Preface

Since 2000 the tax expenditure report has been separated into two documents. This document, Tax Expenditures and Evaluations, is published on an annual basis. It provides estimates and projections for broadly defined tax expenditures as well as evaluations and descriptive papers addressing specific tax measures. Two presentational changes have been made this year. First, the estimates and projections are now grouped by functional category (e.g. small business) for business income tax and goods and services tax measures, as they have been for personal income tax measures. Second, subheadings have been added to the "Memorandum Items" section of the tables to identify various categories of measures that are part of the benchmark tax system (e.g. recognition of expenses incurred to earn income).

This year’s edition of Tax Expenditures and Evaluations includes two studies. The first presents the results of an evaluation of the disability tax credit, which was undertaken further to the Government’s response to the Seventh Report of the Standing Committee on Human Resources Development and the Status of Persons with Disabilities. The second study examines the long-run economic costs imposed by the principal taxes in Canada using a model of the Canadian economy developed at the Department of Finance.

The companion document, Tax Expenditures: Notes to the Estimates/Projections, is being published again this year. It is a reference document for readers who want information on the objectives of individual tax expenditures and who wish to know more about how the estimates and projections are calculated.

Part 1 - Tax Expenditures:
Estimates and Projections

Introduction

The principal function of the tax system is to raise the revenues necessary to fund government expenditures. How much revenue is raised is determined by tax bases and tax rates. It is also a function of a range of measures-special tax rates, exemptions, deductions, rebates, deferrals and credits-that affect the level and distribution of tax. These measures are sometimes called "tax expenditures" because they have an impact on government revenue (i.e. they have a cost) and they reflect policy choices of the Government.

In order to define tax expenditures, it is necessary to establish a "benchmark" tax structure that applies the relevant tax rates to a broadly defined tax base-e.g. personal income, business income or consumption. Tax expenditures are then defined as deviations from this benchmark. Reasonable differences of opinion exist about what should be considered a normal part of the tax system and hence about what should be considered a tax expenditure. For example, a deduction for expenses incurred in earning income is generally considered as part of the benchmark and thus not as a tax expenditure. But in some cases the deduction may confer some personal benefit, making its classification ambiguous.

This report takes a broad approach and includes estimates and projections of the revenue loss associated with all but the most fundamental structural elements of the tax system, such as the progressive personal income tax rate structure. This includes not only measures that may reasonably be regarded as tax expenditures but also other measures that may be considered part of the benchmark tax system. The latter are listed separately under "Memorandum Items." For instance, the dividend tax credit is listed under this heading because its purpose is to reduce or eliminate the double taxation of income earned by corporations and distributed to individuals through dividends. Also included under this heading are measures for which there may be some debate over whether they should be considered tax expenditures or where data limitations do not permit a separation of the tax expenditure and benchmark components of the measure. This approach provides information on a full range of measures.

Caveats

Care must be taken in interpreting the estimates and projections of tax expenditures in the tables for the following reasons.

• The estimates and projections are intended to indicate the potential revenue gain that would be realized by removing individual tax measures. They are developed assuming that the underlying tax base would not be affected by removal of the measure. However, this is an assumption that is unlikely to be true in practice as the behaviour of economic agents, overall economic activity and other government policies could change along with the specific tax provision.

• The cost of each tax measure is determined separately, assuming that all other tax provisions remain unchanged. Many of the tax expenditures do, however, interact with each other such that the impact of several tax provisions at once cannot generally be calculated by adding up the estimates and projections for each provision.

• The federal and provincial income tax systems interact with each other to various degrees. As a result, changes to tax expenditures in the federal system may have consequences for provincial tax revenues. In this publication, however, any such provincial effects are not taken into account-that is, the tax expenditure estimates and projections address strictly the federal tax system and federal tax revenue.

• In the case of the harmonized sales tax in effect in Nova Scotia, New Brunswick, and Newfoundland and Labrador, only the federal cost of the tax expenditures is reported.

• The tax expenditure estimates and projections presented in this document are developed using the latest available taxation data. Revisions to the underlying data as well as improvements to the methodology can result in substantial changes to the value of a given tax expenditure in successive publications. In addition, estimates and projections for some tax measures, such as the half inclusion rate on capital gains, are particularly sensitive to economic parameters and hence may also differ significantly from one publication to the next.

What’s New in the 2004 Report

A number of new tax measures have been introduced since last year’s report and others have been modified. These are described below.

Personal Income Tax

Disability Supports Deduction

• Budget 2004 proposed to replace the attendant care deduction with a broader disability supports deduction, effective for the 2004 and subsequent taxation years. The deduction will recognize, in addition to attendant care, other disability supports expenses incurred for education or employment purposes (such as tutoring for persons with learning disabilities), unless they have been reimbursed by a non-taxable payment (e.g. insurance payment). Individuals will not have to be eligible for the disability tax credit in order to claim the deduction. The deduction will generally be limited to the lesser of the amounts paid for eligible expenses and the taxpayer’s earned income, which includes wages, self-employment income and scholarships. Students may be able to deduct a higher amount.

Mineral Exploration Tax Credit

• In October 2000 the Government introduced a temporary tax credit for mineral exploration to moderate the impact of the global downturn in exploration activity. The credit provides individuals with an additional tax incentive related to the purchase of certain flow-through share investments. The credit is equal to 15 per cent of specified grass roots mineral exploration expenses incurred in Canada by a corporation and renounced to an individual under a flow-through share agreement.

The 2003 budget announced an extension to the scheduled expiry date of the credit by one year to December 31, 2004. It also removed a restriction that had made the flow-through share look-back rule unavailable for the final year of the credit. As a result of the 2003 budget measure, funds raised from an individual under a flow-through share agreement in 2004 can be expended by a corporation up to the end of 2005 and be eligible for the credit as a deemed expense of the individual in 2004.

Although market conditions for mineral exploration have improved since the credit was introduced, Budget 2004 proposed to establish in legislation an expiry date for the credit of December 31, 2005, in order to provide companies with ample time to plan their transition from the credit. Under the look-back rule, this will allow eligible expenses to be incurred up until the end of 2006.

Medical Expense Tax Credit

• Budget 2004 proposed changes to the medical expense tax credit to allow caregivers to claim more of the medical and disability-related expenses that they incur on behalf of dependent relatives.
  • Specifically, medical expense claims made on behalf of minor children will be pooled with the medical expenses of the taxpayer and his or her spouse or common-law partner, subject to the taxpayer’s minimum expense threshold (for 2004, the lesser of 3 per cent of the taxpayer’s net income and $1,813), without regard to the income of the minor child.
  • For medical expenses paid on behalf of other dependent relatives (e.g. grandparent, niece, nephew, etc.), taxpayers will be able to claim qualifying medical expenses paid on behalf of such a dependant that exceed the lesser of 3 per cent of the dependant’s net income and $1,813 (that is, the threshold for the medical expense tax credit that would apply if the dependant claimed the expenses). The maximum eligible amount that can be claimed on behalf of dependent relatives other than minor children will be $5,000.

Tax Relief for Canadian Forces Personnel and Police

• The 2004 budget introduced tax relief for Canadian Forces personnel and police deployed to dangerous international operational missions. Eligible individuals will be entitled to deduct from their taxable income the amount of their related employment earnings from these missions to the extent that those earnings have been included in computing income, up to the maximum rate of pay earned by a non-commissioned member of the Canadian Forces (currently $6,089 per month). This measure applies to the 2004 and subsequent tax years.

Canada Learning Bond/Enhanced Canada Education Savings Grant

• To provide greater support for low-income Canadians to help offset the costs of post-secondary education, Budget 2004 proposed two measures to assist low- and middle-income families to save towards their children’s future post-secondary education.
  • Budget 2004 introduced the Canada Learning Bond (CLB) program, designed to kick-start education savings for children in low-income families. The CLB will provide up to $2,000 of education savings in a registered education savings plan (RESP) by age 16 for children in families entitled to the National Child Benefit supplement.
  • The budget also proposed enhancements to the Canada Education Savings Grant (CESG) program to strengthen assistance for low- and middle-income families that wish to save for their children’s post-secondary education using an RESP.

• While the CLB and CESG do not directly represent a tax expenditure, they increase the cost of the tax expenditure associated with RESPs to the extent that they encourage their increased use.

Business Income Tax

Accelerating the Increase in the Small Business Limit

• The 2003 budget provided that the amount of active business income eligible for the small business deduction would increase from $200,000 in 2002 to $225,000 for 2003, $250,000 for 2004, $275,000 for 2005 and $300,000 after 2005. The 2004 budget proposed to accelerate the implementation of the measure by increasing the eligible amount to $300,000 for 2005 and subsequent years.

Goods and Services Tax

Increased GST Rebate for Municipalities

• As announced in the February 2, 2004, Speech from the Throne, the rebate in respect of the goods and services tax and the federal portion of the harmonized sales tax for municipalities was increased to 100 per cent from 57.14 per cent. This measure has been legislated and is effective February 1, 2004.

The Tax Expenditures

Tables 1 to 3 provide tax expenditure values for personal income tax, corporate income tax and the goods and services tax (GST) for the years 1999 to 2006.

Estimates and projections are developed using the methodology set out in Chapter 1 of Tax Expenditures: Notes to the Estimates/Projections.^[1] The economic variables used to develop the estimates and projections are based on the private sector average forecast presented in the March 2004 budget.

The tax expenditures are grouped according to functional categories. This grouping is provided solely for presentational purposes and is not intended to reflect underlying policy considerations.

All estimates and projections are reported in millions of dollars. The letter "S" indicates that the cost is less than $2.5 million, "n.a." signifies that data is not available to support a meaningful estimate/projection, and a dash means that the tax expenditure is not in effect. The inclusion in the report of items for which estimates and projections are not available is warranted given that the report is designed to provide information on measures included in the tax system even if it is not always possible to provide their revenue impacts. Work is continuing to obtain quantitative estimates and projections where possible.

^[1] Available on the Department of Finance Web site at www.fin.gc.ca. [Return]

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