My take on the federal Budget 2016

Here we are the day after the federal budget landed and those of us not in budget lockup have had a chance to ruminate on the budget document.

I think it is important to remember that these documents are quite challenging to go through. My approach to reviewing this budget was as follows: quickly scan the front matter to get the lay of the land; do a quick Ctrl+F for some key items I was interested in (e.g. exploration expenses, stock option deduction, working income tax benefit); a look at the table of contents to find and read sections of interest; a read of the whole document; and finally worry about the underlying assumptions and technical details of the budget.

By 5pmMT I had done all but the last item. In the five minutes I had before I had to catch my bus home, I tried various words to search for how much of the deficit being booked was due to the contingency. I found nothing and put out a question on twitter. There were some early answers that indicated that indeed this was going to take some time for the experts to piece together. Fortunately, over night the usual folk buried their teeth into the details and have developed well-formed criticism on the lack of transparency in this budget.

In addition, it is clear that there is no real plan to balance the budget. Well, the plan is to grow our way out of the deficit, which given the increase in expenditures outlined in this budget, the gloomy economic forecasts, the lag time for any infrastructure projects to potentially pay off, and the fact that there are four more budgets to go, that plan is akin to

A bit churlish for sure, but growth in four years is not going to offset the growth in expenditures. I imagine given the criticism we will likely see more focused details emerge in the coming year on this point (hint, hint, nudge, nudge).

In terms of what was missing from the budget? There is no movement yet on implementing to platform’s commitment to revising the tax rules about Canadian exploration expenses (CEE). I am not surprised at this as this change is not as simple as the platform made it out to be. I am also happy because I have a paper coming out soon on this particular item and am happy the budget did not render it moot. The government did, though, extend the Mineral Exploration Tax Credit which I was a bit surprised about at first, but then again granting a short one year extension while developing the plan forward on CEE is actually fairly sensible from a political point of view (certainly not from an evidence-based policy point of view, though).

There was also no change to the tax treatment of stock options. It may be that the government may have bowed to the nonsensical pressure from the tech lobby group on this one or it may be that they are still working on the technical details. There is nothing in the budget about a much anticipated pilot or study on guaranteed annual income, to match Ontario’s initiative. There was also no change to the Working Income Tax Benefit. There are other items missing, but overall my sense here is that there are several years left in their mandate and it would be silly to think that all platform items could and would be implemented in the first budget. So I would not yet get to concerned about missing items. That is, there is still hope.

There was some hope that the budget would announce a comprehensive tax review. We did get a little of the way there, in that the government will proceed with reviewing the tax system but only with a view to eliminating poorly targeted and inefficient tax measures. The budget kicked this off with the elimination of the tax credits for child fitness and arts (here, here, and here) along with the tuition and textbook amounts, but then proceeded to introduce similar poorly targeted an inefficient tax measures, namely the LSVCC tax credit and the one directed to teachers for teachers for supplies. With respect to the tax credits for fitness and arts, the credit will be 50% for the 2016 tax year and fully phased out by 2017. This may prompt parents to try to claim some of their 2016 expenses in 2015 (since we are still more than a month away from the filing date); however, I expect that these tax credits will be subject to fairly heavy review for the 2015 tax year and 2016 tax year.

As someone who works in the area of tax compliance, I was giddy with glee to see so many pages dedicated to tax compliance and improving client services at CRA. However, I really did not see anything really novel in here, more of the same ol’stuff (similar to the chapter on innovation, though I am told a novel plan will come next year). One of the best things we can do to improve tax compliance is to increase third party reporting of income and broaden withholding. The OECD has been saying this for years. Yet Canada lags behind many of its sister countries and this budget makes no move to change that. Tax compliance also takes a fair amount of knowledge, and yet CRA’s documents are very much written for and directed to a technical tax audience. CRA needs to improve the plain language communication of tax policy in this country and, again, there is no real move towards that in this budget. In addition, many countries around the world are spearheading efforts to help business activities transition from under to above the table and I see nothing aimed here either.

There is a commitment to improving CRA’s direct correspondence (letters) with tax payers, which is great, but that is not as broad as what I am asking for. In addition, I am not sure if this change in the language of CRA correspondence is also related to the tone, because CRA correspondence is fairly offensive. I am also fairly skeptical of the estimates of how much it will collect in additional tax debt, but I imagine the government knows something in this area that I don’t that will make their estimates true. It will be interesting to watch this, though given how nontransparent this budget document is in many place, I don’t know if I will ever be able to know for sure how this all plays out.

The budget also commits to expanding the community volunteer income tax program along with attempting to notify low-income non-filers about possible tax credits they are missing out on. I hope this include notifying low-income filers and non-filers alike about the free money available to them for the RESP program under the Canada Learning Bond. It is a total of $2000 in funding for a child’s RESP and no requirement to put in of your own money into the RESP. That money is allocated as follows

  • $25 to help cover the cost of opening an RESP
  • $500 to add to the RESP when it is opened
  • And $100 each year until the child turns 15

This money should be automatic for qualifying households, but it is not.

Part of the Liberal platform document was aimed at curtailing the aggressive use of CCPCs and there are some items in this budget related to that. The budget looks to ensure that income qualifying for the small business deduction is active, not passive, income. If you have a CCPC and you don’t know what this means, go talk to your accountant. I know quite a few CCPCs that are running afoul of this rule and now is the time to clean up your act. There are also measures to related to setting up complicated structures to access the small business deduction multiple times, among others. What I see here is the start towards cracking down on the aggressive us of CCPCs but there is still room to move. For example, they are (still) being used to get around the employee for tax purposes rule and I imagine (hope) that will be included in the next phase of compliance items.

In terms of some really cool items in the budget, I love the change in the EI waiting period from two to one week. People have said this was impossible, apparently not! The budget also commits to repealing the existing Capital Cost Allowance regime and replace it with something simpler. This is something I recommended here if you want to read about this. And as expected the budget brings in a richer and simpler child tax benefit system and Jennifer Robson has a great piece all about that. However, I see nothing related to reframing these benefits as family benefits as suggested here by Frances Woolley.

In terms of something I hoped for but did not expect to see was leadership on infertility in this country. I wrote about this here (third from bottom) for Macleans in the lead up to the budget. I look forward to this being discussed in future budgets though. Or better yet, maybe the Department of Finance will approach me about filling the Clifford Clark visiting economist position and this is something we can work on together (a nod is as good as a wink to a blind man).

Overall, the budget has all the makings of a good western: the good, the bad, and the downright ugly. In essence, there is something for everyone to hate.

 

 

 

 

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Tax Implications of the Second-hand Economy

This morning I had a lovely interview with Steve Paikin, host of TVO’s The Agenda, regarding my research on the second-hand economy. Wonderfully, the conversation turned to the tax implications of the second-hand economy and his questions have inspired this blog post. Here I will parse all the tax rules regarding second-hand transactions.

Are second-hand transactions subject to tax? The basic answer is, generally, no; however a detailed answer to that question is actually quite technical and you have to look at different segments of the second-hand economy.

First, traditional bricks and mortar stores(excluding those with a social mission) that specialize in selling second-hand goods account for 15% of the share of the second-hand economy. Because these stores are operating as a business, these transactions are subject to GST (and potentially provincial sales taxes depending on the rules in the province) and the revenues generated subject to income tax. While the second-hand economy survey results do not allow for specific calculations in this area, back of the envelope calculations indicate that these stores could contribute up to $720 million in federal tax revenues. Provincial government would also accrue their share based on provincial sales and businesses tax rates. Again, because most second-hand transactions would not otherwise occur, most of these revenues represents additional revenues that would not accrue to the government if the second-hand economy did not exist.

It is clear from the survey, however, that the bulk of second hand-transactions occur between individuals and there are concerns that the second-hand economy may contribute to tax avoidance. Understanding if these concerns are warranted requires an understanding of the tax rules that apply to second-hand transactions. These rules dictate whether a used purchase is subject to GST/HST and whether the income derived from a sale is subject to income tax.

Generally the sale of what is referred to as personal use property is not subject to GST/HST. Personal use property is an item that people own and use for their own personal use. If you sell a used personal use item then the transactions is generally not subject to GST/HST. There are, however, important exceptions to this rule. One relates to the “small supplier” threshold. If the sales of personal use property in a given year exceed $30,000 then you are required to be a GST/HST registrant and you are required to charge and remit GST/HST. The second relates to commercial property. The personal use exemption does not apply to the sale of used commercial property, which is generally always subject to GST/HST.

The survey results make it clear that most second-hand transactions pertain to personal use property and most the sales of most individuals are well below the “small supplier” threshold meaning that most transactions are not subject to GST/HST. However, there are some commercial property transactions and some sellers may be exceeding the small supplier threshold. In both cases, these transactions are subject to GST/HST. Whether or not these transactions are appropriately taxed and the tax remitted to the Canada Revenue Agency (CRA) is not known. To the extent that this did not occur, means that these transactions were not tax compliant and the sellers would be potentially be subject to fines and penalties, in addition to being liable for the tax owed, if caught.

Whether or not the income generated from an individual’s second-hand transactions is taxable also has set rules. When selling a good, the income generated from the transaction is calculated as being the net proceeds of the sale, generally calculated as being the difference between the price at which the good was sold less the price which the seller paid for the good (also known as a capital gain). Since most used goods are sold for a price below its original purchase price, the good is sold at a loss and it not considered be taxable income.

If, however, you sell personal use property for more than you paid for it, as often happens in the case of items have appreciated in value, the income may be taxable. If the income from the sale, calculated as being the difference between the price at which the good was sold less the price which the seller paid for the good, is less than $1,000 then the income is not tables. If the income is above $1,000 then it is taxable but as a capital gain, the amount above the $1,000 threshold is taxed. However, because the income is considered to be a capital gain, it is only taxed at 50%. Second-hand goods most likely to fall into this category are art and collectibles, which according to the survey account for a small share (1%) of second-hand economy transactions.

The final case concerns individuals from whom the selling of used personal products is considered to be a business activity. Notably, if a person frequently sells used goods, the income derived from this activity is taxable as ordinary income. That said, there are some heavy resellers who may, in fact, whose activities may qualify as business activities. In this case, the income generated would legally need to be reported to CRA and subject to income tax. To the extent that this did not occur, means that these transactions were not tax compliant and the sellers would be potentially be subject to fines and penalties, in addition to being liable for the tax owed, if caught.

Clearly, understanding the tax rules is important for participants in the second-hand economy. While most peer-to-peer transactions in the second-hand economy are not subject to either sales or income tax, there is a small amount of activity that is. Given the increase in the second-hand economy, it is worthwhile for CRA to monitor this marketplace for compliance with tax rules. In addition, sellers should ensure that are sufficiently informed about the tax rules to ensure their compliance, especially given costs of not following the rules.

Thanks Steve Paikin for inspiring this post and helping educate Canadians about the tax rules related to second-hand purchases. I wish, though, that CRA had this information in one spot in an easy to read format for Canadians to refer to. I guess in the meantime, I’ll have to do the job for them.

*NOTE: yes there are unique rules for used cars, and these rules varies by province.

The Second-hand Economy in Canada

A few months ago I was approached about whether I was interested in partnering with Kijiji and OCR in Montreal to produce a report on the second-hand economy in Canada. Today we released that report and you can peruse it for yourself at www.secondhandeconomy.kijiji.ca. I also summarize the report here, Jennifer Robson has produced her only analysis here, and Trevor Tombe is providing a nice real time commentary on Twitter.

I can’t thank Kijiji enough for investing in such a valuable exercise (and for their patience with the academic process of interpreting said survey data). I also want to make it clear that while this research is sponsored by Kijiji (survey data, after all, is not cheap), Kijiji in no way influenced our findings or analysis of the survey data. In fact, the academic team owes Kijiji a debt of thanks for providing the space for those of us involved to freely discuss (and sometimes argue) the data, hash out the methodology, and interpret the results.

I am very excited about this report, because it is based on some very important survey data that really shines important light on a key debate revolving around the second-hand economy: does it simply crowd out the purchase of new goods? While the economic theory does not provide a definitive answer to this question, this survey does, at least for the Canadian context. Notably, that most (two-thirds) of second-hand transactions would not otherwise occur.

Based on the economic principle that people only make a purchase if they are both amenable and able to do so, there are two types of individuals, therefore, who primarily benefit from the second-hand economy. How this comes about is clear if we think about our standard microeconomics model, the infamous supply and demand diagram. First, demand for a new good only exists if something is both willing AND able to purchase the good. This means you have to not only want to buy the good, but you must have the income to do so. It is not wishful thinking. So those without sufficient income (ability) are essentially excluded from the market for new goods. However, we learn from this study that the second-hand economy address the ability portion, allowing low- and middle- income earners to access goods that they would otherwise not be able to afford. Doing so thereby increases their purchasing power and helps narrow economic inequality.

Second, recall that only those individuals whose value of the good meets or exceeds the price end up purchasing the new good. All those individuals who are both willing and able to buy a good but for whom the economic value of the goods is less than the market price are excluded from purchasing the good. Because the price of similar goods is up to 50% less on the second-hand market, these individuals are able to access the used good at a price that better represents the value they place on that good, leading to substantial welfare gains for these consumers and for the economy.

This result, in and of itself, provides important information for economists and our economic models. While the more global results reported in the survey are also of interest, as an academic micro economist this is the one I am most excited about. It is one that I hope I will be able to follow up on in more detail. And for those teaching EC101, it also gives you an answer to that age old student question of what happens to all those people whose demand schedule lies solely below the market price.