Benefactors’ Lecture Speaking Notes

by Kevin Milligan

On November 25th at about 8pm Eastern Standard Time, I will be giving the annual Benefactors’ Lecture, sponsored by the C.D. Howe Institute and the Chartered Professional Accountants of Canada.

The full lecture document will be released by the C.D. Howe Institute on Wednesday the 26th. I will post a link when that is available.

Below are my speaking notes for the lecture.

Speaking Notes

 Our tax system is based on a 1960s design that’s not well-suited for the challenges of today’s economy. There are many pro-growth reforms we should be looking at– corporate tax changes, GST reform, or even putting prices on pollution through green tax reform.

All of these improvements would make our economy more efficient and promote investment and the jobs of the future. But to build the necessary political support to get these changes through, we need to ensure Canadians have complete confidence in the fairness of our tax system.

So, with this lecture, I’m trying to start a conversation on how we can design our tax system to promote both fairness and growth.

In Burnaby BC tonight, someone may be working on a new idea that will launch a world-leading Canadian company. Maybe in five years, Google will buy her out. Give her ten years, and maybe she could buy Google.

I bet if you asked her, she might care a lot more about producing a cool product than what the capital gains tax rate will be in five years. But to get her idea out of that Burnaby basement she will need to attract financial and human capital away from their current uses. A pro-growth tax system helps get that capital where it is needed.

I’m going to start the lecture with the principles underlying our current system. I will explain why I think we’re in a New Era for Tax Policy, and the real problems it presents us. Finally, I will sketch out a three-tiered reform package that aims to reset the tax system to promote both fairness and growth.


 Accountant Kenneth Carter spent four years working with a large staff to produce the 1966 Report of the Royal Commission on Taxation which has been a touchstone for the Canadian tax system ever since.

At the centre of Carter’s efforts was the ideal of fairness. Carter argued that a tax system required confidence across society that the tax burden was fairly distributed.

The way to do so, according to Carter, was to pool together all forms of income into a ‘comprehensive income’ measure. Alongside earnings and interest, items like capital gains, unemployment insurance, and even the family allowance were also to be included. This very broad measure of income, Carter argued, was the best gauge of the family’s ability to pay and would be the fairest base for taxation.

The premise of the lecture is that we should move beyond Carter because we’re now in a New Era, defined by two elements.

Income concentration:

The first element is the rise in income concentration at top income groups, as famously documented by economists like Thomas Piketty and Emmanuel Saez. Income concentration has emerged in countries ranging from the United States to India.

The chart shows the growth in income from 1982 to 2012 in Canada. This is individual, pre-tax, inflation-adjusted, total income. Over this thirty year period, incomes grew most sharply at the very top—150% for those in the top 0.01%, compared to just 8% growth for those in the bottom 90%. This lopsided growth pattern is consistent with the trends in other countries.

In Canada, the middle and bottom have done better over the past 10 years than other countries, and the growth of top incomes seems to have plateaued. However, these recent developments have only taken some of the edge off the broad generational trends seen in the chart.

The source of the concentrated income growth might surprise some of you—it’s mostly employment compensation. It’s not greater returns on investment, but sharply increased pay envelopes for highly-skilled employees. Piketty, in his famous book, attributes this to the advent of the “supermanager”; executives at large firms. In the United States Piketty reports that about 2/3rds of the top 0.1% of income earners are supermanagers. The same appears to be true in Canada.

The highest federal tax bracket in Canada now starts at $136,270, which is below the threshold for membership in the top 1%. This means that all the growth in the top one percent is taxed at the same marginal rate. Our system has not responded at all to the emergence of income concentration.

Efficiency costs:

The second element of the new era is an increasing awareness of the efficiency costs of taxation on the economy. At the time of the Carter Commission in the 60s, little was known empirically about how individuals and firms respond to taxation. Over the last twenty years, great progress has been made in understanding these costs.

A primary focus of the empirical studies has been the responsiveness of income to tax rates. The picture on the slide is the original drawing made by economist Arthur Laffer on a napkin in a Washington DC restaurant in 1974. The Laffer Curve emphasizes that higher tax rates lead people to take action to lower their tax liability. If such a response is large enough, it can even counteract the static revenue gain and lead to lower overall government revenue.

The importance of behavioural response to taxation is at the heart of modern thinking on tax policy. Progressive economists like Piketty, Saez, and even Krugman now adopt this framework to think about the effect of high taxes, though they believe we are far below the Laffer peak.

Top earners respond to higher taxes in diverse ways. For some, they might adjust their labour supply by taking fewer clients. For others, decisions about saving and investments may be distorted. In addition, many high earners have access to tax planning opportunities. When confronted with higher tax rates, it would be surprising to expect those with access to the best tax advice fail to heed it.

Evidence in Canada suggests that the income of high earners is quite responsive to tax rates—to the point where pushing tax rates higher than 50% in our current system gets close to the range where we might expect little extra revenue to be raised.

So, these are the two pieces of the New Era: income concentration and awareness of efficiency costs.

Why does this matter? Implications:

Why does this New Era present a challenge to Carter?

Here’s the reason: income concentration is raising concerns about fairness. But the responsiveness of top earners to higher tax rates makes it very difficult for us to raise rates to meet those fairness concerns.

So, is it a problem if we can’t raise tax rates on high earners? I think it is a problem.

The central tension is this: many growth-oriented tax reforms are held back because of concerns about fairness. Corporate tax reform to encourage investment and growth. Sales tax reform through broadening the HST base. Green tax reform to put a price on pollution. Fairness concerns impede these changes.

If we want to move to a tax system that encourages investment and growth, we need to work harder to ensure the tax system is perceived as fair by Canadians.

The solution:

The solution I propose is to break free of the constraints imposed by the Carter comprehensive income framework. Canada should move to tax income on two separate schedules.

One schedule is for employment compensation. Income from a job would be taxed progressively—perhaps moreso than today.

The other schedule is for capital income—the return on investments. Investment income would be taxed at a simple, common, flat rate.

This is called a Dual Income Tax, and has been used for 20 years in Sweden and other Nordic countries. Moving to a Dual Income Tax would require more study and take time to implement. For that reason, I’ve positioned it as the 3rd tier of a three-tier reform package.

The first two tiers of the package set the stage for that full reform, but also stand on their own merits and could be implemented immediately. Here’s what the package looks like.

 Tier I: CLEAN the base

The first tier of reform aims to CLEAN the tax base by removing tax expenditures. The goal here is to broaden and simplify the tax base in order to increase efficiency. This may also bring in extra revenue which can be recycled into lower rates or higher bracket thresholds.

There are two targets I propose for base broadening.

The first target is ineffective tax credits. Since 2006, so-called ‘boutique’ tax credits have proliferated, allowing tax recognition of activities ranging from children’s fitness to volunteer firefighting. These credits are inefficient, and they are biased toward higher earners who are more tax-savvy.

Normally. when we raise revenue using high marginal tax rates, there is a tradeoff: we distort economic activity but we get tax revenue that can be spent on productive public projects. With boutique tax credits, we end up with the worst of both worlds—we distort decisions with higher tax rates, but the issuance of credits means that we don’t raise as much revenue.

The second target for base broadening is the taxation of stock options granted as employment compensation. Stock options make up an important part of executive compensation, which is a main driver of income concentration.

Compensation from employment should be taxed as compensation from employment—it is that simple. Currently, tax is deferred until the option is exercised and then taxed at capital gains rates in many cases. The deferral until exercise is likely unavoidable since valuing options at issuance requires an option-pricing model that might lack needed information for non-traded stock. However, taxing fully at exercise is a feasible compromise.

 Tier II: SIMPLIFY capital income taxation

The second tier of reform aims to SIMPLIFY the taxation of capital income. Canada currently has a notionally-integrated regime for dividend taxation, and partial exclusion for capital gains. In both cases, there are two motivations.

First, integration attempts to account for the fact that dividends and capital gains come from income that has already passed through the corporate tax system. Taxing those sources at full rates on the personal tax form would result in excessive taxation that would bias corporate distributions and bias organizational form choices. I think it is important to maintain recognition for corporate taxes paid.

The second reason for our current system is to ensure the resulting income is taxed on our progressive income tax schedule—this comes from Carter’s view that companies should be seen as a veil, and all tax based on personal ability to pay. I don’t think we need this anymore.

Each Canadian is now entitled to Tax-Free Savings Account contribution room of $30,500. Within a few years, very few Canadians will have any need to hold taxable assets—only the top few percent of families would have taxable assets in a ‘mature’ TFSA system.

If almost all taxable capital income goes to top-bracket earners, we can set a simple flat tax rate approximately equal to today’s integrated top tax rate for dividends and capital gains.

Capital gains are now taxed at 14.5% federally for top bracket earners, and eligible dividends at 19.3%. A common rate for dividends and capital gains in the range of 15 to 19% would work.

To be clear, the goal here is neither to substantially raise nor to lower taxation of dividends and capital gains. Instead, we can simplify the system by taxing dividend and capital gains income at a simple flat rate. This reform is worthy on its own, but also sets the stage for a full Dual Income Tax regime in the third Tier of reform.


The final tier of reform is a three-part transformation of the tax system.  All three parts of this 3rd tier rely on each other; all three need to be present for it to work as intended.

The first part takes the final step toward a Dual Income Tax by moving the taxation of interest and other investment income down to the same flat rate charged on capital gains and dividend income.

The second part of the transformation increases tax rates on employment income for high earners. Today’s top federal bracket at 29% starts at about $136,000. We could add to that a bracket of 32% at $250,000 and 35% at $400,000 as possible targets.

With provincial taxes included, marginal tax rates on employment income would reach over 50% for top earners. With a cleaner more efficient tax base, we need not be as worried about behavioural response as with today’s tax base. A tax rate over 50% may strike some of you as harsh—but I think it’s necessary to build support for the other pro-growth elements of the package. That’s the tradeoff.

The third part of the transformation is a corporate tax reform to improve investment opportunities. Today’s corporate tax system favours debt, and taxes the normal return to capital investments. An Allowance for Corporate Equity system allows firms to deduct the ‘normal’ return to capital invested, meaning that the normal return on investment will not face marginal taxation.

This move beaks with the Carter ideal and improves efficiency by transforming the corporate tax system from one integrated with the personal tax system to one that taxes only excess corporate returns. To maintain revenue levels, it might be necessary to increase tax rates on the remaining corporate tax base. The aim for the resulting system is one that raises revenue efficiently while sharply improving the investment climate for Canadian corporations.

The challenges:

Any major tax reform raises challenges. Here are two.

First, we’re always concerned that high-earning professionals might push some of their compensation through a corporation rather than taking it directly as employment income.  It’s important that different routes face approximately the same taxation, but this kind of balance condition can be managed inside this reform.

Second is the concern that high earners will migrate out of Canada. Solid empirical evidence showing strong fiscally-induced migration is hard to find—but everyone has heard the stories. I don’t think we should rely on stories, but we must still be careful. If the executive market is particularly mobile then the result of taxing them at higher rates may be to increase their pre-tax pay in order to compensate them for the higher taxes. This would push pre-tax income concentration even higher.

These and other concerns need attention and further study, but we should not let the presence of some challenges derail the drive to reform. We need to weigh the bundle of problems we have now against the bundle of problems we would have to face with a new system.


To sum up, Canada faces a New Era for tax policy, defined by income concentration and awareness of the efficiency cost of higher taxes. These factors constrain how our tax system responds to calls for more fairness. In turn, this holds us back from necessary and productive pro-growth reforms.

The solution I propose here is to break free from the Carter Commission framework by implementing a Dual Income Tax.

But, in case that’s too big a step to contemplate, I’ve also laid out a plan for immediate reforms to restore fairness and improve efficiency by cleaning up the tax base and simplifying the taxation of capital income.

Many Canadians are worried about the future of the middle class. Most of the economy of the future doesn’t even exist today, but will be built idea by idea, dollar by dollar, investment by investment, and job by job. To my mind, the best way to ensure we have a prosperous middle class a generation from now is to do everything we can to get people like that young woman in Burnaby to invest in her ideas.

But—and this is crucial—in order to secure support to build a pro-growth tax environment, we need first to do more to ensure that all Canadians believe our tax system is fair.

The reform package described in this lecture decisively moves us in the direction of a tax system that aims both for fairness and growth.

Thank you.