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Canadian Provincial Payroll Taxation:
A Structural and Policy Analysis
Jonathan R. Kesselman*
PRÉCIS
L’imposition par les provinces de charges salariales comme source générale
de revenu représente un phénomène grandissant et important. En ce
moment quatre provinces, dont les deux plus grandes, et les Territoires du
Nord-Ouest ont recours aux impôts sur la masse salariale. Dans trois
provinces, les recettes découlant de ces impôts sont supérieures à celles
provenant de l’impôt des sociétés. Sur une base annuelle, les recettes
totales découlant de l’ensemble des charges salariales des provinces
atteignent maintenant 6 milliards de dollars. Les impôts provinciaux sur la
masse salariale continuent d’évoluer, et deux provinces les ont étendues en
1993 aux travailleurs indépendants et aux particuliers. Les Territoires du
Nord-Ouest viennent d’introduire des charges salariales en 1993; cependant
contrairement aux autres provinces, ces charges sont perçues auprès des
employés au lieu des employeurs. L’augmentation des impôts provinciaux
sur la masse salariale a également amené le gouvernement fédéral à
proposer des changements dans les impôts afin de réduire leur impact sur
les recettes fédérales. Malgré l’ampleur du phénomène, les impôts
provinciaux sur la masse salariale sont un sujet à peine traité dans les écrits
sur les finances publiques.
Cet article présente une description des impôts provinciaux sur la masse
salariale ainsi qu’une comparaison des principales caractéristiques qui
varient de façon considérable d’une juridiction à l’autre. L’auteur procède
ensuite à une analyse des questions d’ordre structurel et conceptuel par
rapport à ces cotisations : leur couverture et les exemptions, les avantages
sociaux et les cotisations de pension, le type d’organisation, les structures
de taux et les instruments d’allégement fiscal, et l’administration et
l’observance. Ceci est suivi d’un exposé des principaux problèmes
économiques et politiques reliés aux charges salariales, notamment les
* Of the Department of Economics, University of British Columbia, Vancouver, and
director of the Centre for Research on Economic and Social Policy, University of British
Columbia. This article draws from a chapter of a monograph being prepared for the Canadian Tax Foundation, “Payroll Taxation for General Revenues.” Officials of the finance
departments have generously assisted in providing materials and statistics used in this study:
Christopher J. Butt, Newfoundland; Jean St-Gelais, Quebec Finance; Diane Gobeil, Quebec Revenue; Conrad D. Gibbs, Ontario; Leslie Snell, Manitoba; Andy Robinson, British
Columbia; Jean A. Guertin, Northwest Territories; Jack Jung and John H. Sargent, Canada.
I also thank Bev Dahlby and Jack Jung for helpful comments. All analyses, findings, and
errors are the author’s sole responsibility.
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CANADIAN PROVINCIAL PAYROLL TAXATION
151
distorsions économiques causées par certaines modalités; la compétitivité
commerciale des provinces; la comparaison avec les primes d’assurancemaladie et les taxes de vente au détail; les interactions au niveau des
finances publiques; et les appellations, l’affectation à des fins particulières
et l’acceptation du public. En général, on peut dire des charges salariales
provinciales qu’elles couvrent de vastes domaines et que leur application
est généralement réussie; cependant nous indiquons également certains
aspects qui, dans la plupart des cas, pourraient être améliorés.
L’expérience des provinces en ce qui concerne les charges salariales
constitue un exemple utile aux autres provinces qui envisageraient
d’instaurer ce genre d’impôt. Nos résultats sont particulièrement pertinents
pour les deux provinces qui perçoivent toujours des primes à taux unique
pour financer, en partie, leurs régimes d’assurance-maladie. Par ailleurs, les
impôts sur la masse salariale pourraient constituer une alternative
intéressante comme source de revenu pour toute province qui désirerait
supprimer la taxe de vente au détail. Des charges salariales générales
pourraient également être appliquées au niveau fédéral pour remplacer les
revenus provenant de la taxe sur les produits et services; l’auteur de cet
article effectue en ce moment d’autres recherches sur cette manière
d’utiliser les charges salariales. Compte tenu de ces applications
potentielles, les résultats qui ressortent de cet examen des régimes
provinciaux actuels sont à la fois importants et prometteurs.
ABSTRACT
Provincial use of payroll taxes for general revenue purposes has become a
growing and important phenomenon. Currently four provinces, including the
two largest, and the Northwest Territories apply such payroll taxes. For three
provinces the revenues from payroll tax exceed those from the corporate
income tax. Total annual revenues from all of the provincial payroll taxes
now approach $6 billion. The provincial payroll taxes are still undergoing
evolution, with two provinces extending them to the self-employed or
individuals in 1993. The Territorial payroll tax was instituted just in 1993, and
unlike that of the provinces it was designed as a levy on employees rather
than as an employer tax. Growth of provincial payroll taxes has also
provoked the federal government to propose tax changes to curtail the
impact on federal finances. Despite the magnitude of these developments,
provincial payroll taxes have been almost totally neglected in the public
finance literature.
This article offers a description and comparison of the key features of the
payroll taxes, which differ considerably across the jurisdictions. It then
undertakes an analysis of the structural and design issues for the payroll
taxes, including coverage and exemptions, fringe benefits and pension
contributions, the form of business organization, rate structures and tax
relieving devices, and administration and compliance. This is followed with
analyses of key economic and policy issues of the payroll taxes, including
the economic distortions of the design features; provincial business
competitiveness; comparisons with medicare premiums and retail sales
taxes; the public finance interactions; and labeling, earmarking, and public
acceptance. The general assessment of the provincial payroll taxes is that
(1994), Vol. 42, No. 1 / no 1
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they have been remarkably broad in their coverage and generally successful
in their application, although areas in which most of the taxes could be
improved are also indicated.
The provincial experience with general payroll taxes provides useful
guidance for other provinces that might consider instituting such a tax.
These findings are particularly germane for the two provinces that still rely
on flat-rate premiums to help finance their medicare programs. However,
general payroll taxes may be an attractive alternative to replace some
revenues currently derived from retail sales taxes in any province. A general
payroll tax could also be imposed at the federal level to replace the
revenues of the goods and services tax; this application of a payroll tax is
being pursued in further research by the author. For all of these possible
uses, the insights derived from the existing provincial payroll taxes are both
invaluable and promising.
INTRODUCTION
Payroll taxes are currently operated in four Canadian provinces—Newfoundland, Quebec, Ontario, and Manitoba—and in the Northwest Territories.
Two of the provinces initiated their payroll taxes as recently as 1990 and
the Territories in 1993. These levies have grown to be large generators of
revenues and now rank as the third or fourth largest source of taxation
revenues in the provinces that use them. The structures of these taxes vary
considerably, which offers insight into alternative ways of applying such
a tax. Provinces now imposing a payroll tax may learn from other provinces about ways in which they could beneficially reform their own structures.
An assessment of the operation and effects of the payroll taxes can suggest whether they are a suitable source for raising incremental revenues.
For the provinces that currently do not impose a tax on payrolls, the provincial experience may be useful in assessing whether to initiate their own
levies. This choice is particularly relevant for the two provinces that still
impose separate medicare premiums, British Columbia and Alberta. Provincial experience with payroll taxation may also be instructive for the
design and assessment of a possible federal levy of this kind.1
This article will review the history and structure of Canadian provincial payroll taxes.2 It begins with a broad general description of the provincial
levies and attributes common to all of them. This is followed by a more
detailed description of the provisions of the payroll taxes in each province, following a chronological sequence. The treatment then turns to an
1 In this article, the term “provincial” will be construed to include the Northwest Territories.
2 It is surprising that the provincial payroll taxes have not previously been documented
or assessed, with the exception of a recent study of Ontario’s employer health tax: see Bev
Dahlby, “Payroll Taxes,” in Allan M. Maslove, ed., Business Taxation in Ontario, Research
Studies of the Fair Tax Commission (Toronto: University of Toronto Press, 1993), 80-170.
The summary report of the Ontario Fair Tax Commission, Fair Taxation in a Changing
World: Highlights (Toronto: University of Toronto Press, 1993), also makes recommendations for reform of the Ontario payroll tax.
(1994), Vol. 42, No. 1 / no 1
CANADIAN PROVINCIAL PAYROLL TAXATION
153
issue-oriented comparison and analysis of key design and structural aspects of the taxes. The topics examined include coverage and the tax base,
exemptions, forms of business organization, rate structures, and administrative and compliance aspects. Several economic and policy issues are
then investigated. Given the lack of empirical studies, qualitative analyses are undertaken for the economic effects of payroll taxes, including
their economic distortions and likely effects on business competitiveness.
The payroll taxes are next compared with medicare premiums and the retail sales taxes. Interactions between the provincial payroll taxes and finances
of the federal government are examined. Finally, the earmarking and public acceptance of payroll taxes at the provincial level are considered.
BASIC FEATURES OF PROVINCIAL PAYROLL TAXES
The four provinces’ payroll taxes are imposed explicitly on employers; no
levies are made directly on employees.3 Moreover, all of these taxes are
based on aggregate payrolls and other types of compensation without regard to individual workers’ payments. Only the payroll tax of the Northwest
Territories is applied as a direct deduction from the gross compensation of
employees. Unlike the premiums charged by the federal government to
finance the social insurance programs, there are no maximum levels of
taxable wages or salaries per worker under any of these payroll taxes. The
key features of the payroll taxes of each province (except the Territories)
are summarized in table 1. The provinces are listed in the chronological
sequence of their payroll tax introductions, beginning with Quebec in 1970.
All four provinces have labeled their payroll taxes for health-care spending purposes; two also include post-secondary education in their labels. In
practice, though, all the provinces’ payroll taxes except those of Quebec
flow into their consolidated revenue funds, so that they act as taxes for
general revenue purposes.
Payroll taxes have become large generators of tax revenues in the provinces that employ them. In each of the two largest provinces, the payroll
taxes produce over $2.6 billion per year. In three of the four provinces, the
payroll tax is the fourth largest source of taxation revenues; in Quebec it
is the third largest tax. Payroll taxes rank behind personal income tax and
retail sales tax in all four provinces, but they come in ahead of corporate
tax in all the provinces except Ontario.4 Although the payroll taxes are
relatively large, they still do not produce as much as one-fourth of the
total expenditures for which they are nominally intended in any of the
provinces. This explains why any earmarking is notional and has little
practical effect on the allocation of public expenditures. In all four provinces the costs of health services (and higher education) must draw heavily
on other general revenues.
3 This article does not address provincial payroll taxes for purposes such as workers’
compensation.
4 In Manitoba and Newfoundland, payroll tax revenues are also exceeded by motor fuel
tax revenues.
(1994), Vol. 42, No. 1 / no 1
4.8
Fourth largest; after RST,
PIT, MFT
8.6
Fourth largest; after
PIT, RST, CIT
7.1
Fourth largest; after
PIT, RST, MFT
2,917
11.9
Third largest; after
PIT, RST
Projected revenues for fiscal year
1993-94, $ million . . . . . . . . . . . .
Percent of province’s total tax
revenues, 1993-94 . . . . . . . . . . . .
Rank of payroll tax in province’s
taxesa . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
(1994), Vol. 42, No. 1 / no 1
No
Renewable resource
sectors (fishing, forestry,
farming) taxed at rate of
1%
Yes, above $40,000 of
total net selfemployment income,
at graduated rates
None
No
Commercial truckers
get tax reduction for
out-of-province
employment
Yes, above $5,000
(includes other nonemployment income),
1% rate with ceiling
None
Self-employed coverage . . . . . . . . .
Exempt or tax-preferred sectors . .
a Personal income tax (PIT); retail sales tax (RST, administered as part of the GST in Quebec); motor fuel tax (MFT); and corporate income tax
(CIT). b Exemption scheduled to rise to $750,000 at beginning of 1994, with notch rate applied from $750,000 to $1,500,000.
2
$100,000 exemption; no
“notch” rate
1.95
Graduated scale of
rates for payrolls
below $400,000,
beginning at 0.98%
below $200,000
2.25
$600,000 exemption;
“notch” rate of 4.5%
from $600,000 to
$1,200,000 of payrollb
3.75
None
Tax rate for 1993, % . . . . . . . . . . . .
Tax relief for small businesses . . .
67.4
August 1990
January 1990
July 1982
November 1970
Initiated, month/year . . . . . . . . . . .
2,670
Health and post-secondary
education tax
Employer health tax
Health and post
secondary education
tax levy
Health services fund
contributions
Name of payroll tax . . . . . . . . . . . .
190.8
Newfoundland
Ontario
Manitoba
Summary of Features of Provincial Payroll Taxes, 1993
Quebec
Table 1
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CANADIAN PROVINCIAL PAYROLL TAXATION
155
Basic rates of employer payroll tax range from a low of 1.95 percent in
Ontario to a high of 3.75 percent in Quebec; the rate of employee payroll
tax in the Territories is just 1 percent. However, three of the provinces
allow relief through lower effective tax rates for smaller businesses. Their
methods used to provide such relief differ quite markedly. These include
an exemption in Newfoundland, an exemption with a notch range in Manitoba, and a series of graduated rates in Ontario. The tax relief methods are
assessed in greater detail in a later section of this article. Quebec taxes the
entire payroll of all firms at its full basic rate. This fact, along with Quebec’s highest basic tax rate, explains why the payroll tax yields the largest
share of total tax revenues for that province. All the provinces include the
full range of federally taxable fringe benefits along with compensation
such as wages, salaries, vacation pay, commissions, and bonuses in their
payroll tax bases. But no provincial scheme taxes employers’ contributions to pension plans. Two of the provinces—Ontario and Quebec—extended
their payroll taxes to include net self-employment income in 1993.5 Exemption levels are provided for self-employed income that are not available
for ordinary employer payrolls.
The provincial payroll taxes are extremely comprehensive in their scope.
They cover virtually all employers in the private, non-profit, quasi-public,
and public sectors, and at all levels of governmental jurisdiction. A few
exceptions are Newfoundland employers in the renewable resource sectors, which are taxed at half the basic rate; commercial truckers based in
Manitoba that supply services to out-of-province employers; and Quebec
businesses in the international finance field.6 Otherwise almost all payrolls and related forms of compensation beyond the allowable exemption
levels are fully taxable.
HISTORY OF PROVINCIAL PAYROLL TAXES
In implementing or expanding its payroll tax, each province was reacting
to the financial needs of its health-care or educational system. In some
cases, the payroll taxes were a response to federal restraints on transfers
to the provinces for health-care and educational purposes. Only in the
Northwest Territories was the payroll tax motivated by different concerns,
concerns related to problems of taxing seasonal and temporary non-resident
workers. Several aspects of the description of the individual provincial
payroll taxes have been deferred to later sections that discuss design and
structural issues. This approach has been taken both for some areas where
there is similarity across the provinces in their provisions, such as the
definition of employee compensation and benefits that are taxable, and
areas where the contrasts warrant closer study. Administrative and compliance aspects of the taxes are also deferred to a joint treatment.
5 As detailed later, Quebec initially included the self-employed (and employees) in its
payroll tax from 1970, but this provision was abolished after 1977. Quebec now also includes non-employment incomes.
6 Some other minor exclusions are noted in the provincial tax histories.
(1994), Vol. 42, No. 1 / no 1
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Quebec’s Payroll Tax
The application of a payroll tax in Quebec dates back to the initiation of
its medicare plan in November 1970.7 Its medicare plan has been operated
by an independent public agency, the Régie de l’assurance-maladie du
Québec (Quebec Health Insurance Board, or QHIB). Funds to operate the
QHIB are drawn from general revenues in addition to those derived from
the payroll tax. The original employer payroll tax was accompanied by
contributions from employees and the self-employed, also ostensibly for
financing health care. While the non-employer contributions were terminated at the end of 1977, Quebec introduced another form of levy on the
self-employed and non-employment income to help finance medicare in
1993. The main focus of this article is on the employer portion of these
taxes, but the passing and return of the related contributions provides insight into changing views about the propriety of a pure payroll tax.
The Quebec payroll tax has always covered the entire payroll of all
employers. No exemption or taxable threshold has been provided, so that
even the smallest employers are subject to the tax. The coverage of industry sectors and types of employer is sweeping, with only minor exceptions.
Native employers are exempt so long as their establishment is on a reserve, whether or not the employees are Indians. Since 1986 employers
have been exempted from QHIB levies on their employees working in international financial businesses. The definition of worker compensation
covered under the payroll tax was quite broad from the outset but has
been expanded over time. For example, beginning in 1978 the benefits of
employees’ reduced rate loans were included, and from 1984 receipts of
gratuities were included. Initial responsibility for the payroll tax fell under the Health Insurance Act; its administration was transferred to the minister
of revenue in 1976. Total revenues from the tax by fiscal year since inception appear in table 2.
Rates of the tax have been as follows: 0.8 percent from November 1970
through May 1976; 1.5 percent from June 1976 through March 1981; 3.0
percent from April 1981 through April 1986; 3.2175 percent from May
1986 through mid-May 1989; 3.36 percent from mid-May 1989 through
April 25, 1990; 3.45 percent from April 26, 1990 through August 1991;
and 3.75 percent since September 1991.8 The hike in the rate to 1.5 percent in 1976 was justified by an extension of the financing to include hospital
insurance along with health insurance. Municipal employers were granted
a delay in the rate hike until the beginning of their next fiscal year, presumably to give them time to adjust their local tax rates to reflect their
higher payroll tax liabilities. Similarly, with the rate hike to 3 percent in
April 1981, municipalities were given the benefit of the lower rate until
the end of 1981. This doubling of the rate was paired with the creation of
7 Health
Insurance Act, SQ 1970, c. 37, now RSQ, c. A-29, as amended.
rate increases above 3 percent beginning in 1986 reflect surtaxes that were also
applied to other Quebec business taxes, such as the tax on paid-up capital of corporations;
with the rate increase to 3.75 percent, the surtax was subsumed in the contribution rate.
8 The
(1994), Vol. 42, No. 1 / no 1
CANADIAN PROVINCIAL PAYROLL TAXATION
Table 2
157
Revenues from Provincial Payroll Taxes for Fiscal Years
1970-71 to 1993-94
Quebeca
Fiscal year
Manitoba
Ontario
Newfoundland
millions of dollars
1970-71 . . . . . . . . . . . .
1971-72 . . . . . . . . . . . .
1972-73 . . . . . . . . . . . .
1973-74 . . . . . . . . . . . .
1974-75 . . . . . . . . . . . .
1975-76 . . . . . . . . . . . .
1976-77 . . . . . . . . . . . .
1977-78 . . . . . . . . . . . .
1978-79 . . . . . . . . . . . .
1979-80 . . . . . . . . . . . .
1980-81 . . . . . . . . . . . .
1981-82 . . . . . . . . . . . .
1982-83 . . . . . . . . . . . .
1983-84 . . . . . . . . . . . .
1984-85 . . . . . . . . . . . .
1985-86 . . . . . . . . . . . .
1986-87 . . . . . . . . . . . .
1987-88 . . . . . . . . . . . .
1988-89 . . . . . . . . . . . .
1989-90 . . . . . . . . . . . .
1990-91 . . . . . . . . . . . .
1991-92 . . . . . . . . . . . .
1992-93 . . . . . . . . . . . .
1993-94, projected . . .
33b
93
110
117
158
202
369
438
483
521
602
1,275
1,337
1,441
1,510
1,601
1,829
2,049
2,160
2,469
2,641
2,754
2,816
2,917
55.5b
108.1
111.1
118.9
126.6
187.5
199.2
191.3
186.5
188.7
191.8
190.8
477b
2,662
2,648
2,592
2,670
23.8b
47.8
63.2
67.4
a Includes only revenues from tax on employers; does not include projected $172 million
from individuals for 1993 tax year, which will be collected after the end of the 1993-94
fiscal year. b Tax was in effect for only part of the fiscal year.
Sources: Budget speeches of the provinces and provincial finance departments.
a health services fund to receive the revenues; thereafter half of the payroll tax funds were allocated to hospital services.
From the outset the Quebec employer payroll tax was accompanied by
contributions from employees and the self-employed. These were effectively a flat-rate tax levied at a rate of 0.8 percent (1.2 percent for 1976
and 1.5 percent for 1977) on the net income of the individual. These contributions also allowed an exemption level ($2,000 for single persons and
$4,000 for married couples, initially) and had a maximum annual liability
(initially $125 for employees and $200 for the self-employed). The contributions for employees were not applied as an employee payroll tax but
rather as a tax on income from all sources. These contributions were abolished at the end of 1977, based on the view expressed in the 1978 budget
that they “constitute a regressive income tax.”9
After an absence of 15 years, contributions by individuals to the health
services fund were resumed at the start of 1993. This change was justified
9 Québec,
Ministère des Finances, 1978-1979 Budget, April 18, 1978, 39.
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CANADIAN TAX JOURNAL / REVUE FISCALE CANADIENNE
in the Quebec budget of 1993 as follows: “All Quebecers benefit from
health services, the cost of which continues to grow. While it is easier to
require only wage earners and their employers to contribute, it is preferable to adopt a more equitable policy.”10 The structure of this renewed tax
differs from the earlier form. First, its base excludes wages and compensation that are already subject to the employer payroll tax; otherwise it
includes most items that are taxable under the personal income tax.11 Second, it allows an annual exemption of $5,000 per person but does not
recognize marital status or dependants. Third, its rate structure is odd: 1
percent of income between $5,000 and $20,000 (up to $150), no incremental tax charged on income between $20,000 and $40,000, and another
1 percent of income between $40,000 and $125,000, for an annual total
maximum of $1,000 per individual. A non-refundable tax credit of 20 percent is also allowed for these contributions under the Quebec personal
income tax.
Manitoba’s Payroll Tax
Manitoba initiated its payroll tax in 1982 in response to concurrent and
impending cuts in federal transfers for health care, post-secondary education, and equalization. The province considered the alternative of raising
its rate of retail sales taxation but argued that a payroll tax was a fairer
approach. In an unusually detailed background paper, Manitoba’s 1982
budget advanced the following key points:12
1) An increase in the sales tax would strike lower-income persons, including pensioners, and would generally be regressive despite the taxexempt commodities.
2) The proposed payroll tax would apply only to employers, so that no
employee would be required to pay the tax.
3) Even if the burden of the payroll tax were shifted fully to workers
as lower wages, it would be mostly progressive, at least for families from
the lowest incomes to incomes somewhat above the median.
4) A payroll tax would have little impact on those at the lowest incomes, derived mostly from pensions and transfer payments.
5) A payroll tax would be more neutral in its application across sectors
of the economy than a sales tax increase.
6) The impact of the new tax on businesses would be cushioned by its
tax deductibility, which would also shift part of the burden onto the federal government.
10 Québec,
Ministère des Finances, 1993-1994 Budget, May 20, 1993, 15.
it does exclude taxable alimony receipts, one-fifth of the grossed-up dividends of taxable Canadian corporations, and several other items.
12 Manitoba, Department of Finance, 1982 Manitoba Budget, May 16, 1982, appendix
III.B.
11 However,
(1994), Vol. 42, No. 1 / no 1
CANADIAN PROVINCIAL PAYROLL TAXATION
159
Manitoba’s health and post secondary education tax levy became effective July 1, 1982, at a rate of 1.5 percent without any exemption level to
relieve smaller payrolls.13 It applied to all industry sectors and types of
employers, but a delay until the beginning of 1983 was allowed for municipal governments and school divisions. The bill was amended during
the legislative process to clarify that the federal government was liable to
the tax as an employer. However, from December 1988 special provisions
were introduced to relieve commercial truckers based in Manitoba from
payroll tax liability associated with their out-of-province activities. In 1991
this trucking exemption was extended to remuneration directly related to
all interprovincial and international traffic.
From its initial rate of 1.5 percent and no exemption level, the Manitoba payroll tax evolved over the years to relieve progressively more
employers with small and intermediate payrolls. First an exemption level
of $50,000 was provided at the start of 1984, and a notched rate of 4.5
percent applied to that portion of payrolls falling within the so-called notch
range between $50,000 and $75,000 per year.14 The full 1.5 percent rate
continued to apply to all payrolls that exceeded $75,000. Table 3 shows
the evolution toward ever-higher exemption levels and notch ranges over
the years, as well as the hike in the full rate to 2.25 percent in April 1987.
Effective January 1994 the exemption rises to $750,000 and the full rate
applies only at payrolls above $1.5 million. Table 3 also displays the decline in the total number of payroll taxpayers over this period—falling
from 29,500 at the outset of the tax to an estimated 2,085 in 1994. A minority of taxpayers fall in the notch range with average tax rates on their
payrolls of less than 2.25 percent.
As part of a broader program to improve worker skills, in 1991 Manitoba introduced a payroll tax credit for a portion of employers’ training
costs. The amount of the credit, formally called the workplace training tax
refund, is limited to qualified training of employees for whom payroll tax
has been paid and cannot exceed 0.3 percent of a firm’s payroll.15 Set against
the full payroll tax rate of 2.25 percent, this maximum credit yields a net
rate of 1.95 percent. Perhaps not coincidentally, this figure is identical to
the full payroll tax rate for larger employers in adjacent Ontario. Originally restricted to firms in the goods-producing sector, in 1992 the tax
refunds were extended to include wholesale and retail trade, finance, and
insurance, as well as the centralized operations of service companies. Regulatory changes in 1993 once again excluded the finance and insurance
sectors.
13 The Health and Post Secondary Education Tax Levy Act, CCSM 1987, c. H24, as
amended.
14 When the exemption was first introduced, it was done ex post, so that refunds of tax
had to be paid to some employers.
15 These refunds are processed anywhere from 3 to 11 months after the year-end, depending on when applications are received from the taxpayer, whether an audit is required,
and other factors.
(1994), Vol. 42, No. 1 / no 1
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Table 3
Manitoba Payroll Tax, Rates and Thresholds, 1982-1994
Effective
month/yeara
Notch
range, $
thousand
Notch
rate, %
Full
rate, %
Notch
rate
Total
number
na
50
100
100
300
600
750
na
50- 75
100- 150
100- 150
300- 600
600-1,200
750-1,500
na
4.5
6.75
6.75
4.5
4.5
4.5
1.5
1.5
1.5
2.25
2.25
2.25
2.25
na
2,000
1,800
1,800
1,400
880
670
29,500
10,900
8,400
8,400
4,300
2,500
2,085
July 1982 . . . . . . . . .
January 1984 . . . . . .
January 1987 . . . . . .
April 1987 . . . . . . . .
January 1989 . . . . . .
January 1990 . . . . . .
January 1994 . . . . . .
na
a
Number of
employers paying
Exemption
level, $
thousand
not applicable.
First day of the month.
Source: Manitoba Department of Finance.
Ontario’s Payroll Tax
Of the four provinces that have enacted payroll taxes, only Ontario did so
as a means to abolish medicare premiums. The government also cited reduced federal transfers as a reason for the new tax. This reform delivered
on a 1985 pledge by the provincial Liberals and had been supported by the
Ontario Social Assistance Review Committee in 1988.16 Although the previous OHIP (Ontario health insurance plan) premiums had provided reductions
for lower-income persons, they still required full or partial payments from
many working poor individuals and families. The employer health tax (EHT)
came into effect in early 1990, with different starting dates for small employers and large employers.17 In announcing the payroll tax, the government
also increased the rate of provincial personal income tax “[t]o maintain
balance in the funding of health care.”18 “Historically, the funding for health
care has been shared by people and business.”19 The elimination of OHIP
premiums was estimated to cost the province $515 million in fiscal 198990 and $1,843 million in a full year. Offset against this were estimated
revenues from the payroll tax of $549 million in fiscal 1989-90 and $2,114
million in a full year, as well as the increased income tax revenues.
16 Ontario, Social Assistance Review Committee, Report: Transitions (Toronto: Queen’s
Printer for Ontario, 1988), 466.
17 Employer Health Tax Act, RSO 1990, c. E.11, as amended. Small employers, defined
as those with annual payrolls not exceeding $400,000, had to make quarterly payments
beginning in April 1990, whereas large employers were required to make monthly payments beginning in January 1990. Given that OHIP premiums had to be paid quarterly and
in advance, with the last payments in December of 1989, this caused business groups and
the political opposition to charge that the government was levying a double tax on large
employers, creating an alleged windfall of over $500 million. “Province Collecting Twice
on Health Tax, Business Groups Say,” The Sunday Star, October 22, 1989.
18 Ontario, Ministry of Treasury and Economics, 1989 Ontario Budget, May 17, 1989, 7.
19 Ibid.
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Table 4
161
Ontario Employer Health Tax Rates, Employers
Range of total payroll
Up to $200,000 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$200,001 to $230,000 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$230,001 to $260,000 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$260,001 to $290,000 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$290,001 to $320,000 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$320,001 to $350,000 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$350,001 to $380,000 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$380,001 to $400,000 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Over $400,000 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Tax rate on total payroll, %
0.98
1.101
1.223
1.344
1.465
1.586
1.708
1.829
1.95
The Ontario payroll tax covers all major forms of employee compensation and fringe benefits. Its coverage of industry sectors and types of employer
is comprehensive.20 Although the tax provides no exemption for smaller
employers, it does provide a graduated series of eight lower tax rates for
payrolls21 not exceeding $400,000 per year (see table 4). The lowest rate
of 0.98 percent applies to payrolls of $200,000 and less. For payrolls falling within the other tabulated ranges, the relevant tax rate is applied to the
entire payroll. The top rate of 1.95 percent, or about twice the lowest rate,
applies to employers having total payrolls above $400,000. The rate structure
of Ontario’s employer payroll tax is unconventional in applying a set of
graduated rates to the entire taxable base rather than simply the portion
falling within the rate bracket; this matter will be examined more closely
in a later section that compares the four provinces’ payroll tax rate structures. Table 2 shows the revenues generated by the Ontario tax by fiscal
year since its inception.
Beginning in the 1993 tax year Ontario extended the Employer Health
Tax Act to self-employed individuals, although with a distinct rate structure and rules. Table 5 shows the tax calculation for self-employed individuals,
which is based on a measure called total net self-employment income (TNSEI).
Unlike the employer tax, an exemption of $40,000 per year is allowed for
each self-employed individual. Similar to the employer tax, the bottom
and top rates of tax for the self-employed are 0.98 and 1.95 percent, but
these are marginal rather than average rates for the self-employed. The
bottom rate applies to TNSEI up to $200,000, and the top rate applies to
TNSEI above $400,000. Instead of the multiple rate brackets of the employer tax, the rate structure for the self-employed applies a notch method
for determining intermediate tax rates. An effective marginal rate of 2.726
percent arises within the notch range of incomes. The cited rates of em-
20 Minor exempt areas include embassies, consulates, payrolls relating to native people
working for a corporation on a reserve, and payments to employees of registered charities
who work outside of Canada for a continuous period of at least 183 days.
21 The term used in the Ontario legislation for taxable compensation and benefits is
“remuneration”; the term used in the text and tables of this article is simply (taxable) payrolls.
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Table 5
Ontario Employer Health Tax, Self-Employed Individuals
Total net self-employment income (N)
Up to $40,000 . . . . . . . . . . . . . . . . . . . . . . . . . . .
$40,001 to $200,000 . . . . . . . . . . . . . . . . . . . . . .
$200,001 to $400,000 . . . . . . . . . . . . . . . . . . . . .
Over $400,000 . . . . . . . . . . . . . . . . . . . . . . . . . . .
Calculation of tax a
nil
(N – $40,000) × 0.0098
$1,568 + (N – $200,000) × 0.02726
(N – $40,000) × 0.0195
a All of the computed tax amounts are reduced by 22 percent to reflect the “non-deductibility
tax credit.”
ployer health tax paid by self-employed individuals are all reduced by a
special 22 percent provincial tax credit.
Essentially, TNSEI embraces most forms of unincorporated business
income and self-employment income, including those from a partnership,
proprietorship, or joint venture. All non-business incomes, such as dividends or rents, are excluded. The tax applies to the worldwide TNSEI of
Ontario residents and exempts non-residents from tax on their income sourced
in Ontario. This approach departs from the more complex arrangements
originally proposed in the 1992 budget. These would have taxed non-Ontario
residents on TNSEI sourced in Ontario, and they would have applied the
tax only to the Ontario-source income of residents (though requiring the
calculation of the effective tax rate using worldwide income).22 Business
losses cannot be carried back or forward to offset taxable income in other
years for purposes of this tax. Any employees of a self-employed person
are also subject to the employer payroll tax.
Newfoundland’s Payroll Tax
Newfoundland initiated an employer payroll tax in 1990 as a response to
renewed cutbacks in federal transfers for health care and education; this
was similar to Manitoba’s motivation for instituting a payroll tax eight years
earlier. Remuneration types covered by the health and post-secondary education tax were similar in breadth to those in the other provincial payroll
taxes. Coverage of industries and types of employer was also comprehensive with the exception of the renewable resource sectors. Under the 1990
Act23 employers in fishing, farming, and forestry were zero-rated, or effectively exempted from tax. Both producers and a wide range of secondary
processors in those sectors were zero-rated. The rate on all other employers was set at 1.5 percent of taxable payrolls, allowing an annual exemption
of $300,000 (but no notch). Associated corporations or partnerships were
entitled to only one tax exemption among them. However, employers registered as charities or recognized as private non-profit organizations are
22 Jim Nesbitt and Louis J. Provenzano, “Ontario Employer Health Tax” (April 20, 1993),
vol. 1, no. 4 Canadian Tax Highlights 28; and “If At First . . .” (September 21, 1993), vol.
1, no. 9 Canadian Tax Highlights 69.
23 Health and Post-Secondary Education Tax Act, RSN 1990, c. H-1, as amended.
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163
entitled to the exemption amount for each separate location.24 Self-employed
activities have never been covered by the Newfoundland tax.
In 1992 the Newfoundland payroll tax was amended to generate additional revenues. The following changes were made, all effective July 1, 1992:
1) The rate of tax was raised to 2 percent.
2) The tax exemption level was reduced to $100,000 on an annual basis.
3) The previously zero-rated employers in the renewable resource sectors became taxable, albeit at a preferential 1 percent rate, on their payrolls
above the exempt level.
The reason given in the 1992 budget for these changes was to replace tax
revenues that would be lost from abolishing the commercial property tax
for school finance: “Government did not feel taxpayers should have to
bear the relatively high administration costs of a commercial property tax
system when other more cost-efficient alternatives were available.”25 In a
later measure, payroll tax relief was provided for new and expanding small
businesses in 1993; the provision was modeled after the Unemployment
Insurance employer premium relief but was not extended for 1994.
Northwest Territories’ Payroll Tax
The latest jurisdiction in Canada to implement a payroll tax was the Northwest
Territories, which in July 1993 imposed a tax on employees rather than
employers. The employers are charged with collecting and remitting the
taxes, but these taxes are withheld from the gross remuneration of employees. This feature of the Territorial payroll tax was dictated by the
motivation for enacting the tax, which differed from that of the provinces.
As stated in the 1992-93 budget, the goal was to “correct the situation of
having many individuals who work at isolated work sites or take seasonal
construction jobs in the north but do not pay Northwest Territories income
tax.”26 The reason these workers pay no Territorial income tax is that they
reside elsewhere on the December 31st date used to assess the province of
residence for personal tax. It was estimated for recent years between 15
and 18 percent of total wages and salaries paid in the Northwest Territories was earned by persons who were non-resident at year-end.27 Given
24 To qualify, an employer must be a registered charity for the purpose of the Income
Tax Act, RSC 1952, c. 148, as amended by SC 1970-71-72, c. 63, and as subsequently
amended, or deemed by the Newfoundland Minister of Finance to be a private sector nonprofit organization.
25 Newfoundland and Labrador, Department of Finance, 1992 Budget, March 26, 1992,
14. Also cited were regional disparities in property values. The budget simultaneously abolished
the other main source of school tax revenues, a poll tax, putting the total annual savings in
administrative costs from eliminating the school taxes at $4.5 million (ibid., at 12).
26 Northwest Territories, Department of Finance, 1992-93 Budget Address, September
10, 1992, 8.
27 Northwest Territories, Department of Finance, Budget Address, February 19, 1993,
35. It was estimated “that there are at least 3,000 people, who earn in total about $200
(The footnote is continued on the next page.)
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this background, it is not surprising that the Northwest Territories is the
only lower jurisdiction in Canada to label its payroll tax by its literal name
under its Payroll Tax Act.28
The Territories payroll tax is a very simple and comprehensive one. It
applies to all industry sectors and types of employment at a flat rate of 1
percent of total remuneration without any exemptions. Its only exclusion
relates to work outside the Territories for a Territorial employer. For the
1993-94 fiscal year the tax was projected to raise $8.2 million and $12
million annually thereafter. At the same time the Northwest Territories
initiated a cost-of-living income tax credit, which will cost $10 million in
a full year. This new credit will be paid annually in connection with personal income tax returns; its amount rises with net income at a declining
rate to a maximum payment of $645 to taxpayers with net income of $66,000
or higher.29 Hence it will mostly or fully offset the payroll tax liability for
the great majority of employees who are also tax-resident in the Territories. Because the tax credit is paid only to those who file their income tax
returns in the Territories, the “non-resident” workers will bear the net differential burden of the payroll tax: $2 million per year on an estimated
$200 million of earnings.
DESIGN AND STRUCTURAL ISSUES
The design and structure of a payroll tax have significant implications not
only for its ease of operation but also for its economic effects such as
equity and efficiency. This section considers the key design and structural
issues—industry coverage and exemptions, fringe benefits and pension
contributions in the tax base, and the treatment of compensation from selfemployment and closely held corporations—and several design issues related
to the tax rate structure. It will be seen that a uniform, flat rate structure
(such as in Quebec’s employer levy or the Northwest Territories’ levy on
employees) poses the minimal complications for other design aspects of
payroll taxation. The administrative and compliance features of the provincial payroll taxes are then examined, including both cost estimates and
operational aspects. The economic effects of the design and structural features
are considered in the next major section, “Economic and Policy Issues.”
Coverage and Exemptions
Industry Sectors
One of the most remarkable aspects of the provincial payroll taxes is their
broad coverage of industry sectors and types of employment. The only
27
Continued . . .
million annually in the Northwest Territories, but who, for various reasons, pay income tax
to another province” (ibid., at 7-8).
28 Payroll Tax Act 1993, SNWT 1993, c. 11.
29 The scale of the credit is 1.25 percent of net income up to $12,000, plus 1 percent of
net income between $12,000 and $48,000, plus 0.75 percent of net income between $48,000
and $66,000. Credits are paid on a refundable basis to individuals with little or no Territorial personal income tax liability.
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general exceptions are firms with payrolls below the exemption levels allowed in two provinces and self-employment in two provinces and the
Territories. Otherwise, whether the work is part-time or full-time, the payroll
taxes cover virtually all employers in the private, public, quasi-public,
and non-profit sectors without distinction; in all sectors of the commercial and industrial economy; in both corporate and unincorporated enterprises;
and at all levels of jurisdiction in the public sector. The few exceptions
that arise in some provinces only highlight the unusual breadth and uniformity of the payroll taxes, as compared with all other major forms of
direct and indirect taxation in Canada.
The exceptions to the broad coverage of the payroll taxes were noted in
the individual provincial histories and are briefly summarized here. Quebec and Ontario exempt native employers and employees where the
establishment is on a reserve. Quebec also provides an exemption for
employees working in international financial businesses, and Ontario also
exempts embassies and consulates. Manitoba exempts trucking payrolls
to the extent that they are generated from interprovincial and international
traffic. No industry sectors are excluded from the Northwest Territories
payroll tax. The largest exempt area was provided originally by Newfoundland for employers in the renewable resource sectors (fishing, farming,
and forestry), but in 1992 it converted the tax-free treatment to a preferential positive tax rate. One practical difficulty of a sectorally defined exemption
or preference is that firms engaged in multiple business sectors have to
allocate their total payrolls between the fully taxable and preferred activities.30
Geographical Application and Residence
Like any tax in a federal or international setting, each provincial payroll
tax needs to define what types of employment and activities fall within
the realm of that province. This aspect of tax design is commonly known
as the residence rules for taxability. The rules used by the provinces for
their payroll taxes are typically very simple, but in some circumstances
can be more complex. Employers are subject to the payroll tax if they are
located within the province and with respect to employees who report to
work at an establishment within the province. In Quebec, if the employee
is not required to report for work at an employer’s premises, the criterion
for taxability is whether the employee is paid from an establishment within
the province. In one minor exception, Ontario applies a residence rule
based on the employee’s attributes: no payroll tax is levied on employees
of registered charities who work outside of Canada for a continuous period of at least 183 days.
Most of the statutes refer to the existence of a “permanent establishment” within the province, but interpretation of the term is considerably
30 Under the 1992 amendments to the Newfoundland tax, each employer engaged in
both a renewable resource industry and another business is required to file annual declarations of its actual payments to employees in the two types of business and adjust its taxes
paid for the year correspondingly.
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broader than its literal meaning. For example, section 2(2)(g) of the Manitoba Act states: “where an employer has no fixed place of business, he has
a permanent establishment in the principal place in which the employer
conducted business and in each place from which the employer carried on
or transacted any substantial portion of his business.” Section 1(2) of the
Ontario Act describes a wide range of circumstances taken to characterize
a “permanent establishment.” Under section 1(2)(b) “a person shall be
deemed to have a permanent establishment in a jurisdiction in which the
person carries on business through an employee or an agent either of whom
has general authority to contract for the person.” Section 4 of the Ontario
Act further extends liability to “[a]n Ontario resident who enters into an
agreement with a non-resident employer under which work is performed
or services are provided during a year for the benefit of the Ontario resident by an individual employed by the non-resident employer.”31
Similar to the provinces, the Northwest Territories applies a concept of
“fixed place of business” in defining the scope of its payroll tax. This
concept is also quite elastic to cover almost any form of employee or agent
relationship where the activity is performed within the Territories. However, the Northwest Territories had a different motivation for applying a
payroll tax than the provinces, which led it to add two other provisions.
An employee who works part of the year outside of the Territories for a
Territorial employer has a payroll tax liability based on total pay from that
employer prorated by the proportion of total days worked for that employer within the Territories. Moreover, an employee of a Territorial employer
is not liable for tax if he or she works outside the Territories for more than
half the total days worked for that employer, so long as the employee’s
total pay from that employer does not exceed $5,000 for the year.
Fringe Benefits and Pension Contributions
In addition to ordinary cash compensation of employees in the form of
salary, wages, bonuses, and commissions, the provincial payroll taxes require the inclusion of most fringe benefits and allowances. The criterion
for inclusion in the case of all provinces is whether the benefit or allowance is deemed taxable under the federal personal income tax. Typically
this is done by reference to sections 5, 6, and 7 of the Income Tax Act
(Canada) and whether the amount appears as a taxable benefit on the employee’s T4 slip. This method of proceeding greatly eases the measurement
and enforcement of the payroll tax base for the provinces. If a province
wished to include additional items of employee compensation in its payroll tax, it would have to assume extra burdens in auditing and enforcement.
31 In those cases the Ontario resident is deemed to pay the remuneration and to be the
employer for the purposes of the employer health tax. Section 21 of the Act additionally
imposes responsibility for tax remittance upon persons paying an “out-of-province employer” unless an appropriate certificate from the minister is provided; an out-of-province
employer is one that does not ordinarily maintain a permanent establishment in Ontario but
will do so for a period of no longer than 24 months.
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The only significant omission from the base of all the provincial payroll taxes is the employer contributions to registered pension plans (RPPs).
Since employee contributions to these plans (as well as contributions to
registered retirement savings plans [ RRSPs]) are taken from employee
compensation, they are included in the payroll tax base. It is economically
appropriate to include the employer contributions as well, since the eventual proceeds of the pension plan will not bear any payroll tax. Under an
income tax, both the employer and employee contributions are tax deferred because all withdrawals, usually in the form of pension payments,
will be taxable. Under a payroll tax it is neutral and consistent to tax all
contributions at the time they are made to the plan.
The failure to include employer pension contributions may provide incentives for firms to offer more of the total compensation package in this
form; at low rates of payroll tax this distortion is likely to be minor. Perhaps more objectionable is the distributional impact of the omission.
Employer pension contributions are more prevalent, and larger relative to
wages, for higher-paid workers than for lower-paid workers. Hence their
omission from the payroll tax base is relatively disadvantageous for lowerpaid workers, for any given amount of revenues to be raised by the tax. In
fact it should be relatively easy to extend the payroll tax base to include
employer pension contributions. For money purchase plans the measure
of benefit is simply the employer cash contributions to the employees’
accounts. The recent innovation of the “pension adjustment amount” for
the federal income tax also makes it simple to measure the value of employer contributions under defined benefit plans.
Form of Business Organization
The payroll taxes are applied to employee compensation without respect
to the form of business organization. In that sense, corporate and
unincorporated businesses, as well as non-profit and government organizations, are all treated uniformly. However, in those jurisdictions with payroll
taxes that exclude the self-employed, businesses organized as selfemployment entities are not subject to the tax unless they have employees.
Even in the two provinces that extend their payroll taxes to the self-employed,
their treatment differs from that of employers. Moreover, in the case of
closely held corporations the compensation of owner-operators may be
influenced by the presence of the payroll taxes. Firms otherwise subject
to payroll tax may also be influenced in their use of independent contractors by the presence of payroll tax, depending on the exemption and
self-employment provisions. The provinces generally are guided by the
rulings of Revenue Canada in determining whether a relationship is one
of an employer-employee or an independent contractor.
Self-Employment
It is consistent to apply payroll tax to labour earnings from all sources,
regardless of the form of business organization. Provincial payroll taxes
that exclude compensation from self-employment may, in effect, largely
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exempt industry sectors where self-employment is the predominant form
of business. Some examples would include doctors and dentists in the private health care sector. The two provinces that now apply their payroll
taxes to self-employment income use very different approaches. Quebec
applies a special rate schedule to essentially all net income other than
employee compensation that has already been subject to the employer payroll
tax; it thus strikes returns to capital as well as labour earnings. In Ontario
the supplementary tax is confined to net self-employment income so that
financial investment returns are excluded. However, since net selfemployment income includes a return to capital invested in a business, the
tax also strikes a portion of capital income.32 To exclude this effect would
require an additional deduction from self-employment income to reflect a
normal rate of return on tangible capital used in a self-employed business.
Quebec initially applied a supplementary levy on net income of individuals, including employee compensation that was also subject to the
employer payroll tax. This was levied at a flat rate above an individual
exempt level but subject to annual dollar ceilings. As noted earlier, this
tax was abolished at the end of 1977 because of its “regressive” character.
In 1993 Quebec reintroduced a supplementary levy on the total income of
individuals, but this time its base excludes the employee compensation
subject to the employer payroll tax. The justification given for this levy is
that all Quebecers benefit from the health care system. Although the rate
schedule for the individual contributions is more progressive than the earlier flat-rate levy, it still caps annual payments at a maximum of $1,000
when the individual has income subject to contribution of $125,000 or
higher. The inclusion of investment income in this supplementary levy
clearly departs from the principles of a pure payroll tax. The projected
1994-95 yield of this new levy is a substantial $172 million.
When Ontario’s payroll tax was introduced in 1990 and medicare premiums abolished, some commentators33 noted that professionals and other
self-employed people would no longer be paying for the costs of their
medicare. The official response was that the changes included a hike in
the personal income tax rate and that higher taxes would be borne by wellpaid self-employed professionals.34 Yet these higher personal tax rates were
also borne by higher-paid employees, whose remuneration also carried
the employer payroll tax. For this reason, a separate tax on self-employment
income rather than higher income taxation is consistent with the goal of
taxing labour income from all sources. In extending the employer health
tax to self-employment income in 1993, the Ontario government argued
32 Net self-employment income for purposes of the payroll tax is the same as that defined in the federal personal income tax. Hence, it allows deductions for depreciation on
tangible capital and interest expense of the business, but it does not allow for a normal
return on equity invested in the business.
33 See, for example, Donald Grant, “Professionals No Longer Paying Medicare,” The
Globe and Mail, April 24, 1990.
34 Ibid.
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169
that this remedied an “inequity.” Yet one might query whether the complexities and compliance burdens of Ontario’s new self-employment levy
can be justified by the modest annual revenues of $35 million—less than
1.5 percent of the amount generated by the employer payroll tax.35
Closely Held Corporations
A self-employed individual who incorporates would become an employeeofficer of the corporation, and any compensation received in the form of
salary or director’s fees could be subject to the employer payroll tax. If
the payroll exemption level is quite high, this is unlikely to influence either
the decision to incorporate or choices about how to compensate an ownerproprietor. If the exemption level is low or zero, or if self-employment
income is not subject to a supplementary payroll tax, then some of these
choices may be affected by the payroll tax.36 In particular, dividends are
not subject to the payroll tax, whereas salary or director’s fees could incur
payroll tax if the corporation’s total remuneration exceeds any threshold
level. At low rates of payroll tax, factors such as the small business deduction, the dividend tax credit, and the linkage of tax shelters for retirement
savings to salaries are more vital determinants of compensation. At higher
payroll tax rates, one might expect to find growing avoidance of payroll
tax by diverting compensation into dividends; a proposal to counter this
incentive is noted below under the heading “Economic Distortions of Design Features.”
Independent Contractors
If a province’s payroll tax has a zero exemption level and a uniform rate
schedule, and also covers income from self-employment, then it should
not bias a firm’s choice of whether to perform work in house or through
independent contractors. Only Quebec’s payroll tax approaches most of
these conditions. With a non-uniform rate schedule (or an exemption) or
self-employment excluded, a payroll tax will favour the use of independent contractors. This point has not been fully recognized in the legislation
of any province by deeming such contractors to be employees of the client
business or government entity. This may reflect the moderate rates of payroll tax that have been applied to date by the Canadian provinces, and it
has also been covered by the recent extension of payroll tax liability to the
self-employed in two provinces. In contrast, most of the Australian states
35 An estimate of $45 million was given in Ontario, Ministry of Treasury and Economics, 1992 Ontario Budget, April 30, 1992, 22. With some adjustments to the self-employment tax the 1993 budget projected a decrease of $10 million in the full-year yield, which
makes it just $35 million per year.
36 Effects on the choice between dividend and salary payouts for the owner of an Ontario corporation that is eligible for the corporate tax small business deduction are discussed in Jack Bernstein, “Tax Planning for the 1989 Year-End,” in Report of Proceedings
of the Forty-First Tax Conference, 1989 Conference Report (Toronto: Canadian Tax Foundation, 1990), 17:1-42, at 17:17-20.
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have enacted special provisions to deal with independent contractors in
their payroll tax legislation.37
Rate Structures and Related Issues
The rate structure of a payroll tax affects many aspects of the policy design and associated economic effects of the tax. A payroll tax can more
fully approach a true flat-rate schedule than most other forms of taxation,
with the resultant simplicity and neutrality. Yet only the Quebec payroll
tax on employers and the Northwest Territories tax on employees achieve
this potential.38 Departures from a flat-rate schedule are motivated primarily by the goal of relieving smaller businesses from tax and secondarily
reducing the costs of administration and compliance. These reliefs can
take several forms: an exemption (sometimes called a tax-free threshold),
an exemption with a notch range, or multiple graduated rates. Each form
of tax relief has implications for the accounting procedures used for the
periodic remittances of payroll tax. Reliefs also create incentives for tax
avoidance and thereby necessitate association rules for related businesses.
Alternative Relieving Devices
The simplest rate structure is a flat rate with no exemption, as applied by
Quebec for all employers. Figure 1 displays the relationship between taxes
paid by an employer and its payroll, which includes all forms of taxable
remuneration. The lower panel of the figure shows the pattern of marginal
tax rates (MTR) and average tax rates (ATR) with respect to the payroll
(percentages shown in all figures are for the 1993 tax year). A flat rate
with no exemption carries uniform MTRs and ATRs, both at the rate of the
payroll tax. Only slightly more complex is a flat-rate structure with an
exemption, shown in figure 2 for Newfoundland. Payrolls below the exemption level (E) bear no tax and therefore have zero MTR and ATR. For
all payrolls above the exemption, the MTR equals the statutory tax rate,
but the ATR only gradually approaches the statutory rate with larger payrolls.
A payroll tax can use a notch provision to make all larger payrolls bear
the full statutory rate of tax while relieving employers with smaller payrolls through an exemption. A notch provision operates by applying a higher
tax rate, the notch rate, on payrolls between the exemption level and a
level at which the ATR rises to equal the statutory rate. Figure 3 shows
how this approach operates in Manitoba. The basic payroll tax rate of 2.25
percent applies only above the notch level (N); the notch rate of 4.5 per-
37 The need for such provisions has been driven by the relatively high payroll tax rates
and exemption levels used in the Australian payroll taxes. For a description of the legislation for “relevant contracts,” see Eric Risstrom, The Taxpayers’ Guide, 1991-1992 (Melbourne: Wrightbooks, 1991), 1014-17.
38 For analysis of the behavioural effects of non-uniform tax rate structures in the context of direct personal taxation, see Jonathan R. Kesselman, Rate Structure and Personal
Taxation: Flat Rate or Dual Rate? (Wellington, NZ: Victoria University Press for the Institute of Policy Studies, 1990).
(1994), Vol. 42, No. 1 / no 1
CANADIAN PROVINCIAL PAYROLL TAXATION
Figure 1
171
No Exemption: Quebec
(1993 Tax Year)
Tax
Payroll
MTR, ATR
3.75%
MTR
ATR
0%
Payroll
cent applies for all payrolls between the exemption of $600,000 per year
(in 1993) and the notch level of $1.2 million per year, but it applies only
to that part of the payroll above the exemption. The sloped dotted line in
the upper panel of the figure shows how the tax operates like a pure flatrate structure without an exemption for payrolls above the notch level.
Table 3 presents the notch rates and notch ranges over the life of the Manitoba
payroll tax.39
Another method of applying the full rate for higher payrolls while granting
lower rates to smaller payrolls is used by Ontario. To understand the spe39 A properly designed notch provision has the following relation: n(N – E) = rN, where
r is the basic or full rate, n the notch rate, E the exemption level, and N the notch level.
Using this relation, it can be seen from table 3 that the Manitoba notch provision was defective for the first quarter of 1987; a firm with payroll just below N was liable for more taxes
than a firm with payroll of N or slightly higher.
(1994), Vol. 42, No. 1 / no 1
172
CANADIAN TAX JOURNAL / REVUE FISCALE CANADIENNE
Figure 2
Exemption, No Notch: Newfoundland
(1993 Tax Year)
Tax
Payroll
E
MTR, ATR
2%
MTR
ATR
0%
Payroll
cial properties of the Ontario payroll tax rate schedule, a more conventional rate structure is first reviewed. Figure 4 shows a pattern of linked
brackets similar to that used in the rate structure of a progressive personal
income tax. However, no exemption is provided so that even the lowest
payrolls, between B1 and B2, would bear tax at a low rate. As seen in the
lower part of the figure, this structure consists of a series of successively
higher MTRs.
The Ontario structure, in contrast, uses a system of discrete rate brackets as shown in figure 5. While this also has a series of successively higher
MTRs, at the boundaries of the brackets the effective MTRs are extremely
high (not shown in the lower panel). The figure displays only the lowest
and highest rates, 0.98 and 1.95 percent, respectively, and just one intermediate rate rather than all of the seven intermediate rates (see table 4).
This approach means that an employer that moves across the boundary
between two brackets bears a relatively high incremental tax. A payroll
rising one dollar from $200,000 to $200,001 incurs $242 in extra tax; a
one dollar increase from $400,000 to $400,001 incurs $484 in extra tax.
Although these figures represent effective marginal tax rates of many thousands of percents, they arise only over very narrow ranges of the payroll.
(1994), Vol. 42, No. 1 / no 1
CANADIAN PROVINCIAL PAYROLL TAXATION
Figure 3
173
Exemption and Notch: Manitoba
(1993 Tax Year)
Tax
Payroll
E
N
MTR, ATR
4.5%
2.25%
MTR
ATR
0%
Payroll
This fact and the inability of most firms to set their annual payrolls with
any precision suggest that any disincentive effects are likely to be muted.
Ontario’s application of the employer health tax to self-employed individuals utilizes a different rate structure than for employers. As shown in
figure 6, it offers an exemption followed by a lower-bracket rate of 0.98
percent for total net self-employment incomes (TNSEI) between E and B2.
A notch rate of 2.726 percent applies for TNSEI between B2 and N, but this
notch does not restore a uniform ATR on TNSEI above N on account of the
exemption. The notch provision operates only partially; it eliminates
the advantage of the lower-bracket rate for those with large TNSEI but not the
benefit of the exemption. Above N the marginal tax rate is 1.95 percent,
the same rate as applies to larger employers. Table 5 shows the levels of
(1994), Vol. 42, No. 1 / no 1
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CANADIAN TAX JOURNAL / REVUE FISCALE CANADIENNE
Figure 4
Linked Brackets
Tax
Payroll
B11
B2
B3
MTR, ATR
MTR
ATR
Payroll
TNSEI at which these various brackets apply. The cited tax rates are also
reduced by the 22 percent tax credit allowed for individual payments of EHT.
Although Quebec has always used the simplest payroll tax rate structure for employers, its rate structures for the companion tax on individuals
have been relatively complex. Both its earlier version of this tax, from
1970 through 1977, and its version applied since 1993 have had annual
ceilings on the individual “contribution.” This is consistent with the view
that payments are a form of medicare premium charge. These ceilings can
be seen by the flat ranges of the tax schedules shown in the upper panels
of figures 7 and 8. In its earlier form the tax offered an exemption (differentiated by single or married status), a basic tax rate (1.5 percent in its
final year), and a ceiling amount (higher for the self-employed than for
others). It also offered a fill-in notch, which assured that no individual’s
income would be reduced below the exemption level on account of the
tax. This implied an MTR of 100 percent between E and N. However, this
arose over a narrow income range—just $84 for a married employee in
1977, for example.
(1994), Vol. 42, No. 1 / no 1
CANADIAN PROVINCIAL PAYROLL TAXATION
Figure 5
175
Discrete Brackets: Ontario, Employers
(1993 Tax Year)
Tax
Payroll
B11
B22
B33
MTR, ATR
1.95%
0.98%
0%
MTR
ATR
Payroll
In its recent version the Quebec health care tax on individuals has a
very unusual rate structure. It applies a tax rate of 1 percent but only within
two ranges of taxable income (which excludes remuneration already subject to the employer tax)—between $5,000 and $20,000 and between $40,000
and $125,000 per year. Taxable income in the range from $20,000 to $40,000
bears no incremental tax. As shown in the lower panel of figure 8, this,
along with the ceiling, yields a very erratic pattern for the ATR with respect
to income. It is not clear what policy objectives or other elements of the
Quebec tax system motivated the choice of this unusual rate structure.40
Accounting Operation of Devices
Given the need for periodic remittances of payroll tax during the year, a
tax-relieving device needs some accounting rules. Each firm’s tax rate
will be known only at the end of the year after its total payroll for the year
has been paid. Quebec’s lack of a tax-relieving device obviates this prob40 This rate structure might be explained in part by the elimination of a $750 Quebec
employment tax deduction that corresponded in value to $150 for taxpayers over a range of
earnings and in part by an attempt to minimize the impact on middle-income taxpayers.
(1994), Vol. 42, No. 1 / no 1
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CANADIAN TAX JOURNAL / REVUE FISCALE CANADIENNE
Figure 6
Exemption, Dual Rate, and Partial Notch: Ontario,
Self-Employment (1993 Tax Year)
Tax
E
BB22
N
TNSEI
MTR, ATR
2.726%
1.95%
0.98%
0%
MTR
ATR
TNSEI
lem; all firms simply remit the tax rate multiplied by their entire taxable
payroll in each remittance period. No reconciliations of tax are needed at
year-end, unless a firm has erroneously reported its payroll during the
year. Newfoundland’s exemption also operates relatively simply. Each firm
is allowed to use up its $100,000 tax-free amount in the first months of the
year before paying any payroll tax at the statutory rate when its year-todate cumulative payroll exceeds this threshold. One incidental effect of
this approach is that the province’s payroll tax collections will be depressed
in early months of each year.
Accounting under Ontario’s multiple rate scheme operates in a quite
different manner. Since 1992 employers with payrolls up to $200,000, based
on their payroll in the previous tax year, can remit their taxes once per
year with their annual tax returns. Employers with payrolls up to $400,000
(the maximum level for reduced rates) can determine the tax rate for their
periodic remittances based on their previous year’s payroll. An annual
return is required of all employers in Ontario, and at that point they can
make any reconciliation of taxes based on the actual payroll and applicable tax rate for the year.
(1994), Vol. 42, No. 1 / no 1
CANADIAN PROVINCIAL PAYROLL TAXATION
Figure 7
177
Exemption, Fill-In Notch, and Ceiling: Quebec,
Individuals (1970-1977 Tax Years)
Tax
E
N
Income
C
MTR, ATR
100%
MTR
ATR
1.5%
0%
Figure 8
Income
Exemption, Linked Brackets, Flat Range, and Ceiling:
Quebec, Individuals (1993 Tax Year)
Tax
E
MTR, ATR
C11
C
C22
C
B22
Income
MTR
ATR
1%
0%
Income
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CANADIAN TAX JOURNAL / REVUE FISCALE CANADIENNE
Manitoba’s notch provision and exemption complicate the operation of
its payroll tax. If an employer expects its payroll for the year to fall below
the exempt level, it can file a declaration before the start of the year and
be relieved of tax remittances. If it finds at the end of the year that its
payroll actually exceeded the exemption, taxes will be assessed on the
incremental payroll at the notch rate. An employer with payroll expected
to fall within the notch range, based on its payroll for the previous year,
remits nothing during the first part of the year until its cumulative payroll
exceeds the exemption; it then pays tax at the notch rate on incremental
payrolls. Those employers that are expected to have payrolls above the
notch level, based on their previous year’s payroll or declaration, must
remit tax at the full basic rate on all of their payrolls from the first month
of the year.
Relieving provisions for lower-income taxpayers under the two provinces’ individual payroll tax provisions also need accounting rules. In Ontario
an instalment payment must be made by November 15th of each year based
on TNSEI for the previous tax year; final payment must be remitted with
an annual return by May 15th following each tax year. In Quebec, individual payments are due for each year by the following April 30th. However,
any individual required to make personal tax instalments is also required
to make quarterly instalments on their health services fund contributions;
these are based on contributions paid for the preceding year or estimated
contributions for the current year. The final due dates in both provinces
are at or after the due dates for personal income tax returns, which eases
tax compliance since self-employment income will already have been
computed.
Coverage of Smaller Firms
The tax relief devices have been justified by provinces in terms of recognizing the “unique circumstance[s] . . . [of] employers with small payrolls”
or concern over the administrative and compliance burdens of collecting
modest amounts from numerous small employers.41 On the other hand,
Quebec and Ontario both require payments from even the smallest employers on the basis that all citizens enjoy public health services. Indeed,
both have used this principle to extend their taxes to include the self-employed
(in Ontario) and all individuals (in Quebec). The Quebec arrangements,
which not only include all employers but also offer no rate relief for smaller
employers, do not suggest that the administrative costs are unduly high.
However, Quebec can combine collection of its employer payroll taxes
with other Quebec taxes (provincial income tax and Quebec Pension Plan)
whose counterparts are collected by the federal government elsewhere in
Canada.
41 The quotation is from the 1989 Ontario Budget Speech, supra footnote 18, at 7; the
latter concerns were expressed in correspondence from the Newfoundland Department of
Finance. Dahlby, supra footnote 2, at 146-53, offers an extended analysis of the treatment
of small business under the Ontario EHT and recommends that the relief provision be converted to an exemption with a uniform rate.
(1994), Vol. 42, No. 1 / no 1
CANADIAN PROVINCIAL PAYROLL TAXATION
179
Manitoba’s payroll tax policies show the approach of repeated increases
in the exempt level, with parallel increases in the notch range.42 It has
become a tax on fewer and fewer employers, as seen in the last column of
table 3. While it began in 1982 covering all 29,500 employers in the province, with the 1994 hike in the exemption it will cover just 2,085 or about
7 percent of all employers. Taking the opposite approach, Newfoundland
has substantially lowered its exemption level. It began its legislation in
1990 with an exemption level of $300,000 and reduced this to $100,000 in
1992, at the same time removing the zero-rating for the resource industries.
Although Ontario provides rate relief for employers with payrolls under $400,000, it does not fully exempt even the smallest employers.
Employers with payrolls up to $200,000 pay about half the full rate; employers with payrolls between $200,000 and $400,000 are subject to rates
graduated between the bottom and the full rate. Table 6 shows the distribution of employers by size of payroll in Ontario for 1992, along with the
distributions of total payrolls and tax revenues. Employers paying tax at
the lowest rate constituted 86.1 percent of all employers but comprised
just 8.4 percent of all payrolls and paid just 4.5 percent of all employer
health tax. At the other end of the spectrum were the 7.9 percent of employers who paid tax at the full rate, generating 86.7 percent of total payrolls
and 91.7 percent of tax revenues. The largest 2.5 percent of employers,
with payrolls above $1,500,000, accounted for 75 percent of total payrolls
and over 79 percent of all EHT paid.
Using the figures on which table 6 is based, we can examine several
alternative methods of taxing smaller businesses in Ontario for 1992. We
first calculate that the rate reliefs reduced Ontario payroll tax revenues in
1992 by just 5.5 percent relative to a flat rate of 1.95 percent on all employers. Applying the full rate to all employers would have raised an
additional $145 million in annual revenues. To achieve the actual revenues without any rate relief for smaller employers would have entailed a
rate of 1.843 percent. An exemption without a notch would be a simple
way to provide rate relief. With an annual exemption of $50,000 per employer, just 35 percent of all employers would have paid payroll tax, and
the rate needed to raise the actual revenues is 1.987 percent. That would
have reduced taxes for employers with payrolls below about $99,000. With
a $100,000 exemption, only 23 percent of employers would have paid tax,
at a basic rate of 2.079 percent. This system would have benefited all
employers with payrolls below about $189,000.
Related Businesses and Association Rules
The provision of tax relief for smaller employers creates an incentive for
firms to fragment their total business into multiple identities so as to maximize
their tax benefit. Only the flat-rate schedules used in the Quebec and North42 The political pressures for raising the payroll tax exemption level in Manitoba are
described by James M. Dean, “Manitoba: Provincial Public Finances,” in Melville McMillan,
ed., Provincial Public Finances, vol. 1, Provincial Surveys, Canadian Tax Paper no. 91
(Toronto: Canadian Tax Foundation, 1991), 184-208, at 197-98.
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Table 6
Size Distribution of Payrolls and Employer Health Tax,
Ontario, 1992 Returnsa
Employer’s payroll
range,b $
Percent of
employers
25,000 and less . . . . . . . . . . .
25,001–50,000 . . . . . . . . . . . .
50,001–75,000 . . . . . . . . . . . .
75,001–100,000 . . . . . . . . . . .
100,001–150,000 . . . . . . . . . .
150,001–200,000 . . . . . . . . . .
200,001–230,000 . . . . . . . . . .
230,001–260,000 . . . . . . . . . .
260,001–290,000 . . . . . . . . . .
290,001–320,000 . . . . . . . . . .
320,001–350,000 . . . . . . . . . .
350,001–380,000 . . . . . . . . . .
380,001–400,000 . . . . . . . . . .
400,001–500,000 . . . . . . . . . .
500,001–600,000 . . . . . . . . . .
600,001–700,000 . . . . . . . . . .
700,001–800,000 . . . . . . . . . .
800,001–900,000 . . . . . . . . . .
900,001–1,000,000 . . . . . . . .
1,000,001–1,500,000 . . . . . .
More than 1,500,000 . . . . . . .
52.23
12.45
7.46
4.74
5.75
3.45
1.43
1.20
0.96
0.83
0.71
0.56
0.36
1.36
0.94
0.70
0.54
0.42
0.35
1.08
2.47
Total c . . . . . . . . . . . . . . . . . . . 100.00
⎫
⎪ 86.1
⎬
⎪
⎭
⎫
⎪
⎬ 6.1
⎪
⎭
⎫
⎪
⎬ 7.9
⎪
⎭
Percent of total
payrolls
0.82
1.31
1.33
1.19
2.04
1.73
0.89
0.85
0.77
0.73
0.69
0.59
0.40
1.76
1.50
1.32
1.18
1.03
0.97
3.82
75.07
100.00
⎫
⎪ 8.4
⎬
⎪
⎭
⎫
⎪
⎬ 4.9
⎪
⎭
⎫
⎪
⎬ 86.7
⎪
⎭
Percent of total
EHT revenue
0.44
0.70
0.71
0.64
1.09
0.93
0.53
0.57
0.56
0.59
0.60
0.55
0.40
1.87
1.59
1.40
1.24
1.09
1.02
4.04
79.45
⎫
⎪ 4.5
⎬
⎪
⎭
⎫
⎪
⎬ 3.8
⎪
⎭
⎫
⎪
⎬ 91.7
⎪
⎭
100.00
a
These figures are based on tabulations for the 1992 calendar year and hence do not
agree exactly in total revenues with those reported for the 1992-93 fiscal year; the latter
also include payments for interest, penalties, prior years’ shortfalls, etc. The total number
of employers filing for 1992 was 392,031; total remuneration, $135.2 billion; and total
taxes $2.5 billion. b The term “payroll” in this table includes total taxable remuneration.
c Not all columns add to 100 percent because of rounding.
Source: Ontario, Ministry of Treasury and Economics.
west Territories payroll taxes eliminate this avoidance incentive. The other
provinces have found a need for provisions for mandatory grouping of
related businesses, or so-called association rules. This matter was most
evident in the province with the highest exemption level, Manitoba. It
reportedly found many firms establishing separate corporate bodies to operate
each segment of the business, with each segment keeping its payroll costs
below the exemption level. Manitoba combatted this first, in its 1991 budget,
by adopting association rules identical to those defined in section 256 of
the Income Tax Act (Canada). This required prorating the exemption and
the notch relief among associated firms. Succeeding budgets provided for
ministerial discretion to waive the association rules and for circumstances
under which associated corporations could apply to have the rules waived
for a given year.43 Newfoundland and Ontario have also followed the federal rules for associated corporations.
43 For example, a waiver could be requested when one corporation acquired a controlling interest in a second corporation through the fulfilment of an agreement.
(1994), Vol. 42, No. 1 / no 1
CANADIAN PROVINCIAL PAYROLL TAXATION
181
Administration and Compliance
A major attraction of payroll taxes, relative to most alternative forms of
taxation, is their relative ease and economy of administration and compliance. For example, in doubling the rate of the Quebec employer payroll
tax in 1981, Finance Minister Jacques Parizeau noted that “[s]uch contributions are easy to administer.”44 In enlarging the scope of its payroll tax
in 1992, the Newfoundland government also cited its low administrative
cost vis-à-vis the commercial real property tax that was being abolished.
Simplicity for administration and compliance have been primary concerns
for most provinces in designing their payroll taxes. Newfoundland has
cited simplicity as a reason for choosing an exemption without a notch
provision, and Ontario’s system of discrete rate brackets has appeal from
the standpoint of taxpayer comprehension relative to a notch system. The
Northwest Territories also cited simplicity in designing its payroll tax “in
order to minimize the administrative burden on employers and to ensure
that it is easy to understand.”45
Administration and Costs
The provinces vary in how they coordinate administration of their payroll
taxes with other provincial taxes. Quebec’s employer payroll tax is collected by the minister of revenue, and collection of the contributions is
combined with other provincial taxes that are withheld at source. Administrative, collection, and enforcement activities for Manitoba’s payroll tax
are coordinated with activities for other taxes. This occurs because the
Taxation Division of the Manitoba Department of Finance is organized on
a functional basis. Hence, it is likely that audits for retail sales tax and
payroll tax would be conducted at the same time.
Ontario administers its employer and individual payroll taxes through
the Employer Health Tax Branch of the Ministry of Treasury and Economics. These taxes are operated separately from other Ontario taxes. An
audit function for the employer tax was scheduled to begin only in the
1993-94 fiscal year. The 1993 budget announced the assignment of 147
staff to tax collection and audit positions to reduce non-payment of payroll and other taxes. Newfoundland’s payroll tax is administered by the
Tax Administration Branch of the Department of Finance, which also collects other provincial taxes. Collection of the payroll tax is coordinated
with retail sales tax for taxpayers who remit both taxes. The coordination
is done through a computerized tax management system, which identifies
taxpayers with outstanding tax balances and/or outstanding returns. Taxpayers are audited simultaneously for both payroll and retail sales taxes
where both taxes are applicable.
44 Québec, Ministère des Finances, 1981-1982 Budget, March 10, 1981, 25. Parizeau
also made some puzzling comments about the higher payroll contributions: “Their effect
will be to increase business productivity which, in the context of markets that are protected
less and less, is an excellent achievement” (ibid.).
45 Northwest Territories Budget, supra footnote 27, at 36.
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Only two of the four provinces have reported administrative costs for
their payroll taxes separate from the costs of other taxes. Ontario reports
$10 million for fiscal 1992-93, or just 0.38 percent of the associated tax
revenues. Newfoundland estimates the incremental costs of collecting its
payroll tax in 1993 at $325,000 per year, with $245,000 for the operating
cost of the computer system and $80,000 for staff. This represents a similarly low figure of just over 0.5 percent of the associated tax revenues.
These cost figures are substantially lower than for most other taxes. They
are also in line with estimates of 0.25 to 0.4 percent of revenues for the
administrative costs of the relatively larger payroll taxes in the states of
Australia.46 Although figures are not available for the administrative costs
of Quebec’s payroll tax, the integration of collections with other provincial taxes should make it even more economical. The only estimates available
for the collection costs of the Canadian social insurance premiums, forms
of a payroll tax, are unavoidably merged with the joint costs of collecting
personal income taxes.47
Operational Requirements
The operational aspects of the provincial payroll tax statutes are similar to
those of other taxes administered by the provinces. They include provisions for employers to maintain adequate books and records, ministry audits
and tax assessments, time limits for issuing tax assessments, legal remedies
to enforce collection of unpaid taxes, refunds of overpayments, the charging of interest on overdue tax and the payment of interest on tax refunds,
objections to and appeals from tax assessments, and penalties for failure to
comply with the Act. Indeed, the operational aspects of the statutes tend to
be much more extensive than the descriptions of the substance of the payroll taxes. In Newfoundland, for example, out of a total of 14 pages for the
Health and Post-Secondary Education Tax Act, just 2 pages were needed to
describe the substance of the tax.48 Unlike the provinces, the Northwest
Territories payroll tax has provisions for notice of objections, appeals, and
assessments that can include employees as well as employers, since the tax
is supposed to be deducted from employee remuneration.49
46 For example, costs of collecting payroll taxes in Western Australia are estimated at
0.42 percent of revenues as against an overall average for taxes in that state of 0.73 percent:
Ian Kerr, “In Defence of the Payroll Tax” (mimeograph, Curtin University of Technology,
Department of Economics, November 1993). Costs of collecting payroll taxes in Victoria, a
state with a larger economy, were just 0.24 percent of revenues collected as against a state
all-tax average of 1.08 percent: Victoria, Committee of Inquiry into Revenue Raising in
Victoria, Report, vol. 2 (Melbourne: Victorian Government Printer, 1983), 641.
47 The overall cost works out to about 1 percent of total revenues from federal/provincial personal tax, Canada/Quebec pension plans, and unemployment insurance. See François
Vaillancourt, The Administrative and Compliance Costs of the Personal Income Tax and
Payroll Tax System in Canada, 1986, Canadian Tax Paper no. 86 (Toronto: Canadian Tax
Foundation, 1989), 84.
48 Health and Post-Secondary Education Tax Act, RSN 1990, c. H-1, as amended.
49 Other than a simple computational error or negligence by an employer, inaccurate
amounts withheld under the Northwest Territories payroll tax are most likely to arise with
(The footnote is continued on the next page.)
(1994), Vol. 42, No. 1 / no 1
CANADIAN PROVINCIAL PAYROLL TAXATION
183
The provinces vary in their requirements for filing payroll tax returns.50
The absence of an exemption for the Quebec tax means that all employers
must file returns. Similarly, under Ontario’s multiple-rate but zero-exemption
system, all employers must make periodic remittances. Additionally, they
must file annual returns reconciling their total instalments paid during the
year with their actual tax liability based on their total payroll for the year.
Newfoundland requires all employers to file an annual return even if no
tax is due when payrolls fall below the exemption level. After introducing
an exemption to its payroll tax in 1984, Manitoba required all employers
with payrolls below the exemption to file annual declarations of total remuneration. Beginning in 1990, such declarations have been required only
when officially requested of an employer.51 All employers registered for
the Northwest Territories tax must submit annual returns, which include a
listing by individual employee of total remuneration, taxable remuneration, and payroll tax collected.
Quebec, Manitoba, and Newfoundland all require monthly remittances
of payroll tax, regardless of the size of the employer. Payments are due on
the 15th day following the end of each month. In Ontario the frequency of
required remittances varies with the size of the employer. Larger employers, those with payrolls above $400,000 who pay the full rate, must remit
on a monthly basis. Employers with annual payrolls between $200,000 and
$400,000 can remit on a quarterly basis. And those with payrolls up to
$200,000 can remit tax once a year along with their annual returns since the
1992 Ontario budget. The Ontario system of varying the frequency of remittances with the employer’s payroll complicates the comprehension and
operation of payments, since some firms have payrolls that fluctuate from
year to year or within a year and have to adjust their remittances.52 The
Northwest Territories also varies the frequency of remittances based on the
estimated size of the employer’s total annual payroll: once annually for
payrolls not exceeding $200,000; twice annually for payrolls up to $600,000;
quarterly for payrolls up to $1 million; and monthly for payrolls exceeding
$1 million. Seasonal employers in the Territories must remit payroll taxes
on a monthly basis regardless of the size of their total annual payroll.
49
Continued . . .
respect to issues of how much of an employee’s pay is attributed to work within the Territories and items of non-monetary remuneration. The regulations allow for delayed remittances of tax on the latter items when their value can be assessed only with a lag or after a
year has ended.
50 Requirements for the filing of returns and frequency of remittances for the self-employed and individuals in Ontario and Quebec are described above.
51 Since 1992, in addition to their monthly returns, associated businesses must file annual returns that compute their taxes on an individual and aggregate basis to ensure proper
sharing of the benefits of the tax exemption and notch provisions.
52 These complexities are apparent from the brochure issued by the Ontario Ministry of
Finance: Employer Health Tax: Guide for Employers (Toronto: Queen’s Printer for Ontario, 1993). Ontario also has provisions for special returns for once-a-year payroll payments exceeding $200,000.
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Compliance and Costs
None of the provinces has computed the extent of non-compliance with
its payroll tax or the compliance costs borne by employers under the tax.
However, as expressed by finance officials of Newfoundland, “It is our
expectation that the nature and design of the tax will work against successful evasion and that this is a strong point in favour of this type of
tax.”53 Comparison of actual revenues from the Newfoundland payroll tax
with revenue forecasts that drew on data sources independent of the tax
roll suggested no significant evasion. The costs of compliance with the
provincial payroll taxes would also be expected to be relatively low, given
that the taxes draw on information that employers must already calculate
to comply with income tax withholding. In the case of Quebec, the joint
remittance of payroll taxes with other provincial taxes should make for
particularly low compliance costs.54
ECONOMIC AND POLICY ISSUES
There are several important issues in regard to the economic effects and
policy role of provincial payroll taxes relative to other methods of raising
revenues. The focus of this article is on the effects of particular design
features of the provincial payroll taxes rather than the general question of
payroll taxes versus taxes on other bases. The latter topic has been investigated in depth elsewhere, as has been the issue of the employment effects
of payroll taxes.55 However, it is pertinent to consider comparisons between the provincial payroll taxes and medicare premiums as well as retail
sales taxes. Other topics of interest include the interprovincial effects on
business of payroll taxes imposed at the provincial level, the public finance interactions of payroll taxes, and their labeling, earmarking, and
public acceptance.
Economic Distortions of Design Features
Any assessment of the provincial payroll taxes must highlight the unusual
breadth and uniformity of their bases, as compared with almost all other
taxes. They cover all sectors of the economy: public and private; federal,
53 Letter from Christopher J. Butt, Director, Tax Policy Division, Newfoundland and
Labrador, Department of Finance, to Jonathan R. Kesselman, September 14, 1993.
54 For evidence on compliance costs of the rather different payroll taxes of the Australian states, see J. Pope, R. Fayle, and D.L. Chen, The Compliance Costs of EmploymentRelated Taxation in Australia (Sydney: Australian Tax Research Foundation, 1993), 87-96.
Chapter 3 of the study by Vaillancourt, supra footnote 47, also provides estimates of compliance costs for Canadian federal payroll taxes, but they are combined with employers’
costs of complying with income tax source withholding.
55 All of these issues will be reviewed in depth elsewhere in the full study of which this
article is a part. It is notable that there has been neither official nor academic research of an
empirical nature into the incidence and the employment effects of the provincial payroll
taxes. A study of payroll taxes in Quebec merged the health contributions with other provincial and federal payroll-type levies: François Vaillancourt and Nicolas Marceau, “Do
General and Firm-Specific Employer Payroll Taxes Have the Same Incidence? Theory and
Evidence” (October 1990), 34 Economics Letters 175-81.
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provincial, and municipal; for-profit and non-profit; Crown corporations
and public corporations; and community and church groups. Only two
provinces and the Northwest Territories omit unincorporated self-employed
enterprises (except in their capacity as employers), and only one province
treats a broad industry group in a preferential fashion. The coverage of
employee compensation is similarly very broad, the only notable exception being employer pension contributions. As a result of the breadth of
the payroll tax bases, one would expect there to be few distortions of resource allocation. However, no formal attempt has been made to date to
quantify the remaining economic efficiency costs.
Economic distortions may arise related to the exemptions and rate structures in some of the provincial payroll taxes. Only Quebec and the Territories
avoid this problem through the use of a flat-rate schedule and no exemption. With an exemption level (Manitoba and Newfoundland) or graduated
rate schedule for smaller employers (Ontario), there is a lower effective
tax rate on smaller firms. This may lead to the diversion of more resources
into smaller firms or the use of a smaller scale of production than is economically efficient. Again, the resulting efficiency costs have not been
quantified. In particular, Manitoba’s high exemption levels would be most
likely to yield such inefficiencies. Moreover, only Manitoba uses a notch
method in its rate schedule, and this raises the effective marginal tax rate
over a range of payrolls. Both Ontario and Newfoundland consciously
avoided a notch range in designing their taxes out of a desire to maintain
simplicity. However, Ontario’s graduated rates do impose high marginal
tax rates at particular payroll levels.
One recommendation of the Ontario Fair Tax Commission is that the
province’s payroll tax eliminate its graduated rate structure and adopt a
flat rate like Quebec’s.56 It noted that the graduated rates had originally
been provided to reflect the lower proportion of OHIP premiums paid by
smaller employers and a desire to reduce the impact of shifting from the
premiums to the payroll tax. It then argued that (1) a firm hiring additional workers that bumped its payroll into a higher rate bracket would
have to pay the higher rate for all of its workers, possibly discouraging
job growth; (2) the rate structure could cause very high incremental taxes
for a small change in payroll, as indicated in our earlier figures; and (3) the
preferential rates are provided without respect to the pay level of individual employees, so that highly paid employees of a small employer could
derive the benefits.
For the reasons given by the Fair Tax Commission, but even more for
simplicity and economic efficiency, the analysis in this article supports
the prescription for a flat-rate scale for Ontario. Yet this conclusion does
not rule out the possible use of an exemption to provide tax relief for
smaller employers. Ontario’s payroll tax now requires even the smallest
56 Ontario Fair Tax Commission, supra footnote 2, at 59-60. It apparently contemplated
raising all of the lower rates to the full basic rate, as it projected a $150 million annual
revenue increase.
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employers to comply and hence already incurs the associated administrative and compliance costs. These costs could justify the use of an exemption
to exclude the smallest employers from the payroll tax, as in Newfoundland. This conclusion would need to balance the resulting economic
inefficiencies—of the kinds cited above—against the savings of real resources in administration and compliance. It should be noted that an
exemption may still require some filing by firms, and checking by provincial authorities, to establish that their payrolls do in fact fall below the
exempt level.
The last major area in which payroll taxes can distort economic activity
is in the form of business organization. Depending upon the design of a
payroll tax, these distortions can arise in the following dimensions:
1) self-employment versus employment;
2) corporate business activity versus unincorporated business activity;
and
3) performance of work by an employer in-house versus contracting
out the work.
To avoid all of these potential distortions would require the following design features:
1) taxation of both employers and the self-employed at a uniform, flat
rate without any exemptions for either;
2) allowance for a normal return to capital in taxing self-employment
incomes; and
3) inclusion of dividends and allowance for a normal return to capital
in taxing owner-managers of closely held corporations.
These are quite austere requirements for the design of a payroll tax, given
that we have no information on how serious the distortions and resulting
efficiency costs of existing payroll taxes might be. It is remarkable that
the Fair Tax Commission actually recommended reforms along these lines,
departing only in keeping an exemption level for owner-managers and the
self-employed.57
Provincial Business Competitiveness
Given the large and growing scale of provincial payroll taxes, particularly
in Quebec and Ontario, one might query their effects on a province’s business competitiveness. Virtually no research has been undertaken on this
important topic; a cursory review of the matter concluded “it seems unlikely that [an expansion of] payroll . . . taxes would be in aid of
competitiveness.”58 Some qualitative analysis of the issue is presented in
57 Ibid.,
at 122.
Couzin, “Tax Options for Competitiveness,” in Report of Proceedings of the
Forty-Third Tax Conference, 1991 Conference Report (Toronto: Canadian Tax Foundation,
1992), 7:1-21, at 7:18.
58 Robert
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this section, focusing on the differential effects of payroll taxes and other
types of provincial taxes. If payroll taxes are increased in order to increase the level of provincial expenditures, this raises questions similar to
those for increased spending financed by other taxes. Namely, a province’s business competitiveness may be augmented if the incremental public
projects add to the productivity of business or reduce the costs of doing
business to a greater extent than the additional tax burdens borne by the
business sector.
If a province raises its payroll taxes, or imposes a new payroll tax, in
order to reduce other types of provincial taxes, any effects on business
competitiveness hinge on several factors. The province might be able to
shift part of its total tax burden onto the federal government or taxpayers
in other provinces. Some taxes could be shifted onto the federal government, provided it continues to pay provincial taxes in its capacity as employer
in the province. The federal government and other provincial governments
(for provinces that have a claim on that corporate income) also bear part
of the tax burden through deductibility of payroll taxes in the corporate
income tax. Either of these effects could enhance the competitiveness of
business in the province if its payroll tax hikes were offset by reduced
business taxes of other kinds. However, as will be discussed later, in its
1991 budget the federal government announced a proposal to undermine
the ability of the provinces to shift their tax burdens further in this manner, and in early 1993 it stated that interim measures would be taken to
block any provinces that tried to do so.
The effect on business competitiveness of a payroll tax relative to other
taxes depends upon their incidence. If one tax is borne more by workers
or households, as against the costs of doing business, it will be relatively
more favourable for the competitiveness of that province.59 Although the
immediate impact of an employer payroll tax increase will fall almost entirely on business, the empirical evidence suggests that after an adjustment
period the taxes will be shifted largely or entirely into lower worker compensation.60 The time needed for full adjustment may be several years,
spanning one or more bargaining cycles for unionized workers. In contrast, the immediate as well as longer-run impact of increases in personal
income taxes falls mostly if not entirely on workers and households. Hence,
raising employer payroll taxes in place of personal taxes will probably
have some adverse impact on a province’s business competitiveness in
the short to middle term; but after a couple of years this differential im-
59 This statement includes the possibility that decreased net earnings of workers or higher
costs of living for households will drive workers away from the province (or deter them
from coming there), which in turn would raise the wage levels needed to retain a work force
of given skills and abilities in the province.
60 Extensive reviews of the literature appear in Daniel S. Hamermesh, Labor Demand
(Princeton, NJ: Princeton University Press, 1993), 169-73, and in Dahlby, supra footnote 2,
at 133, who concludes that “labour bears over 80 percent of the employer payroll tax burden in the long run.”
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pact should dissipate. Of course, the form of payroll tax used in the Northwest
Territories avoids any transitory period of adverse business effects by placing
the tax burden directly on employees at the outset.
Other provincial taxes bear more directly on the costs of business even
in the short run. These include corporate income taxes, commercial property
taxes, and the 30 to 40 percent of retail sales taxes borne by business
inputs. The ultimate longer-run incidence of these taxes is controversial
in the literature, so that it is difficult to predict how a shift from any of
these taxes to higher payroll taxes will affect competitiveness. To the extent that businesses would bear more of the alternative tax, increasing the
payroll tax will improve the long-run competitiveness of that province.
As a general proposition, the smaller a province and the closer its proximity to other major economic regions, the less is the prospect that the incidence
of any business tax will fall ultimately on firms in that province. This
follows because there is a greater chance that factors of production, such
as business capital, will leave the province in response to the lower aftertax returns.
Comparison with Medicare Premiums
Only two provinces (Alberta and British Columbia) still charge medicare
premiums as a condition for coverage under their public health insurance.61
These premiums also generate substantial revenues that would have to be
replaced if they were abolished. The provincial payroll taxes were instituted to replace medicare premiums or to avoid other tax increases
necessitated by restraints on federal transfers for health care and postsecondary education. Only Quebec began its public health system with an
employer payroll tax, which also had individual contributions based on
net income. Hence, it is reasonable for Alberta or British Columbia to
consider an employer payroll tax (with or without contributions from the
self-employed and/or individuals) as one way of abolishing medicare premiums. A complete analysis would also consider other alternative revenue
sources; the next section will review the comparison between payroll taxes
and retail sales taxes.
British Columbia’s situation can be considered to illustrate the issue.
In fiscal 1993-94 a projected $797 million of medical services plan premiums will be paid in British Columbia. As of late 1993, BC residents
must pay monthly premiums of $36 for single persons, $64 for families of
two, and $72 for families of three or more. It has been estimated that about
60 percent of premiums are paid on behalf of employees by their employers, and taxable benefits arise in those cases. For persons at lower incomes,
61 The issue of whether premiums serve any positive purpose for the medicare system
lies beyond the scope of this article; these premiums are not considered to be user charges
since they are unrelated to individuals’ actual or expected use of health care services. See
Greg L. Stoddart, Morris L. Barer, Robert G. Evans, and Vandna Bhatia, Why Not User
Charges? The Real Issues, Discussion Paper HPRU 93:12D (Vancouver: University of British
Columbia, Centre for Health Services and Policy Research, September 1993).
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189
with adjusted family incomes up to $19,000, an assistance program reduces premiums by 20 to 100 percent.62 An estimated 430,000 people have
their premiums fully eliminated.
Ironically, British Columbia’s assistance program compromises the one
clear economic advantage of premium finance. Since premiums are like
non-distorting lump-sum taxes, they have the economic efficiency of head
taxes. Premium assistance poses inefficiencies by raising the effective
marginal tax rates for persons at lower incomes.63 Although the assistance
program alleviates the vertical inequity of premiums for the lowest incomes, they remain extremely regressive across all higher incomes. Yet,
the progressivity of other elements of the tax system, particularly personal income taxes, should fully offset this regressivity. Moreover, switching
from premium finance to a payroll (or sales) tax would increase the effective tax burden on the lowest earners, who now benefit from premium
assistance. That effect could be readily offset by expanded refundable tax
credits similar to those now used in several provinces. The main appeal of
replacing medicare premiums with another tax—other than enhancing health
care access—may lie in reduced administrative costs.
Ontario’s experience in abolishing medicare premiums at the end of
1989 suggests that the administrative savings could be sizable. It eliminated 309 positions in the provincial health ministry needed for collecting
premiums and operating the premium reductions for those at lower incomes.64 If one attributes salary-plus-benefits cost of $40,000 per year for
those jobs, a figure more than $2 million above the $10 million costs of
administering the employer health tax results. And that figure does not
consider the non-salary costs of collecting medicare premiums. Hence, a
payroll tax reduces administrative costs relative to a premium system. In
part this stems from the fact that it is not necessary to maintain records on
the insurance payments for individual persons and families without the
linkage to premiums. Whether such token use of a user-pay system for
public health insurance is worth the added expense lies beyond the scope
of this article.
A consultant’s report undertaken for the BC government in 1992 reviewed several tax policy options, including the possibility of replacing
medicare premiums with an employer payroll tax. It estimated that a payroll tax rate of 2.0 to 2.4 percent, depending on relief provided to small
businesses, would be needed to replace the premium revenues. It described
the potential attractions and drawbacks of such a change as follows:
62 Adjusted family income is defined as net income from an applicant’s (and spouse’s)
tax return, less $3,000 per dependant and per person aged over 65 or disabled. Hence larger
families can obtain partial premium assistance at total net incomes into the $30,000 range.
63 British Columbia applies the method of discrete reduction brackets, similar to the
Ontario EHT as displayed in figure 5. This imposes very high MTRs at discrete points on
the income scale.
64 “Ontario Axes 309 Health Ministry Jobs,” The Montreal Gazette, July 8, 1989. About
70 percent of OHIP premiums were paid directly by employers.
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Payroll taxes are easy to administer, have a broad base, generate substantial
income and would in effect, put the British Columbia tax system on a comparative basis with the other provinces. At the same time, like any new tax,
they would result in some shift in tax burden and alter the cost of production in the province. Those could lead to efforts to avoid the tax and have an
impact on investment and employment decisions.65
Of course, the short-run effects on business would depend in part on whether
firms had been paying for their employees’ medicare premiums prior to
the change.
Comparison with Sales Taxes
A natural alternative to a payroll tax is an indirect consumption tax, such
as a retail sales tax or a value-added tax like the goods and services tax
(GST). The close similarity of their bases in economic terms is well established in the technical literature.66 Indeed, the government of Manitoba
considered an increase in its retail sales tax before proceeding with a payroll tax in 1982. Among its points was the observation that the payroll tax
approach posed a much more progressive pattern of incidence across income groups than an increase in the sales tax. Table 7 replicates the figures
given in the Manitoba budget document to support this point.67 The main
reason for this result is that families at lower incomes receive a higher
proportion of their incomes from transfers that are not subject to payroll
tax. If desired, a low-income tax credit of a kind that Manitoba had in
place in 1982 can be used to reverse the regressive pattern of a sales tax.
In the one previous study of Canadian provincial payroll taxation, which
focuses on Ontario’s tax, a comparison is also made between payroll and
sales taxes. The analyst, economist Bev Dahlby, concludes tentatively by
finding “a number of efficiency and equity arguments that appear to favour a sales tax.”68 The claim regarding the relative equity of the two tax
forms would appear at odds with the distributional pattern of the two taxes.
However, as Dahlby argues, the incidence pattern of the two taxes should
be quite similar if averaged over the lifetimes of individuals, and any shortterm regressivity of sales taxes can be redressed through the use of refundable
tax credits for those at lower incomes. His argument for the equity superiority of sales taxes rests on the fact that they are paid by the current elderly
65 KPMG Peat Marwick Stevenson & Kellogg and Peat Marwick Thorne, “Project Report: British Columbia Financial Review: The Issue of Revenues and Recoveries,” February 27, 1992, 18.
66 This point will be examined in the complete study from which this article is taken.
67 For more recent evidence illustrating the same result for Ontario in 1991, see the
report of the Fair Tax Commission, supra footnote 2, at 14, figure 2. Of the four provincial
taxes charted, the payroll tax is the second most progressive, after the personal income tax,
and contrasts with the regressive pattern of retail sales taxes.
68 Dahlby, supra footnote 2, at 157.
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CANADIAN PROVINCIAL PAYROLL TAXATION
191
Table 7 Relative Incidence of Sales Tax and Payroll Tax as
Percentage of Family Income, Manitoba, 1982
1.5% employer payoll tax is shifted
Family income, $
Under 6,000 . . . . . . . . . . . . . . .
6,000–8,000 . . . . . . . . . . . . . . .
8,000–12,000 . . . . . . . . . . . . . .
12,000–16,000 . . . . . . . . . . . . .
16,000–20,000 . . . . . . . . . . . . .
20,000–25,000 . . . . . . . . . . . . .
25,000–30,000 . . . . . . . . . . . . .
30,000–35,000 . . . . . . . . . . . . .
Over 35,000 . . . . . . . . . . . . . . .
Retail sales
1.87
1.68
1.90
1.77
1.69
1.66
1.67
1.52
1.47
taxa
Half to employeeb
0.29
0.20
0.35
0.44
0.52
0.57
0.59
0.62
0.60
Fully to employee
0.59
0.40
0.68
0.88
1.03
1.14
1.18
1.24
1.19
a Based on Manitoba’s 5 percent sales tax rate in 1982, ignoring the cost-of-living tax
credit offset for low and moderate incomes. b Ignores any shifting of the employers’ burden
into higher prices for consumers and any impact on families as owners of businesses.
Source: Manitoba, Department of Finance, 1982 Manitoba Budget, May 16, 1982, appendix
III.B, at 6.
generation, who would be spared the burdens of a payroll tax rate increase.69
It might be deemed unfair for retirees with wealth to escape their share of
these taxes. Yet an increase in taxes for upper-income or wealthy retirees
can equivalently be derived through adjustments to other taxes, such as
the extra credit for age in the income tax or tax provisions for retirement
savings.
The other part of Dahlby’s assessment relates to the comparative economic efficiency of the two forms of taxation. His argument that sales
taxes may be more efficient than payroll taxes is twofold. First, he states
that the limited available empirical evidence suggests that payroll taxes
may have greater effects on employment than sales taxes. However, after
all economic adjustments to changes in payroll tax rates have taken place,
there is very little effect on employment since workers bear most of the
tax. Moreover, virtually no research has been undertaken that would isolate the effects of sales taxes on employment. Second, Dahlby claims that
“a revenue-neutral shift from a payroll tax to a sales tax may reduce the
size of the underground economy.”70 Similar claims have been advanced
by public finance economists and policy protagonists for many years, but
a recent theoretical analysis of the problem discredits the claim.71 In ef69 Dahlby, ibid., at 158, also makes a relatively technical argument about the equity
superiority of a sales tax based on intergenerational transfers. However, this argument is far
less compelling in the context of comparing two flat-rate taxes such as a sales tax and
payroll tax. Its main appeal is in the context of a progressive personal tax with respect to
whether the base should be labour income or expenditures; these are alternative ways of
implementing a progressive personal consumption tax.
70 Ibid., at 159.
71 Jonathan R. Kesselman, “Evasion Effects of Changing the Tax Mix” (June 1993), 69
Economic Record 131-48.
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fect, shifting the mix of taxes induces changes in the prices of output supplied by the legitimate and underground sectors, which prevents the
government from gaining leverage on the economic resources of underground workers.
The preceding arguments also ignore differences in payroll and sales
tax design that may affect the horizontal dimension of equity as well as
economic efficiency.72 All of the provincial retail sales taxes exempt categories such as groceries and residential rents for distributional reasons
and, with the exception of Quebec, include many business inputs in their
tax bases. These exemptions, while reducing regressivity, introduce inequities of the horizontal kind since they discriminate by the consumption
choices that families make at any given level of income. The application
of retail sales taxes to business inputs creates economic inefficiencies on
the economy’s production side.73 In contrast, the provincial payroll taxes
are very broad in their industry and product coverage, which avoids almost all of the production inefficiencies and horizontal inequities. The
analysis in this article, like Dahlby’s, does not claim to have strong results, but it inclines toward the superiority of payroll taxes over retail
sales taxes on both equity and efficiency grounds.
Public Finance Interactions
One of the most attractive features of payroll taxes for provincial governments is that they allow some shifting of their fiscal burden onto the federal
government. This shifting arises through two channels:
1) payment of these taxes by the federal government and agencies as
employers within the province; and
2) the deduction of payroll taxes by incorporated and unincorporated
employers in computing their income for federal income tax purposes.
The federal government’s opposition to such tax shifting has been translated into proposed restrictions, the effective application of which has been
delayed three times. Similarly, the provincial governments themselves will
bear part of the burden of their payroll taxes as employers and through
impacts on their share of corporate and individual income taxes. This slippage in the net revenues of a payroll tax can be offset by higher tax rates.
Table 8 illustrates the rough magnitudes of the various public finance
interactions of a payroll tax, based on Quebec’s situation in 1981. Just
two-thirds of the gross payroll tax burden was borne by the private sector,
72 It is apparent that Dahlby’s comparison of sales taxes and payroll taxes is based on
ideal or generic forms of these taxes so that it can ignore real-world imperfections in policy
design. However, in practice even the best of the provincial retail sales taxes manifests
major imperfections such as taxation of capital and business inputs, whereas the best or
even typical provincial payroll tax is much closer to the ideal base.
73 As is now well recognized, the use of a value-added tax (like the goods and services
tax) avoids the inefficiencies of a retail-level tax by providing input tax credits for business
purchases of capital goods and intermediate inputs. Although Quebec has partially harmonized its sales tax with the GST, it still imposes tax on several inputs.
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CANADIAN PROVINCIAL PAYROLL TAXATION
Table 8
193
Sectoral Distribution of Payroll Tax (PRT) Burden,
Gross and Net, Quebec 1981
Sector of the
economy
Private sector
Corporations . . . . . . . . . . . . . .
Individuals, cooperatives,
and non-incorporated
businesses . . . . . . . . . . . . . . .
Total private sector . . . . . . . . .
Public sector
Government of Canada . . . . . .
Government of Quebec . . . . . .
Municipalities and subsidiary
bodies . . . . . . . . . . . . . . . . . .
Federal Crown corporations . .
Quebec government
corporations . . . . . . . . . . . . .
Total public sector . . . . . . . . . .
Total . . . . . . . . . . . . . . . . . . . . .
Share of gross
PRT burden, %
Tax relief as % of
gross PRT burdena
Share of net
PRT burden, %b
61.6
27
55.7
5.4
67.0
38
28
4.1
59.8
4.1
21.1
0
0
5.1
26.2
3.8
2.2
0
21
4.7
2.2
1.7
33.0
9
2
2.0
40.2
100.0
19c
100.0
a
These figures are expressed as percentages of the gross payroll tax burden for the
specified sector. b Designating the three columns of figures as A, B, and C, respectively, the
last column can be derived as follows: C = A(1 – B/100)/(1 – 0.19), where 0.19 enters as
the average rate of tax relief for all sectors (in non-percentage terms). c Average across all
sectors.
Source: Computed from figures on distribution of burdens from 1981 increase of payroll
tax rate; Québec, Ministère des Finances, 1981-1982 Budget, March 10, 1981, appendix
III, at 10.
with the other one-third carried by public sector employers. The government of Canada plus federal Crown corporations paid a total 6.3 percent
of the gross payroll taxes; a much larger share was paid by Quebec public
sector employers.74 Averaged across all payroll taxes, the relief resulting
from tax deductibility averaged 19 percent. No breakdown was provided
for the effects of tax deductibility by level of government. After accounting for the effects of tax deductions, the private sector carried just under
60 percent of the net payroll tax burden; this is less than its share of the
gross tax burden because on average the private sector faced higher tax rates
than public sector employers. Assuming that 60 percent of the tax impact
is federal, one can calculate just over 17 percent of the payroll tax burden
being shifted onto the federal government.75
74 To the extent that Crown corporations are operated on a business-like basis, higher
payroll tax could create higher prices for their products, but most of the output of Quebecbased federal Crown corporations is probably sold outside of the province.
75 This computation assumes that (1) payroll tax paid by federal Crown corporations,
net of tax savings, is shifted onto the federal government rather than customers; and (2) Quebec
residents and businesses do not bear any of the federal government’s higher outlays or
lower tax receipts through higher federal tax rates.
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Only the payroll tax of the Northwest Territories, as a tax deducted
directly from the remuneration of employees, does not involve public finance interactions with other levels of government. Since the tax is deducted
from employees, it does not add to gross wage or salary costs of governments or quasi-public bodies that are involved in the tax only in a withholding
capacity. As a direct tax on individuals, this payroll tax is deductible in
neither the corporate nor the personal income taxes of any level of government. Hence, this form of payroll tax has no immediate shifting of
effective tax burden either onto higher or lower levels of government. For
there to be any such shifting in the longer run would require that employees react to incremental payroll taxes by bargaining some offset in their
gross levels of compensation. As noted in our discussion on the effects of
employer payroll taxes on business competitiveness, the evidence is that
the bulk if not all of payroll tax burdens will rest on employees regardless
of which party nominally pays the tax.
Government as Employer
The federal government pays provincial payroll taxes based on its employees in provinces levying such taxes and has done so since their inception.
The government stated its position in the 1991 budget as follows:
The federal government is under no obligation to pay these taxes as the
Crown is immune from taxation. However, in the interests of consistency
with other employers, and in conjunction with the decision to limit their
deductibility, the government has decided to continue to pay provincial payroll
taxes on a voluntary basis.76
At that time the federal government estimated its payroll tax payments to
the provinces at $230 million per year. It makes sense from an economic
efficiency perspective for federal and other public sector employers to
pay the payroll taxes. Without such liability public departments and agencies might be induced to choose in-house production over contracted services
even where the latter were less costly in real resources. However, this
point must be weighed against the possibility that the market price of labour exceeds the economic scarcity value of labour; that would tend to
argue against imposing payroll taxes on public sector employees.77
The provincial payroll taxes bear on payments not only to federal public employees but also to those of the province itself and the so-called
MUSH (municipalities, universities, schools, and hospitals) sector. Figures estimated for Ontario show the approximate magnitude of these tax
shares, with a relatively large share for federal employees on account of
their large presence in that province. In 1992 public sector employers paid
about $655 million or just over 25 percent of the total payroll taxes. The
federal government paid $130 million, or more than half of its total payroll taxes to all the provinces. The Ontario government paid about $80
76 Canada,
Department of Finance, The Budget, February 26, 1991, 150.
supra footnote 2, at 156-57, offers analysis suggesting that it might be advisable for efficiency reasons not to levy payroll taxes on the MUSH sector.
77 Dahlby,
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million. The MUSH sector paid about $445 million: $120 million from
municipalities, $50 million from universities and colleges, $180 million
from school boards, and $95 million from hospitals.78 Taxes levied with
respect to federal employees probably shift some fiscal burden to provinces outside of Ontario. 79 Payroll taxes borne by other public sector
employers may largely increase the province’s own expenditure needs,
depending upon financial arrangements between the province and its municipalities and school districts.
Deductibility of Payroll Tax
The 1991 federal budget also proposed to curtail the deductibility of provincial payroll and capital taxes with respect to the federal corporate income
tax.80 It noted that the provincial corporate income taxes were not deductible against income subject to federal income tax, whereas the provincial
payroll and capital taxes were deductible. It found this to be an inconsistent treatment and also an increasing drain on the federal treasury, as the
provinces moved toward greater reliance on deductible forms of taxes.
The resulting annual cost to federal revenues was put at $700 million in
1991. Consequently, the government stated that it would “provide [the]
provinces with an unbiased choice between these alternative tax instruments”81 through a mechanism based on the following principles:
• the consistent treatment of payroll and capital taxes with income taxes
and removal of the existing bias in favour of such deductible taxes;
• the insulation of small businesses from the effects of the change;
• the introduction of the measure over a period of time sufficient to allow businesses and provincial governments an opportunity to adjust to the
new regime; and
• the generation of no additional revenue for the federal government.82
As indicated earlier, most provinces enacting or increasing payroll taxes
had referred to the advantages of shifting part of the effective tax burden
onto the federal government.
The 1991 budget offered a mechanism as consistent with its expressed
principles and as a matter for consultations with provincial governments.
Its basic design features were
78 These estimates are based on extraneous data on total compensation paid by the public sector groups and also assume that the full 1.95 percent rate was charged. Dahlby, ibid.,
at 154, reports that in 1990 Ontario Hydro paid $80 million in EHT but suggests a curiously
low figure of $35 million for the entire MUSH sector’s payments.
79 Dahlby, ibid., at 155, argues that payroll taxes on federal employees will be shifted
out of province rather than shifted onto those employees because of the national uniformity
of federal civil service salaries.
80 In fiscal 1990-91, provincial payroll taxes constituted 75 percent of the total $7.2
billion generated by provincial payroll and capital taxes combined.
81 Supra footnote 76, at 150.
82 Ibid.
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1) a $10,000 annual cap on the amount of provincial payroll tax83 and
capital taxes that an individual corporation could deduct in computing its
taxable income;
2) an offsetting “tax allowance” that a firm could also deduct from
income, equal to the amount by which 6 percent of taxable income exceeds $10,000; and
3) a phase-in period, from January 1, 1992 to January 1, 1994, to implement these features.
The proposal also specified a method for treating associated corporations.
The operation of the proposed mechanism would have generally benefited
firms in provinces relying less on payroll and capital taxes at the expense
of those in other provinces.84
Provinces relying heavily on payroll and capital taxes have opposed
the implementation of the federal limitations on tax deductibility; they
have been joined by employers who would have to bear the cost.85 Consultations with the provinces have extended much longer than anticipated.
The federal government has thrice agreed to delay the start of the phase-in
period; the phase-in is now scheduled to begin on January 1, 1995.86 The
government in March 1993 announced its intention to move to offset the
tax savings for any province that expanded its existing payroll or capital
tax or enacted a new tax of this form. In 1992 some provinces had taken
advantage of the delay to expand their taxes. Also in late 1992, the federal
government indicated changes in the proposed mechanism:
1) a specified proportion of the taxes would remain deductible in addition to the $10,000 per firm ceiling; and
2) the federal corporate tax rate would be reduced rather than using a
tax allowance.
The rationale for the proposed federal limitation on deductibility is straightforward. It would remove a tax-based motivation for provinces to rely on
particular forms of taxation instruments.87 It would also constrain the growth
83 Payroll taxes were defined to exclude contributions for pensions and workers’
compensation.
84 No technical analysis of the specific proposed mechanism for limiting deductibility is
offered here. However, it is noted that the proposal would be relatively adverse for larger
firms that have a low current income or loss, since the offsetting tax allowance would be
small or nil; under full deductibility, any deductions not used currently could be carried
over to future years in the form of larger tax losses.
85 For example, “Employers’ Group Will Continue Fight for Withdrawal of Taxes on
Payroll Costs,” The Montreal Gazette, December 17, 1991.
86 These delays and related developments were announced in Canada, Department of
Finance, Release, no. 91-138, December 13, 1991; Release, no. 92-097, December 18, 1992;
Release, no. 93-013, March 2, 1993; and Release, no. 93-059, October 1, 1993.
87 The Ontario Fair Tax Commission reflected the typical provincial view in complaining that federal limitations on deductibility “would have the effect of limiting the ability of
(The footnote is continued on the next page.)
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of tax losses to the federal treasury as provinces moved toward greater
reliance on deductible forms of taxes. One might question why payroll
and capital taxes were singled out, whereas the deductible property and
retail sales taxes paid by corporations were not treated in a parallel fashion.88 Possible reasons are that provinces choose their sales tax rates primarily
with respect to their impact on households rather than businesses, and
property taxes paid by businesses to some extent reflect local services.
Moreover, property and sales taxes are not good substitutes for corporate
income taxes. Hence, provinces are less likely to shift toward these deductible forms of taxes primarily out of an interjurisdictional tax motive.
One might also critique the government’s threat to act in an interim fashion as discriminating against provinces that have little initial reliance on
payroll and general capital taxes.89 Once a permanent measure is implemented, this interim restraint on provincial policies will be removed.
The supplementary payroll taxes levied by Ontario on the self-employed
and by Quebec on individuals do not raise issues of revenue-shifting across
jurisdictions. Reportedly, the federal government advised Ontario that its
tax on the self-employed is a form of income tax and therefore not deductible for federal tax purposes.90 In lieu of deductibility in the provincial
income taxes, these levies are granted special credits, at a rate of 22 percent in Ontario and 20 percent in Quebec. Fittingly, Ontario calls this a
“non-deductibility tax credit.” Quebec administers its credits as nonrefundable tax credits in the provincial income tax; Ontario uses the simpler
approach of scaling down the gross payroll tax rates applied to self-employed
taxpayers. Regardless of the method used, these devices are appropriate
for equitable treatment of individuals in view of the deductibility of employer payroll taxes.
Labeling, Earmarking, and Public Acceptance
All the existing provincial payroll taxes except for the Territorial tax were
introduced with a label of health care and, in two cases, post-secondary
education (see table 1). Although the labels were meant to convey a direct
linkage between the taxes and the funding they provided, in fact none of
the provinces instituted any genuine form of earmarking. In three provinces the proceeds of the payroll taxes are paid into the consolidated revenue
fund (CRF), though Manitoba uses a special account within the CRF. Only
Quebec utilizes a separate health services fund, under the minister of finance,
87
Continued . . .
provincial governments to structure their mix of direct taxes to meet provincial priorities,”
supra footnote 2, at 60. Dahlby, supra footnote 2, at 144-46, argues that a bias in provincial
choices between payroll and other taxes does not necessarily mean that the federal corporate tax deductibility of provincial payroll taxes is economically inefficient.
88 It has been estimated that 30 to 40 percent of provincial sales taxes are paid on business inputs.
89 All of the provinces impose taxes on the paid-up capital of banks, but only some have
general capital taxes.
90 Nesbitt and Provenzano, supra footnote 22, at 28.
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to receive the payroll taxes. Since April 1981, revenues in this fund have
been distributed equally to health insurance by the Régie de l’assurancemaladie du Québec and the balance to consolidated revenues for hospital
services. Yet the Quebec minister of finance is mandated to supplement
the payroll tax revenues with funds from consolidated revenues to meet
the full needs of health care and hospitals.
In none of the provinces do the payroll tax revenues come close to covering the full costs of health care or hospitals. Moreover, the actual
expenditures on medicare are not related to the amounts collected from
payroll tax, but rather are dictated by health policy and general budgetary
considerations. For these reasons, any labeling of the taxes is purely notional and has none of the economic advantages that have been claimed for
earmarked public programs.91 Rather, the use of these labels for the provincial payroll taxes was motivated by a political desire to enhance their
public acceptance. In Quebec’s case the tax was coterminous with the initiation of public health insurance, and for Ontario the tax was used to replace
medicare premiums. One observer has remarked of Manitoba’s tax
The name, levy for health and education, helped to focus attention on the
perceived need for revenues to maintain spending in areas of great social
concern. A levy for general government excuses and social services was
unlikely to touch the self-interested voter in the same way, although in fact
the funds were not earmarked for specific purposes and went into general
revenues.92
An analyst of Ontario’s payroll tax also observed that, despite its label,
there was no earmarking of the funds. He urged on the basis of “truth in
advertising” that “the name of the tax should be amended to remove any
connection with health care expenditures.”93 The Ontario Fair Tax Commission accepted this suggestion with the following commentary:
the name of the tax is misleading because it bears no relationship to provincial spending on health in Ontario.94
Nor should Ontario create the impression that taxes are earmarked by
creating names that describe an expenditure program rather than the base of
the tax (for example, by naming its payroll tax the Employer Health Tax).
Accountability is not served when revenues are linked only rhetorically to
expenditures in order to garner support for the adoption of a new tax.95
Yet insofar as taxes are needed to finance services that the public values,
such labeling may be useful in garnering public support. In an era when
most taxes are widely resented, it may serve some purpose to remind the
public of the general connection between their tax burdens and their public
services.
91 See the studies in a volume edited by Richard E. Wagner, Charging for Government:
User Charges and Earmarked Taxes in Principle and Practice (London: Routledge, 1991).
92 Dean, supra footnote 42, at 196.
93 Dahlby, supra footnote 2, at 154.
94 Ontario Fair Tax Commission, supra footnote 2, at 58.
95 Ibid., at 22.
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One other reason for the apparently high acceptability of provincial
payroll taxes is their comparatively low visibility for individuals. Since
they are imposed on employers, these levies are commonly perceived as a
tax on business (and government entities) rather than a tax on individuals.96 This ignores the ultimate incidence of employer payroll taxes in the
form of lower gross compensation for employees. In the interests of greater
visibility and greater government accountability to taxpayers, it might be
desirable to collect these taxes as payroll deductions directly from employees. This would have the added advantage of eliminating any short-run
adverse effects on business competitiveness or employment when rates of
payroll tax are increased.97
Since the Northwest Territories payroll tax does operate as a direct levy
on employees, it highlights the preceding points. It is a highly visible tax
because it is deducted directly from workers’ gross earnings. However,
because the tax is fully or more than offset by a tax credit for the great
majority of Territorial residents, it may not be an unpopular move. Instead, it can be presented as a way to tax non-resident workers, “to spread
the tax burden fairly among all those who benefit from the economy. All
those who work here will pay the tax regardless of their province of residence.”98 Of course, those who lose from the measure are only temporary
or seasonal residents and are less likely to vote in Territorial elections.
Application of the tax to employees also carries a modest increase in compliance burdens; employers have to deduct tax from each employee rather
than aggregate payrolls.
CONCLUSION
The experience with employer payroll taxes at the provincial level in Canada
has in general been a highly successful one. The bases and coverage of the
payroll taxes are remarkably broad compared with almost any other taxes
used in Canada. They raise large amounts of revenue at low rates of tax.
They are among the least costly forms of taxation to operate, both in terms
of the administrative costs borne by governments and the compliance costs
of employers. They are significantly simpler in concept and in application
than most other types of provincial taxes. Payroll taxes also appear to offer
economic advantages relative to the other forms of flat-rate or regressive
taxes with which they are most closely comparable—that is, retail sales taxes
and medicare premiums.99 These include greater economic neutrality or efficiency, low operational costs, and the equity of their distributional pattern.
96 For a discussion of tax visibility, with early reference to the role of payroll taxes, see
Richard M. Bird, Financing Canadian Government: A Quantitative Overview, Financing
Canadian Federation no. 1 (Toronto: Canadian Tax Foundation, 1979), 37-42.
97 Converting to an employee payroll tax would eliminate the shifting of tax burdens to the
federal government and hence might not appeal to the provinces. However, the prospective
federal changes may partially or fully eliminate this fiscal benefit to provinces in any event.
98 Northwest Territories Budget, supra footnote 27, at 7.
99 Comparison of payroll taxes with increases in personal income taxes lies beyond the
scope of this article but will be treated in the full monograph.
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The design and structure of payroll taxes vary across the provinces but
do not depart from ideal principles as sharply as do most other types of
taxes. Notable deficiencies of the taxes can be reduced to a short list:
1) the omission of employer pension contributions from the base (all
of the provinces);
2) preferential treatment of a broad industry group (only Newfoundland);
3) a high exemption level and notch range (Manitoba) or graduated
rate brackets (Ontario) that complicate administration, create economic
distortions, and may discourage job growth in some firms;
4) the absence of coverage for the self-employed (Manitoba, Newfoundland, and the Northwest Territories); and
5) in those provinces that cover the self-employed or individuals, high
compliance requirements relative to the modest revenues (Ontario more
than Quebec) and mismeasurement of labour income (Quebec more than
Ontario).
All these deficiencies would be simple to fix, both in statute and in practice.
Payroll taxes are a promising avenue for expansion in the provinces
that have them and for implementation in the other provinces. In particular, they would be an attractive means to replace the revenues from medicare
premiums in Alberta and British Columbia. Despite their innate benefits,
it is reasonable for the federal government to remove the interjurisdictional
appeal to provinces of increased reliance on payroll taxes. The effects of
new or expanded payroll taxes imposed on employers could include some
short-run adverse effects on employment in a province; the effects on business
competitiveness of the province would depend upon what other types of
taxes were being replaced by the payroll tax. Any such negative effects
could be obviated simply by converting the employer payroll taxes to
employee payroll taxes, such as that already used in the Northwest Territories. This change would further enhance the visibility of the tax but perhaps
at the cost of reduced public appeal.
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