume working (that is, the loss of benefits), because they do not have to reapply for benefits if
their attempt to rejoin the work force is not successful. The authors focus on the
responses of individuals in the Ottawa-Gatineau metropolitan region, where a
“natural experiment” took place in the area of publicly funded pension benefits for
disabled individuals. The residents of Gatineau are covered under the Quebec Pension Plan disability (QPPD) program, which introduced an earnings disregard in the
1960s and does not have an automatic reinstatement provision, while the residents
of Ottawa are subject to the rules under the CPPD program. Otherwise, the two
populations share similar demographic, economic, and geographic characteristics.
The study employed data from 1998 to 2006 from Statistics Canada’s Longitud­
inal Administrative Databank, which collects annual confidential data on T1 and T4
tax files. The authors found that the earnings disregard exemption did not increase
the probability of entering or leaving the disability program. However, after the
introduction of the automatic reinstatement provision under the CPPD program,
there was a 5.1-5.7 percentage point increase in the employment of male beneficiaries and a 7.9-9.5 percentage point increase for female beneficiaries relative to the
QPPD, for which there was no change in policy. The automatic reinstatement provision did not appear to have a statistically significant effect on participation in the
CPPD program or the employment status of its beneficiaries. The authors suggest
that the absence of any effects on participation from the two policy changes may be
due to the screening for disability benefits. They conclude that “tougher screening
requirements for access to disability benefits could reduce many of the potential
negative incentive effects associated with allowing disability beneficiaries to work or
even more generous disability benefits.”10
B.D.
Michael Kobetsky, International Taxation of Permanent Establishments:
Principles and Policy (Cambridge, UK: Cambridge University Press, 2011),
459 pages, ISBN 978-0-521-51632-7
This book provides the most comprehensive account in the literature to date of the
application of the arm’s-length principle under article 7 of the OECD model tax
treaty11 as the basis for the allocation of the business profits of a multinational enterprise to its permanent establishments (PEs). The account is framed in the context
of both the lengthy OECD project on PEs, which culminated in a report released in
10 At 315.
11 Organisation for Economic Co-operation and Development, Model Tax Convention on Income
and on Capital: Condensed Version (Paris: OECD, July 2010).
current tax reading  n  527
2008 and revised in 2010,12 and consequent changes to the model treaty and commentary. The book consists of 10 substantive chapters (plus an introduction and
conclusion) in which the author combines a broader normative analysis with an analysis of the practical limits of the application of the arm’s-length principle to PEs.
Both aspects of the analysis are framed against the background of the development
of the bilateral tax treaty network and the ongoing debate over the arm’s-length
principle and formulary apportionment as profit allocation methods. Because the
branch form of operation is most common in the financial sector, there is considerable discussion of the practical application difficulties to this sector. Consistent with
much of the academic literature, Kobetsky views the arm’s-length principle as an
unworkable and theoretically flawed method of profit allocation that must eventually
be replaced with some form of formulary allocation, perhaps some day following
the lead of the European Union in an international context.
T.E.
Heather M. Field, “Experiential Learning in a Lecture Class: Exposing
Students to the Skill of Giving Useful Tax Advice,” Pittsburgh Tax Review
(forthcoming) (www.ssrn.com/abstract=1985269)
This article recounts the author’s experience with the incorporation of an experiential
learning module in a law school lecture class devoted to the delivery of substantive
tax law. The module consists of two case study exercises: the development of a taxeffective corporate reorganization, and the design of a partnership profit allocation
provision providing for interests for services. The discussion of the two case studies
is preceded by a general discussion of the teaching of clinical skills and is followed
by a reflection on what requires further work on the author’s part. Before becoming
a full-time faculty member at the law school of the University of California, Hastings,
Field practised as a transactional tax lawyer for several years. As a result, she is particularly well positioned to reflect on the potential of experiential learning in a tax
law class setting.
T.E.
Antonella Caiumi, The Evaluation of the Effectiveness of Tax
Expenditures—A Novel Approach, OECD Taxation Working Papers no. 5
(Paris: Organisation for Economic Co-operation and Development,
November 2011) (http://dx.doi.org/10.1787/5kg3h0trjmr8-en), 56 pages
This paper provides an empirical assessment of the effectiveness of regional tax
incentives for investment in Italy. The paper asks three questions:
12 Organisation for Economic Co-operation and Development, Report on the Attribution of Profits
to Permanent Establishments (Paris: OECD, July 2008) and Report on the Attribution of Profits to
Permanent Establishments (Paris: OECD, July 2010).
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(2012) 60:2
1. How much additional investment was stimulated by government intervention?
2. Has public financing displaced private financing?
3. To what extent would the outcomes on firm performance have been achieved
without public support?
Caiumi uses a rich data set based on Italian corporate tax returns to apply a matching
approach composed of recipient and non-recipient firms of otherwise identical
characteristics. Caiumi also constructs an empirical model to estimate firm’s investment behaviour to test both tax-price elasticity and the sensitivity of investment to
the availability of internal funds.
The study finds that the available tax assistance was carried forward each year by
a large number of firms and that the efficacy of the assistance at the firm level depends very much on the total amount available. In this respect, it is observed that a
downsizing of the program resulted in more needy firms being less likely to receive
public support, suggesting that a large amount of support was absorbed by firms that
claimed the assistance as an additional source of finance. Nonetheless, the findings
imply that a 10 percent reduction in the user cost of capital stimulated as much as an
additional 8.6 percent of investment. Much of the responsiveness is attributable to
the temporary nature of the program with large intertemporal substitution effects.
The assistance also raised productivity growth significantly in low-productivity
firms. Only a small increase was observed for otherwise high-productivity firms.
T.E.