GDP and illegal activities

The newswires are a flutter today with the ‘big’ news that the UK will be incorporating illegal drugs and prostitution activity into its measure of GDP, beginning with its data release in September 2014.

How big of news this is to you really depends on how much you follow EU statistical discussions. In reality, the European System of Accounts has recommended for years that all its 28 member states include the illegal economy in GNP. In ESA2010, it then laid down the obligation to do so by September 2014. So for many of us this is not really news. You should also know that it is not only illegal activities that have to be included, but also includes revisions to R&D and military expenses, and software must be valued.

However, for the last few weeks, member countries have begun to release their individual plans for doing so, including Italy, Spain, the Netherlands, and now the UK. That is probably why the media seems to think this is a ‘new’ thing.

The requirement from ESA is that illegal economic actions involving mutual agreement shall be included in GDP. What problem exists right now is that each EU country has been including varying degrees of illegal activity in their GDP, making cross country comparisons of GDP difficult. For example, the UK already includes the smuggling of alcohol and tobacco and this is why it will ‘only’ be incorporating illegal drugs and prostitution activity. By ensuring that all member states include the same illegal activities in their GDP, the hope is that GDP measures will be more directly comparable.

It also means that starting in 2014: GDP measures for these countries will suddenly jump (expected to jump around 2-4% depending on the country, which is no small amount); direct comparisons of GDP with other countries that do not include illegal activities will be difficult; and comparisons of GDP pre and post definitional change for these countries will be difficult. Indeed, I suspect many researchers will use the data and not be aware of the definitional change over their sample period. This is particularly true since the change will take place before the calendar year is up meaning that the last quarter GDP measure for 2014 will include illegal activity making the 2014 GDP figures the most difficult to use.

Now EU countries are at an advantage in terms of including illegal activities in GDP. There is a rich academic literature that exists measuring the underground economy in the EU and its member states. The EU and its member states also already measure the tax gap, which is an important measure along side the underground activities. The EU and its member states already have thrown a lot of resources at measuring the underground economy. ESA has also produced detailed guidelines for the member states to follow in producing their new measures. None of this exists for Canada, other than Statistics Canada’s dismal attempt at measuring our underground economy and I would not want to bet our statistical work horse (GDP) on that product.

That said, including illegal activities in GDP, even with all this support, is still a guessing game at best. This is a very difficult task and no way to confirm or deny the figures. Despite the shortcoming, the EU and its member states should be applauded in their efforts. Understanding the underground economy and associated illegal activities are important to understanding the health and well-being of a nation’s economy. Canada has a lot to learn from this exercise.

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Implementing User Fees

You might be wondering what has kept me silent of late. As you might know, I have been working on a book. The book is being published by the Canadian Tax Foundation and is currently titled Implementing Municipal User Fees. I am coauthoring said book with my colleague, Catherine Althaus, who has just successfully navigate the tenure and promotion gauntlet.

While we had completed a draft back in January, we have spent the last few months doing extensive consultations with municipal public officials to get their feedback on the pièce de résistance, a guide that leads officials through the steps needs to successful implementation of a user fee. This guide is based on extensive review of the economics and public administration literature as well as the case law. These consultations yielded informative and helpful comments which we just finished addressing and incorporating. We also had to go through the book from front to back and make it a cohesive piece, as well as comply with the publishers style guide. This is the least sexy part of academic writing, by far, yet so very important. One last review and we should be sending the book manuscript off to the CTF, who has been very patient with us. While the research was completed before I went on maternity leave, the bulk of the writing, re-writing, editing, reviewing and what have you was done while bouncing a baby in my lap.

I have also just been asked to present this work at the annual Tax Policy Research Symposium – Perspectives from Law and Accounting (see symposium tab). So the next week will be spent putting a package together for this conference, before I head off to the CEAs next weekend. This is my first conference presentation in about two years (I was not allowed to travel while pregnant due to complications), so suffice to say I am a bit out of practice.

In the meantime, I leave you with a very short summary of our book. Hopefully this peaks your interest:

The primary purpose of this book is to provide a detailed review of the existing academic literature and Canadian case law to highlight key legal, technical, and administrative issues that present design and implementation challenges for user fees for Canadian municipalities. The work provides an analysis of the economic, legal, and public administration considerations and integrates these to derive design and implementation lessons that apply both to jurisdictions contemplating user fees and those willing to undergo reviews of already implemented user fees. These implementation lessons lead to a presentation of an ex ante smart practice user fee implementation guide. In presenting this guide, it is our hope the “missing link” of implementation will begin to be filled and implementation of user fees will prove a more successful exercise, suitably balancing competing interests of economics, law, and public administration.

 

Bargaining Away Tips

You may have read about the new restaurant in Parksville, BC (for those of you living east of the Rockies, that is a small town on Vancouver Island, home to the Tigh-Na-Mara resort and the annual Quality Food Canadian Open Sand Sculpting Competition) opening up at the Pacific Shores Resort. That, in and of itself, is not that newsworthy, but what is is that the restaurant, called Smoke and Water, will not allow tips. Instead, its wait staff will be paid “a living wage.” That wage is reported to be between $20-$24 an hour for servers and $16-$18 an hour for cooks.

You might be interested to know that the minimum wage in BC is currently $10.25 an hour, or $9.00 an hour for liquor servers. So cooks would normally earn $10.25 an hour and servers $9.00 in an environment that allows tips. This means that Smoke and Water is willing to pay a premium of about $7 an hour for cooks and $11-15 and hour for servers in order to attract servers to this non-tipping environment.

Is this a good deal? That depends on how much servers normally earn in tips. According to a CRA audit of server income, tips normally amount to between 100 to 200 percent of wage income (and as high as 400%). This means that in a tip environment you can expect to earn $9 an hour in wage income plus between $9-$18 an hour in tip income. But wait, you can’t just compare this amount to the wage premium being paid by Smoke and Water. This is because the wage premium being paid does not account for payroll taxes and withholding taxes.

Let’s take an example. Assume we have a server that makes $24 (the upper amount) an hour at Smoke and Water and works 35 hours a week. That is a weekly income of $840 gross. Assuming standard deductions, this employee’s net pay is $670.20.

Let’s compare that to the server who earns tip income. Assume that server makes minimum wage of $9 an hour and works 35 hours a week. That is a weekly income of gross income of $315, or a net amount of $287.68. However, this employee also earns tips. If we assume that the tips amount to 200% of income, that is an additional $630. Now here is the kicker. We know from a CRA audit, as well as common sense, tip income is rarely reported for tax purposes. This means that this employee nets $917.68, nearly $250 more a week than the server at Smoke and Water. In fact under these assumptions, in order for a server to make more at Smoke and Water, under the assumptions stated here, that server earning tip income would have to earn less than 133% of their income in tips.

These calculations show that while the hourly wage being advertised by the Smoke and Water restaurant may appear generous, they may not be high enough to offset the loss of tip income by their staff.

There are, though, benefits to the employees at Smoke and Water. Their full salary is being used to calculate their CPP payments and RRSP contribution room (HT sksimon), and hence, benefits later on in life. While many teenagers and 20 somethings may not be appreciative of these things now, they will be later on in life. In addition, their full salary will be used to calculate their EI benefits, should they find that they need to claim EI. For the server making tips, they are only afforded the same treatment if (1) they chose to report their tips for tax purposes and (2) chose to have CPP and EI withheld on that amount.

The above also makes it clear that taxpayers should be advocating for all bars and restaurants, heck all service industries where tips are common place, to move to this business model of not allowing tips and instead paying a “living wage”. It means that these types of employees (those that earn tips) will pay the appropriate amount of taxes AND benefit premiums, putting them on a level playing field as all other employees and leading to at least an additional $1-2billion in tax revenues per year. That $1-2billion could be used to fund health care, schools, affordable housing, or child benefits. The opportunity cost of that lost revenue is, for many, substantial.

Appearance Before the House of Commons Standing Committee on Finance

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Speaking Notes for Lindsay Tedds

Associate Professor of Economics

School of Public Administration, University of Victoria

Appearance Before the House of Commons Standing Committee on Finance

In Relation to its Study of Parts 1 to 4 of Bill C-31

May 8, 2014, 5:00PM-6:30PM EDT

 

Good afternoon, my name is Dr. Lindsay Tedds and I am an Associate Professor of Economics in the School of Public Administration at the University of Victoria. My primary area of expertise is Canadian tax policy, particularly the design and implementation of tax policy. I have written a number of peer reviewed journals articles, book chapters, and technical reports, as well as two books in this field.

I would like to thank the Committee for providing me with the opportunity to share my views on two tax policy measures included in Bill C-31, namely:

  • The elimination of the need for individuals to apply for the GST/HST tax credit and allowing the Minister of National Revenue to automatically determine if an individual is eligible to receive the credit; and
  • Yet another one-year extension of the mineral exploration tax credit for flow-through share investors.

Change in application for GST/HST Credit

One of the biggest challenges levied against the GST/HST is that it is regressive. However, there are features of the GST/HST implementation that offset its regressivity, including the GST/HST tax credit. The purpose of the GST/HST tax credit is to help offset the amount of GST/HST taxes paid by low and middle income households.

Without the passage of Bill C-31, the status quo for applying for this important tax credit would remain, which would be very unfortunate. The current administration of the GST/HST tax credit requires individuals to apply every year by “checking the GST/HST Credit application box on their annual income tax return.” (Budget 2014, p. 327). By using this opt-in method low income individuals who overlook the box or do not understand what is meant by the question and do not check the box miss out on this very important tax credit.

Through Bill C-31, the federal government is making a very significant and important reform to the administration of the GST/HST tax credit. Bill C-31 eliminates the need for an individual to apply for the GST/HST Credit and to allow the Canada Revenue Agency to automatically determine if an individual is eligible to receive the GST/HST Credit.

I applaud this move: away from the opt-in method and towards this assessed method. This credit is an important way to get money into the hands of low and middle income Canadians and this simple change will likely make a big difference to some very deserving households.

Extension of the Mineral Exploration Tax Credit

The Mineral Exploration Tax Credit (METC), in form and function, dates back to 2000, when it was called the Investment Tax Credit for Exploration (ITCE). The impetus for this 15% non-refundable investment tax credit for investors in flow-through shares of mineral exploration companies was the low price of metals that occurred throughout the 1990s and which caused a significant contraction in mineral exploration. Despite metal prices rebounding by the mid-2000s, the tax credit, originally set to expire in 2003, has been continuously renewed for between one- to three-year periods. The METC was last set to expire in March 31, 2014, but Bill C-31 extends this tax credit for yet another year, despite metal prices currently being at historically high levels.

Not only have the conditions that prompted the creation of the tax credit disappeared, that of low mining prices, there is no evidence of the effectiveness of the tax credit. There is no evidence that the METC induces increased exploration activityover that stimulated by commodity prices. On the investor side, the METC subsidizes high risk investments and appears to be predominately used for tax planning purposes by high income taxpayers rather than for calculated investment purposes. The consequence is that the tax credit channels investment money away from other more lucrative, but unsubsidized investments. In fact, the rate of return of investments that qualify for the METC have been very poor, suggesting that the tax regime is the sole impetus for the investment. On the administration side, the METC regime is associated with high administrative and compliance costs, benefiting only tax lawyers and accountants.

It is time to end this tax credit that benefits wealthy investors and subsidizes poor performing investments. Doing so will help restore fairness to our tax system and close a loophole with little discernable benefit to the tax payers that fund it.

 

In closing, I want to thank you for providing me with this opportunity to provide you with my views on these two measures contained in Bill C-31. I look forward to your questions.

Thank you.