canadian tax journal / revue fiscale canadienne (2015) 63:4, 1133 - 61
Current Tax Reading
Co-Editors: Robin Boadway, Tim Edgar, Jinyan Li, and
Alan Macnaughton*
Tim Edgar, Jinyan Li, and Thaddeus Hwong, eds., “Tax Policy for a Better
Tomorrow: Intersectoral and Multidisciplinary Connections, a Workshop in
Honour of Neil Brooks” (2015) 52:2 Osgoode Hall Law Journal 377-551
This symposium issue of the Osgoode Hall Law Journal consists of five papers that
were presented at a workshop held on May 12-13, 2013 in Toronto to honour Professor Neil Brooks on his retirement after 40-plus years of teaching tax law and
policy at Osgoode Hall Law School, York University. Tax scholars in law and economics, as well as tax policy makers and practitioners, had been invited to prepare
and present papers in celebration of Brooks’s distinguished career as a tax-law academic; participants in the workshop came from Canada, Europe, the United States,
Australia, and New Zealand.
All aspiring tax academics should read Brooks’s body of work, beginning with his
1985 article on the subject of tax scholarship.1
The five articles in this symposium issue are motivated, at least in part, by one or
more of the major themes that Brooks has explored over the course of his career.
The overriding theme of his tax scholarship is the need for a comprehensive and
progressive income tax as the principal fiscal instrument for realizing a more economically just society; throughout his work, Brooks emphasizes the role of a progressive
income tax within the mix of various taxes commonly used in Canada and other
countries. His early work was the basis for his staunch opposition to the introduction
of the federal goods and services tax (GST).2 He later softened his position somewhat when he came to view a comprehensive sales tax as a defensible element of the
tax mix, accepting that such a tax can be an effective and efficient revenue-raising
instrument,3 provided that it is combined with a comprehensive and progressive
* Robin Boadway is of the Department of Economics, Queen’s University, Kingston, Ontario.
Tim Edgar is of Osgoode Hall Law School, York University, Toronto. 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.
1 N. Brooks, “Future Directions in Canadian Tax Law Scholarship” (1985) 23:3 Osgoode Hall Law
Journal 441-75.
2 Neil Brooks, The Canadian Goods and Services Tax: History, Policy, and Politics (Sydney: Australian
Tax Research Foundation, 1992).
3 See, for example, Junko Kato, Regressive Taxation and the Welfare State: Path Dependence and
Policy Diffusion (New York: Cambridge University Press, 2010).
 1133
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income tax as the principal policy instrument to realize a more equitable distribution of resources. Brooks’s work on the comprehensive income tax also includes a
more specific focus on narrower issues, including (1) the choice of the individual or
the family as the tax unit;4 (2) the principles governing the deduction of business
expenses;5 (3) the case for a comprehensive capital gains tax;6 (4) the case for a progressive tax rate structure;7 and (5) the role and design of the corporate income tax.8
Two other themes that Brooks has explored in depth are closely related to his
work on a comprehensive and progressive income tax. One of these themes is the
power of tax expenditure analysis that focuses on government spending delivered
through the tax system. Brooks pursued this subject throughout his career, leading
to a seminal article, published as a book chapter in 2009, that emphasizes the need
for an understanding of tax expenditures as a critical component of tax system reform.9 The conceptual clarity of Brooks’s argument is simply breathtaking. This
article is essential reading for anyone working in the area of tax expenditure accounting and tax expenditure analysis.
The other theme clearly related to Brooks’s work on a comprehensive and progressive income tax is the use of the tax system to pursue the collective aspirations
of a country’s citizens. Brooks explored this theme most recently in the popular bestseller The Trouble with Billionaires,10 which he co-authored with Linda McQuaig, the
well-known Canadian business journalist and public intellectual.
A fourth theme of Brooks’s tax scholarship is the theory and practice of statutory
interpretation. His argument in this area is a radical one, positing a role for the judiciary as pragmatic policy analysts who perform an essential function complementary
4 Neil Brooks, “The Irrelevance of Conjugal Relationships in Assessing Tax Liability,” in John
G. Head and Richard Krever, eds., Tax Units and the Tax Rate of Scale (Burwood, Victoria:
Australian Tax Research Foundation, 1996), 35-80.
5 Neil Brooks, “The Principles Underlying the Deduction of Business Expenses,” in Brian G.
Hansen, Vern Krishna, and James A. Rendall, eds., Essays on Canadian Taxation (Toronto: De
Boo, 1978), 249-309.
6 Neil Brooks, “Flattening the Claims of the Flat Taxers” (1998) 21:2 Dalhousie Law Journal
287-369.
7 Rick Krever and Neil Brooks, A Capital Gains Tax for New Zealand (Wellington: Victoria
University Press for the Institute of Policy Studies, 1990). See also Neil Brooks and Arthur
Peltomaa, “The Case for Full Taxation of Capital Gains” (1979) 1:1 Canadian Taxation:
A Journal of Tax Policy 7-12.
8 Neil Brooks, “Canadian Corporate Tax: Logic, Policies and Politics,” in John G. Head and
Richard Krever, eds., Company Tax Systems (Sydney: Australian Tax Research Foundation,
1997), 115-57.
9 Neil Brooks, “The Under-Appreciated Implications of the Tax Expenditure Concept,” in Chris
Evans and Richard Krever, eds., Australian Business Tax Reform in Retrospect and Prospect
(Pyrmont, NSW: Thomson Reuters, 2009), 233-58.
10 Linda McQuaig and Neil Brooks, The Trouble with Billionaires (Toronto: Viking Canada, 2010),
reviewed in this feature (2010) 58:4 Canadian Tax Journal 1053-68, at 1056-57.
current tax reading  n  1135
to that of the legislature in the development of a coherent tax system.11 Grounding
his argument in a deep knowledge of legal theory and statutory interpretation,
Brooks rejects legal formalism as well as a purposive approach to statutory interpretation. Instead, he argues that the judiciary should strive to reach a result in a
particular case that is a sensible one when framed within the relevant policy context.
He criticizes the Supreme Court of Canada for its formalistic approach to statutory
interpretation and contrasts that approach with the one espoused by the former
chief justice of the Tax Court of Canada Donald Bowman. Bowman’s decisions exemplify a pragmatic approach to statutory interpretation that strengthens the coherence
of the tax system rather than undermines it.12 It is probably fair to characterize this
theme as one that has resonated with tax practitioners, who do not always agree with
Brooks’s argument but will admit that they must engage with it, in particular by reexamining many of their assumptions underlying more conventional approaches to
statutory interpretation.
The articles in the symposium issue begin with “Taxation and Inequality in Canada and the United States: Two Stories or One?” by Richard M. Bird and Eric M.
Zolt. The authors consider the tax contours of the “fiscal contracts” in Canada and
the United States, and their article unpacks some of the underlying detail of a 2006
study in which Brooks and his co-author Thaddeus Hwong13 demonstrated a statistically significant relationship between levels of taxation and various measures of
desirable social outcomes. Bird and Zolt make the important point that, contrary to
popular belief, the Canadian tax system is actually less progressive than the US system,
primarily because of the much greater role in the Canadian tax mix of regressive
sales taxes, particularly the GST at the federal level. However, the Canadian transfer
system provides a much higher level of redistribution through the targeting of taxbased and non-tax-based programs at lower-income households. The US system
provides what are largely cross-subsidies among middle-income households. Bird and
Zolt conclude their article with some interesting speculation about future alterations
to the fiscal contracts in Canada and the United States, which remain markedly different. The article is a timely one, given the current debate over income inequality,
its effects, and possible policy responses.
Kathleen A. Lahey’s article, “Uncovering Women in Taxation: The Gender
Impact of Detaxation, Tax Expenditures, and Joint Tax/Benefit Units,” documents
11 Neil Brooks, “The Responsibility of Judges in Interpreting Tax Legislation,” in Graeme S.
Cooper, ed., Tax Avoidance and the Rule of Law (Amsterdam: International Bureau of Fiscal
Documentation, 1997), 93-129.
12 Neil Brooks and Kim Brooks, “Going for the Jugular: Justice Bowman’s Approach to the Craft
of Judging” (2010) 58, special supp. Canadian Tax Journal 5-28.
13 Neil Brooks and Thaddeus Hwong, The Social Benefits and Economic Costs of Taxation: A Comparison
of High- and Low-Tax Countries (Ottawa: Canadian Centre for Policy Alternatives, December
2006). See also Neil Brooks and Thaddeus Hwong, “Tax Levels, Structures, and Reforms:
Convergence or Persistence” (2010) 11:2 Theoretical Inquiries in Law 791-821, reviewed in this
feature (2010) 58:4 Canadian Tax Journal 1053-68, at 1058-59.
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in detail the impact of Canada’s tax and transfer system on women historically, with
a particular emphasis on federal budgetary initiatives from the mid-1990s to the
present. Lahey focuses on the gender impact of such initiatives. She first considers
how various reductions in tax levels have affected women in a general way, and then
moves on to more specific initiatives, presenting a detailed critique of the family tax
cut/income-splitting initiative of the Harper government, referred to as the family
tax credit (FTC). As enacted legislatively and as introduced on October 30, 2014, the
FTC provides income splitting for families with children under the age of 18, up to a
limit of $50,000.14 Given the surprisingly thin state of the literature on gender-based
budgeting, Lahey’s article makes a notable contribution; it fits thematically with the
article by Bird and Zolt, and it is also conceptually linked with an essay by Brooks
published in 1996.15 In that essay, Brooks articulated a control theory of income
intended to justify the use of the individual as the tax unit for income tax purposes
but the household or family for the delivery of income support, presumably because
of the different distributional features associated with each. Lahey seems to prefer
the use of the individual wherever gender is implicated in the effect of a tax measure,
regardless of other considerations such as income and underlying empirical assumptions about the sharing of resources.
Peter W. Hogg and J. Scott Wilkie, in “Tax Law Within the Larger Legal System,” emphasize the constraints of the legal environment on the implementation of
tax policy in legislative form. Their thesis is that tax policy making does not occur in
a vacuum but is inevitably subject to the broader legal context, which can affect intended policy outcomes. This thesis is illustrated with two quite different examples.
The more obvious example concerns the limitations imposed by the Canadian Charter
of Rights and Freedoms,16 both generally and more particularly with respect to the
investigative powers of the Canada Revenue Agency (CRA). A principal focus of the
first part of the article is the recent Guindon case17 and its consideration of the characterization of the adviser civil penalties regime in the Income Tax Act18 as either
civil or criminal in nature. The less obvious example, considered in the second part
of the article, is the increasingly influential role of the Organisation for Economic
Co-operation and Development (OECD) in the evolution of Canada’s international
tax regime. As emphasized in a high-profile transfer-pricing case recently decided by
the Supreme Court of Canada,19 the OECD’s influence is constrained by the status
of principles as soft law or as hard law in the sense of their specific incorporation in
14 Canada, Department of Finance, News Release, October 30, 2014 and accompanying Notice of
Ways and Means Motion To Amend the Income Tax Act.
15 Supra note 4.
16 Part I of the Constitution Act, 1982, being schedule B to the Canada Act 1982 (UK), 1982, c. 11.
17 Guindon v. Canada, 2015 SCC 41.
18 RSC 1985, c. 1 (5th Supp.), as amended (herein referred to as “the Act”).
19 Canada v. GlaxoSmithKline Inc., 2012 SCC 52.
current tax reading  n  1137
Canada’s domestic law. Hogg and Wilkie’s argument is one that is often ignored in
the tax literature.
In “The Responsibility of Judges in Interpreting Tax Legislation: Japan’s Experience,” Yoshihiro Masui surveys Japan’s judicial approach to statutory interpretation
in both a non-tax-avoidance and a tax-avoidance context. There is very little literature in English on the Japanese tax system, and this article is worthwhile for that
reason alone. It provides a unique view into the evolving approach of the judiciary in
Japan in tax appeals, including an interesting change in judicial attitudes to tax avoidance. In fact, the case-law survey provided by Masui suggests a creative, purposive
approach to statutory interpretation, which—although not quite the approach advocated by Brooks—is arguably much less formalistic than that of Canadian courts.
Sijbren Cnossen’s article, “What Kind of Corporation Tax Regime?”, concludes
the symposium issue with a survey of the role and design of corporate income tax
systems both in practice and in theory. Cnossen usefully contrasts the two approaches
and suggests some directions for future reform along the lines of the innovative
systems adopted in the early 1990s by the Nordic countries. In contrast to Cnossen’s
approach, Brooks’s work in this area separates the choice of corporate income tax
from the use of dual tax rates for income from capital and labour, arguing that the
Canadian corporate income tax, although conceptually somewhat opaque, has
functioned effectively. Brooks prefers a dual income tax primarily for its consistent
treatment of all forms of capital income, an approach that tends to constrain wasteful tax planning.20
The five articles in the symposium issue are preceded by a delightful retrospective on Brooks’s body of scholarship, written by his daughter, Kim Brooks, former
dean of the Schulich School of Law, Dalhousie University, and a well-known tax
academic herself. In describing her father’s work, Kim Brooks emphasizes the four
related themes discussed earlier in this review, and she provides an important annotated bibliography of that work, much of which has been published out of the
mainstream of tax writing and is hard to track down. But her retrospective offers
much more in including many entertaining personal anecdotes that only a daughter
could provide.
Many readers may be unaware that Neil Brooks was initially a leading scholar on
the law of evidence and then, for no obvious reason, switched to tax law and policy.
For that change of direction, countless students who have gone on to careers as tax
practitioners, academics, policy makers, and administrators are eternally grateful.
For many of them, his enthusiasm and passion for the public good have made a lasting impression. The debt that all members of the Canadian tax community and the
broader public owe Neil Brooks is captured in the following tribute written by
20 Neil Brooks, “An Overview of the Role of the VAT, Fundamental Tax Reform, and a Defence
of the Income Tax,” in Richard Krever and David White, eds., GST in Retrospect and Prospect
(Wellington, NZ: Brookers, 2007), 597-658.
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Linda McQuaig in the acknowledgments section of her 1987 bestseller, Behind Closed
Doors: How the Rich Won Control of Canada’s Tax System:
Over the years, he has taught thousands of law students the importance of approaching the tax system critically, of asking why the tax system is the way that it is and who
benefits from it. Neil Brooks is really the unsung hero of tax in Canada. He brings an
intellectual rigour and a deep sense of justice to a subject too often approached in a
purely technical manner. Like many who have been exposed to his ideas and spirit, I
have been deeply inspired. This book is a product of that inspiration.21
T.E.
Michael P. Devereux and John Vella, “Are We Heading Towards a Corporate
Tax System Fit for the 21st Century?” (2014) 35:4 Fiscal Studies 449-75
Wei Cui, “A Critical Review of Proposals for Destination-Based Cash-Flow
Corporate Taxation as an International Tax Reform Option,” paper presented
at the Oxford University Centre for Business Taxation Academic Symposium
2015, 22 pages, www.sbs.ox.ac.uk/sites/default/files/Business
_Taxation/Events/conferences/symposia/2015/cui-paper.pdf
Corporate tax systems are coming under increasing scrutiny as a result of the growing
recognition that they are outmoded, inefficient, and prone to compliance problems.
The corporate tax distorts various business decisions, such as where to invest, how
much to invest, how to finance investments, how much risk to take, and where to
book profits. Recent high-profile cases have illustrated how multinational corporations (MNCs) can apparently game the system to reduce their tax liabilities. National
governments in turn face competitive pressure to make their tax systems more attractive to firms by reducing tax rates and distortions, though doing so also compromises
their ability to raise revenues. The OECD’s base erosion and profit shifting (BEPS)
initiative attempts to address some of these issues in a coordinated manner.
In the first of the two publications reviewed here, Devereux and Vella argue that
the problems with the current international corporate tax system arise from two
sources:
1. The system for allocating profits of MNCs among countries is incoherent. It
is based on a 1920s League of Nations compromise that proposed using the
source principle to allocate active business income and the residence principle to allocate passive investment income (dividends, interest, royalties).
The rationale, now discredited, was that source taxation should reflect the
benefit principle while residence taxation should be based on ability to pay.
The compromise implicit in this dichotomous treatment is reflected in the
21 Linda McQuaig, Behind Closed Doors: How the Rich Won Control of Canada’s Tax System . . . And
Ended Up Richer (Toronto: Viking, 1987), at x.
current tax reading  n  1139
OECD model treaty and in most existing tax treaties based on that model. It
has led to an international tax system in which tax avoidance is rampant—a
phenomenon that has motivated the BEPS initiative.
2. Tax competition is endemic. It encourages countries to use the corporate tax
system to attract business activity and favour their own firms, leading to the
perception that corporations pay too little tax.
Devereux and Vella argue that the piecemeal approach of the BEPS initiative is
insufficient and that more fundamental reforms of the international corporate tax
system are required. They begin by describing in more detail the two sources of the
problems with the existing system. With respect to the first, the compromise system
for allocating profits among countries has become ineffective because the concepts
of source and residence are no longer clearly defined. Given the complex and widely
dispersed activities of the modern MNC, it is unclear how to determine where profits
are being earned; the distinction between residence and source itself has become
untenable. The problems are evident in attempts to allocate royalties by country of
residence and active business income by country of source, and in the difficult valuation issues that this approach entails. In addition, hybrid financing instruments
make the distinction between debt and equity—and thus the definition of active
business income—ambiguous.
Allocation difficulties also arise with respect to transfer pricing—in particular,
the applicability of the arm’s-length principle (ALP) to the modern MNC. Not only
can the ALP be difficult to apply, but even where the conditions for its application are
satisfied, its use can lead to profit shifting to low-tax jurisdictions. Devereux and Vella
provide two examples of this, one based on the use of so-called cost-contribution
arrangements to allocate the costs of developing intangible properties among affiliates, and the other based on shifting risk from one affiliate to another. Even though
the ALP criteria are satisfied, outcomes are achieved that make little sense from an
economic point of view.
With respect to the second source of problems with the existing system—the
incentive for national governments to use the corporate tax to attract investment
and favour domestic firms—two examples are illustrative. One concerns the United
Kingdom, which recently pursued a policy of attracting investment by lowering its
corporate tax rate, introducing a patent box system, and reforming the controlled
foreign company rules, particularly the “finance company partial exemption” regime. Devereux and Vella argue that these measures are meant to (1) encourage
corporations to locate in the United Kingdom, (2) provide domestic firms with a
competitive advantage, and (3) in the case of the last reform, encourage the use of
offshore finance companies by UK MNCs, resulting in the erosion of foreign tax
bases. The second example concerns the United States and its check-the-box regulations. The authors cite the case of a US MNC that arranges to have royalties from
intellectual property shifted to a tax haven country rather than being taken in by a
foreign affiliate operating in a high-tax country. The royalty income will eventually
be taxed in the United States when it is repatriated, but tax is avoided in the high-tax
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home of the affiliate. Effectively, the regulation has caused the tax base to be eroded
in the high-tax country with no ultimate effect on the United States. Thus, the US
MNC is being favoured at a cost to the high-tax country’s revenue. Thus, as these
examples show, the international tax regime encourages countries to compete with
one another both to attract investment and to protect their own firms.
Devereux and Vella then turn to a critique of the BEPS action plan. The central
challenge as enunciated by the OECD is to address double non-taxation or undertaxation rather than to reform the tax structure itself. The proposed actions do not
change the standards for allocating taxing rights across countries: the source/residence
logic and the active/passive income distinction are retained. The only alternative
mentioned by the OECD is formulary apportionment, but it is given short shrift.
According to the action plan, there is a need to realign the location of taxation with
“relevant substance” or “value creation” in order to prevent the segregation of taxable income from activities that generate it.
The authors discuss six problems with the action plan’s approach of basing taxation rights on the location of economic activity:
1. Aligning taxation rights with economic activity is a departure from existing
practice, particularly for passive income, and has been proposed without
careful explanation or evaluation.
2. Superimposing on the current structure a principle based on the location of
economic activity makes the system even more incoherent. The authors
provide examples showing that taxation by this principle will be aligned with
economic activity in some, but not all, cases. Inevitably, vague tests using
concepts such as “artificial” or “excessive” must be relied on.
3. It is possible that the economic activity test wrongly identifies instances of
low or zero economic activity—for example, in the case of royalty payments
from intellectual property.
4. The focus on economic activity suggests a misdiagnosis of the problem in
some cases—for example, where the problem arises from the inability to correctly price interfirm transactions. Devereux and Vella argue that such a case
should be addressed directly rather than through some economic activity
criterion.
5. Tax planning and the possible movement of real activity to satisfy the criterion will undermine the test and create inefficiencies.
6. In the case of MNCs that are involved in many coordinated activities, it is
unclear where economic activity is created, so the principle itself will be
ambiguous.
As well as these issues involving the location of taxation rights, the BEPS action
plan’s approach will not alleviate the incentives for tax competition in the existing
system, except to the limited extent that changes are embedded in negotiated tax
treaties. Many recommendations call for nations to change domestic legislation. It
current tax reading  n  1141
is not clear that states will fully comply by legislating against their perceived selfinterest. Moreover, the fact that not all states are party to the BEPS process undermines
changes based on voluntary state behaviour.
Devereux and Vella then consider whether wholesale changes might be made to
the international taxation system to resolve existing problems and discourage wasteful tax competition. They propose three options, without going into detail about
practical implementation.
n
n
n
The first option is formulary apportionment, analogous to the system used in
Canada to allocate profits among provinces. The formula that is chosen will
never result in a true allocation of profits, since that is an unachievable ideal,
but the existing system also fails to do so. Countries would have to agree on
the tax base and the allocation formula, a requirement that would be difficult
to satisfy; and even then, this option would not eliminate competition in tax
rates.
The second option is the allocation of taxation rights according to the location of final sales—that is, destination-based corporate taxation. Since final
consumers are relatively immobile, this would insulate the tax system from
competition for a mobile tax base. A destination-based corporate tax could
operate similarly to a value-added tax (VAT), especially if the corporate tax were
a cash flow tax, except that a deduction would have to be given for labour costs
where they were incurred. A destination-based corporate tax would not affect the location of investment, and if it were a cash flow tax, it would not
distort the intensity of investment or the financing decision. It could be implemented in a manner similar to a VAT, and securing international cooperation
would be less difficult than in the case of the first option. Countries would
have an incentive to join such a system once it had been implemented by a
subset of countries.
The third option is to implement a simpler corporate tax system, possibly one
that violates production efficiency. Examples include turnover taxes, payroll
taxes, and taxes based on asset size. Such taxes would not only distort production; they would also not be immune to tax competition.
Of these alternatives, a destination-based cash flow tax (DCT) offers the most
promise. It is arguably the most efficient of the options and has been proposed
elsewhere, notably by the Mirrlees review.22 In the second of the two publications
discussed here, Cui offers a critical review of DCT proposals that is both instructive
22 James Mirrlees, Stuart Adam, Timothy Besley, Richard Blundell, Stephen Bond, Robert Chote,
Malcolm Gammie, Paul Johnson, Gareth Myles, and James Poterba, Tax by Design: The Mirrlees
Review (Oxford: Oxford University Press, 2011), reviewed in this feature (2012) 60:1 Canadian
Tax Journal 257-74, at 263-65.
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and comprehensive. He begins with the motivation for the DCT. Existing corporate
taxes are designed to be withholding devices for the personal income tax system;
however, this role has become unnecessary in a world where much shareholder income is sheltered from personal tax and international capital markets imply that
shareholder after-tax rates of return are impervious to personal taxes. In the process,
corporate taxes distort business decisions on three margins: location, investment
intensity, and where to book profits. The DCT is intended to avoid these distortions.
Cui argues for more clarity in this motivation. What inefficiencies are involved in
deciding where to book profits? Doesn’t the destination basis undermine the case
for cash flow taxation, since location and profit shifting are less relevant? Why not
simply rely on a VAT, since it also avoids distorting the three margins? Should the
DCT apply only to corporations, in which case there will be implementation problems? How do we identify the destination country for a firm that mostly sells goods
and services to other firms?
To clarify some of the other issues, Cui outlines three separate forms that the
DCT could take:
n
n
n
Version 1, the benchmark case, would tax corporate profits in the country of
destination, not the country of origin. Implementing such a system would be
difficult. One would need to know what costs in the country of origin or
production should be attributed to sales to the destination country. Moreover,
corporate profits of firms that sell only intermediate goods would have to be
attributed to a final destination country. Cui argues that it would be both
feasible and efficient to tax firms on the basis of the residence of their owners
rather than the location of their final sales.
Version 2 is a VAT with a deduction for labour costs, since a VAT is effectively
a tax on rents plus labour income. Again, attributing the cost of labour to the
destination country would be difficult and would also give rise to negative tax
liabilities in the country of origin, which would need to be refunded there.
More generally, this version would involve the tax authorities of different
countries, with the country of origin needing to verify the labour costs claimed
by exporting firms.
Version 3 would tax exports in the country of origin, but at the destination
country’s tax rate. Having the revenues stay in the country of origin would
avoid negative tax liabilities in that country, but could create negative tax liabilities in the destination country; therefore, little would be accomplished.
Cui points out that all versions of the DCT could give rise to implicit export subsidies,
in violation of the rules under the general agreement on tariffs and trade (GATT).
A further important issue with the DCT, and one that applies more generally to
all corporate tax systems, concerns loss refunds. Cash flow tax proponents typically
call for full loss offsetting, or its equivalent, which entails either refundability of
losses or carryforward (or carryback) of losses with interest. Firms winding up with
tax losses on their books would require refundability. Tax systems almost never allow
current tax reading  n  1143
for refundability on windup—a limitation that can be used as an argument for preferential small business tax rates. Proponents of full loss offsetting argue that it is
required to avoid discouraging risk taking. (Corporate profits include both rents and
returns to risk, but losses are presumably due to the latter.) Cui takes issue with full
refundability and argues that there are two reasons why losses should not be refunded,
or (to use his term) subsidized. First, corporate losses entail losses to shareholders,
who can often offset realized capital losses against other income. As well, accrued
capital gains need not be realized, so that there is an asymmetry in favour of losses.
Second, losses might arise as a result of negative rent rather than ordinary risk, and
there is no reason why the government should subsidize investments anticipating
negative rents. These arguments, if accepted, would justify the current practice of
not refunding tax losses.
Cui concludes his paper with a discussion of some of the technical difficulties
involved in implementing a DTC. He takes the position that residence-based corporate taxation is at least as feasible as destination-based taxation from an informational
point of view, and has the same efficiency properties. In his view, the onus is on
proponents of the DCT to defend their view or at least to clarify their arguments.
His arguments are fairly persuasive.
R.B.
Alain Deneault, Canada: A New Tax Haven: How the Country That Shaped
Caribbean Tax Havens Is Becoming One Itself, trans. Catherine Browne
(Vancouver: Talonbooks, 2015), 224 pages, ISBN 9780889228368
For tax practitioners, policy makers, academics, and administrators, the provocative
title of this book by a Quebec-based journalist will likely be seen as unsupported by
sufficient analytical rigour. The author’s intended audience however, is not the
professional tax community but rather the general Canadian electorate. The book
is an attempt to provide an accessible account of tax avoidance, broadly defined, that
brings the subject into the political arena. Deneault does not want to limit his political call to arms to civil society and tax justice organizations but, in effect, seeks to
bypass these groups and appeal directly to Canadian voters. His approach is similar
to that of tax justice organizations in conflating under the rubric “tax avoidance”
activities that are regarded by the professional tax community as exhibiting distinctive
fact patterns with distinct legal consequences—namely, tax evasion, sham transactions,
aggressive tax planning, and structured tax-avoidance transactions.23 Deneault acknowledges that he has conflated these distinct legal categories in an effort to avoid
23 See, for example, Allison Christians, “Avoidance, Evasion, and Taxpayer Morality” (2014) 44:1
Washington University Journal of Law and Policy 39-59, reviewed in this feature (2014) 62:4
Canadian Tax Journal 1211-33, at 1223-25; and Allison Christians, “Drawing the Boundaries
of Tax Justice,” in Kim Brooks, ed., The Quest for Tax Reform Continues: The Royal Commission on
Taxation Fifty Years Later (Toronto: Carswell, 2013), 53-79.
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transforming into a legal debate what he believes needs to be a political debate. In
effect, his goal is to politicize the issue of tax avoidance, the role of tax havens, and
Canada’s role in facilitating tax haven accommodation by Caribbean countries, and
by the Canadian business community and Canadian governments themselves, for
the benefit of Canada’s political and business elites. Given that Canadian political
parties have no interest in politicizing these issues, one can see why Deneault, or
some other tax justice advocate, is required to present the Canadian electorate with
a direct appeal similar in content and tone to a political platform. His text bleeds a
passion that is nothing if not admirable.
Deneault defines a “tax haven” somewhat conventionally as “a jurisdiction whose
tax rate is or approaches zero and whose legal systems . . . [create] a level of bank
secrecy that conceals the identity of account holders as well as the nature of their
transactions.”24 He characterizes such jurisdictions as being highly permissive and
accommodating, and as providing not only tax advantages but also a wide range of
privileges of a regulatory and legal nature. His principal point of emphasis is Canada’s involvement in developing certain Caribbean countries as tax havens and then
using the lessons learned through that process to become, directly and indirectly,
something of a tax haven itself—a country whose tax laws and regulatory environment are designed to accommodate the wealthy and powerful, while denying similar
advantages to less privileged social classes (which constitute the majority of the
population).
Following a brief introductory chapter, the core of the book consists of 12 substantive chapters, 8 of which provide, in turn, a narrative of Canada’s involvement
in the development of a particular country as a tax haven. Of the other 4 chapters,
3 focus on provincial initiatives in Alberta, Ontario, and Nova Scotia that are cited
as evidence of Canada’s shift to tax haven status, while the fourth makes the case
for Canada’s tax haven status on the basis of aspects of the federal income tax system, particularly the corporate income tax. All of this material is wrapped up in a
concluding chapter. As Deneault notes, each of the chapters is intended to be read
independently, and there is some overlap in the material covered. The chapters are
presented chronologically rather than thematically, with the result that the chapters
describing the involvement of Canada’s business and political elites are separated by
the 4 chapters detailing Canada’s alleged descent into tax haven status. Each of the 8
country chapters is organized around what Deneault sees as a defining moment in the
development of the particular jurisdiction as a tax haven. The focus of these chapters
is almost exclusively on the design of accommodating regulatory and non-tax legal
regimes. The singular exception is the chapter on Barbados, which focuses on the
1980 Canada-Barbados tax treaty as the gateway to exempt surplus treatment for
third-country earnings of Canadian-based MNCs, relying on the lookthrough rule
in subparagraph 95(2)(a)(ii) of the Income Tax Act. Deneault then embarks on a
24 At 3.
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meandering discussion of tax information exchange agreements (TIEAs), the transferpricing decision in GlaxoSmithKline,25 the recent trio of tax treaty-shopping cases,26
and the Garron trust case.27
The 3 chapters citing the initiatives in Alberta, Ontario, and Nova Scotia similarly focus on the development of lax regulatory regimes for, respectively, the oil
and gas, mining, and finance sectors. The tax perspective for Alberta that is cited as
evidence of tax haven status is the reduction of rates under the royalty tax regime in
the 1990s, which Deneault compares unfavourably with the very different approach
and status of Norway (an oil- and gas-dependent country). The tax perspective for
Ontario is the tax expenditure regime provided by the treatment of Canadian exploration expenses and Canadian development expenses using flowthrough shares.
The tax perspective for Nova Scotia is its recently adopted payroll subsidy regime for
back-office expenses of hedge funds. The principal point of emphasis of the chapter
focused on federal initiatives that supposedly support a characterization of Canada as
a tax haven is the phased series of reductions in the corporate income tax rate. This
chapter, however, casts a wide net, also citing reductions in the capital gains tax rate
and customs duties, tax deferral generally, weak access to information in a crossborder context, income trusts, treaty relief from section 116 withholding on taxable
Canadian property, and the weakness of the general anti-avoidance rule in section
245 as interpreted by Canadian courts. At a general level, Deneault acknowledges
that reductions in the corporate income tax rate, as well as the provision of narrower
tax reduction regimes such as that for exempt surplus of Canadian-based MNCs, can
be—and conventionally are—justified on the basis of a perceived need for the Canadian income tax system to be competitive with the tax systems of other developed
countries. More particularly, policy makers can justify the adoption of tax regimes
that are seen to realize gains in national welfare on the basis that those gains exceed
the associated revenue loss. Although it is arguable that this relationship does not
stand up all that well to any sort of rigorous analysis, it is a conceptual leap to follow
with a characterization of Canada as a tax haven on the basis of a reluctance on the
part of our elected officials to repeal the relevant tax regimes.
The concluding chapter is almost frantic in tone and analytically thin in its attempt to weave together various topics as evidence of Canada’s shift to tax haven
status. Deneault canvasses a wide range of issues in a relatively superficial manner,
although virtually all of those issues have been explored in the existing analytical
literature, both empirical and theoretical. The sources reviewed with respect to
each discrete subject are very narrowly, and somewhat oddly, selected. There are,
25 Supra note 19.
26 See, for example, MIL (Investments) SA v. The Queen, 2006 TCC 460; aff ’d. 2007 FCA 236. See
also Velcro Canada Inc. v. The Queen, 2012 TCC 57; and Prévost Car Inc. v. The Queen, 2008
TCC 231; aff ’d. 2009 FCA 57.
27 Fundy Settlement v. Canada, 2012 SCC 14; aff ’g. St. Michael Trust Corp. v. Canada, 2010 FCA
309; aff ’g. Garron Family Trust v. The Queen, 2009 TCC 450.
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however, some interesting sources cited that are published in French only and that
readers may otherwise be unaware of. At the end of it all, Deneault provides nothing
more than a well-worn laundry list of policy initiatives that includes the following:
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eliminating the link between tax treaties and TIEAs on the one hand and exempt surplus treatment on the other;
requiring consolidated reporting of tax earnings broken down by country;
ensuring, through transfer-pricing rules, that earnings are located for income
tax purposes in the jurisdiction in which the relevant activity occurs;
adopting automatic exchange-of-information requirements in a cross-border
context; and
strengthening anti-avoidance laws generally.
It is odd that the book opens with a brief mention of the release of financial
records—first in 2008 by an employee of HSBC Bank in Geneva and then (involving
a different set of records) in 2013 by the International Consortium of Investigative
Journalists—yet never returns to discuss either episode in any detail. The CRA’s passive response to these document releases is curious, to say the least, and warrants
much more exploration than Deneault provides. Perhaps he avoids such exploration
in order to avoid focusing narrowly on tax evasion and information reporting,
which these episodes tend to highlight. He also avoids any mention of base erosion
and profit shifting—currently under review by the OECD—even though it is an obvious example of a form of tax avoidance that warrants political treatment. It might
be worthwhile for a subsequent edition of the book to incorporate a discussion of
the outcome of the BEPS initiative, including Canada’s response to an agreed-upon
action plan.
T.E.
Jonathan Rhys Kesselman, Family Tax Cuts: How Inclusive a Family?
(Ottawa: Caledon Institute of Social Policy, November 2014),
36 pages, ISBN 1-55382-632-9, www.caledoninst.org/
Publications/PDF/1055ENG.pdf
The introduction of the family tax credit (FTC) in 2014 by the former (Conservative)
government has spawned a small and recent literature assessing the revenue-loss
and distributional effects of the initiative.28 This policy paper assesses the distributional features of the income-splitting tax credit within the broader context of a
longstanding debate in the tax-policy literature over the appropriate concept of
a “family” (as opposed to the individual) as the unit of taxation. In adopting this
28 See, for example, Kathleen A. Lahey, “Uncovering Women in Taxation: The Gender Impact of
Detaxation, Tax Expenditures, and Joint Tax/Benefit Units” (2015) 52:2 Osgoode Hall Law Journal
427-59, reviewed in this issue. See also Richard Shillington, The Big Split: Income Splitting’s
Unequal Distribution of Benefits Across Canada (Ottawa: Broadbent Institute, June 2014); Sunhil
current tax reading  n  1147
perspective, Kesselman’s approach is similar to that of Kathleen Lahey (noted in the
first review above), which focuses on the gender impact of the credit.
Kesselman’s critique of the FTC is based on the Harper government’s earlier version of formal income splitting. He acknowledges that the conversion of this measure
to a tax credit addresses two aspects of his critique: (1) the otherwise automatic incorporation of the regime by the provinces, and (2) the legal liability for tax payable
by the transferee spouse where income is split. However, all other aspects of his
critique remain. Most importantly, at a general level, Kesselman observes that the
credit has two inconsistent rationales. One is the equalization of tax burdens for
couples with the same total household income. The other is the provision of income
support for families with children. Kesselman is most critical of the first rationale,
which he sees as the weaker of the two. He argues that the credit suffers from an
overly narrow concept of a family, excluding low- to moderate-income couples and
all single parents while concentrating benefits on high-income single-earner couples.
Moreover, delivery of the credit to provide the effect of a 50/50 income split within
the $2,000 annual cap assumes full sharing of income, which is not necessarily the
case empirically. This aspect of the credit also fails to consider economies of living
together, which are reflected in adult equivalence scales, and it ignores the value of
services provided by a stay-at-home spouse.
The stronger rationale for the FTC, in Kesselman’s view, is the provision of income support for children. But in this respect he notes that the credit remains
skewed in its distributional impact (presumably because of its other inconsistent
rationale) to 13 percent of all households with average income of $123,000. Fewer
than 3 percent of households will also be constrained by the capped amount of the
benefit than were constrained by the $50,000 limitation on the amount of income
that could be formally split under the earlier proposal. Kesselman then canvasses the
companion legislative changes that were introduced along with the credit, including
an increase in the amount of the universal child care benefit, the elimination of the
child tax credit, and an increase in the amount of the allowable deduction provided by
the child-care expense deduction. He argues that these changes represent a missed
opportunity to bolster income support for all low- to moderate-income families and
single parents who have children at younger ages (which are most critical in a child’s
development). He suggests that this goal could be achieved, for example, by introducing a new “birth bonus,” payable in monthly instalments, that would remain
revenue-neutral. The constraint of revenue neutrality would still allow a total payment of $7,000 per newborn as compared with the cost of the credit alone and
$11,000 per newborn in the case of a package that includes the FTC and the other
ancillary changes to the delivery of existing income support provisions.
T.E.
Johal, Income Splitting or Trojan Horse: The Federal Government’s Proposal and Its Impact on
Provincial Budgets (Toronto: Mowat Centre, September 2014); and David Macdonald, Income
Splitting in Canada: Inequality by Design (Ottawa: Canadian Centre for Policy Alternatives,
January 2014), reviewed in this feature (2015) 63:2 Canadian Tax Journal 606-26, at 610-11.
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William B.P. Robson and Alexandre Laurin, Adaptability, Accountability
and Sustainability: Intergovernmental Fiscal Arrangements in Canada,
C.D. Howe Institute Commentary no. 431 (Toronto: C.D. Howe Institute,
July 2015), 33 pages
It is a common among federations worldwide, as well as among multigovernment
unitary nations and within provinces or states, that higher levels of government
collect more revenue than they need for their own purposes and transfer the excess
to lower levels. The size of the so-called fiscal gap varies widely among federations,
and Canada ranks as having one of the smallest. Various arguments are made for
using federal-provincial fiscal transfers rather than requiring provincial governments
to collect sufficient revenue to fund their own programs. These arguments include
the equalization role of transfers; the use of block transfers to encourage common
standards in the provision of important public services; the correction of interprovincial benefit spillovers; and the retention of sufficient tax room at the federal level
to achieve standards of redistributive equity, to maintain federal-provincial tax
harmonization, and to preclude wasteful tax competition. At the same time, there
is a natural tension in a federation between the alleged benefits of a fiscal gap and
the advantages of decentralized revenue raising, especially the supposed accountability benefits of requiring provinces to finance their expenditures from their own
revenues.
Robson and Laurin revisit this issue in light of mounting fiscal pressures that the
provinces will face in coming years because of demographic changes that will both
increase public spending and dampen tax revenues. Should these fiscal pressures be
met mainly by expenditure restraint and increased provincial tax effort, by increases
in fiscal transfers, or by some or all of these?
The authors begin with a historical review that traces the evolution of fiscal
transfers in Canada since the time of Confederation and culminates in a succinct
explanation of the current system. They emphasize that the current system is not
the result of some grand design based on underlying principles, but rather has been
shaped by periodic responses to events that cause fiscal stresses.
Robson and Laurin next present a concise but thorough summary of the principles
of fiscal federalism, highlighting the tension between the benefits of decentralized
fiscal responsibility, subsidiarity, and healthy fiscal competition, and the benefits of
federal transfers and influence. They also point to a concern that fiscal transfers
could induce a perception that soft-budget constraints are limiting the fiscal discipline of provincial governments.
Finally, Robson and Laurin document quantitatively the fiscal pressures that
provinces will face in coming decades owing to the aging of the population in combination with implicit and explicit public-sector liabilities built into the system. They
consider alternative policies to address this problem, including tax increases, spending controls, the pre-funding of social insurance programs by the provinces, and
increased transfers by the federal government. They argue for relying mainly on
provincial consolidation, and in addition giving provinces more tax room, especially
current tax reading  n  1149
for consumption taxes. They argue that this approach will make provincial decision
making more efficient and accountable, and improve long-term fiscal sustainability,
thus implicitly outweighing any benefits that federal transfers might achieve.
R.B.
Sebastian Eichfelder and François Vaillancourt, “Tax Compliance Costs:
A Review of Cost Burdens and Cost Structures” (2014) 210:3 Hacienda
Pública Española 111-48
The administration of tax laws entails both compliance costs for taxpayers and collection costs for the government. From an economic perspective, compliance and
collection costs are like dead-weight costs, which, to the extent that they are avoidable,
are a waste of resources. Identifying compliance and collection costs is a prerequisite for designing tax policies that minimize them, especially policies that aim to
reduce the complexity of the tax system. Eichfelder and Vaillancourt focus on tax
compliance costs and present a broad survey of empirical studies of such costs covering different types of taxpayers, different taxes, and different types of compliance
activities. The literature on tax compliance is surprisingly large and is well documented in this comprehensive article.
The authors begin by outlining the methods used to measure compliance costs
and identifying some of the problems arising from those methods. The most common approaches used are surveys (by mail or interview) and time and motion studies
(usually for a single country). More detailed approaches include the simulation
method developed by the Internal Revenue Service (IRS) in the United States, which
combines detailed survey and tax return data, and the standard cost model in some
European countries, which is based on representative businesses. Among the methodological problems common to survey approaches are low response rates, which
have an unpredictable effect on results; the sensitivity of survey answers to the framing of questions; the problematic valuation of compliance time; and the difficulty of
separating compliance costs from the overhead costs of firms.
Next, the authors document the estimated size of the compliance cost burden for
various types of taxpayers. For employees, these costs are minimal (about 1 percent
of income), but they are much higher for the self-employed (up to 10 percent). Over
two-thirds of the burden consists of time and effort, though this is gradually decreasing as the use of tax software becomes more prevalent. Most of the remaining costs
are payments for external assistance. In the case of businesses, cost burdens are much
higher for small enterprises relative to medium-sized and large ones, and the burden
decreases for small businesses as they become larger. Moreover, the cost of tax compliance for businesses is high relative to the overall burden of administrative red
tape, such as complying with regulations. Not surprisingly, temporarily high burdens result from the introduction of new tax measures.
For individual taxpayers, compliance costs are high for income and wealth taxes
and for the property tax. Business taxpayers incur high costs for business-income
taxes, VAT, and payroll taxes, and much lower costs for import duties and excise taxes.
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For both individuals and businesses, documentation activities (record keeping and
tax filing) constitute the major part of compliance activities. Tax-planning activities
are limited for individuals and small businesses, but increase in importance with the
size of the firm.
Empirical studies also document the drivers of compliance costs. The most relevant driver is the complexity of the tax system. Others include the responsiveness
of the tax administration; tax accounting and its interaction with financial accounting, especially for smaller firms; and international or interprovincial tax issues for
firms that operate in more than one jurisdiction.
The upshot of these studies is the importance of bookkeeping and taxfiling activities, especially in complex tax systems. This suggests that tax simplification is a
critically important objective of tax policy. The user-friendliness of tax administration is also relevant.
R.B.
Michael P. Donohoe, “Financial Derivatives in Corporate Tax Avoidance:
A Conceptual Perspective” (2015) 37:1 Journal of the American Taxation
Association 37-68
Michael P. Donohoe, “The Economic Effects of Financial
Derivatives on Corporate Tax Avoidance” (2015) 59:1
Journal of Accounting and Economics 1-24
These two articles reflect an ambitious research agenda that is the basis of Donohoe’s
doctoral dissertation work focused on the use of derivative financial instruments
(DFIs) in corporate tax-avoidance transactions. In the first article, Donohoe (who is
an accounting academic at the University of Illinois) provides what he refers to as a
conceptual framework for clarifying thinking about the questions of why and how
DFIs are used in corporate tax-avoidance transactions. He defines “tax avoidance”
for his purposes broadly, to mean any reduction of explicit taxes.29
As to why DFIs are used in such transactions, Donohoe emphasizes their ability
to smooth income, mimic virtually any economic position, blur economic substance, and create ambiguity in tax reporting, making their use difficult to detect by
tax authorities. As to how DFIs are used in corporate tax-avoidance transactions, he
describes a continuum of transactions. At one end lie hedging transactions that are
intended to smooth taxable income. At the other end lie aggressive tax-avoidance
transactions that use DFIs to create tax attributes and that have no non-tax purpose.
In between lie those transactions that have a non-tax purpose that may even be the
dominant purpose but that also generate tax savings by their being structured to
access a tax benefit. As an example of the latter type of transaction, Donohoe reviews
an interest rate swap with a combination of periodic and non-periodic payments
that provide timing and character advantages within the context of the US notional
29 At 41.
current tax reading  n  1151
principal contract regulations.30 As an example of an aggressive tax-avoidance transaction, he reviews the loss-creation transaction that is the subject of IRS Notice
2002-50.31
Donohoe’s suggested conceptual framework is largely based on the existing legal
literature, which he cites extensively. What is decidedly lacking with regard to the
two questions that he poses—why and how DFIs are used in corporate tax-avoidance
transactions—is systematically rigorous empirical evidence, as opposed to the usual
anecdotal reporting that consigns tax policy making to a state of blissful ignorance.
Accounting academics are uniquely positioned to engage in this line of inquiry, because they possess the methodological skills to do so and because they tend to work
with data sets that lend themselves to this kind of research. Donohoe’s second article
is, in fact, a good example of this line of inquiry. Using a data set for fiscal years 20002008, Donohoe estimates that corporate tax savings from the use of DFIs are in the
range of 3.6 to 4.4 percentage point reductions in three-year current and cash effective tax rates. The criteria for inclusion in the data set are public trading, domestic
incorporation, non-financial and non-utility sector classification, and at least three
years of consecutive observations. New users of DFIs are identified by searching form
10-K from the Securities and Exchange Commission’s EDGAR database. The reduction in cash effective tax rates is estimated to generate tax savings of US $10.69 million
for the average firm and US $4.0 billion for the entire sample of 375 new users of
DFIs. Interestingly, Donohoe interprets the data as suggesting that US $8.75 million
and US $3.3 billion of these amounts, respectively, are incremental tax savings that
are incident to risk management practice rather than aggressive tax planning.
T.E.
Ruud de Mooij and Gaëtan Nicodème, eds., Taxation and Regulation
of the Financial Sector (Cambridge, MA: MIT Press, 2014),
407 pages, ISBN 9780262027977
In the wake of the financial crisis of 2007-2009, an arguably new literature has
emerged that focuses on the interplay between the public finance literature and the
regulatory and finance literature. Oddly, this somewhat obvious link has largely
been ignored until now. This collection of 14 papers (plus an editors’ introduction)
is, to our knowledge, the most comprehensive and explicit attempt yet to study this
interplay. The authors and paper (chapter) titles are as follows:
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Ruud de Mooij and Gaëtan Nicodème, “Taxation and Regulation of the Financial Sector” (chapter 1)
Michael Devereux, “New Bank Taxes: Why and What Will Be the Effects?”
(chapter 2)
Reint Gropp, “Taxes, Banks, and Financial Stability” (chapter 3)
30 Treas. reg. section 1.446-3 under the Internal Revenue Code of 1986, as amended.
31 Notice 2002-50, “Partnership Straddle Tax Shelters,” 2002-28 IRB 1.
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Brian Coulter, Colin Mayer, and John Vickers, “Taxation and Regulation of
Banks To Manage Systemic Risk” (chapter 4)
Jin Cao, “Insolvency Uncertainty, Banking Tax, and Macroprudential Regulation” (chapter 5)
Donato Masciandaro and Francesco Passarelli, “The Political Economy of
Containing Financial Systemic Risk” (chapter 6)
Ben Lockwood, “How Should Financial Intermediation Services Be Taxed?”
(chapter 7)
Thiess Buettner and Katharina Erbe, “FAT or VAT? The Financial Activities
Tax as a Substitute to Imposing Value-Added Tax on Financial Services”
(chapter 8)
Julia Lendvai, Rafal Raciborski, and Lukas Vogel, “Assessing the Macroeconomic Impact of Financial Transaction Taxes” (chapter 9)
Guiseppina Cannas, Jessica Cariboni, Massimo Marchesi, Gaëtan Nicodème,
Marco Petracco Giudici, and Stefano Zedda, “Financial Activities Taxes,
Bank Levies, and Systemic Risk” (chapter 10)
Ruud de Mooij, Michael Keen, and Masanori Orihara, “Taxation, Bank Leverage, and Financial Crises” (chapter 11)
Gunther Capelle-Blancard and Olena Havrylchyk, “Ability of Banks To Shift
Corporate Income Taxes to Customers” (chapter 12)
Timothy J. Goodspeed, “Incidence of Bank Regulations and Taxes on Wages:
Evidence from US States” (chapter 13)
Ricardo Fenochietto, Carlo Pessino, and Ernesto Crivelli, “Impact of Bank
Transaction Taxes on Deposits in Argentina” (chapter 14)
Lawrence L. Kreicher, Robert N. McCauley, and Patrick McGuire, “The 2011
FDIC Assessment on Banks’ Managed Liabilities: Interest Rate and BalanceSheet Responses” (chapter 15)
Part I of the book, consisting of chapters 2 through 6, explores conceptually the
interplay between taxation and regulation of the financial sector. Like all of the chapters, these 5 can be read independently of one another. However, chapters 2 and 3
are worth reading first if only because, to some extent, they set the stage for the
other chapters by canvassing the relevant economic and political economy issues.
Part II, consisting of chapters 7 through 10, focuses more specifically on the design
and effect of various taxes, such as a financial activities tax (FAT) originally proposed
by the International Monetary Fund,32 a financial transactions tax, and bank levies
generally. Arguably, however, the more interesting papers are the empirically focused
ones found in part III, which consists of chapters 11 through 15.
One of the more notable empirical papers is chapter 11. Using aggregated financial data covering 29 countries over the period 2001-2009, de Mooij, Keen, and
Orihara estimate that a reduction of 1 percentage point in the corporate income tax
32 Staff of the International Monetary Fund, A Fair and Substantial Contribution by the Financial
Sector: Final Report for the G-20 (Washington, DC: IMF, June 2010).
current tax reading  n  1153
rate reduces the aggregate leverage ratio of banks by somewhere between 0.08 and
0.11 percentage points. The estimated percentage is, however, slightly smaller when
inferred from macrodata; therefore, the authors consider the range of sensitivity to be
somewhere between 0.04 and 0.15 percentage points. Not surprisingly, they find that
the impact of a marginal increase in leverage on the likelihood of crisis depends on the
initial leverage ratios, which they assume, for illustrative purposes, to be 90 percent,
93 percent, or 96 percent of assets. Estimates of increases in the probability of crisis
are derived for these different leverage levels using the lower and upper bounds of
the tax-sensitivity estimates for increases in leverage, as well as a midpoint between
these two bounds. In general, the authors conclude that the increase in the probability of crisis attributable to an increase in leverage associated with a tax-debt bias
is not inconsiderable, especially at higher initial levels of leverage.
Other notable empirical papers are chapters 12 and 13. In chapter 12, CapelleBlancard and Havrylchyk explore the incidence of bank taxes. Unlike earlier studies,
which have tended to find that bank taxes are passed on to consumers, their study
uses a panel of data on European banks to eliminate the systemic effect of a bank’s
corporate tax burden on net interest margins and finds that there appears to be little
to no passthrough of taxes into interest margins; instead, the banks bear the economic incidence of these taxes.
In chapter 13, Goodspeed uses a database of over 500,000 records of US citizens
to find that there is a wage premium of 45 percent in the financial sector that can
only be explained by economic rents and educational attainment. The premium also
seems to follow deregulation in the relevant US states, while the corporate income
tax appears to have no impact on the wage premium in the financial sector, but adversely affects wage levels in the manufacturing sector.
T.E.
Susan C. Morse, “Safe Harbors, Sure Shipwrecks,”
UC Davis Law Review (forthcoming)
Boundaries in the tax law give rise to discontinuities whereby small changes in the
non-tax features of a transaction result in disproportionate tax treatment. Discontinuities tend to be a focus of tax planning in the absence of non-tax constraints on
the ability to undertake the necessary changes in transactional form. One of the
sources of boundaries in the law generally and in tax law in particular are safe harbours, which Morse defines as rules-based descriptions of behaviour that will not be
proscribed, and that leave other transactional forms to be judged on a case-by-case
basis. Another source of boundaries in the tax law are what Morse refers to as “sure
shipwrecks,” which she characterizes as the mirror image of safe harbours—rulesbased descriptions of behaviour that will be proscribed, and that leave other kinds of
behaviour subject to a case-by-case judgment. Both safe harbours and sure shipwrecks
combine rules and standards in legislatively articulating the law. Rules attempt to describe ex ante the relevant behaviour and relevant legal consequences, while standards
leave the determination of behaviour subject to legal consequences to be determined ex post as fact patterns unfold.
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Although Morse is a tax-law academic, her article draws mainly on examples in
the non-tax law. She does, however, also extend the relevance of her analysis to
boundaries in the tax law. She argues that both safe harbours and sure shipwrecks can
suffer from problems of overinclusiveness and underinclusiveness. Through the use
of a standard on one side or the other of the boundary, they avoid the sharp discontinuities and costs associated with unqualified bright lines. However, as the content
of a standard becomes more familiar through the determination of legal consequences
on a case-by case-basis, the standard can start to take on the features of a rules-based
description, and the costs otherwise associated with a sharper bright line.
Morse argues that the principal difference between safe harbours and sure shipwrecks is that a safe harbour results in the clustering of behaviour on both sides of
a boundary in the law, whereas a sure shipwreck results in clustering on one side
only. Morse suggests that this can have important efficiency effects, in that a safe
harbour may result in compliant behaviour shifting to partially compliant behaviour
and a sure shipwreck may result in non-compliant behaviour shifting to compliant
behaviour. Sure shipwrecks are preferable, therefore, as a policy instrument intended to discourage a specified behaviour. Safe harbours also have the negative
property of being more vulnerable to interest-group behaviour.
T.E.
Michael Smart, The Reform of Business Property Tax in Ontario:
An Evaluation, IMFG Paper on Municipal Finance and Governance no. 10
(Toronto: University of Toronto, Institute on Municipal Finance and
Governance, 2012), 24 pages
The business property tax has been identified as one of the profit-insensitive taxes
that can discourage business investment; and, since it is levied by local governments,
it can also influence business location. The Ontario government implemented a
significant reform of the tax in the first decade of the 21st century, which capped
property tax rates in high-tax municipalities and led to a reduction in business tax
rates relative to residential ones. In this paper, Smart investigates empirically the
effect of the tax reform on the change in the number of business establishments by
industry and municipality in Ontario over the period 2000-2006.
The effect of a reduction in the level and variance of business property rates
depends on who bears the incidence of the tax. Smart begins with a summary of the
theory of property tax incidence, emphasizing two different views: the capital tax
view and the benefit view. According to the former, the property tax is essentially a
tax on capital embedded in property structures. Since capital is mobile, one expects
that the business property tax will discourage investment, distort location decisions,
and reduce productivity. Therefore, a reduction in high property tax rates would be
a commendable reform. The benefit view argues that the property tax is a tax on
immobile land and is capitalized in local land values. Accordingly, the tax is of no particular concern from an efficiency point of view, though the fact that it is borne by
local property owners might constrain the rates chosen by municipal governments.
current tax reading  n  1155
Smart reviews the empirical studies of property tax incidence, focusing particularly on whether the tax affects investment or capitalization, or both. The evidence
turns out to be inconclusive. Complicating matters is the fact that property tax rates
may be influenced by tax competition effects, under the capital tax view, or by taxexporting effects if local property is owned by non-residents. The latter may account
for the fact that business property taxes are higher than residential ones, though it
is harder to explain the high rates of business taxation per se.
Smart then provides an overview of some evidence concerning business property
taxation and the location of businesses in Ontario. Compared with 2000, in 2008
business property tax rates were much lower, and differentials were reduced, including
those between core areas and suburbs. This is a consequence of Ontario’s mandated
reductions in business tax rates in combination with the caps on property tax rates
in high-tax municipalities. Surprisingly, there is little evidence of changes in the
suburbanization of employment as a result of reductions in urban-suburban tax rate
differentials.
The key contribution of the paper is an evaluation of the property tax reforms
using econometric techniques. Estimates of the effect of business property taxes on
business location are obtained by regressing the change in the logarithm of the
number of business establishments by industry and municipality on the changes in
the logarithms of the effective tax rate in the municipality and the effective tax rate
in neighbouring municipalities. In addition, other control variables are used. The
estimates yield an elasticity of the number of establishments with respect to ownmunicipality tax rates of about −0.2, and with respect to neighbours’ tax rates of
about 0.2. These estimates are statistically significant but rather small in magnitude.
They are consistent with either relatively low mobility of business property among
municipalities or capitalization of business property taxes into land values. Smart
concludes that the estimates suggest that the gains in productivity from more property tax rate harmonization are small, and that the reduction in property tax rates
leads to a transfer from the government to land and business owners with little cost
to municipality residents.
R.B.
Fiona Martin, “Has the Charities Act 2013 Changed the Common
Law Concept of Charitable ‘Public Benefit’ and, if So, How?”
(2015) 30:1 Australian Tax Forum 65-87
In what is perhaps the most prominent example of path dependency in tax policy
making, the concept of a registered charity for tax purposes in the United Kingdom,
Canada, and other Commonwealth countries continues to be defined by the preamble
to the 17th-century Statute of Elizabeth.33 This state of affairs would be amusingly
quaint were it not for the fact that the concept is so consequential. Numerous proposals in Canada over the years to modernize and expand the statutory concept of a
33 43 Eliz. 1, c. 4 (1601) (also known as the Charitable Uses Act).
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registered charity have been unsuccessful. As interpreted by Canadian and other
Commonwealth courts, charitable purposes fall under four heads:34 (1) relief of
poverty, (2) advancement of education, (3) advancement of religion, and (4) other
purposes beneficial to the community. The interpretive pressure point with respect
to these four heads is the concept of public benefit, the expansion of which has been
the goal of various unsuccessful attempts to legislatively define a charity for tax and
non-tax purposes.
Australia, however, managed to break out of this policy-making inertia and in
2013 enacted an exhaustive legislative definition of a charity, effective for 2014 and
subsequent years. In this article, Martin comprehensively reviews the new legislative definition in order to identify where it largely codifies the existing Australian
law as it developed under the recognized heads and where it differs from the judicial
articulation of the concept of a charity. For an organization to qualify as a charity,
the legislation requires that
n
n
n
n
the organization is a not-for-profit entity;
all of the entity’s purposes are charitable and for the public benefit (or are
ancillary or incidental to and in furtherance of or in aid of such purposes);
none of the entity’s purposes are disqualifying purposes; and
the entity is not an individual, political party, or government entity.
The legislative definition of a charity provides long and detailed descriptions of
charitable purposes, under enumerated heads. These purposes include promoting
or opposing a change to any matter established by a law, policy, or practice in the
Commonwealth, a state, a territory, or another country so long as the promotion or
opposition is in furtherance or in aid of any of the purposes that are otherwise
enumerated. These kinds of activities have proved to be especially contentious in
determining charitable status under the public benefit head as articulated by the
courts. Martin concludes, however, that the most important shift under the legislation is the elimination of the barrier to charitable status for certain organizations for
indigenous Australians that were previously considered ineligible because the ultimate beneficiaries are in a family relationship.
T.E.
Kevin M. Morrison, Nontaxation and Representation: The Fiscal
Foundations of Political Stability (New York: Cambridge University
Press, 2015), 148 pages, ISBN 9781107076778
The author of this book, a political scientist at the University of Pittsburgh, challenges what he perceives to be two generally accepted propositions articulated in
the political science literature. One is that taxation leads to representation. Morrison
34 Commissioners for Special Purposes of Income Tax v. Pemsel, [1891] AC 531.
current tax reading  n  1157
argues instead that higher levels of taxation destabilize political regimes and their
leaders, and can cause authoritarian regimes to move toward democracy and dem­
ocracies to move away from representation. The other proposition is that reliance
on non-tax revenues destabilizes political regimes through the phenomenon known
as the “resource curse.” Morrison argues that non-tax revenues can be stabilizing
because they allow governments to reduce taxation levels while increasing spending.
In other words, taxation hurts regimes and leaders, spending helps them, and nontax revenues increase spending.
Morrison defines non-tax revenues broadly to include foreign aid, resource revenue,
intergovernmental transfer payments, and borrowing. His concept is an aggregated
one that includes any revenue that provides a source of spending in place of taxes.
Oil revenues are included to the extent that they are generated through state-owned
enterprises rather than through royalty payments owed by foreign private-sector
firms, which are considered taxes. Morrison asserts that this aggregated approach
allows for an emphasis on the features that these sources of non-tax revenue have in
common, the most important of which is that they are all potential replacements for
taxation as source of spending. He uses cross-country, time series data to support
his arguments regarding the links between taxation, representation, spending, and
political stability. He also presents two countries—Mexico and Kenya—as case
studies, and analyzes an experiment undertaken in Brazil with intergovernmental
transfer payments.
Morrison suggests that his revisionist account of the two propositions is entirely
consistent with the obvious phenomenon of the resource curse and recognized
problems in the delivery of foreign aid. Indeed, his argument about non-tax revenue
leading to stabilization can be characterized as suggesting that these revenues have
good effects on democracies and bad effects on authoritarian regimes, because the
former tend to be associated with “good” institutions of government in general and
with health and education in particular, while the latter tend to be associated with
“bad” institutions. The feature common to both types of government is the use of
the institutional framework as the delivery mechanism for spending. An intriguing
line of future inquiry raised by Morrison is the extent to which democracies and
authoritarian regimes use different patterns of public finance in combination with
features of good and bad institutional frameworks. In terms of policy prescription,
Morrison concludes that some of the lessons from countries’ experience with foreign aid can be applied to break the resource curse. In particular, a movement away
from attempts to bypass government in the delivery of foreign aid and a reliance on
an approach of selectivity to limit aid to those governments that are perceived to
have good institutional frameworks might be modified to operate similarly with
resource-dependent countries.
T.E.
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Mark Tonkovich, “ ‘Render unto Caesar . . .’—Using the Freedom
of Conscience and Religion To Challenge Canadian Taxes”
(2015) 34:2 National Journal of Constitutional Law 121-43
This article provides a thorough and thoughtful review of Canadian case law considering challenges to the imposition of tax based on the argument of freedom of
religion as guaranteed by section 2(a) of the Canadian Charter of Rights and Freedoms.35 Tonkovich characterizes these Charter-based challenges to the imposition
of taxes as standard acts of civil disobedience, with the taxpayer’s challenge being an
indirect one to a particular government spending or other policy, such as legalized
abortion, legalized use of marijuana, or same-sex marriage. His review of the Canadian case law, as well as some of the US case law, reveals a categorical rejection of
these challenges. Tonkovich notes in this respect that Canadian courts are not always clear as to whether their rejection of a particular challenge is owing to their
failure to find a prima facie right or to their finding that there is such a right but
that the imposition of taxes to fund the relevant spending program out of general
revenue is a reasonable limitation.
Tonkovich suggests that section 15 of the Charter may be a means to challenge
successfully certain tax benefits that are provided, either formally or functionally, to
some organizations but not others. He cites as possible examples of such benefits
the income tax deduction for rent paid or accommodation provided to members
of the clergy, the granting of charitable registration to religious organizations, and
funding for political parties. Considering these examples, he observes that Canadian
courts may be more likely to interpret the relevant expenditure provisions as including less formal religious organizations or to strike down the particular benefit
provision because of its discriminatory impact. He speculates that indirect challenges to government policies through a challenge to the imposition of taxes have
generally been unsuccessful because of the uniform application of both the taxes
and the relevant policy.
T.E.
Stephen Smith, Taxation: A Very Short Introduction (Oxford: Oxford
University Press, 2015), 131 pages, ISBN 9780199683697
This book is part of the “little book” series published by Oxford University Press.
The series is intended to provide an introduction to a wide range of academic and
professional subjects, accessible to readers outside the particular field or discipline.
The author of this contribution to the series, Stephen Smith, is a UK tax economist.
He draws on his work for the Mirrlees review36 in providing a broad conceptual
overview of most of the main issues that are the focus of tax policy making. The
goal is to provide an interested reader with a basic tool kit for better understanding
35 See supra note 16 (herein referred to as “the Charter”).
36 Supra note 22.
current tax reading  n  1159
and thinking critically about the role of taxes and their effects. With an imperative
of accessibility in mind, there is little detailed discussion of second-order technical
design. In style and content, the book is generally comparable to, and can be compared favourably with, Taxing Ourselves: A Citizen’s Guide to the Debate over Taxes by
the US tax economists Joel Slemrod and Jon Bakija.37
Following a two-page introduction, the book consists of six chapters. Chapter 1
deals with basic concepts, establishing at the outset the two principal roles of taxation: (1) raising revenue to fund the collective provision of goods and services, along
with social insurance; and (2) altering market outcomes to realize a more desirable
distribution of income and wealth. Smith defines taxes formally and conventionally
as “compulsory payments enacted by the state, that do not confer any direct individual entitlement to specific goods or services in return”38—a definition that
clearly distinguishes taxes from user fees. His emphasis in this chapter is much more
on the revenue-raising function than on the income- or wealth-redistribution function. Smith does make a somewhat contentious claim that it should be possible to
consider efficient and equitable tax-system design independently of the depth of the
role or intervention of government in the marketplace. To illustrate this point of
emphasis, he includes some OECD data on the growth of levels of taxation as a percentage of gross domestic product.
Chapter 2 considers the mix of tax bases commonly used in various countries,
with basic reviews of the personal income tax, sales taxes (particularly VAT), and
business taxes (particularly the corporate income tax), along with brief mentions of
wealth taxes, land taxes, environmental taxes, and resource rent taxes. The discussion
of the principal tax bases—personal income taxes, sales taxes, and business taxes—is
largely descriptive, although Smith does allude to their efficiency and distributional
effects. Smith emphasizes that the most dramatic development in the pattern of taxation in most countries over the past 50 years has been growth in the level of taxation
rather than a change in the mix of taxes. The mix of taxes has, however, been altered
in an important way by an increased reliance on sales taxes while the pattern of
personal and corporate income taxation has remained relatively stable. Again Smith
cites some cross-country OECD data to illustrate these points.
Chapter 3 reviews the incidence of taxation and notes the important distinction
between legal and economic incidence. Appropriately, the discussion is focused more
on the latter, describing for illustrative purposes the factors that determine economic
incidence in three contexts—sales taxes, labour taxes, and taxes on land and business
profits. Smith follows this review with a discussion of distributional incidence. He
observes that income taxes tend to be more progressive than sales taxes in their
distributional incidence, but points out that the regressivity of sales taxes tends to be
37 Joel Slemrod and Jon Bakija, Taxing Ourselves: A Citizen’s Guide to the Debate over Taxes, 4th ed.
(Cambridge, MA: MIT Press, 2008).
38 At 4.
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(2015) 63:4
offset by more strongly progressive income taxes, especially when the benefits of
government spending are fully brought into account.
Chapter 4 provides an account of the efficiency costs of taxation, including administrative costs, compliance costs, and the costs of behavioural responses. The
emphasis is on behavioural responses. In this respect, Smith provides an especially
lucid and accessible account of the economic concept of “excess burden,” which he
illustrates primarily in the context of sales taxes and the notion of an optimal tax. With
respect to the taxation of labour, Smith provides an interesting and slightly more
detailed discussion of the tax wedge—the gap between employer cost and employee
after-tax return—imposed by income and sales taxes. This chapter also includes
important, albeit brief, discussions of the poll tax and the taxation of land, identified
as efficient taxes because they evoke little, if any, behavioural response. The poll tax
discussion is for point of emphasis only, because of its undesirable distributional
properties. Land taxes are seen as preferable to the poll tax and as realistic, but they
are acknowledged to have undesirable transitional effects. There is surprisingly little
discussion of the supposed efficiency effects of consumption taxes versus income
taxes with respect to their impact on the savings decision, presumably because it is
now generally recognized that the effect is ambiguous at best.
Chapter 5 provides an overview of tax evasion and enforcement under both the
personal income tax and VAT systems. With respect to tax evasion, the standard economics model is described and then suitably modified with real-world detail, such
as psychological and moral considerations that affect the decision to comply. Smith
briefly contrasts evasion and avoidance, limiting his discussion of the latter to the
context of the corporate income tax. Enforcement mechanisms such as withholding
at source and third-party information reporting are reviewed, along with estimates
of the level of tax evasion.
Chapter 6 is conceptually the broadest. Smith provides a set of criteria drawn from
Adam Smith to judge the efficiency of tax system design. “Neutrality,” defined in
terms of consistency of treatment of activity, is emphasized, with the author contending that broad bases and low rates are both needed to avoid a behavioural response,
to simplify design, and to mute the influence of interest groups. Smith also provides
some discussion of the use of flat tax rates, drawing on the experience with such
systems in the Baltic states, in some of the former Russian republics, and in Russia
itself. Smith acknowledges that these experiences do not suggest much, if any, positive
impact on economic growth, and that flat taxes share one universal and undesirable
distributional property—upper-income households benefit disproportionately. This
chapter includes a discussion of sales tax exemptions that are intended to offset the
regressivity of the tax, and Smith notes that the policy preference is to use targeted
transfer payments. Political economy effects are seen, however, to undermine the use
of transfer payments and full taxation under VAT systems—a general theme of this
chapter in assessing the efficiency-equity tradeoff that tax policy makers commonly
face. The chapter concludes with brief reviews of environmental taxes as corrective
taxes and with a couple of cliché-ridden pages on the effect of the global context
on tax policy making. A subsequent edition of the book might more usefully include
current tax reading  n  1161
at this point a discussion of international taxation and of the concept and importance
of tax expenditures. The inclusion of such material need not undermine the accessibility of the book and its associated goal of informing a general readership about
tax-system design.
As noted above, Smith draws on relevant data to strengthen the discussion at
various points in the text. He also summarizes relevant empirical research, though
without including formal citations to the literature (which, indeed, are not required,
given the intention of the book). Smith does provide references to general readings
for the material in each chapter, in a selected bibliography. To lighten the subject
matter and make it more appealing to prospective readers, the book also includes
references to popular culture, as well as cartoons and photographs with a tax-related
theme or association.
T.E.