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. Please note the blog posts are time sensitive and subject to changes in legislation or law.

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.