My name is Mark Goodfield. Welcome to The Blunt Bean Counter ™, a blog that shares my thoughts on income taxes, finance and the psychology of money. I am a Chartered Professional Accountant and a partner with a National Accounting Firm in Toronto. This blog is meant for everyone, but in particular for high net worth individuals and owners of private corporations. The views and opinions expressed in this blog are written solely in my personal capacity and cannot be attributed to the accounting firm with which I am affiliated. My posts are blunt, opinionated and even have a twist of humor/sarcasm. You've been warned.

Monday, June 8, 2015

Overtaxing the Rich

Tim Cestnick of The Globe and Mail recently wrote a two-part column on how overtaxing the rich is counterproductive to the income tax system and Canada’s economy. Today you will receive my comments based on over 25 years' experience in dealing with high net worth people, when they perceive the personal income tax rate(s) to be excessive.

Tim’s first column used a parable (A parable is a story that illustrates one or more instructive lessons or principles) about ten men who go to dinner every night. The dinner bill was split based on our current marginal rate tax system, so four of the men paid nothing, the next five paid increasing amounts from $1 to $18 and finally the richest man paid $59 out of the $100 bill.

The restaurant owner decided to reduce the nightly bill by $20 because the men were such good customers. He also decided to reduce the individual bills on a proportionate basis such that the richest man saved $9 and the others, smaller amounts in the $1-$3 range. In Tim’s parable, the 9 other men were outraged at the savings the richest customer received and assaulted him. Obviously, the richest man stopped coming to dinner and the other nine men now had to come up with $50 more dollars for dinner.

Tim suggested that the restaurant owner was correct in how he divvied up the $20 reduction and that our tax system should provide the greatest relief in absolute dollars to those who pay the highest taxes.

He also suggested that should the Liberals come into power and follow through on their pledge to increase taxes on the rich, while reducing taxes on the middle class; that such an action would push the highest marginal rate past 50% and cause the rich to explore ways to bring down their tax burden and drive some to leave.

As soon as I read this column I had two thoughts.

1. This was a very innovative way to present the issue of taxes and tax cuts.

2. Tim was going to get a ton of negative comments about his viewpoint.

My second prediction was correct, as The Globe and Mail has received over 660 comments to date on Tim’s article.

Tim followed up his first column with a second column to address several of the various comments he received. Tim spoke to whether the rich will leave Canada over taxes and questioned if there is a psychological barrier to taxation over 50%.

I provide my thoughts on these two issues below.

The Rich Won’t Leave Over Taxes


Tim noted that Eugene Melnyk, owner of the Ottawa Senators moved to Barbados in the 1990’s to avoid taxes. According to David Macdonald of the Canadian Centre for Policy Alternatives; in his paper titled "Outrageous Fortune Documenting Canada’s Wealth Gap", 14 of Canada's wealthiest individuals reportedly no longer hold Canadian tax residency (see page 15 of the report).

The United States has also had several people leave for tax reasons, including Ken Dart of the Dart Styrofoam cup fame. According to this 2008 Los Angeles Times article,  Mr. Dart who renounced his U.S. citizenship in 1994, so incensed former President Bill Clinton, that the President would not attend a function with Mr. Dart.

Although I am not privy to every person who leaves Canada for tax reasons, I have had several very high net worth individuals threaten to leave Canada over the years. In each case, after looking into the income tax consequences of leaving (deemed disposition on departure of their capital assets), taking into account their family ties and lifestyle, they all stayed in Canada. I do concede my sample may not be representative of other accountants and my sample although containing some extremely wealthy people, does not necessarily contain the ultra-wealthy of Canada, who as reflected in the report above, may indeed move for tax reasons.

Although I personally don’t see the threat of the rich leaving Canada as a major concern, I agree with Tim when he notes “their capital is very mobile” and can be invested elsewhere in the world and that under the correct circumstances, can sometimes escape Canadian taxation.

The Psychological 50% Barrier


In Canada's two largest provinces, Ontario and Quebec, the highest marginal tax rates are now 49.53% and 49.97% respectively. Tim notes a psychological barrier is broken when tax rates exceed 50% and you are paying the government more than you keep resulting in a disincentive to work. In his second column, he quotes a high net worth taxpayer who says he does not need to work, he could stop anytime and that flow of taxes to the government would stop and not be replaced. This is very similar to the high earner in the parable.

Unlike the threat to leave Canada over taxes, which as I note above, often tends to be more grumbling than reality, my experience is that when you break the 50% barrier, entrepreneurs often do pull back by not investing in their current business(es) or by not making new investments in start-up businesses. The reality, whether you like it or not is; entrepreneurs and business people create the vast majority of jobs in Canada. They may need the skilled labour provided by the Canadian workforce, but in many cases, these “rich” businessmen can pull back with no impact to their standard of living, which certainly cannot be said by the average worker.

Often people who complain about the rich fail to consider the risk these business people took for their reward. If successful business people perceive the reward altered by the requirement to pay excessive tax, they may not want to open new businesses or expand current businesses. Many of my successful clients operate not just one business, but multiple businesses that create hundreds of jobs. These clients are habitual entrepreneurs and while for some (but definitely not all) their main objective may be to create substantial net worth for themselves, they create hundreds of new jobs in achieving their goals.

If we circle back to Tim’s comments, personally, I am not overly concerned that there will be a mass exodus fleeing Canada’s tax system if income tax rates exceed 50%. However, since I have already heard grumbling over the last year about the increase in personal tax rates, I do feel that should taxes exceed the psychological 50% barrier, there will be people who will try to utilize foreign jurisdictions to reduce their income tax burden and on the domestic front, cut back expansion of their current businesses and forgo aggressively pursuing new opportunities.

This site provides general information on various tax issues and other matters. The information is not intended to constitute professional advice and may not be appropriate for a specific individual or fact situation. It is written by the author solely in their personal capacity and cannot be attributed to the accounting firm with which they are affiliated. It is not intended to constitute professional advice, and neither the author nor the firm with which the author is associated shall accept any liability in respect of any reliance on the information contained herein. Readers should always consult with their professional advisors in respect of their particular situation.

14 comments:

  1. I think this is bang on. As an employee and a job I didn't particularly like, I eventually assessed my savings and determined I could quit and live off my savings for several years, and I did. It wasn't taxes that drove me off, but if taxes were significantly high, that would have done it too.

    I sometimes wonder what keeps the ultra-rich working, and come to the conclusion they love what they do rather than the money. They do have the luxury of retiring though, so any number of factors might drive them away, including taxes.

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    1. Thx Gene:

      My experience is the ultra-rich keep working because they love the challenge. I have had so many clients sell and plan to retire and a year later are back working.

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    2. The Economist recently reported on a study that shows that people who have a high hourly wage tend to work more hours. This may partly be because they enjoy their work, but it's also partly because of the value of the opportunity.

      If you can earn a few hundred dollars per hour, it makes sense to drop a lot of other things so you can work more. Skipping those things to earn $10 - 20 / hour would not make sense.

      After a while this likely become an ingrained habit, and once they do have the option of retiring it's hard to come up with something else to do.

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    3. Thx Richard,

      I wonder what the study would have concluded if those working more hours for more pay saw their tax deductions begin to exceed their take home pay?

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  2. I won't get into it too much Mark, I'll make a quick rant and say that Ontario is a mess. And she (the Premier) wants more politicians next election time. Right.

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    1. Hi Anon

      Ah come on, I was hoping for a long rant :)

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  3. Normally I don't respond online but I appreciate your column and the advice/information in it.
    I'm not sure I completely buy the idea that entrepreneurs will stop investing their money and energy into their businesses if taxes exceed 50%:
    1. As I understand it, marginal tax rates were much higher after the second world war but that was also a period of great growth in the North American economies. I realize that there were enormous structural differences at that time but I do think that militates against the idea that high tax rates are the governing factor.
    2. Many entrepreneurs begin their activities as young 'garage mechanics' for whom money is not the be-all and end-all (See the recent Globe & Mail article about the originator of Spotify.) Therefore, they may not be as conscious of tax rates (although as their businesses and fortunes mature, I am sure that the issue of taxation will be brought to their attention by their professional advisors.)
    3. Entrepreneurs and business people are not the only taxpayers who would be affected by a tax rate over 50%; 'rent-seekers' would also be subject to such taxation (or, perhaps I should say, SHOULD be subject to such tax rates were it not for preferential treatment given to capital income) and I presume that the arguments about the dis-incentive of high taxation would not apply in the case of such rent-seekers.
    4. Finally, entrepreneurs and business people benefit from government services as much as - and an argument could be made, more than - other tax payers and I think there is an ethical argument to be made about paying their fair share.
    Finally, concerning the threat of moving to another jurisdiction: I well remember the kerfuffle in the City when UK lawgivers threatened to pull the plug on rich bankers in London. The London bankers threatened to move to Switzerland but quickly back tracked when they found out that housing in Zurich was more expensive than in London...and there wasn't as much to do.
    Thanks again for your website.

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    1. Hi Anon

      Thanks for your well thought out response, some of which I agree with and some which i dont agree with. My experience is tax rates have a huge impact on the level of business investment, however, we can agree to disagree.

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    2. I found this post through a link from another blog. Tried to post on my I-phone but no luck.

      @ anonymous

      The trial of taxing the rich was already completed and failed in France in December 2014.

      http://www.theguardian.com/world/2014/dec/31/france-drops-75percent-supertax

      Please also note that taxing the super rich results in a very tiny amount of taxes collected in proportion to debts created. So this becomes nothing more then window dressing to get votes and create a wedge between the classes.

      @ adam

      You sound like one of the people supporting Obama's now famous "you did not create the job" speech, somehow the government creates all the jobs. (which is ridiculous) Maybe you should look into the root causes of why there is a wealth gap in the US and what is killing them. Mostly poor policies and over-regulation and obama-care forcing companies to hire part time workers to avoid paying the fees. I can't wait until the self serve Kiosk's open in states that now have a $15/hr wage. (I guess those companies will be labelled as "UN-american" The author's "Chicken and the egg" remark is spot on.

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    3. Paul, thx for your comments, now whey dont you tell us what u really feel :)

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  4. I disagree that "entrepreneurs and business people create the vast majority of jobs in Canada".

    Yes, by definition, entrepreneurs start businesses, and they risk some capital to hire a (usually small) number people, but It's the markets demand for those goods and services that grow and maintain the jobs, and that demand relies on the financial health of the larger general population (ie: middle class).

    Look at the USA...wealth inequality hasn't been this large since the great depression. If the wealthy truly were the job creators, one would expect there to be an overabundance of jobs, and a high demand for labour and thus an increase in wages (which would provide more excess capital to spur new entrepreneurs) , but real wages have been stagnant for decades.

    I (and many others) believe the term "Job Creators" is a made up buzz word to push political agendas.

    -----------
    As far as the restaurant parable, it’s also worth remembering 2 points:
    1) It assumes the rich pays the most tax. That isn’t necessarily true, as it is income, not wealth that is taxed. (The richest man at the table may have been one of the 4 that paid nothing). The man who earned the most (taxable) income past year, paid the most taxes….which leads to…

    2) High income earners don’t earn their wealth in a bubble, by themselves without any support. They were provided a landscape in Canada (political, social, moral, environmental, etc) in which to earn their income, and that landscape requires money to maintain (ie: keeping people healthy, providing an educated workforce, penalizing criminals, building infrastructure, providing safe markets, etc) and thus those who financially benefit the most from these public systems, should arguably give the most back to maintain them.

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    1. Hi Adam

      Thx for your insightful comments. I especially like your point regarding the US wealth inequality. However, a bit of chicken and egg. If the "financial health of the larger general population (ie: middle class)" determines the job market, where do the middle class come from without the "job creators"?

      Anyways, I appreciate your comments and perspective.

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    2. More chicken and egg .. it could be argued that the middle class as we know it was rooted by government policy after WW2 in conjunction with strengthening labor unions at the time. Returning servicemen were given money for training and education, to start up businesses, and mortgages. With this new money to spend this created demand which spurred more job creation. Today we have "job creators" telling us we're lucky to have jobs at all amid constant threats to move their money elsewhere holding governments hostage. Many economists would point to government intervention and policy that created the middle class as we know it.

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    3. Opus, thx for your thoughts, you guys are way to intellectual for me., I am just a simple thinking accountant :)

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