Solution to Assignment Problem One-1
There is, of course, no one solution to this problem. Further, student answers will be limited as, at
this point, their understanding of tax concepts and procedures is fairly limited. However, the problem
should provide the basis of an interesting discussion. What we have provided here are some
suggested comments related to the various qualitative characteristics.
Equity Or Fairness The increase provides both horizontal and vertical equity. Individuals with the
same income will receive the same treatment, while individuals with different income will be treated
differently.
Neutrality The increase is not neutral. It targets high-income individuals and is likely to influence
their economic decisions.
Adequacy While the increase was intended to create additional revenues, there is some evidence
that the opposite has happened. This reflects the fact that individuals with high levels of income are
sometimes in a position to move some, or all, of that income out of Canada (e.g., move their residence
to the U.S.).
Elasticity This increase is unlikely to respond to changing economic or social conditions.
Flexibility With respect to flexibility, the rate can be changed at any time. However, as a practical
matter, such changes would need to be on an annual basis.
Simplicity And Ease Of Compliance This change would not appear to present any compliance
issues.
Certainty The increase makes it clear to individual taxpayers the amount of taxes that they will be
required to pay.
Balance Between Sectors Unfortunately, this change will increase the imbalance in the Canadian
tax system between corporate and individual taxpayers. Before the change, individuals were already
paying a disproportionate share of tax revenues. The intent of this change was to further increase
this imbalance.
International Competitiveness This increase further widens the gap between Canadian and U.S.
tax rates, making Canada far less competitive with the U.S. However, Canadian tax rates are not
out of line with tax rates in other industrialized countries.
Solutions Manual for Canadian Tax Principles 2020-2021 1
, Solution to AP One - 2
Solution to Assignment Problem One-2
Instructor Note There is obviously no definite solution to this problem. What follows
represents only possible comments that could be made.
For the Canadian tax system to be more competitive with the United States, both individual and
corporate tax rates in this country would have to be lowered. The most obvious conflict that would
arise would be with ADEQUACY of revenues. Tax rate reductions reduce revenues and would create
additional problems with the large budget deficits that are currently being experienced in Canada.
Another issue is BALANCE BETWEEN SECTORS. The Canadian system is already heavily
dependent on individual income taxes as opposed to corporate income taxes. Lowering corporate
rates would further exacerbate this problem.
The question of NEUTRALITY could also be involved. Trying to match either U.S. individual or U.S.
corporate rates could have an impact on economic decisions.
Any change in tax rates has an impact on CERTAINTY in that such changes alter expectations.
Depending on whether changes are made to corporate rates or, alternatively, individual rates, this
could have an impact on FAIRNESS or EQUITY.
Trying to match rates in the U.S. reduces the FLEXIBILITY of the Canadian tax system.
As noted, other comments could be appropriate.
Solutions Manual for Canadian Tax Principles 2020-2021 2
, Solution to AP One - 3
Solution to Assignment Problem One-3
A. Diamonds, South Africa In a monopoly, the tax will probably be entirely shifted to employees
and/or consumers. The incidence shift will depend on competition in world markets and
employment levels. If the international diamond market is price sensitive and there is high
unemployment in South Africa, then the tax will be shifted almost entirely to employees.
The shifting assumptions affect evaluation of the tax using the characteristics of a “good” tax
system. A tax that is entirely shifted to employees is similar to one on wages and is non-neutral,
as it affects the decisions of employees to continue working. Some employees will work less and
thus increase the excess burden resulting from the imposition of the tax.
B. Diamonds, Sierra Leone The taxing authorities will find it difficult to enforce the tax, due to their
inability to track diamond movements. Records maintained by the mine will likely be inaccessible,
and those presented will be incomplete. The tax will not be effective and the tax revenue will be
uncertain and inadequate.
C. Principal Residences, Canada This exemption is non-neutral because investment decisions
are affected by the tax preference. Given the choice of investing in real estate to hold for resale
or a principal residence, both of which are likely to appreciate, a taxpayer will invest in a principal
residence so that the gain on disposition is tax exempt.
It is also vertically inequitable because it benefits high-income families who can invest in more
expensive residences, which have the potential of earning greater returns.
This tax expenditure is spread among all taxpayers, and general tax revenue must be larger to
compensate for the revenue forgone.
D. Business Meals, Canada This restriction adds complexity to accounting for deductible expenses,
as all business meals have to be accounted for and accumulated separately from other promotion
expenses. The tax could be shifted to consumers, employees, and/or shareholders. If it is shifted
to consumers, it could be more advantageous to raise personal taxes so that incidence is more
certain. If it is shifted to shareholders or employees, then it would be non-neutral as it could affect
investment decision making and willingness to work.
E. Head Tax A head tax is neutral as it does not affect economic choices. However, it is vertically
inequitable, based on the ability to pay concept of equity, as all taxpayers, regardless of their
income levels, are taxed the same. The head tax is very inelastic. This tax serves the objectives
of certainty, simplicity, and ease of compliance. It could promote stability in the economy.
Solutions Manual for Canadian Tax Principles 2020-2021 3
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