Saturday, May 30, 2009

Tax Time

Many Canadians and Americans are wondering if taxes will go up, when they'll go up, and how they will will go up. The answer to the first (if) is quite easy, the second (when) a little more difficult and the third (how) is still on the drawing board. Nonetheless, the scribbles are happening...



If?
With unsustainable debt and deficits in Canada and the U.S., every political insider knows that taxes are going up. They just won't talk about it because it's unpopular. Furthermore, they'll try and use clever names to try and avoid the word 'tax', which has always had negative connotations. A quick look at the projected numbers (table below) makes it pretty obvious that without an unfathomable decrease in government spending, taxes are going up. An additional problem is the large projected increases in entitlement costs (pensions and health care) over the next several decades.

Fiscal Year US Deficit* Canada Deficit**
2008/2009$459 billion$9.1 billion
2009/2010$1.7 trillion>$50 billion (up from $33.7 billion)
2010/2011$1.1 trillion$13 billion (not revised)
2011/2012$693 billion$7.3 billion (not revised)
*Congressional Budget Office
**Canada's Economic Action Plan

When?
The economy is showing signs of reflation with commodity prices increasing. Rising Treasury yields are a clear sign that cost of borrowing cannot be held artificially low for much longer. The foreign apetite for holding U.S. debt is falling. It is "time to sell" treasuries, said Kim Heeseok. Heeseok is the head of South Korea's National Pension Service, the country's largest investor in U.S. treasuries. All of this is an indication that the answer to the question of 'when', is likely sooner rather than later.

How?
There are three general classes of options for increasing taxes:
  1. Sales Taxes (Value-Added-Tax, Sales Tax, Point-of-Purchase Tax, etc.)
    This class of tax is added whenever a 'taxable' good or service is purchased. Everyone in Canada is familiar with the GST. It was the Mulroney version of a "tax shift". The next government (Chretien) promised to eliminate it and failed to deliver. Ultimately, the GST was reduced by two percentage points. While it was a popular political move, the annual government revenues were reduced by an estimated $10 billion, nearly the same amount as the current account deficit. A federal sales tax is now the leading candidate for a universal tax increase in the United States, according to sources.

  2. Income Taxes
    Income taxes are levied on all legitimate forms of compensation for services rendered. The structure of these taxes is often complicated as they are often 'marginal' to allow for higher tax rates for higher income earners. Capital gains and dividends are also typically taxed, albeit at different rates than 'standard' income. There is usually little room to maneuver upwards on income tax because these rates need to be competitive in order to keep people and businesses from migrating to other regions with more favorable income tax rates. They can also be evaded in instances where stringent records of income is not kept--as is the case with many small businesses.

  3. Duties, Royalties, Excises and Levies
    These are miscellaneous taxes charged towards specific items. Politicians like this type of tax because they don't necessarily have the word 'tax' in it and the amount of the tax can usually be hidden inside the cost of the item itself. For example, most people have no idea how much excise taxes are on alcohol and cigarettes. California is now considering monetizing its underground marijuana industry by legalizing and taxing the substance. The resulting potential revenues for California would be massive in this case, but this example is the exception, not the rule for this class of taxes.

  4. Savings and Property Taxes
    This type of tax is the most controversial as it is a direct raid on the savings of the citizens. One common example is an estate tax--when some of the savings of a deceased person are transfered to the government instead of to their designated beneficiaries. Properties are often subject to annual taxation indefinitely despite the perceived ownership by the landowner.

  5. Phantom Taxes
    This is an indirect tax that tends to be the easiest for politicians to implement without creating public backlash. That's because citizens don't even realize that their savings are being raided. It occurs when the government decides that instead of borrowing money to finance deficits, they will print it to make up the shortfall. This leads to inflation and devaluation of the currency. The effective reserves (savings accounts) of the currency holders will fall. Many people attempt to use gold and other precious metals as an inflation hedge to hold value during this decline in the purchasing power of the dollar. The only trouble with using this inflation hedge strategy is that any 'appreciation' is subject to another type of tax--a capital gains tax.
No matter what you word it, the tax man is coming. Politicians will try and evade the question because any hint of an increase is unpopular; but the question still stands.

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