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What happens if a tax is found to be unconstitutional?

It might seem axiomatic that any revenue generated by the tax in question would have to be refunded. That’s true in Canada today – but only since 2007, following successful arguments by New Brunswick night clubs before the Supreme Court of Canada.

That case, Kingstreet Investments Ltd. v. New Brunswick, played a part in this month’s effort by Ottawa and Saskatchewan to amend the Constitution in order to strip Canadian Pacific Railway Ltd. of its historical tax exemption on its main line running through the province.

CP Rail says that decision was the trigger for its years-long effort to seek repayment of $341-million in taxes it paid to Saskatchewan after 2002.

Before Kingstreet, the ability of taxpayers to recover funds from an unconstitutional tax was uncertain, at a minimum. “Governments usually tried to retain taxes paid under an unconstitutional statute, and taxpayers were often unsuccessful in enforcing recovery in the courts,” constitutional expert Peter Hogg wrote in a 2008 article analyzing the decision. The “fiscal chaos” resulting from repayment had been cited by courts as one reason to avoid such refunds, Mr. Hogg noted.

Then, came the case of New Brunswick night-club owners, unhappy with a provincial user charge levied on the retail price of alcohol purchased, set at 5 per cent at the time of the court challenge.

The original trial judge had ruled that that measure was an unconstitutional indirect tax. The Supreme Court decision centred on the question of whether Kingstreet was entitled to reclaim the money it had paid in provincial user charges.

In a 9-0 decision, the Supreme Court ruled that the night-club company had that right, creating (or at least clarifying) that governments are not entitled to the proceeds of unconstitutional taxes. “Such restitution is warranted to guarantee respect for constitutional principles, in particular, in this case, the principle that the Crown may not levy a tax except with authority of the Parliament or the Legislature,” the court wrote.

As for the concern about fiscal chaos, the court said legislatures are able to enact constitutional, and retroactive taxes, if they wish, to avoid any outsized costs.

And, ironically enough, that appears to be the intent of the federal and Saskatchewan governments: the constitutional amendment that the House of Commons and provincial legislature have approved would be retroactive to 1966.

Taxing questions

One question (or rather, assertion) about British Columbia’s carbon tax that continues to pop up online concerns the notion that residents there don’t benefit from the rebates paid under federal carbon pricing, and hence are much worse off.

The first half of that idea is true; the second is not, with a couple of caveats. To recap: B.C. introduced its own carbon tax in 2008, promising that it would be revenue neutral from the taxpayer’s point of view. Cuts to the rates for personal income taxes, corporate taxes and small business taxes were enacted alongside the rollout of the carbon tax. The result was that personal income taxes were reduced, in aggregate, by more than the added levy of the carbon tax. Businesses, however, were not quite so fortunate; their tax cuts didn’t offset the additional carbon tax they paid.

Plus, the province introduced additional credits for low-income earners.

Fourteen years later, those personal income tax cuts and the low-income credits are still around, although the corporate tax rate has been increased to its pre-carbon tax rate of 12 per cent. (The small business rate is less than half of its 2007-2008 level.)

For individuals, then, there remains a considerable tax benefit, more than $600 for someone earning at least $97,000. And that doesn’t take into account any credits for individuals with lower incomes.

So, for lower and middle-income earners, there remain substantial tax benefits that were put in place to offset the cost of the carbon tax. And, depending on the number of earners and children in the household, those benefits compare favourably to the carbon rebates on offer from Ottawa. A two-earner household in B.C. could nab more than $1,200 in tax benefits, far more than any rebate available in Alberta, Saskatchewan, Manitoba or Ontario.

Now for the caveats. British Columbia scrapped the idea of a revenue-neutral carbon tax several years ago; increases in the last few years, and in future, are not being offset with tax cuts. That means the benefit will stagnate, for the most part, while the carbon cost for households rises.

And the historical tax cut savings for higher-income earners has already been trimmed significantly, with the introduction of new income tax brackets. The top B.C. personal income tax bracket in 2008, the year the carbon tax was launched, was 14.7 per cent, kicking in at incomes at or above $97,366.

In 2022, B.C. has boosted the tax rate on income between $159,484 and $222,240 to 16.8 per cent, with a rate of 20.5 per cent on income above $222,241. Someone earning $222,240 pays an additional $1,321 in tax because of those higher rates – about double the value of the benefit from the reduction in the rates of lower tax brackets.

So, most B.C. taxpayers continue to be net beneficiaries of historical tax cuts, though higher earners do not. And that latter group will grow over time, if the province continues with its plan to increase the carbon tax each year.

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Pay me later: University of Calgary economist Jack Mintz is floating the idea for a much different approach to corporate taxation that would allow companies to avoid paying taxes until they distribute profits to investors. Such a deferral, Prof. Mintz writes, would help “to build up productive capacity in a post-COVID world.” He contends that a distributed-profits approach would be revenue-neutral, since current tax incentives for companies would be eliminated. The measure would also be triggered by deemed distribution of profits, such as share buybacks.

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