Kevin Milligan

Notes for my presentation to the 2023 Tax Policy Research Symposium, organized by the Waterloo Centre for Taxation in a Global Economy, University of Waterloo. The symposium was held in Toronto on May 4, 2023.

I’m here to give an economist’s view on the General Anti-Avoidance Rule (GAAR). I’m not the one to ask about case law or parsing the meaning of specific words in the legislation. What I hope I can add is an outsider’s view in what you’re engaged in.

I’ll begin with a general framework for thinking about some of these issues. I’ll then get into some specific criticism and suggestions.

My general framework comes from…the bible. I’ll introduce what I’m calling Zacchaeus problems and Moses problems and how they relate to the GAAR.

First is Zacchaeus.

Zacchaeus is from the New Testament, and he is famous for climbing a sycamore tree in Jericho in order to see Jesus. Zacchaeus had to climb the tree to remain hidden from the crowd, as Zacchaeus was unpopular. If this were Sunday School I might go on to tell you how Jesus did that thing where he was kind to the most unpopular person in the crowd. But this isn’t Sunday School, so I’ll focus on why Zacchaeus was unpopular. He was unpopular because he was a tax collector. In those days, there weren’t really tax rules and so tax collectors just kind of made it up based on what they saw. The modern term for this is ‘presumptive taxation’. The tax collector sees some things and presumes the tax liability.

Presumptive taxation typically refers to a situation where there aren’t prescribed tax rules and the tax collector has discretion in assigning tax liabilities. There are two economic consequences of a Zacchaeus kind of system.

On equity and fairness, there are threats to both consequential and procedural notions of justice. It’s not transparent and the outcomes might not be consistent.

On efficiency, the key concern is that the uncertainty will lead to a curtailment of productive economic activity. If you think it’s a “heads I win tails you lose” tax environment, you may be reluctant to make risky, productive investments for fear of losing your winnings if you should be successful.

So, a ‘Zacchaeus problem’ is tax uncertainty inhibiting productive investment.

Second is Moses.

Moses is from the Old Testament, and one of his key moments was transcribing the Ten Commandments onto two stone tablets.

Thinking about tax, this is another way to run a tax system, in contrast to Zacchaeus. You can write down rules that people should follow. The problem that arises is people innovate ways around the rules. This cycle continues and it seems that our CRA Moses can’t chip new rules in the tablet quickly enough.

What are the economic consequences of a Moses system?

On equity and fairness, people worry about economic spoils going to those with the best tax lawyers rather than the best economic ideas or the most needy.

On efficiency, economists worry that as a society, devoting resources to the tax planning industry is wasteful. Tax avoidance largely just shifts the tax burden around from one set of people to others, without producing anything useful on net.

So, a ‘Moses problem’ is economic waste through resources devoted to tax avoidance.

That’s my framework here. Zacchaeus problems stem from uncertainty discouraging productive investment. Moses problems stem from the wasteful ‘whack-a-mole’ cycle of rules-avoidance-morerules.

In this framework, what does a GAAR do?

A GAAR tries to patch the holes in a Moses tax system by applying a little Zacchaeus to fill the gaps.

How has this worked?

Did adding some Zacchaeus to the system introduce big Zacchaeus problems?

In 1988, David Dodge writing in the CTJ addressed concerns that the proposed GAAR would “seriously affect commercial life in
Canada.” (Canadian Tax Journal Vol. 36, No. 1, p. 21)

Also writing in the CTJ, Howard J. Kellough argued that the GAAR would be “all encompassing” and “herald an era of virtual total uncertainty”. (Canadian Tax Journal Vol. 36, No. 1, p. 24)

In short, I think these concerns were greatly overstated. The concerns about arbitrariness, consistency, and fairness had more bite, in my view. But I don’t much concern that the introduction of the GAAR seriously impacted commercial life in Canada or introduced economy-freezing ‘total uncertainty’.

[Update: Panelist Erin Towery of the University of Georgia points me toward Jacob et al. 2022, which finds some evidence that capital investment is delayed by tax uncertainty. https://pubsonline.informs.org/doi/10.1287/mnsc.2021.4072]

But did we solve our Moses problems? I’d say not entirely. I suspect there is less stop-gap anti avoidance legislation than we would’ve seen without a GAAR. But, we’ve introduced new Moses problems by shifting attention from arguing about specific tax avoidance rules to arguing about whether the GAAR should apply in a particular circumstance. There seems to be endless parsing of the “true” meaning of words like ‘business purpose’, ‘economic substance’ and ‘bona fide transaction’. People argue about the meaning of those words in order to avoid being ensnared by the GAAR.

This was foreseen by Kellough in the same CTJ article. He predicted “the attempt to interpret and apply the rule will likely spawn a sizeable industry.” Seems like he was right.

What’s worse, the way the GAAR seems to work is that you can get away with a lot of tax avoidance if you add some windowdressing to meet whatever rhetorical bar the case law has set for avoiding the application of GAAR. So, now you get the economic waste of the tax avoidance and you stack on top of that the economic waste of devising a way to get just enough windowdressing cover within the transaction to avoid triggering GAAR. That doesn’t sound good!

So, in my view, we haven’t eliminated our Moses problems but we haven’t really pushed the limit of Zacchaeus problems.

I’ll end with some recommendations.

These are very high level as I’m not going to offer thoughts on how to interpret the meaning of legislation.

First, the circumstances where the GAAR applies should be laid out as clearly and transparently as possible. If our tax fights and wasted resources are arising from fuzziness in when the legislation intended to apply the GAAR, then the legislation should be as clear as possible. I think that’s likely obvious to everyone, but it’s still worth saying.

Second, in setting the rules for when GAAR applies, I think we should minimize the tendency to have the tax authority guess at the motives for transactions. I am wary of tax collectors substituting their judgment for a business person’s own judgment.

Who knows why people do things?

Did Elon Musk really think he could make money on Twitter? If you ask me, it is highly likely he will lose a big chunk of his $44 billion purchase price. But maybe I’m wrong and in the fullness of time his vision will win and he will turn Twitter into a $100 billion company. What I don’t want is a tax collector deciding whether he had ‘reasonable’ expectation of profit. If tax collectors made these kinds of business decisions we’d end up with very cautious decision making, and that would be bad for innovation.

Third, I think we should err on the side of making GAAR more generally applicable (in a transparent and clear way). Why do I think this? Because one of the big concerns from 1988 was that the Zacchaeus-style uncertainty from GAAR would hold back our economy. But that didn’t happen. So let’s push further.