Why do we even have to file a tax return in the first place?

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Jamie Golombek: Automatic tax filing could ease the burden for taxpayers, but our tax systems will need to be simplified first

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The Canada Revenue Agency last week released the 2021 income tax packages in preparation for the upcoming tax season and, while electronic filing doesn’t open until Feb. 21, now is a great time to start gathering all your information to prepare your 2021 return.

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Complying with our complex tax system costs time, effort and money, and is aggravating to boot. As a result, most turn to tax-preparation service providers. Others use software packages that help guide even the most novice tax filer through the process. But even those who file their own returns need tax advice and must keep proper documentation to take advantage of all the various tax credits and deductions, which increases their tax compliance costs.

A 2013 study estimated that the total costs of complying with personal income tax provisions, including the value of time spent, money spent and costs of appeals, ranged between $4.6 billion and $6.7 billion in 2011. All of this cost and hassle begs the question: Why do we even have to file tax returns in the first place?

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A new report, Automatic Tax Filing: A Challenging Idea for Canada, released this week by the C.D. Howe Institute, attempts to shed some light on this question. Its authors, Alexandre Laurin and Nicholas Dahir, compare Canada’s tax filing system with those of 57 countries in the Organisation for Economic Co-operation and Development and come up with some interesting observations and conclusions about our system, and suggest what automatic tax filing might look like in Canada, and whether or not it’s even feasible.

Many countries don’t require everyone to file a tax return. For example, some countries do not require tax filing at all for people in simple tax situations, particularly those employees whose tax is withheld at source by the employer, remitted to the tax authority and adjusted throughout the year so that the total amount withheld at year-end corresponds to their exact tax liability. Individuals facing more complicated tax situations, however, must still file a tax return.

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In other countries, particularly in Scandinavia, tax filing is semi-automated, whereby eligible taxpayers with basic sources of income receive prepopulated tax forms with their tax liabilities already computed by the tax authority, so taxpayers simply need to verify the prefilled information for accuracy.

The completeness of prepopulated tax forms and the accuracy of the tax calculations prepared by the tax authorities ultimately depend on the complexity of the filers’ tax situations. The greater the number of taxpayers with “basic” tax returns, the more practical it would be to introduce fully automated tax filing.

The idea of automated filing in Canada was floated in the September 2020 Speech from the Throne. The federal government indicated it would “work to introduce free, automatic tax filing for simple returns to ensure citizens receive the benefits they need.” A simple return, presumably, would be a tax return for which the CRA has all the required information on file to enable the automatic and accurate assessment of taxes and benefits. But how many tax filers present the characteristics of a simple or basic federal tax return?

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A 2013 study estimated that the total costs of complying with personal income tax provisions, including the value of time spent, money spent and costs of appeals, ranged between $4.6 billion and $6.7 billion in 2011.
A 2013 study estimated that the total costs of complying with personal income tax provisions, including the value of time spent, money spent and costs of appeals, ranged between $4.6 billion and $6.7 billion in 2011. Photo by Getty Images/iStockphoto

The authors of the C.D. Howe report, using simulation database modelling, estimate only about 32 per cent of all potential filers would have a basic federal tax return, that is, one for which the CRA would have on file all the required details on income, investments, expenses and personal circumstances (provided the CRA has your age, marital status and family composition on file) to enable the automatic and accurate calculation of taxes and benefits.

Indeed, the main barrier to automated filing is the complexity of Canada’s personal income tax system. Canada’s third-party reporting system is reasonably comprehensive and captures most sources of income, such as employment income, pension income, investment income and government benefits, but what’s not captured is self-employment income, rental income, most taxable capital gains and foreign income.

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But the real problem lies with the myriad deductions and credits Canadians claim when preparing their own returns, which is information not already available to the CRA. For example, parents can deduct child-care expenses, ex-spouses can deduct spousal support payments, employees moving closer to work can claim moving expenses, members of the clergy can claim a deduction for their residence, and employees working from home due to COVID-19 can claim employment expenses for a home office.

The list is even longer on the credit side. There are credits for medical expenses, disability, purchasing a home, volunteer firefighting, donating to a charity, contributing to a political party, school teaching supplies, tuition fees, and the list goes on and on.

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The real obstacle to a widely available, fully automatic filing system is our Income Tax Act itself, which simply contains too many deductions and credits recognizing specific personal circumstances, expenses and activities. The number of federal personal income tax preferences, including so-called “boutique” tax credits, deductions and benefits measured in the annual federal tax expenditures reports, increased to 143 in 2021, from 105 in 1991.

The authors conclude that given the complexity of our tax system, fully automatic tax filing for all is “a blunt instrument to get to the narrower problem of non-filing eligible benefit recipients … More targeted strategies to reach these people are preferable, such as decoupling the requirement to file a tax return from eligibility to receive benefits.”

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As an alternative, they suggest establishing a new body specifically tasked with delivering income-tested benefits to Canadians, which would better serve the poverty-reduction objectives of government support programs currently tied to tax filing.

In the meantime, the closest thing we have to automated filing is the optional CRA “Auto-Fill” feature for taxpayers who electronically complete their tax returns. This government service allows individuals (or their authorized tax preparers) who use CRA-certified software to automatically fill in sections of the return with information the CRA receives from third parties on income, benefits and registered retirement savings plan contributions. In fiscal year 2018/19, Auto-Fill was used nearly 12 million times.

But until our tax system is simplified, it’s unlikely the government will move to automated filing for anything other than the most basic of returns.

Jamie Golombek, CPA, CA, CFP, CLU, TEP is the managing director, Tax & Estate Planning with CIBC Private Wealth in Toronto. Jamie.Golombek@cibc.com

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