Andrew Sharpe

Fred Gorbet

Stanley L. Winer

English

Research Papers in Economics

New Directions for Intelligent Government in Canada 205
Reflections on the Role of 
Optimal Design in the Tax 
Policy Process
Stanley L. Winer
Carleton University
MY REMARKS ARE STIMULATED BY MY READING of Robin Boadway’s contri-
bution in this volume in honour of Ian Stewart on rethinking tax/transfer
policy in Canada (Boadway, 2011). His paper provides an interesting and
readable overview of contemporary applied tax theory as embodied in the
Mirrlees Review (2011). It begins with a concise survey of theory concerning
business taxation, the individual income tax, transfers to low income people,
indirect taxation and, going somewhat beyond taxation, of public policy to
ensure equality of opportunity. The design in these respects that emerged
from the Mirrlees Review (2011) is the center of attention.
In the main portion of the paper, Professor Boadway considers how the ideas
about design that emanate from the Mirrlees Review play out when placed in
the Canadian context. Five features of the country are acknowledged as being
of particular importance to the application of Mirrlees to Canada: our federal
structure; the role of natural resources, especially their geographical concen-
tration as well as control by provinces; the absence of inheritance taxation; the206 New Directions for Intelligent Government in Canada
relative (to the U.K.) unimportance of congestion; and the treatment of
human capital which was not dealt with by Mirrlees for some reason that puz-
zles Robin. The paper then goes on to provide an erudite discussion of what a
Mirrlees type tax design might look like in this Canadian context.
Since I am an observer and modeler of tax systems as they are, and not a tax
designer, my comments on the paper will reflect that perspective.
The tax reform process as I observe it and have written about it with Walter
Hettich (Hettich and Winer, 1999, and 2006), consists of three components:
comprehensive reforms – the object of the present paper – which involve
major readjustments, usually of several parts of the tax system, and which are
quite rare; coordinating reforms that realign or readjust important parts of the
system that have fallen out of sync – such as personal and corporate tax sys-
tems, which are intertwined and may need important changes in the face of
shocks such as a decline in the cost of international transactions; and technical
reforms which deal with specific features of particular taxes. Technical reforms
are always ongoing, and coordinating reforms are the subject of budget
speeches, in contrast to the rarely seen comprehensive reform. In recent years,
perhaps only the introduction of the GST in place of the manufacturer’s sales
tax (MST) constitutes a comprehensive reform of the federal tax system in
Canada.
All of these reform processes occur in a political context. I interpret their
consequences as equilibrium outcomes of political competition that are condi-
tional on, and evolve with knowledge about technical issues supplied by tax
departments and academic and other advisers, along with information about
various interests and constraints that are generated by political competition.
The approach to policy design that Robin Boadway takes explicitly ignores this
broader equilibrium context, and in the first instance engages in optimizing
logic played out as if the political process did not exist. Such a choice is not a
matter of being naïve. It is a choice about how to conduct normative policy
design with a view to making sure that no possibly beneficial alternatives are
ruled out.
The implicit view of the tax policy process here (I think this is a fair judg-
ment) is that the job of actually implementing tax reform is that of the elected
government, and that it will pick and choose what parts of the optimal designNew Directions for Intelligent Government in Canada 207
will actually be adopted. So expanding the set of ideas about what may be
socially desirable, which hopefully will influence what governments do, is the
object of the analysis. And certainly, at least, this paper does the former.
Of course, if the politician ends up picking and choosing from the designer’s
optimized menu, the original design is no longer relevant in a basic sense. This
is an important point.
To continue, let's assume that we are not prepared to argue that any devia-
tion from the economically optimal design is a result of politics corrupting
good sense – if you believe that there are legitimate political costs, and that
one cannot be sure of how to handle them or estimate them, then there should
not be an implication that those who can do so and have to do so will get it
wrong in the end. Then, is there another way to present a set of proposals from
which political choices will be made in such a way that the analysis helps to
channel those decisions in a desirable direction?
I think that, in the end, one has to make a guess about ‘feasibility’ while cre-
ating alternatives based on desirable general principles from which politicians
may choose.1 Boadway actually goes down this road at a few points in moving
from the Mirrlees Review to the Canadian context. For example, in consider-
ing the desirable form of commodity taxation, the greater control by Quebec
of the GST compared to control of the HST in other provinces is taken as a
given. Federalism generally is another such constraint that is accepted, just as
is section 25 of the Constitution Act that forbids the Crown from taxing the
Crown, a basic source of the lack of access of the federal government to natural
resource revenues (that properly concerns him) and a key source of the strain
in the equalization system in Canada. These are not ‘ordinary’ economic con-
straints, and there will always be debate about what is relevant when defining
them.
Once one does that sort of thing – that is, delve into feasibility – one is then
in a deeper second best world where one is guessing at constraints that partly
1 There is nothing new in this view. Debate over the importance of feasibility as
a necessary (but not sufficient) criterion for designing or choosing among pol-
icies has a long history. See for example, Yehezkel Dror (1968). See also Dror
(1969), who warns that assessments of feasibility should sometimes be taken
up as a challenge rather than accepted as an absolute constraint.208 New Directions for Intelligent Government in Canada
stem from places that lie outside the realm of economic theory. The end result,
despite appearances, may be a set of proposals that is better than if theory were
held onto regardless of where it leads. For the real choice is not between an
optimal design and the world as it is. It is between alternative conceptions of
what is both possible and desirable.
It is useful to recall the experience of Charles McLure who in the1980s
directed a team drawing up a U.S. tax reform that came to be referred to as
Treasury I. This document proposed a broad based federal income tax for the
United States despite economic theory which at the time had swung heavily in
favor of an expenditure tax, a tax that in a somewhat more evolved form is also
part of the Mirrlees Review. The rationale for the Treasury proposal, accord-
ing to the account in McLure and Zodrow (2007), was that the designers in the
Treasury knew that some components of the expenditure tax system would
never be accepted by the President and, as a result, the outcome would be
worse than if the Treasury proposed a broad-based, Schanz-Haig-Simons type
income tax.
The component they were sure would be missing was the taxation of inher-
itances and bequests, which is required to preserve tax equity when an expen-
diture tax replaces a personal income tax. That is one key issue in Boadway’s
application to Canada also, though it is just one of several. It is key for at least
two reasons: capital income is sheltered in the Mirrlees proposal for direct tax-
ation of individuals, so that inheritance taxes are required to restore the pro-
gressivity that comes from indirect taxation of wealth via taxation of capital
and capital gains incomes. Inheritance taxes are also recommended as a way to
improve equality of opportunity.2
The problem facing those who want to put more emphasis on inheritance
taxes and wealth taxation generally is that the taxation of inheritances has been
declining in most western countries for a long time, for reasons that are not
well understood. (The issue deserves further study). Perhaps the decline is the
result of an aging electorate that wants to pass on hard-earned wealth to their
children? But whatever the reason, it is a good guess that meaningful inherit-
2 On the role of wealth taxation in fostering equality of opportunity, see Boad-
way et al., 2010, chapter 8.New Directions for Intelligent Government in Canada 209
ance taxation is not likely to be part of any comprehensive Canadian tax
reform. Such taxes were eliminated in Canada as a result of the Carter Com-
mission reforms in the early 1970s when the tax was handed over to the prov-
inces who then proceeded to compete it away.
What then? Should one take this as a ‘constraint’ to be used in tax design? If
so, it would appear that the proposals in the Boadway paper would look some-
what different. Boadway in fact suggests a Nordic style dual income tax as an
alternative if inheritance taxation cannot be restored, involving the separate
taxation of capital income at a uniform rate much lower than that on labour
income.
Another possible alternative, given this 'constraint', is to drop the inherit-
ance tax and combine the other tax elements with proposals for investment in
education – as a package – which is not a pure tax reform. I guess that Boadway
would not be opposed to such investment in any case. But in the tax reform
context, doing this would preserve desirable elements of the design at some
cost in terms of government size, or in terms of changes in the structure of
public expenditure if we hold to revenue neutrality.
I have little faith in the ability of the tax-transfer system to redistribute
income over long periods of time. As a whole the annual incidence of the tax
system appears to be proportional (Vermaeten et al, 1995), while explicit taxa-
tion of inheritances and bequests is absent and the taxation of capital incomes
is declining in the face of globalization.3 It is also relevant to note here that
there is some evidence that suggests that the smaller rise in inequality we have
had in Canada since 1970 than that experienced in the U.S. stems in part from
a relatively bigger increase in the supply of university graduates in Canada,
which may have prevented as large a rise in the university/high school gradu-
ate wage differential( Murphy et al., 1998)
Together, these observations raise the questions of whether and to what
extent education – especially perhaps access by lower income or disadvantaged
3 Calculated pre-tax Gini coefficients are always larger than post-tax ones,
suggesting that the public sector does redistribute. But by how much in the
long run when human capital and bequest decisions are involved? The problem
is that uncovering the pre-tax Gini requires a complicated general equilibrium
calculation encompassing such longer run decision making, and I think that
such a calculation still remains to be made in a convincing manner. 210 New Directions for Intelligent Government in Canada
children to early education, as well as the income contingent loan program for
higher education Robin Boadway also favors – may serve as a desirable
replacement for an inheritance tax in a feasible tax design?
References
Boadway, Robin (2011) “Rethinking tax-transfer policy for 21st century Canada,” in 
Fred Gorbet and Andrew Sharpe (eds.) New Directions for Intelligent Government 
in Canada: Papers in Honour of Ian Stewart (Ottawa: Centre for the Study of Living 
Standards).
Boadway, Robin, Emma Chamberlain, and Carl Emmerson (2010) ”Taxation of 
Wealth and Wealth Transfers,” in Stuart Adam, Timothy Besley, Richard Blun-
dell, Stephen Bond, Robert Chote, Malcolm Gammie, Paul Johnson, Gareth 
Myles, and James Poterba (eds.) Dimensions of Tax Design (Oxford, Oxford Uni-
versity Press), Chapter 8.
Dror, Yehezkel (1968) Public Policy Making Reexamined (Chandler Publishing Co).
Dror, Yehezkel (1969) "The Prediction of Political Feasibility," Futures, Vol. 1, No 4, 
pp. 282-288.
Hettich, Walter, and Stanley L. Winer (1999)"Information, Co-ordination and Tax 
Policy Making,", in R. Bird and T. Wilson (eds.), Rationality in Public Policy: Retro-
spect and Prospect; A Tribute to Douglas Hartle. (Toronto: Canadian Tax Founda-
tion), pp. 19-42.
Hettich, Walter, and Stanley L. Winer (2006) "Explaining Tax Reform," in Jim Alm 
and Mark Ryder (eds.) The Challenges of Tax Reform in a Global Economy, 
(Springer), pp. 347-361.
McLure, Jr., Charles E., and George Zodrow (2007) "Consumption-Based Direct 
Taxes: A Guided Tour of the Amusement Park," Finanzarchiv, Vol. 63, pp. 285-
307.
Mirrlees, James, Stuart Adam, Tim Besley, Richard Blundell, Stephen Bond, Robert 
Chote, Malcolm Gammie, Paul Johnson, Gareth Myles, and James Poterba (The 
Mirrlees Review) (2011) Tax by Design (Oxford: Oxford University Press).
Murphy, K.M., W.C. Riddell, and P.M. Romer. (1998) “Wages, Skills, and Technol-
ogy in the United States and Canada,” in General Purpose Technologies and Economic 
Growth, ed. E. Helpman (Cambridge, MA: MIT Press), pp. 283-309.
Vermaeten, Arnt, W. Irwin Gillepie, and Frank Vermaeten (1995) "Who Paid Taxes 
in Canada 1951-1988?" Canadian Public Policy, Vol. 21, pp. 317-343.

(The Mirrlees Review)

Consumption-Based Direct Taxes: A Guided Tour of the Amusement Park,&quot;

Explaining Tax Reform,&quot;

Public Policy Making Reexamined

Rethinking tax-transfer policy for 21st century Canada,”

Taxation of Wealth and Wealth Transfers,”

The Prediction of Political Feasibility,&quot;

Who Paid Taxes in Canada 1951-1988?&quot;

Winer (1999)&quot;Information, Co-ordination and Tax Policy Making,&quot;,

Reflections on the Role of Optimal Design in the Tax Policy Process

Reflections on the Role of Optimal Design in the Tax Policy Process

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