Thursday 21 October 1993

Underground economy

Ministry of Finance

Roy Lawrie, assistant deputy minister, tax division

Peter Wallace, manager, current issues, office of economic policy

Peter Spiro, manager, macroeconomic policy, office of economic policy


*Chair / Président: Johnson, Paul R. (Prince Edward-Lennox-South Hastings/

Prince Edward-Lennox-Hastings-Sud ND)

Vice-Chair / Vice-Président: Wiseman, Jim (Durham West/-Ouest ND)

*Caplan, Elinor (Oriole L)

*Carr, Gary (Oakville South/-Sud PC)

*Cousens, W. Donald (Markham PC)

*Haslam, Karen (Perth ND)

*Jamison, Norm (Norfolk ND)

*Kwinter, Monte (Wilson Heights L)

Lessard, Wayne (Windsor-Walkerville ND)

Mathyssen, Irene (Middlesex ND)

*Phillips, Gerry (Scarborough-Agincourt L)

*Sutherland, Kimble (Oxford ND)

*In attendance / présents

Substitutions present / Membres remplaçants présents:

Dadamo, George (Windsor-Sandwich ND) for Mr Lessard

O'Connor, Larry (Durham-York ND) for Mr Lessard

White, Drummond (Durham Centre ND) for Mr Wiseman

Clerk / Greffière: Mellor, Lynn

Staff / Personnel: Campbell, Elaine, research officer, Legislative Research Service

The committee met at 1014 in committee room 1.


The Chair (Mr Paul R. Johnson): The standing committee on finance and economic affairs will come to order. Today is the first day the committee is examining the subject matter of the underground economy. Our first presentation today is by the Ministry of Finance. I certainly know Roy Lawrie, assistant deputy minister, tax division. Roy, if you wouldn't mind introducing your colleagues for Hansard and the committee members, I'd appreciate it.

Mr Roy Lawrie: With me are Peter Wallace, office of economic policy, and Peter Spiro, also of the office of economic policy in the ministry.

The Chair: If you would like to proceed now with your presentation, I'm sure that when you're finished there will be many questions from the committee members. Please go ahead.

Mr Peter Wallace: Does everybody have a copy of the slides now? Everybody's all set, and I'd like to turn to the first slide. I'll speak first, followed by Peter Spiro, followed by Roy. I just want to talk briefly about the structure of the presentation, give you an idea of what's coming, so you can phrase your questions in that context.

First of all, I'll provide an introduction in which we'll talk about the definition of the underground economy, some of the broad, macroeconomic factors that underlie the emergence of the underground economy; some of the more cultural and more specific factors that are driving it; some words about both tobacco tax structures and the province's overall tax structures in terms of personal income tax and other areas, showing where we rank relative to other provinces etc. We will also talk about jurisdictional issues. As you know, jurisdictional issues are very critical in this whole area because there is a substantial amount of overlap.

Peter Spiro, who I think is familiar to many people here because he's written a background economic paper on this subject, will talk about size and measurement issues of the underground economy. He'll do some international comparisons, talk about the existing literature and also talk about some empirical evidence in terms of what it does to tax revenues etc.

Roy will talk about an area I think you're all very interested in, at least I expect you're very interested in, which is the administration and enforcement of Ontario taxes and what the province has done to address this issue.

First, switching over to the next slide now, the first real slide, let's talk about the definition of the underground economy. We should understand that the underground economy is not a brand-new phenomenon. It's been around for ever. There are many reasons why people take economic activity underground. One of the most obvious reasons is simply that it's illegal in the first place. It's associated with narcotics, stolen goods, all sorts of other illegal activities that simply have to be conducted in cash, for all sorts of reasons, one of which is that they're trying to avoid the police.

Secondly, and a major component of the more recent discussion on the underground economy as we talk about a growing or emerging underground economy, is the notion of tax evasion. Tax evasion itself is not a simple phenomenon. People can try to evade retail taxes, they can try to avoid income taxes, they can try to avoid all sorts of other things.

The other thing to understand here is that people can be going underground because they are operating in the illegal sector, because they want to avoid other regulations, for example, labour law regulations, consumer safety regulations; people may want to be sheltering money from spouses for child support payments; all sorts of reasons along those lines.

One of the key points we want to make in this presentation is that the underground economy is very, very hard to get a handle on. Not only is it complex, covering a whole variety of sectors and subsectors in the economy, but is by definition hidden from statistic scrutiny.

It's hidden from revenue scrutiny, by and large. People do not report these items, whether they're done on a criminal basis or whether they're on the basis of simply trying to evade taxes. It's invisible to the economic data as well. It doesn't show up in the GDP or national account statistics or anything that, so again it's very hard to get a handle on that. Peter will talk about that later.

One of the things I do want to say to the committee is that you have an extensive set of hearings with a fair number of expert and good witnesses. Some people will have a fairly good handle on the exact size of the underground economy. In the ministry we will not be able to give you exact numbers on either the size of the underground economy or the potential revenue loss associated with that. We've done extensive research in this area. The best of our capacities are not showing up good, hard numbers on these things, simply reflecting the fact that this stuff is hidden.

It may be that other people will have good evidence on that. You'll have to make up your own minds as to whether or not that's absolutely reliable. This is something the ministry's very interested in, has pursued very rigorously, and has been able to get some good work, such as Peter's work on showing the size of the economy and Roy's work showing some of the types of enforcement activities and how they've been able to increase results etc, showing that there is an underground economy out there and that it does occasionally come to the surface in various ways that can be measured, but in terms of hard and concrete numbers, we don't have any.

I'd like now to talk about some concerns about the underground economy and why policymakers and people in the public policy field should be worried about the underground economy and some of the issues and problems it can bring.


The first thing we want to talk about is one of the most obvious: There are revenue losses. There are simply fewer resources for Ontario's programs and for deficit reduction, no question about that.

Secondly, there's the whole issue of fairness. Basically, the tax burden does fall on honest individuals, people who are paying their fair share. Let's face it, in Ontario it's fully possible for people who do not pay their fair share to get a free ride on the government services paid for by others, so there's a real fairness issue in there as well.

There's also the whole issue of public safety and social policy. I know there are a number of people here who have spoken in the House and elsewhere about the whole issue of public safety in Cornwall and other issues. There are public issues associated with smuggling and other criminal activities in the underground economy, and those are real concerns.

Another thing is that if people are going underground to avoid labour regulations, if they're going underground to avoid consumer regulations etc, they're going to miss the appropriate protection for workers and the appropriate protection for people who buy goods and services. A whole section of the economy can be taking place without the appropriate contract law, without the appropriate legal framework and without the appropriate legislation etc. People are at a substantially greater risk in that sector.

Thirdly, it's going to undermine tobacco and alcohol control strategies to the extent that these products are shifting into the underground economy.

Finally, the lack of labour standards, something I've already mentioned: As people will be willing to work, for example, in non-standard jobs, they won't be getting the normal benefits of unemployment insurance, of workers' compensation benefits, etc, so there are concerns about that.

The last thing we want to talk about is the emergence of parallel markets. Black markets, or underground markets, can apply to both legal and illegal goods. What we're seeing to some extent and what we'll talk about a little bit later is that there are some products, tobacco being the most obvious one, ordinary legal products where you are seeing the emergence of parallel markets. That has some real implications for how Ontario society functions. I don't want to exaggerate these things. I'm not saying that we're seeing a whole criminal class or a whole criminal sector made up of all sorts of people, but there is an issue of how the Ontario economy and society function and the emergence of markets for essentially inefficient economic reasons.

Finally, consumers and corporations can develop a taste for cheating. Basically, as you move into one area of the underground economy, for whatever reason, you may find it convenient to carry through other transactions in the underground economy. The argument there is a bit of a domino theory, that there is some potential for spread.

I would really like to be able to give you hard numbers on these things and to give you some sense of exactly what's occurring and how big a problem these things are in both relative and absolute terms. Quite frankly, we can't. I simply reiterate that this is a very complex issue. It's one that, by its very nature, has not shown itself to be particularly open to detailed and reasonable statistical study.

I'd like to talk now about some underlying macroeconomic factors that we feel are driving some of the underground economy issues and, to the extent that there has been growth in the underground economy, are likely to be driving some of the growth in the underground economy.

First, we have to recognize that the Ontario recession has been very, very severe. The peak-to-trough GDP decline has been 8%. That's twice the national average, so Ontario has been really hammered in the recession. That's going to have an impact and it's going to drive some of the more specific factors that I'll talk about on the next page. Just as people don't have work, are forced to seek alternative forms of employment, need to save money etc, there's going to be an impact there.

Just to amplify the point, Ontario has suffered 70% of the total employment losses that occurred in Canada over the course of the recession, a very disproportionate impact, and unemployment has more than doubled. These statistics are by no means unfamiliar to members of the committee, but they do emphasize the point that the main macro factors in the Ontario economy have changed substantially. That's going to have implications throughout the economy, both the legal, visible economy and the invisible economy.

I'd also like to point out that the prognosis for the Ontario economy is one of continued growth, but restructuring is continuing. The economy has regained 116,000 jobs since the trough of April 1992, but that's only a third of the recession-induced decline, so we are seeing substantial unemployed resources out there, capital resources, human resources etc, in the economy, looking for ways of becoming more productive.

Finally, the unemployment rate and duration remain unacceptably high. It's not just a question of the actual numbers of people unemployed, but the period of time they're being unemployed and the extent to which that will feed through into the underground economy.

I'd like now to flip to the next slide and talk about driving factors. These are some of the more specific factors that we feel are likely to be influencing the underground economy.

First of all, we're seeing a real consumer orientation now towards cost savings. I think we've all seen the real shift in how retail sales are operating in this province with new chains emerging and many traditional chains really having a very, very hard time, margins being squeezed as consumers look for ways of saving money. To some extent, the underground economy, particularly that part of the underground economy associated with tax evasion, does offer consumers an opportunity to save money. It also offers an opportunity for dishonest people to make more money.

Another thing is simply high unemployment. There are many, many people out there who are unable to work in a full-time standard job who would vastly prefer to work in a full-time standard job. This may put people in a position of being willing to accept non-standard employment and under-the-table arrangements. I think you have representatives from the construction sector coming to speak to you in a couple of weeks. I think you may want to explore that issue with them. But quite frankly, you are seeing areas of the economy where you have very high unemployment on a sectoral basis that is going to mean that people, regardless of the tax structure, regardless of other factors, are going to be in a position where they're likely to be seeking alternative income.

The underground economy may allow individuals to generate some income, presumably under-the-table income, while retaining unemployment insurance or other social assistance. I've no idea of the magnitude or the extent to which that happens, but at least in the hypothetical sense it's certainly something that is possible, and you may want to explore that with some of your other witnesses.

Another major factor is simply that networks are becoming established. We'll talk about this a little bit later, but just to preview one point, tobacco taxes have not risen substantially over the last few years, yet it seems to us that tobacco exports, and likely tobacco exports to the US and very likely tobacco smuggling, have increased substantially over the last couple of years. That may be a function of not necessarily the very short-term tax changes but simply networks becoming established over time. Again, this is part of the issue I raised earlier about the potential for institutionalization, frankly, of some areas of the invisible economy and some issues around that.

Finally, the notion that sales tax evasion may be becoming widespread in some sectors: I think everybody here has heard stories about some sectors of the economy where simply not paying the GST and RST -- particularly the GST -- has become common practice.

Finally, there are some issues about public perception. As Peter will talk about in a few minutes, the introduction of the GST appears to have been a real watershed in how people view taxes and in how people react to tax burden. It seems to have had a disproportionate and exceptional impact on how people view taxes and how much people are willing to pay their taxes. It is, after all, an extremely visible tax.

In terms of value for tax dollars, there seems to be a general sense that I think we're all familiar with that people are concerned about the value for tax dollars and may feel they're not getting enough. As they work on this, as they kind of look for rationalizations about why people might participate in the invisible economy, why they might not pay their fair share despite the fact that they know that they're going to free-ride on other government services etc, they may well view tax evasion as a bit of a victimless crime.

So these points here apply more to the emergence or the potential influence of economic factors. These will not apply to the hard-core underground economy that's always existed and has always been reasonably substantial. One of the points I'll point out as we go along and one of the things is that it's very, very hard to distinguish between these factors and the other factors that have traditionally been there -- for example, just illegal activities.

I'd like now to talk about GDP and tax revenue growth, because, from a public policy perspective, one of the major issues here is simply how the underground economy and how any changes in the underground economy will influence the province's fiscal resources.

I think everybody is familiar with the general picture of what's happened to taxes and to nominal GDP, with nominal GDP having a dive and tax revenue diving more substantially than it's been in the past. There's no question that revenues have performed at below expectations. Getting at the root cause of this is very, very difficult.

Let me explain a couple of things. As you all know, the minister has recently made statements about what's happening for the past year's deficit, and this reflects to some extent the revisions in data from an historic period. Basically, the data and the revenue collection material are still coming in from a past period. It's very, very hard to figure out exactly what's happened in the past, let alone what we're likely to see in the future.

There's no question that the vast majority of the change in tax revenue growth has been driven by macroeconomic factors and by changes in the structure of the Ontario economy. There's a real sense that the Ontario economy is changing substantially. As it changes, this will have a really big impact on how revenues are collected and where revenues come from. Distinguishing that from the potential impact of the underground economy is very, very difficult.


A couple of things I'd just point out is that the underground economy is likely to be a share, possibly a small fractional share, of the overall decline; and secondly, that broad revenue declines are shared across Canada. This is not an Ontario-specific problem. In terms of new revenue numbers, which I expect people will be interested in, just save the questions for a little bit later. They will be available in the second quarter finances.

What I'd like to do now is turn the page to a very specific table on taxes, since I know that this is an important issue and one that I think deserves to be treated very directly here. I know that there are a number of hypotheses around about what drives the underground economy. What I'd like to address right now specifically is the tax issue. Without necessarily commenting directly on the role of taxes in the underground economy, I'd like to show how Ontario stands relative to other provinces.

Do people understand the table? The rank here --

Mr W. Donald Cousens (Markham): Is there a date on that table? What date was it?

Mr Wallace: Up to date; it is accurate as of today.

Mr Cousens: So Canadian Club is $20.95 today?

Mr Wallace: As far as we understand.


Mr Cousens: Normally, I buy it from Gerry, and it's cheaper.

Mr Wallace: Well, then, Roy is going to talk to Gerry.

Mr Gerry Phillips (Scarborough-Agincourt): It's a smaller bottle.

Mr Wallace: So, first of all, we have simply the tax area in the first column. The second column is the Ontario rate. The third column, which is the tricky one, is the rank in Canada. It's only tricky because rank can go either up or down. In this case, "1" means Ontario would have the lowest tax, and then of course the highest and the lowest just to give a sense of the overall range there.

So in terms of the RST, which has been at the same level for some time, Ontario has an 8% retail sales tax. It's the fourth-lowest in Canada, so within the norms. It's substantially lower than Newfoundland and obviously, as people from the west continually tell us, considerably higher than it is in Alberta.

In terms of corporate income tax, again, much the same picture. You see the Ontario rate across.

The PIT rates are of course substantially more complex because they apply to different tax brackets. For the combined, it's in the middle. In terms of lower-income workers, Ontario is the third-lowest. In terms of middle-income earners, we're in a range within that context, from third to seventh. We have the highest or next-to-highest taxes in terms of surtaxes in very-high-income taxes.

In terms of how you interpret the PIT tables, you'll have to ask that of yourselves and of other witnesses. But clearly Ontario is within the ballpark of the rest-of-Canada experience.

In terms of cigarette taxes, and I think this is an important chart in terms of what we'll talk about in a couple of other slides as well, it's simply that Ontario is the second-lowest in Canada. Alberta and Newfoundland again set the boundaries. The tax is $2.04, and we'll talk about that in more specific charts a little bit further on.

In terms of alcohol, on beer we have the lowest; wine, and this is on Ontario wine, we have the second; Canadian Club, we're the third. Again, it tends to be Newfoundland and Alberta that set the boundaries, but just to give you some sense of how we stand in terms of aggregate taxation and in terms of specific tax areas. I guess the bottom line here is that Ontario tax rates are not out of line with other provinces.

One thing that I would encourage you to think about in terms of public policy implications for this is that, as you think about approaches to this, we have to remember that what Ontario might do with its own tax structure would have implications for what happens in other provinces etc, and there is some need for interprovincial comparability.

I'd like now to turn to tobacco taxes. This is much the same thing, just made more specific on a very key area. I think everybody is aware that tobacco smuggling is seen as an increasingly serious problem. It's thought to be most severe in Quebec. It certainly is a trans-Canadian problem. It certainly occurs in every province.

I think the mechanism for this is relatively well understood. Canadian cigarettes are shipped tax-free to the US and then these are smuggled back into Canada. I think people are familiar with the statistics on this area, but export sales of Canadian-manufactured cigarettes to the US have been up substantially. For example, they reached nine million kilograms in the first six months of this year compared to about 1.6 million kilograms for the full year of 1990.

As I mentioned earlier, the taxes have been stable over the last couple of years, so one of the things here is simply that the networks may be becoming entrenched and the distribution channels etc may be building up. So there are going to be some leads and lags in this area of the economy just as there are in any other areas of the economy.

One thing that I would point out about tobacco taxes, and this applies to the other taxes as well, is that there are a lot of jurisdictional and complex issues here.

First of all, border enforcement, as we know, is a federal issue. It's under federal control. Without being overly specific here, I think the mechanism by which many of these cigarettes are coming into Ontario is relatively well known. It's a mechanism over which the province of Ontario does not have any direct control.

Secondly, it's very important to look at the specifics of the chart, and I'll draw your attention to the federal and Ontario shares. It's the second column of the chart. With the federal share of the taxes on a package of cigarettes at 39.5% and the Ontario share at 34.4%, what this means is that the federal taxes account for the largest share of the cost of each carton of Ontario cigarettes. It also means that if Ontario were to reduce its tobacco tax to zero or something approximating zero, it may well be that smuggling cigarettes would still remain profitable. It may well be that not only could cigarettes be smuggled into Quebec and other provinces, but they could even be smuggled into Ontario at a profit.

Of course, we don't know what the smugglers' bottom lines are etc -- you may want to ask further questions about that -- but clearly, there's at least the potential that Ontario cigarette taxes could be eliminated and you would still have some aspects of this particular problem. Again, it points to the underlying complexity of the issue and the notion that clean or easy approaches that would involve only one jurisdiction might not necessarily solve the issue.

I'd like now just to expand on that one more time. Again, I apologize for spending so much time on this specific issue, but I think the tobacco taxes are seen as a real issue and are certainly seen as a symptom of the overall underground economy issue. It's simply that in a provincial comparison, breaking it down more specifically, you can see the ranges, again the main point being that Ontario is actually second-lowest.

What I'd like to do now with my final slide is raise the issue of jurisdiction and talk about this briefly. This is an area that both federal-provincial and international relations fall into quite heavily. I think there's no question that in terms of the issues we raised earlier, every government has some stake in them. In terms of public safety and law enforcement, border control is primarily a federal responsibility. It includes the RCMP, Canada Customs and the Coast Guard as well. Also, public safety and law enforcement are areas of the OPP, the QPP and other provincial police forces and of course municipal police forces as well. As Roy will talk about, this is an area that requires some considerable coordination. We've made some strides in coordination, but clearly it's an area where there are substantial overlaps.

In terms of border integrity, it remains very much a federal area. It also involves, quite frankly, the US federal and state agencies. Much of the cigarette smuggling may not violate US laws or may only incidentally or tangentially violate US laws, but it's still an international issue.

In terms of sales taxes, there are sales taxes set by both senior levels of government, and the collection processes are of course different. As I've talked about with the tobacco taxes, they interplay against each other, but a unilateral move by either group would not necessarily address underlying issues.

In terms of personal and corporate taxes, again, there are overlaps in those areas; and finally, the specific tobacco taxes.

What I'd like to do is just spend a couple of minutes, before I turn it over to Peter Spiro, talking about the main message, which is simply that the underground economy has been very, very hard to get a handle on. The ministry and the government have taken it very, very seriously. We're not giving you specific numbers on this, not because we don't want to but because frankly we don't have reliable statistical evidence on the tax policy side in terms of the losses or, on the aggregate side, in terms of the absolute magnitude of it. As Peter will talk about in a few minutes, the number of studies we have on this area, which is a relatively new area, oftentimes show substantial variation.


The second key point is that it's very complex in terms of tax policy and in these other areas. Not only is it complex in terms of what may be driving the underground economy as to the interplay of macro factors, the interplay of tax factors, the interplay of simply illegal activities existing -- all of those factors will be in there and it's obviously impossible to sort out between them in any reliable statistical sense -- but it's also complicated by the jurisdictional issue and by the fact that you have two and in many cases three levels of government operating within these varied contexts. Even if all three levels of government takes these issues very seriously, we have to recognize that this is something that has to some extent emerged and that the concerns on it are relatively recent. This is the first time, as far as I know, that parliamentary committees have been looking into it etc. I'm not saying it's brand-new, but it is something that is just emerging.

Finally, and this will lead to Roy, it will simply be that the government of Ontario is making a number of steps in this area, and Roy will talk about those later. I don't want to leave that as a main message yet because it's still to come in the presentation, but that is something we'll talk about.

I'd like to turn it over to Peter Spiro now. As I mentioned before, Peter Spiro, in addition to his work with the Ministry of Finance, has I think established a reputation as being an expert in this field, as somebody who has done some additional work with his study on this area and who has also done a substantial amount of research in terms of the literature and in terms of understanding how Ontario relates and how the situation in Ontario relates in both macro terms and in international terms. With that, I'd let Peter speak.

Mr Peter Spiro: Thank you, Peter. I hope I can live up to that introduction.

The Chair: Excuse me, if I could just interrupt for a minute. I certainly want to allow you to continue your presentation until it's completed, before we get into major questioning. However, Mr Phillips has indicated he'd like to make a comment.

Mr Phillips: Very briefly, Mr Chairman, I have a conflict this morning. The Provincial Auditor's in another committee with an area of intense interest to me. In case I didn't get a chance to thank the staff personally for what already is a very professional presentation on very short notice, because the presentation may not be over before I want to leave, I want to thank you. I echo the comments hat you've made, and that is that we're dealing with a new and complicated area with no obvious, easy solutions. I think the committee is very much aware of that and I think we're off to a good start with this presentation.

The Chair: Mr Spiro, if you'd continue.

Mr Spiro: There is considerable international literature on the subject of the underground economy and I want to take you through it a little to give you a sense, even though it is a very complicated issue and one where we can't get any precise measurements, a flavour of the types of approaches people have tried to use to measure the size of the underground economy. On page 11 I've summarized the four main ones. This is not even a complete list; there are a variety of other less common methodologies.

The first one, the survey methodology, can be a useful guide to the scope of the underground economy, especially to public attitudes about the willingness to evade taxes and so on. It's not really a good way to measure the total size of the economy. Some people who particularly resent taxes may volunteer that they don't like them and sometimes evade them, but you won't find that the person who's evading a couple of hundred thousand dollars of taxes is going to come forward and tell the anonymous surveyor that he's done that; he'd be pretty naïve to believe it's not a government spy or something. So it's not a good aggregate methodology although it has some uses.

Another method, which I mention mainly because it's been used by Statistics Canada, not because I think it's particularly credible, is the kind of detailed analysis of the labour force, where they go through and count how many people there are in different occupational groups and then just make guesses about what proportion of people in those groups are likely to be involved in the underground economy. Using this kind of methodology, Seymour Berger of Statistics Canada came up with the estimate that it's something on the order of 2% or 3% of GDP in Canada, which is the lowest estimate for Canada. You'll find that whenever an official government statistical agency does an estimate of the underground economy for its country, it's always the lowest estimate. They don't like to admit that there's some part of the economy which they can't measure.

The third methodology, which is in many ways the most attractive, is one which isn't available for Canada; nobody has gone to the considerable expense of doing it. This is to do intensive audits of a scientifically chosen random sample of taxpayers. This is done once every 10 years by the Internal Revenue Service in the United States. You're probably aware that there's always tax auditing going on, and we have it in Ontario and Canada as well, but the auditors want to get the maximum return for their money ordinarily, so they focus on taxpayers, as Roy will tell you, who are the most likely to be cheating, who have the largest incomes and therefore are likely to provide the largest payoff for the audit effort. That way, you don't get a good cross-section.

What the US Internal Revenue Service does every 10 years is this scientific sampling, where it even focuses on very small-income people, people with very low incomes who ordinarily would not be audited. It tries to dig around for all kinds of people engaged in part-time gardening and who knows what else who have never even filed a tax return. You may question whether they can really do that, but anyway, they attempt to do it. I'll get into that in a bit more detail shortly.

The fourth methodology, which is the one which is most widely used and most widely available for Canada as well, is to analyse the amount of cash in circulation relative to other financial magnitudes. The logic of that is that people engaged in the underground economy almost always use cash because it doesn't leave an audit trail. There is some talk of people involved in the underground economy using barter. My hunch is that that's not a very large part of the total. There's no particular advantage to bartering if you're in the underground economy. Cash is always much easier to use than to find somebody else who has what you want. It's like the story that barter is where the naked farmer has to find a hungry tailor, that kind of thing. So you occasionally find that, but it doesn't occur that often.

To give you a sense of how uncertain the measurement is, the table on page 12 has a survey of studies from a wide variety of countries, from a recent book by somebody named Dallago. You can see this isn't completely comprehensive; for example, for Canada he only found two studies, whereas in fact there are quite a few more than that. But if you look at the per cent of GNP and the low and the high column for some of the countries, there's an incredible range. If you look at Italy, where 18 studies of the underground economy have been done, the low range is from 6% of GNP whereas the high estimate is up at 30% of GNP.

Incidentally, the Italian government a few years ago officially declared it to be 18% of GNP, and it consequently revised up its official GNP. So if you ever see data that shows that Italy has dramatic productivity in economic growth in the 1980s, you may question that. It's just because they decided to add back this 18% which they assumed wasn't in there before.

For the United States there have been a lot of studies, 15 in total, that range from 1.4% to 33%. You might throw up your hands when you see numbers like this. You'd say this must be completely worthless if people give such widely varying estimates. There's something to that. I'd like to think that when you look at these studies and evaluate them logically, you can pick out ones that are more reasonable than others, and that gives you some ability to narrow this range down from the very wide range displayed in this table. Nevertheless, even when you do that, I would admit that there's a great deal of uncertainty around it.

Chart 13 does attempt to do this. It's partly based on a recent article in the Economist magazine which focuses in on recent, credible studies for different countries and gives you a sense of the size of the underground economy in different countries as a per cent of GDP. This term the "black economy" is an unfortunate term. It apparently is the British term for the underground economy, so we just copied it from them. You can see again the perception that Japan and Switzerland are at the low end of the scale, essentially have the most law-abiding populations, whereas some of the warmer countries of Europe have a much higher degree of tax evasion.

I want to focus in a bit on the US Internal Revenue Service audits which I referred to earlier because I think they are among the best studies of their type. Unfortunately, there's nothing comparable available for Canada. The middle part of this chart shows the results of their latest audit, which was done in 1989. Based on their random sample audits of different types of taxpayers -- or non-taxpayers, I guess is perhaps the more appropriate term -- for the category that's referred to as informal suppliers, 89% of their income was not reported to the tax authorities. Informal suppliers are the people who work part-time doing home repair, shovel snow from your driveway, do gardening, things like that, so very small-scale businesses that don't have a fixed place of business, just sort of operate out of a truck or something. For that group, only 11% of their income was reported to the tax authorities in the United States.


Turning to small businesses that do have a settled place of business, the sole proprietors, which would be like very small retail establishments and so on, 52% of their income was reported to the IRS, meaning 48% was evaded. For small business corporations 40% of the income was reported; for business partnerships 30%; for rental income 17%. Again, these studies do seem to be fairly carefully carried out. Some people are sceptical whether even these can be accurate. Even when audits are carried out, there's certainly always a disagreement between the person audited and the auditors as to what's the correct value. Some of the techniques involved are fairly esoteric, so there's a margin of error here too, although one would hope that it averages out when you have a large sample like this. They do 55,000 audits, I believe, in order to get these results.

It's hard to say to what extent these particular US values are appropriate to Canada. Obviously, we have some similarities in our economy. On the other hand, the US economy is always considered to be a little bit less law-abiding and more freewheeling than the Canadian economy. These auditing results incidentally imply that the underground economy's at least 8% of GDP in the United States. That, of course, may still understate it considerably, because obviously tax auditors are not going to be able to successfully get hold of people involved in drug trafficking and illegal immigrants and so on.

The next chart looks at the question of, to what extent does the level of tax rates contribute to tax evasion and the size of the underground economy? That's a subject that's much less well known than one might suppose. Economists have all kinds of empirical estimates of virtually everything under the sun, so you would think there'd be dozens of estimates of this around also, but in fact there aren't.

In fact, the only really good empirical study of this is by somebody named Charles Clotfelter of Duke University, who used to work for the IRS. He used this data set I was just referring to. That's really the reason it's so hard to do an empirical study of this: In order to know how much tax rates affect tax evasion, you have to be able to correlate tax rates with the amount of tax evaded. Clotfelter had access to this detailed Internal Revenue Service data set of the amount of evasion by different people at different income levels and in different types of businesses, and he correlated that, using statistical techniques, with the tax rates faced by the different individuals. He had actual individuals, a set of thousands of individuals, the percentage of income they evaded, and he had the information on the tax rates they would have been paying if they had voluntarily reported their incomes.

What he found out was quite interesting. There is a statistically significant relationship, but what's called the elasticity is relatively low; in fact, he estimated it to be something on the order of minus 0.2%. So if tax rates in the United States had been cut by 10%, he estimated, then it would have led to a 2% increase in voluntary reporting of income by taxpayers, so in effect you would have a large revenue loss. You would have some additional honest taxpayers or people who would be slightly more honest, but the increase in honesty as a result of this would be far offset by the revenue loss, due to the fact that of course everybody's getting the tax cut, not just the people who were previously evading their taxes. So he decisively ruled out the supply-side Laffer curve type of notion that a cut in tax rates would actually lead to an increase in revenue, and it should be pointed out that at the time that he was doing the study, US tax rates were quite high. It was based on the time when the top marginal tax rate in the United States was 70%.

That brings us to the interesting issue of which kinds of taxes are more relevant to the size of the underground economy, which one drives people more into the underground economy. Is it marginal personal tax rate? Is it overall taxes and so on? Again, one can't really be very categorical about it, because the data just aren't terribly good, but with some of the monetary studies that have been done, as I'll mention, the technique they use is that they do a statistical fitting between the amount of cash in circulation in the economy relative to total measured expenditure and the tax rates.

They found that average tax rates for the economy were more relevant than the top marginal personal tax rate. The explanation for that would appear to be that the types of people who have the greatest opportunity for engaging in the underground economy are people in relatively small businesses. They're people who, even if they were to fully pay up all the taxes they owe, would not be in the top tax brackets. They're people with relatively low incomes. It's sort of the middle range of taxes that's more relevant for that. Conversely, the people who have high marginal tax rates, the people with the highest incomes, tend to be highly paid professionals and executives who just don't have the same scope for engaging in the underground economy, for one reason or another.

The next two pages contain charts which combine information from the chart that was shown earlier, mainly the Economist magazine's estimates of the underground economy as a percentage of GDP in 14 developed countries, and correlate it with these different measures of taxation. The first chart, on page 16, attempts to correlate the size of the underground economy in each country with the top marginal personal income tax rate. As you can see, it's a very rough scattering. There's really not very much correlation. Japan has the highest marginal personal tax rate at 75%, and in spite of that, most people who've looked at Japan believe it has a very small underground economy.

Turning over to the next page, you get a somewhat different picture, and this ties into what I said earlier. You can see that Japan, although it has a very high marginal tax rate for the highest income earners, has quite low taxes for ordinary working people. Total taxation in Japan amounts to only about 30% of GDP, in spite of the very high top-end tax rate.

Again, even in this diagram there is no perfect correlation between taxation as a percentage of GDP and the estimated size of the underground economy, but this is clearly because of the setup for outliers, the southern European countries, where tax evasion is considered to be much greater. If you leave those out, you can see that there is a tendency for higher taxation as a percentage of GDP to be associated with increases in the underground economy. You have to take this with a considerable grain of salt because just simply the measurement of the size of the underground economy in each of these countries covers a very wide range. Here we've picked the middle of a range.

Turning to the next chart and the main method that's being used in Canada to estimate the size of the underground economy, this is the monetary methodology. Within this broad class, there are a variety of subgroups. The first one is what's called the transactions approach, which is still sometimes used but I would say is, on the whole, somewhat discredited. It gives extremely large, implausible estimates, and it's based on a very questionable methodology which essentially takes some base year back in the 1930s, when they assumed there was no underground economy. It looks at the total volume of financial transactions and assumes there is a fixed relationship between financial transactions and the size of the total transactions.

With this methodology in Canada, you get a value of the underground economy of about 22%, which seems implausibly high. In the US, one researcher using this methodology has gotten an estimate of, I believe, as high as 33%. The logic of the methodology is fairly dubious, because it does assume that over decades there's an absolutely rigid relationship between financial volume and actual transactions in the economy, and the numbers themselves are very hard to believe.


The second one mentioned here, the currency ratio approach, seems intuitively more plausible. It was pioneered by Vito Tanzi of the International Monetary Fund, and it's the one that I referred to a bit earlier where he actually looks at the ratio of cash in circulation relative to some other measures in the economy and correlates the changes in cash with changes in tax rates.

The implications that Tanzi found for the United States again have this corroboration because it yielded estimates for the size of the underground economy which are quite similar to the ones that derive from the Internal Revenue Service studies. So that gives a considerable degree of comfort around it, although his studies actually were done quite a number of years ago; they only go up to around the late 1970s.

A number of Canadian studies have adopted this methodology. The most prolific researchers on this are Professors Mirus and Smith of the University of Alberta, who have done a number of studies over the past two decades, the most recent one just this past August. Back when they studied this in the distant past, using Tanzi's methodology, they found that in the mid-1970s the underground economy was only about 7% of GDP in Canada. Repeating this same type of study more recently, they found that by 1990 it had risen to 15% of GDP.

Again, 15% is certainly not out of the question; I would question it. One of the biggest shortcomings and problems of this particular methodology is the speed at which money recirculates, which is called technically the velocity of money. Basically, when a person gets a certain amount of cash he has it for a while and respends it, so the money is circulating through the economy fairly rapidly. The measurement for it in Canada is essentially that every dollar, if you take the ratio of gross domestic product to actual cash outstanding, turns over 21 times per year.

Mirus and Smith have implicitly assumed that this rate of turnover of cash is the same in the underground economy as in the aboveground economy. That is a very questionable assumption because obviously in the aboveground economy, people get cash, they do use cash for very small transactions, but most of the time they use credit cards, cheques and so on. When somebody receives his income, a person who is employed by the government or whatever, and gets it deposited in his bank account, he never even sees it in the form of cash. To the extent that you can afford to save any of your income, you have it in a savings account on which you earn interest; you might buy mutual funds for it and so on. So you don't use cash as a store of wealth, effectively.

However, when somebody in the underground economy is prosperous and his income is greater than his expenditure and he wants to put aside something for his old age, then he has to keep it in a safety deposit box in the form of dollar bills, hundred-dollar bills, thousand-dollar bills, whatever, in the safety deposit box.

There is also the phenomenon known as money laundering, where they try to transfer this cash and get it into what looks like some legitimate form of income, preferably one that has a lower tax rate, like capital gains or something. So eventually they perhaps do succeed in laundering some of the money, but obviously it's going to take longer. So the velocity of circulation of cash in the underground economy is clearly slower than in the aboveground economy; we have absolutely no way of knowing how much slower.

So for that reason, I would say that the estimate by Mirus and Smith of 15% of GDP for the underground economy is more like the high end of a range estimate, and I could see the plausible range for the size of the underground economy, based on monetary studies, to be about 8% to 15% of GDP in Canada. That's unquestionably an extremely wide range, which, on the one hand, one might say is not a very useful guide. But I would say what we can say with a considerable degree of confidence is, whether it's 8% or 15%, it's very substantial; 8% of GDP is very substantial; 8% of Ontario's GDP is $22 billion. So it's large, no matter how big it is. The absolute size doesn't really matter, because we know that no matter how hard we try we're never going to find all of it. It's not there for the picking. It's not really a cash cow that we can tax, because we're never going to locate all of it. Some people are always going to be able to get away with it.

We can say with a reasonable degree of confidence that it has gotten larger. The underground economy as a percentage of the total economy has gotten larger over the past decade and a half at least and, especially in the last few years, there has been an increasing amount of evidence of growth in the size of the underground economy. That's some research I've done myself, including an article recently in the Canadian Tax Journal.

One of the things that I believe has triggered substantial growth in the size of the underground economy recently is the introduction of the GST, along with the recession, which Peter Wallace referred to earlier. Both of them have been important factors in the past few years. With the GST, it's been a completely unpredictable, one might say, and unusual psychological reaction that's out of proportion to the size of the tax. The federal government tried to make the case that it was even revenue-neutral, that it wasn't raising any net amount of money, that it was just replacing another tax.

One can quibble about that, give or take a few billion dollars, but to a substantial extent that was true. Somehow it really struck a nerve with the public. Perhaps they were unaware or didn't believe it was replacing another tax, but in recent history, no tax move has generated as much resentment. A recent Toronto Star poll showed that 91% of the Toronto Star's readers attempt to cheat on the GST. Obviously, for the Globe and Mail it would be less, but still it's a substantial percentage of the population.

From the point of view of businesses -- service providers, home renovators -- there's always been a big incentive to evade taxes because there's a large chunk of income tax they avoid by doing so. Before the GST had become such a focus for resentment they might have faced some hostility from the public, who felt this wasn't a legitimate thing to do, but the resentment of the GST has to some extent made the public more eager to go along with the vendors who attempt to work in the underground economy.

Again, from the point of view of auditing and enforcement, the GST is clearly a much more difficult problem. The bulk of manufacturers' sales tax was related to 75,000 taxpayers. I've seen various estimates for the number remitting the GST -- from one and a half million to two million. It's hard to believe there are two million businesses in a country of 27 million people, but some people claim there are that many.

The federal government tried to claim at one point that the GST would actually reduce tax evasion because of the paper trail. The person who buys inputs from a supplier gets to deduct the GST that he paid on the inputs from the GST that he remits to the federal government. That is not likely to be a major factor, because most businesses already wanted receipts from the point of view of their corporate tax and so on.

What does change is that for all the businesses that sell to the final retailer, of course, there's no advantage there to having a GST receipt. For all the businesses where there's a large markup between the inputs and the sale price, which essentially include all services, the GST has increased the incentive to evade taxes.

The methodology I use for estimating this is shown on the next slide, page 20. Looking at the ratio of cash balances, that's total cash in people's pockets and purses, in the cash registers of businesses, and the ratio of that to reported consumer expenditure. It's shot up dramatically starting exactly in the first quarter of 1991, when the GST was introduced.

The ratio of cash to total expenditure has been declining steadily since 1953, which is as far back as we have data on it, and that's because people are no longer paid in cash. If you go back to the 1950s, a lot of people would get their pay in cash and that's why you had payroll robberies. You never hear about payroll robberies any more because everybody's paid by cheque or even direct deposit into their bank accounts.


There are credit cards -- that's a big phenomenon -- all kinds of financial innovations, daily interest chequing accounts and everything, that reduce the incentive for people to carry cash around with them; automatic teller machines, which means that if you run out of cash you can get more any time of the night or day so that, again, you don't have to take out a large amount of cash when you get paid or anything.

This has been declining very steadily for four decades or so and all of a sudden in the past two years you've had the biggest increase in cash outstanding, as I say, in the 40-year history for which we have these data. There is a bit of a problem in imputing from this how much the underground economy has grown because, along with this happening, we've also had declining interest rates. When the interest rates that people receive on their bank deposits are lower, people who get cash aren't in such a hurry to rush to the bank to deposit their money to earn interest. It's not likely to be a big phenomenon because people don't like to have large sums of cash around, unless they're in the underground economy, just from the point of view of security purposes. That does create some problems.

There are a variety of statistical problems in imputing this directly. I've used a fairly modest estimate which, as of mid-1992, showed about a 0.8% increase in the size of the underground economy as a percentage of GDP. Since then, to the middle of 1993, that amount has virtually doubled again. That would imply that since 1991 the increase in the underground economy has been something like 1.5% of GDP. Some other people who've looked at this data suggest it's even more. There's a great deal of uncertainty. Generally, I find I'm at the conservative end of the estimates on this, the low end of the estimates. I see Mr Cousens smiling at that term.

Mr Cousens: You don't hear that word too often any more.

Mr Spiro: Because of this problem, especially when you've had a big increase in the underground economy, a lot of the people who have received cash will be hoarding it. It's not necessarily all an increase in transactions; it may just partly reflect the fact that the people who've entered into the underground economy are hoarding more of it. There's a great deal of uncertainty about how large it is, but it is large. It's a significant problem and it's an increasing problem. With that, I'll turn it over to Roy Lawrie.

Mr Lawrie: I thought the committee might well run into some definitional problems with the term "underground economy," so I start with my own understanding of the term as a tax administrator rather than as an economist. As you'll note, this is a broad definition including all forms of non-compliance with tax statutes except unintentional errors. The reason I have included failure to pay in the definition is that tax revenue isn't counted in the public accounts until it's deposited in the consolidated revenue fund, so unpaid tax debts, particularly if they are on the rise, contribute to the province's deficit in current circumstances.

To the extent that these debts have been collected from the public, as in the case of retail sales tax, but not remitted by vendors, they are obviously being put to other uses which are not authorized by the statute.

The second slide deals with collections and shows the accounts receivable for the largest sources of tax revenue administered by the Ministry of Finance. The largest source of provincial tax revenue is of course personal income tax, which is run by Revenue Canada under the tax collection agreement. As you'll note, there's been a considerable rise in retail sales tax and corporations tax accounts receivable in the three years since the effects of the recent recession started to show.

The government's response, announced by the minister in his 1993 budget, was a resources-for-revenues program known as Project Fair Share. The program consists of about a one-third increase in the collections and audit staff of the ministry, designed to improve the enforcement of existing tax law. There were two other thrusts to Project Fair Share: a loophole-closing and enforcement powers initiative, and a new publicity policy for those convicted of tax evasion, which I'll cover later in the presentation.

The additional 43 collection staff are now all on board, the positions having been filled entirely from surplus lists arising from the government's downsizing initiatives. A small number are still in training, but the new staff have already brought in over $3 million, principally in retail sales tax unpaid accounts.

The ministry is currently midway through a six-year program to re-engineer our computer systems. The program was needed to replace the existing statute-based mainframe systems, particularly the corporations tax system, which is over 25 years old and which now requires some manual processing for over 50% of its workload. The main impetus of the re-engineering was to cope with rapidly increasing workload, a 40% increase over the last four years, in the face of constrained resources.

The program has already paid off in terms of policy flexibility with the announcement of health tax for the self-employed in the 1992 budget and this year's announcement of the corporate minimum tax, neither of which would have been possible with the existing systems.

We're in the process of establishing a functionalized collections branch. Collections activity used to be statute-based, and each of the four tax branches had its own collections officers. As part of our re-engineering project, collections staff will all report to a collections director and their operations will be consolidated into six locations across the province instead of the present 14. A new, fully automated collections system is nearing completion, and the transition should be essentially finished by the summer of 1994.

The consolidation of collections operations has allowed us to increase staff-to-supervisor ratio substantially, thus improving cost efficiency.

With respect to other jurisdictions, we have border collection agreements for provincial taxes with Canada Customs with respect to tobacco tax, alcohol levies and importation of motor fuels by non-registered importers. We already have salvage agreements with Revenue Canada with respect to bankruptcies and insolvencies and expect these to be extended to cover GST and health tax in the near future.

A recent example of cooperation with another government agency was finalized with the Ontario Liquor Licence Board in July of this year. Section 6 of the Liquor Licence Act requires the licensee to be financially responsible in the conduct of his or her business affairs. The board has interpreted this to include compliance with the Retail Sales Tax Act.

Although licensees make up approximately 12% of the retail sales tax vendor tax role, they account for about 20% of delinquent payments. The old system involved a board hearing once an RST warrant had been lodged with the sheriff, at which time the licence could be revoked or suspended pending compliance. Although it was eventually effective in most cases, it was slow and very time-consuming.

In August, the board introduced a new system which requires an RST compliance certification issued by the Ministry of Finance prior to renewing, transferring or granting a liquor licence. Licensees with outstanding taxes can enter into a repayment arrangement filed with the board, adherence to which can become a condition of the licence.

In the two months since the introduction of the procedure, the collections branch reports over $2 million in delinquent tax placed under collections arrangement and nearly $300,000 actually recovered. In a full year, we expect the new procedure to result in the collection of at least $10 million in delinquent retail sales tax.

Late filing and late payment penalties are inconsistent across statutes. In some cases, for example retail sales tax, the maximum penalty was not enough to encourage timely payment by large remitters. In the 1993 budget, the minister announced his intention to standardize such penalties across statutes. The new penalties will consist of 5% of the tax due by taxpayers, for example corporations tax, and 10% of tax collected, for example retail sales tax. Small penalties will not be assessed, and there will be no maximum penalties. If approved by the Legislature, these new penalties will bring these deterrents in line with other jurisdictions such as Revenue Canada and Quebec.

Also announced in the 1993 budget, the government proposes to introduce registered liens on real and personal property of tax debtors to assist in collections. The 1992 changes to the federal Bankruptcy Act removed the provincial crown's preferred creditor status in bankruptcies. The proposed lien provisions across all statutes will give provincial tax debts secured creditor status in such cases. Since clear ownership cannot be transferred when an outstanding lien is present, the liens are expected to assist collections in non-bankruptcy situations as well.


Finally, daily compound interest on unpaid tax and also on refunds across statutes is also proposed in order to encourage prompt payment, and again this would bring us in line with other jurisdictions.

The quotation on my third slide is from the 1990 report of the Auditor General of Canada, and it explains the rationale for tax audits. Putting it slightly differently, aside from recoveries resulting directly from tax audits, indirect revenue is generated through increased taxpayer compliance induced by perceived prospects of detection through audit activity. The higher the level of audit coverage, the greater the taxpayers' awareness that they may be detected if they don't comply fully with the law.

The statistics for audit recoveries per audit tend to confirm that voluntary compliance has declined in recent years. The trend of increasing average tax recovered per audit is expected to continue in the current fiscal year, as our audits, particularly on corporations tax, lag well behind current filings.

An additional 107 audit positions were funded under Project Fair Share. Three quarters of these positions have been filled through OPS recruitment, including some assignments off the surplus list. However, as professional accountants are required for the remaining positions, external recruitment is planned for the balance.

There have been very few studies of the effects of tax audits on voluntary compliance. Probably the leading paper is one by US professors Dubin, Graetz and Wilde which appeared in the December 1990 issue of the National Tax Journal. The paper studies the effect of a dramatic decrease in IRS audit rate of individuals for US federal income tax over the 10 years 1977 to 1986. The audit coverage rate declined from 2 1/2% to just over 1% over the 10-year period. The study concludes that had the 2 1/2% rate been maintained, additional direct revenues of $2.6 billion would have accrued, with additional indirect revenues of $15.6 billion over the period, a ratio of six to one. The combined effect would have increased total reported taxes by about 4.6% over the period, far exceeding the savings and administrative costs achieved by the cuts in IRS resources.

Similarly, there appears to be little research on the ideal level of audit coverage. The Provincial Auditor, in recent audits of the corporations tax and retail sales tax branches, has suggested a 5% rate as a worthwhile target. While seeing no reason to disagree with this figure, we feel it requires modification for certain other factors.

For example, under exchange-of-information agreements we receive details of audit adjustments made by Revenue Canada to the income tax returns of corporations. With a limited desk audit of capital tax and provincial tax incentives, we use this information to issue corresponding reassessments of corporations tax. The arrangement is reciprocal. We're currently negotiating a similar one in respect of employer health tax and Revenue Canada's payroll audits. Eventual exchange of audit information on health tax for the self-employed and retail sales tax vis-à-vis their federal equivalents have also been discussed. I should point out, however, that due to differences in tax base, particularly in respect of GST and RST, audit information exchanges have less value than in the case of corporations tax, where the tax bases are almost identical.

With regard to improved methodology, we planned the use of CAATs, or computer-assisted audit techniques, as part of our re-engineering project. We have also experimented with joint audits of large corporations in the Toronto area with Revenue Canada. A reciprocal arrangement to review each other's audit working papers prior to audit also exists so that duplication of audit effort is avoided. Finally, we intend to carry out a pilot project of combined retail sales tax and employer health tax audits once we've gained a year's experience in audit of payrolls.

It's a common saying in tax administrations that the best way to evade taxes is not to join the tax-paying club in the first place. While some of the underground economy involves underdeclaration of income, second job paid in cash, that type of thing, or underdeclaration of taxable sales, particularly where there's a high volume of cash sales, non-filers are also a significant part of the underground economy.

The employer health tax branch was recently authorized to establish an identification and compliance group. The duties of the I & C officers will be to identify those who should be on the tax roll for any of the taxes administered by the ministry and require compliance under the enforcement powers of the statutes.

The main way in which they'll achieve this will be to cross-check our tax roll with various third-party data sources, some of which are named on the slide. We've discussed an exchange-of-information agreement with the Workers' Compensation Board, the Liquor Control Board of Ontario, the Liquor Licensing Board of Ontario and with Revenue Canada excise branch in relation to GST. We anticipate the tax roll comparison will result in identification of non-filers for all parties involved.

I & C officers will also make field visits to businesses to ensure compliance. Retail sales tax branch carried out a compliance blitz in selected areas of the province in 1987-88, visiting all businesses in restricted areas to determine whether or not they were on the tax roll. Compliance was slightly over 99%, and the subsequent non-filers who registered as a result remitted about $750,000 in back taxes.

To illustrate the administrative dilemma involved in enforcement actions like this, if instead the resources involved had been devoted to audits of vendors already on the tax roll, direct recoveries would have been five times greater. Clearly a balance must be struck between audits, which have demonstrable results in recovered revenue, and identification action, with less tangible, indirect effects on the integrity of the system.

Lastly, we're interested in the extent to which we can dovetail our I & C efforts with similar compliance work done by Revenue Canada, as there appear to be cost-efficiency gains for both administrations.

The top quotation of the next slide is from a 1991 paper to the Fair Tax Commission by Professor Kesselman of the University of British Columbia. As you may know, it's an extension of the rationale already discussed under "audit" in relation to audit coverage.

The second quotation is even more pointed and again comes from the Auditor General's 1990 report on Revenue Canada taxation, which was critical of that administration's prosecution publicity policy.

In February of this year, Mr Laughren approved a new policy to publicize convictions for provincial tax evasion, failure to remit taxes collected, and fraud associated with grants, tax credits, refunds and rebates. Press releases containing factual statements of evasion cases are distributed on the day of conviction in the courts. Cases selected for publicity include those where the evasion totals over $10,000, cases involving fraudulent practices known to be common or widespread, and those that are newsworthy because of unusual tax evasion schemes.

The purpose of the new policy is to act as a deterrent to those who are tempted to defraud the government, as well as to reassure honest taxpayers that they aren't expected to pay for the dishonest activity of a few. In the eight months since the introduction of the new policy, the number of informer calls to the ministry has increased by 293% compared to the prior eight months. The press releases were not at all designed to encourage informer calls. This appears to be a spontaneous reaction. The message that cheaters cheat us all has apparently struck a chord with the public.


The minister has also approved an annual tax enforcement bulletin which will contain general descriptions of convictions and sentences imposed under ministry statutes or the Criminal Code. Names will not be published in the bulletin and specific locations will be given only if the offence occurred in a city with a population of over 100,000 people. The purpose of these limitations is to prevent convicted individuals from a second round of media attention. The first such bulletin will be released in the near future.

A change in the ministry's voluntary disclosure policy has also been made. Voluntary disclosures will now involve payment of outstanding tax and interest only, with no civil penalties for late payment or late filing. Reasonable arrangements to pay over time will also be accepted. With the proposed increase of late filing and late payment penalties to a flat percentage of the overdue tax, it was felt that their imposition would discourage disclosures. In order to be fair to honest taxpayers who pay on time, interest will still be charged on voluntary disclosures.

A final statistic on tax evasion cases again points to an increase in non-compliance. Four years ago, a case of retail sales tax evasion involved $19,000 in tax on average. Last year, the average was $84,000.

Mr Cousens: Say that again; sorry.

Mr Lawrie: Four years ago the average tax in a retail sales tax evasion case, the average tax evaded was $19,000. Last year it was $84,000 on average.

The final slide is a summary of the most important anti-underground economy measures announced in the last five provincial budgets. The measures listed under 1993 are still proposals at this stage, with the associated legislation still to be debated in the Legislature. I've referred to many of these measures in my presentation, but I'd be pleased to answer any questions members of the committee might have about specific measures.

The Chair: Thank you very much for your, in my opinion, very comprehensive presentation. If I may, something just came to mind as you were speaking, when Mr Cousens asked you to repeat the average evasion case in dollars. Do you have the numbers of actual cases so that we could compute a total value on those evasion cases?

Mr Lawrie: I don't have the total amounts of tax evaded in each case, but there has been a rise in the number of convictions over the last three years. Charges laid in 1990-91 were 53, about the same in 1991-92, and last year went up to a total of 77, which is a 50% increase. The number of convictions has also been rising steadily over the last three years. It's gone from 44 in 1990-91 to 67 in the last fiscal year. Incidentally, you haven't asked this, but voluntary disclosures have also gone up. There's been a 25% increase last year over the previous year.

The Chair: Thank you very much. We have probably about 20 minutes left, or maybe 25. We'll divide the time evenly between -- Mr Sutherland?

Mr Kimble Sutherland (Oxford): I just want to ask first, I don't know whether we have it down on our agenda as to whether staff would be coming back this afternoon or whether they're available to come back this afternoon. I think originally we had anticipated about an hour presentation, but we're very thankful for the very detailed and thorough information we have here. I'm just wondering about getting a sense from the committee as to whether they may like that to occur, and whether they want to start questions now or whether they may want to wait for now and start questioning this afternoon when the committee reconvenes.

The Chair: Thank you, Mr Sutherland. That poses two questions. First of all, would the committee members like to have the staff back this afternoon? The question that would follow that of course is, are they available? To the committee members, would you like an opportunity for further questioning this afternoon?

Mr Cousens: I would support what Mr Sutherland is saying. You get into it now -- it's been an excellent presentation, and if they're available to come back this afternoon, why not come back for a couple of hours this afternoon?

The Chair: Is the staff available?

Mr Wallace: We'll be guided by your wishes.

The Chair: Am I hearing the committee members correctly, then, that you would like to adjourn at this time and then come back?

Mrs Elinor Caplan (Oriole): Mr Chairman, as I'm not going to be able to be back this afternoon -- I've a commitment actually out of town in London -- I'd like to ask a couple of questions before we adjourn. I won't take long.

The Chair: Very well.

Mrs Caplan: The questions that I would like to ask relate to some of the data and the surveys that are available that you've alluded to, and also there was an article in Maclean's magazine which quoted you, Mr Spiro, and the quote says, "I hesitate to talk on this subject because the data shows that the more people become aware that other people cheat, the more they cheat." I'd like to ask you if you could expand on that statement a little bit, and also what data or studies were you referring to when you said "the data shows"?

Mr Spiro: I might as well start with the second part first. There is quite a variety of studies that have been done, including some by psychologists and sociologists. Among other things, they use two methodologies.

One, they do the survey-type thing, where they ask people, "Do you cheat? What prompts you to cheat?" and so on. They even go to the extent of having university professors use their students as guinea pigs, where they give them monetary rewards, where they play these games and there are various ways in which they can come out with the biggest monetary reward, so they have this incentive to try hard and so on. They rig this thing so as to change conditions, including the perception of fairness of the tax system, the perception of, "Are other people cheating?" and so on. They sort of feed different individuals in the test different pieces of false information to change their behaviour and so on.

Both types of studies come out fairly strongly with the conclusion that people are more inclined to cheat when they think the tax system is unfair; among other things, that people pay different rates of taxes unrelated to the benefits they get back and so on. Of course, that's the problem and the researchers emphasize this, that fairness is in the eye of the beholder. A low-income person may think it's fair for a high-income person to pay a higher percentage of tax, whereas the high-income person may think just the opposite. So there's that aspect of it.

Again, there's the notion of, if people think they're getting value back from the government, they're more likely to pay up. But one of the things that's revealed in this is that if they think other people are not paying their fair share, especially through cheating but also partly if they think the tax system is unfair, then they are more inclined to cheat themselves. So there is a considerable amount of sociological-type evidence in this regard in the behavioural motivations.

As to the quote in Maclean's magazine, that's what that refers back to, that these studies have found this kind of thing, that once people find out it's widespread, they're more likely to engage in cheating. I guess at this point, whether I spoke about it or not, Maclean's was going to do a cover story, so I don't think it made a lot of difference.

One could ask that about whether this committee should be doing this and providing more publicity for it. But I think by now it's a fairly widely known and widespread phenomenon. It's had quite a bit of media attention in the past couple of years. So I don't think at this point we're going to tip the balance for too many people. I don't think at this point it's a major concern.

Mrs Caplan: One of the requests I'd like to make is that we've asked the research person, Ms Campbell, attached to and supporting this committee, to do a literature review and to determine what studies might be available if committee members were interested, and perhaps you could provide her with the names of the studies, I think it would probably assist her in her task. The committee would appreciate that.

Mr Spiro: By all means.

Mrs Caplan: I'm particularly interested in the psychological and sociological studies as opposed to the empirical studies.

Mr Spiro: Yes. The Ministry of Finance library has a book entitled The Psychology of Taxation, which goes into this kind of thing, with all the abstruse psychological terms.

Mrs Caplan: I know there have been a number of books written. There's one that I'm thinking of -- the name escapes me -- which is the history of taxation and public response to it, and public behaviour and what happens when people lose faith in either government policy or value for money. I think it would be helpful if the committee at least had the opportunity -- if I can remember the name of that book, I will also give it to the researcher.


I think we have a lot to learn. Frankly, I have some concerns about the general list of avoidance initiatives that you have at the back, because when I compare that to the graph of what's happened to tax revenues, I think there's a very large question that perhaps we don't have the answer to, but I would like it if you could -- on page 6, the graph shows that for a number of reasons, over the 1980s it seemed that tax revenue and nominal GDP lines trended in fairly close proximity to each other. There were ups and downs for a number of reasons.

Then around 1991-92, when you saw that very large drop in revenue, in fact it didn't trend with the line of GDP. All of a sudden, the differential between nominal GDP and tax revenue lines, at a time when government was significantly increasing the overall tax burden -- we actually see a very large difference between the tax revenue line and the nominal GDP, for which I think we have to look for an explanation. You say it isn't all underground economy or cash economy or avoidance. I'd like to know how you explain that difference, particularly not only the absolute difference but the difference in relation to the two lines on the other side of the graph.

Mr Spiro: It's something we're actually attempting to study. It's extremely complicated. I don't say that as an excuse but there is, as we said earlier, evidence that the underground economy has increased, but at the same time this is the deepest and most prolonged recession since the 1930s. If you look, for example, at corporate profits as a percentage of GDP, in 1991 they went to their lowest percentage of GDP since 1932. We're trying to dig up data on it, because the income tax data come to us from the federal government and they come with a lag and it's a very difficult database to work through.

There is a perception that high-income people have suffered greater relative income losses in this recession than in previous recessions; all the phenomena of layoffs at high or white-collar levels, and generally investment and business losses. It's very hard to sort out for that reason.

As I say, we're just starting to work on this database. Once we've had a chance to sort through this database, we'll have a better sense, because a large part of it is this structural change in the distribution of income, particularly related to the recession, that if you have corporate profits going down phenomenally, if you have the incomes of higher-income people who pay the relatively higher tax rates going down more, then you would expect the revenue to fall more than GDP. In that sense it's not surprising that revenue has fallen more than GDP in this recession. We just don't know to what extent the recession can account for that and to what extent other factors, such as the underground economy, might.

Mrs Caplan: For anyone who's following this or at some point reading Hansard, what I was comparing on the graph on page 6 of the ministry's presentation was the differential between nominal GDP, which stayed above the tax revenue line during the period of 1982-83 to 1984 -- you see a differential there which looks reasonable. Nominal GDP did drop and we know that was because of the recession that was experienced and the differential on the taxes.

Then all of a sudden we cross the line, is the only way I can describe what you see on the graph, somewhere in 1991, and all of a sudden there is not only a huge drop in revenue but in the relationship of the revenue to the nominal GDP. I'm glad to hear that you're studying it, but I think it has enormous implications for public policy. I'm wondering, as we're sitting here discussing attitudes and behaviours of people crossing the line between legitimate avoidance and evasion, are the two words, whether you share my concern about what is happening on that graph.

Mr Spiro: We are very concerned about it, no doubt about it, but again it's something that we have to study before we can really know what's going on with it.

Mr Wallace: I'd like to echo Peter's comments and say that we are very concerned about it.

I just want to make a couple of comments about the correlation. It's not the first time the lines have crossed, so the correlation is in many respects imperfect. Remember, there are tremendous leads and lags involved in this relationship. It's a very complex relationship.

The other thing that I'd really like to emphasize, and I think I mentioned it in the presentation but just to reiterate it, is that the structure of the Ontario economy has changed a lot during that period. If you lose a quarter of the manufacturing employment, all of which is good, high-wage, steady jobs taxed at source etc, and that's being replaced by other types of employment, with long lags, with people on unemployment or drawing other sources of income through that, you're going to get a real skewing, not necessarily of the traditional relationships between the economy -- in other words, the economy may still be fundamentally driving the revenue numbers, and in fact it may be driving almost all of the revenue numbers. It's just that different aspects are driving it and it's the changing nature of the economy that may well be very near a full explanation.

The other point I'd point out is that there's no question that the underground economy, at least our sense of the underground economy, has increased. Whether or not it's increased sufficiently -- remember, this is a marginal change on top of an already existing underground economy -- whether or not that marginal change in a few visible areas like tobacco smuggling etc is able to account for even a small share of these massive numbers, and these are very, very large numbers here, is really open to question.

It remains our view, and this is a judgement call at this point, that probably it's the economic factors that are still driving the revenue factors. We're not denying that the underground economy is an important issue, because we are very concerned about it etc, but it's likely to be a secondary issue. I think that's something you'll want to explore extensively with other witnesses as well. I think that's an area that is of keen interest to everybody.

The Chair: Ms Haslam, you wanted to clarify something?

Mrs Karen Haslam (Perth): On this particular graph, because I was following it very closely when you were talking about this, what is the correlation then between the GST -- that's what you said in your original presentation regarding the time lines and the introduction of the GST on this particular graph, so now I'm wondering why the answer you're giving now is different than the presentation. Could you clarify that for me?

Mr Spiro: I don't believe it's a different answer than the presentation. I was saying that yes, the underground economy probably does increase, underground activity probably does account for some proportion of it, but as to the amount, again based on the estimates of how much the underground economy has grown in relation to the GST and so on, it's hard to believe that it could account for this much. But again, until we study it in much more detail, we really don't know. As Peter Wallace said, it's a judgement call.

In terms of the timing, yes, you're right, it does coincide, or to some extent. The 1991-92 fiscal year is the one immediately after the introduction of the GST, so it does coincide in terms of timing.

Mrs Haslam: Thank you for that clarification.

Mrs Caplan: Just on information, perhaps it would be helpful for the committee if you could give us a list of whatever public opinion polling you have done in this area, perhaps since 1990. It would be really helpful if we knew when you polled or if questions were included in other surveying you were doing, because you did mention surveys, and I would be interested in how often you're --

Mr Spiro: To the best of my knowledge, we haven't done any. Maybe Roy can correct me on that. I was referring to publicly available surveys as in the news media and so on.

Mr Wallace: Just one other comment on the relationship between tax and revenue: One of the complicating factors of course is that in many cases those taxes that we assume or presume are not the easiest to avoid, for example corporate income tax, are the ones that show the biggest variability over time and in fact show the deepest, and that's clearly driven by economic factors, or likely driven by economic factors.

Mrs Caplan: Would you repeat that last sentence?


Mr Wallace: Yes. There are a whole bunch of taxes that go into making up the provincial tax revenue. They all show different performances during a recession, and they're also subject to different rates of evasion. The corporate income tax is one, as Peter mentioned, that shows really substantial variations over time. It reflects in all respects the recession and the impact of loss carry-forwards etc. That is one that is highly volatile over time but is not likely to be driven, for example, by the underground economy.

I'm just pointing out again the issue that there all sorts of factors involved here, and also trying to allay any sense of defensiveness here. We're not trying to be defensive on the notion. What we're trying to do is make the point that it remains a fundamentally opaque issue, quite frankly.

Mrs Haslam: Along that line, on page 14, I wondered if you had any levels of evasion for large corporations. You had them for small corporations, for sole proprietors, partnerships, informal suppliers, but you had none, at least I didn't see any here, for large corporations. Are those numbers available?

Mr Spiro: The IRS audits effectively focus on individuals, and in this case it would be like an individual who owns a small corporation. I'm sure they do audit large corporations as well, but this particular study doesn't contain any data on that.

Mrs Haslam: And there are no other studies you know of that we could have access to or you could list with the researcher?

Mr Spiro: Not that I'm aware of. The general perception is that large corporations use different types of techniques, not what you would call direct evasion.

Mrs Haslam: I love it. I'm going to follow that when we come back in the afternoon. Will there be someone here this afternoon to talk on audits? Will you have somebody here who will help me in my questions about Canadian audits, percentages, that type of thing?

Mr Lawrie: Yes.

Mrs Haslam: That's fine.

Mrs Caplan: One last comment, if I could, because this will be something I will be pursuing, and it's why I'm interested in the sociological and psychological studies. It seems to me, from what I'm hearing from my constituents in Oriole and outside Oriole as well, across the province, is that it's becoming acceptable behaviour, the notion that everybody else is doing it.

Also what I'm hearing from people when they talk about avoiding paying both provincial sales tax and the GST, or any tax frankly, is that it's a way of acting out their frustration if they don't like a government policy or they don't like the leader of the government. I've actually heard some very negative statements about Bob Rae and that's the rationale for not paying taxes, or somebody else being upset at the social contract and this is a way of both acting out their frustration and saying, "I'm angry."

To me, this kind of behavioural change --

Mr Spiro: I should mention that at least one of these studies also suggests, though, that people use this as a rationalization. They were inclined to cheat anyway and they use that as an excuse to make themselves seem less unethical.

Mrs Caplan: These are important parts of it, and I just wanted to say thank you for --

The Chair: Did I not also hear, though -- I'm not sure; it might have been Mr Wallace -- that the underground economy isn't driven just by the fact that there's taxation, that there are other factors? Did I not hear you say that in your --

Mr Wallace: Absolutely. That's right, but the question is a legitimate one. There's no question of that, and I think we acknowledge it. We acknowledge in the presentation both parts of it very explicitly. One, an underlying point here, if I can interpret what you're saying, is the issue of entrenchment, that new mechanisms are being established, and I used the words "parallel economy." I don't know if that resonates or not, but that sense is clearly there.

The magnitude of it is very hard to understand, but it's a real issue that once people develop a taste for cheating, they might keep on cheating. Even if it's not driving the revenue picture now, it has the potential to have a future impact. It's something we're obviously concerned about and I know the committee's concerned about.

The other thing is, of course, the rationalizations. You're interested in the psychological studies and Peter knows something about that. That's clearly a real issue. What drives what is an open question, but clearly people are mad at the GST. They're mad at various aspects of other government policy.

Mrs Caplan: They don't like the social contract very much.

Mr Wallace: They may use this for striking back. Whether it's a rationalization or the cause is almost a moot point.

Mrs Caplan: The last point on this is that what I'm finding is that people are talking about it more, and not talking about it in a negative way but talking about it in a positive way to each other; in other words, sharing advice on how they manage to, in their view, avoid taxes, but actually evade taxes. I think that's a change within our society, where in the past, if you didn't pay tax, you didn't tell anybody about it. Now, with the discussion that's going on, and maybe it's being reflected in voting patterns at election time, people are sending a very clear message that they are feeling overtaxed, that they're not happy with the value they're getting for government services, and that they are going to send that message. That's what I'm hearing from my constituents, and I'm just wondering if the ministry is aware of that as it has discussed policy.

Mr Spiro: Certainly it's widely known throughout the news media, this kind of information.

The Chair: I think it's probably appropriate at this time that we adjourn. I want to thank you very much for your presentation and thank you also for --

Mr Cousens: Are you thanking Elinor for her presentation or the --

The Chair: No, I'm thanking the ministry officials for their presentation and thanking them also for coming back this afternoon to answer more of our questions.

Mr Cousens: What time do we come back?

The Chair: If you would be here at 3:30, we'd appreciate it very much. This committee stands adjourned until 3:30 this afternoon.

The committee recessed from 1156 to 1531.

The Chair: The standing committee on finance and economic affairs will come to order. It's apparent at this point that indeed we don't have a quorum, but, given the nature of our committee meeting today, I think it's not inappropriate to start with questions for the representatives from the Ministry of Finance. Ms Caplan had considerable time prior to the noon break to ask some questions, so we're going to go now to Mr Cousens.

Mr Cousens: I share the feeling of other members of the committee who have already had a chance to comment on the presentations by Messrs Lawrie, Spiro and Wallace. That was a great presentation this morning. There wasn't a lot of notice for it, but you brought to it a sense of understanding the problem already, having commitment to addressing it personally and within the business you're in, doing so responsibly, with a great deal of balance, with the best interests of what the province is all about.

I begin by saying I have no criticism at all of what you had to say or how you said it. I was also impressed by the spirit behind it. It's not often I'm that kind. I'm so used to being mean that it's very difficult to find those words, but they were there somewhere.

Mr Sutherland: Don't worry, Don. They hear every comment you make about the bureaucrats in the Legislature.

Mr Cousens: I'm aware of that too, Kim. It was a good presentation. The problem we as a committee have had from the beginning is how we get our arms around it. We understand the difficulty of doing that, but it helps us when you lead us in some of the right directions. To find the way of coming out of this is really the big challenge.

All the presentations raised questions for me, but on page 24, as we started getting into some of the things Roy Lawrie was talking about, I'm concerned about the resources you have to have within the ministry to chase non-filers and other groups. It takes a tremendous amount within the ministry.

Maybe the New Democrats won't like this form of questioning, but have you asked for more? Have there been any proposals that are public that would give me a sense of how many you've got, what money it takes to run those departments and whether it's one of the areas that is being squeezed and hurt by the social contract? Is it an area in which you're being given some understanding to expand and develop? To me, what you're really saying is that it's a major industry -- no, opportunity. It is an industry out there, but for you there's just so much to it to get into it.

Mr Lawrie: Perhaps I should point out first of all that Project Fair Share came from the Ministry of Revenue, as it then was, and there was no magic to the particular figures that were chosen. It was as many as we could then accommodate within our existing premises without looking for extra accommodation, which is lengthy and obviously very expensive. In the sense of can we take more resources, not without extra accommodation, we got all the resources we asked for.

Have we been affected? We've been affected in some areas of the ministry. For example, there were some surplus declarations as a result of the merger of the three ministries. There were also surplus declarations as a result of the wind-down of the SBDC and ESOP programs. I think we've been able to accommodate virtually all the people in other jobs. We're fortunate in that as tax administration is growing, it can provide homes for people who were laid off in other parts of the ministry.

Mr Cousens: How many people would be in this identification and compliance group, as you start looking at the size of that?

Mr Lawrie: The I&C group is small: eight person-years, which will be spread across six regional offices in EHT. However, I should say that obviously we'll be monitoring the results of the I&C group very closely, and if it looks as if there's a real problem with non-filers, we'll divert resources from elsewhere, which usually means audit resources, the reason being that most other work in the tax administration side of the ministry is regarded as mandatory: You have to answer taxpayer queries over the telephone and letters; you have to publish information, because the system won't work without it; you have to process returns and payments. Virtually the only discretionary resources you have are audit and to some degree collectors.

Mr Cousens: What would your numbers be? I have no sense of what the numbers are in audit versus I&C, as you call it.

Mr Lawrie: Roughly speaking -- I may have the actual figures here. I don't mind talking about numbers of auditors. When we get into how big a percentage of the tax rolls are audited a year, our audit coverage rates, most tax administrations would prefer that that not become public knowledge.

Mr Cousens: And I can see why. That's why I'm being careful, because I think there is a danger in the questioning we have: Not only will the good guys be reading this, there'll be the ones who can benefit from the knowledge that is going to be shared and how we're going about it. Maybe there will be some point when our own committee, and I suggest this to you, Mr Chairman, might consider going in camera at some point if there is some benefit, just respecting some of the confidences we all might know and not want to put into this document.

The Chair: Indeed, Mr Cousens, and if from time to time there are questions asked that you feel, Mr Lawrie, would be better answered in camera, if you would let us know that, then we will certainly oblige you and at some point in time when we do meet in camera we can revisit these questions.

Mr Lawrie: Okay. In tax administration, I have a total staff of 1,550 at the moment. The largest branches are retail sales tax and corporations tax branch, both just under 400 people. In retail sales tax branch, about one half of those are auditors, so I would say the audit strength in retail sales tax is just under 200; about the 180, 190 mark. This is, incidentally, after including extra resources which are not all hired yet as a result of Project Fair Share. In the corporations tax branch, because of the manual intervention in assessing returns at the moment, the proportion of auditors is lower. It would be about one third, which would make it about 120 or 130. The motor fuels and tobacco tax branch also has auditors and fuel tax and tobacco tax inspectors; 25 inspectors and, if my memory serves me right, I think somewhere in the region of 15 or so auditors. The auditors mainly audit interjurisdictional carriers in respect to fuel tax. It's one of our large tax rolls.


Mr Cousens: How many auditors are there? I guess I'm getting lost in your answer. Can you break it down?

Mr Lawrie: I would say about 400 in total.

Mr Cousens: And how many are there in I&C compliance group?

Mr Lawrie: At the moment, eight.

Mr Cousens: It's a good thing you've gone to computers, or you'd be dead. Even then -- have you asked for more than eight?

Mr Lawrie: At the moment, no. Obviously, we wouldn't have asked for these resources if we didn't think they were necessary, but we'd like to test it to see how much non-compliance in terms of non-filing there is out there in the province and, depending upon the results, we will go back to the treasury board and try and persuade it to give us more resources. There's a lot of pressure for resources at the moment.

Mr Cousens: From opposition's point of view, we're usually fighting any government that adds people to the bureaucracy, and I know some of our constituents wouldn't be pleased that we're even thinking of wanting to support additional resources, but may I suggest to you that if this were a business opportunity for Monte Kwinter to sell some of his products, to get out there, he would have a lot more than the number you're talking about going after it, because I don't think there's any doubt that you're looking at a little gold mine that could be almost as good as some of the ones up in northern Ontario that have been opened up. There's got to be a pot at the end of that rainbow you've started down.

I know my time is running short. I support your efforts in that direction. I'll get my turn when it comes around again.

Mr Lawrie: One further thing I'd just like to add. We have 160 collectors. Obviously, next to audit, they're very important in bringing in revenues.

Mrs Haslam: I had some questions around corporations; there are a couple of things I'd like to know around corporations. In the first place, on page 3 of the original presentation, it said, "Consumers and corporations may develop a `taste' for cheating," and then on page 5 you say that tax evasion is seen as a victimless crime. I want to go back to the corporations, any type of cheating they do being done more on a technological level, cheating on supplies, cheating on invoices, cheating on those kinds of things, being seen as a victimless crime. As I understand it, this has probably spread to other businesses and other workers. How prevalent was corporate cheating compared to today?

Mr Wallace: I'll take a stab at the question. I guess the point is kind of an economic point, first of all, just the background we are concerned about, the emergence of parallel markets. One of the things we're concerned about is that once these behaviours are entrenched they may spread to other areas as well. In terms of corporations themselves, most large corporations of course will have relatively little incentive to cheat directly on taxes. There are ways they can manage their tax burden through tax planning that are condoned and set out within the tax code, and that's reasonable and we expect them to do that. The other issue, though, is that there may be instances in some cases in which corporations may engage in some sort of illegal activity. That's, I think, a fundamentally different issue. That's why that then relates back to tax evasion as a victimless crime.

Mrs Haslam: That brings you back to another point about how they found other ways to find loopholes. They have the finances to hire very high-class lawyers to find a lot more tax loopholes and ways of cutting back on the tax they pay, whereas an ordinary fellow out there may not have that capability. What I'm just trying to say is there's been some white-collar crime out there; there's some white-collar evasion, some technological ability to evade taxes and to pay less tax. But now the worry is that it's becoming more prevalent in ordinary Canadians, in ordinary citizens. I wanted to know whether that is true, it's because we haven't been able to find a lot of the corporate ways of tax evasion before this, or is it just because it is easier to find at a lower level and a lower economic bracket?

Mr Lawrie: If I may, I'll take a crack at answering that. It depends on the size of the corporation. For example, very few of our tax evasion cases -- in fact, none that I've seen in the last six years -- have involved large corporations. That's out- and-out evasion cases. I think the reason is that the larger the business operation, the better the internal control system has to be from an accounting standpoint. I think in the corporate sector where you're likely to see evasion is in some of our RST cases, smaller corporations, where they are owner-managed and where there is a blending, at least in the owner-manager's mind, between the corporation and himself in terms of finances.

However, on the other hand, if you look at our audit recoveries for corporations tax, which exceed in field audits $150 million a year, clearly, compliance is a problem in corporations, particularly in larger corporations. But a lot of the ways taxes are minimized are matters of opinion. For example, if you have long-term contracts that extend over a number of fiscal periods of the corporation and you are a profitable corporation, there are various ways in which you can take the profit on that overall contract into each taxation year. Obviously, it's in the corporation's best interests to postpone the tax as long as possible and therefore take the profit only when the contract is completed. On the other hand, if the act requires the profit to be brought in in earlier years, then a reassessment will take place. So basically, you're talking about timing of tax paid and therefore an interest cost of not being as early as you should.

Similarly, there are problems with various reserves, such as reserves for doubtful accounts. They're matters of opinion in an accounting and a legal sense. They're frequently larger than they ought to be from the tax auditor's point of view, but perhaps that's prudent from the corporation's point of view and it just has the incidental effect of reducing the taxes payable. Again, if there's insufficient evidence to back up reserves of that nature, they're reassessed and the tax comes in.

Mrs Haslam: I think what I'm trying to tie together is similar to what my colleague Ms Caplan was talking about, the idea that corporations are able to do it, they have more money to spend on legal ways of doing it, whereas the ordinary person is finally saying, "That's not fair and therefore this is my way of getting some money in my pocket." That's why I was asking about the difference between corporations and -- it seems to have prevailed now and to come right down into a lower economic bracket.

I have a couple more questions. On page 11 you talk about intensive audits. You have the US Internal Revenue Service that does it every 10 years; "not available for Canada." Are you telling me the information is not available for Canada or Canada does not do intensive tax audits?

Mr Lawrie: I can answer that question. Actually, Revenue Canada did conduct a similar study. It was called CMS, compliance management study, in the early 1970s. In fact, I can remember when I was an auditor with Revenue Canada doing a couple of those files. They never did publish the results, and I think one of the reasons was that there were problems in the way files were allocated. They were randomly selected files and the program went on over about a two-year period and because of the additional forms that were necessary to accumulate the results from the audits, the auditors knew when they were assigned the CMS file as opposed to a file which had been selected by the supervisors because of problems evident in the return. I think that biased the results.


Mrs Haslam: So if I were to ask how often have we done tax audits, what is the percentage overall -- because you gave us some percentages when you were talking about the Internal Revenue Service doing 10 years. You gave us percentages and facts and figures, and there are ongoing audits in the US service besides its major one, one every 10 years, but I'm just asking, if we wanted some of that information about Canada, could we not obtain it?

Mr Lawrie: I very much doubt if Revenue Canada would want its audit coverage figures to be public knowledge, the reason being that anyone inclined to take a risk on evasion could then more or less work out the downside risk of being detected.

However, I would suggest that you look at the Auditor General's report on Revenue Canada for 1990. I think in a couple of my slides I quoted that study. Although audit coverage figures are not specifically governed, I think you'll see some critical comments from the Auditor General about office-audit and field-audit coverage of taxpayers where there is very little third-party information available to Revenue Canada. I'm talking about the self-employed and particularly people who have large capital gains either from real estate or from investments. This is on an individual site where there is no information reporting to contrast the situation from a third party; plus a situation with employment income, for example, where T4s are made up by the employer and sent in separately to Revenue Canada. So it's a third party or investment income such as dividends and interest where the corporation or the financial institution has to send in T5s to Revenue Canada. Again, it's an independent verification source.

The areas that are high in non-compliance are where there is no third-party information. It is like, for example, subcontractors who are self-employed, stock exchange transactions or capital gains where there's absolutely no information reporting at all. Interestingly, before Michael Wilson became federal Finance minister, it used to be true of government bills as well. He introduced information reporting because he was passionately aware of the abuse that was going on because there was none, and as a result, tax on government bills went up substantially when information reporting went in.

Mrs Haslam: Do I still have time for another?

The Chair: As a matter of fact, we should move on to Mr Kwinter and we can come back.

Mr Monte Kwinter (Wilson Heights): I just want to make a comment and then I'd like to ask a couple of questions. In the discussion that just took place, at the beginning of it, there seemed to be some confusion, certainly in my mind, in talking about tax avoidance and tax evasion. I don't think anybody objects -- I shouldn't say that; philosophically there may be an objection -- to tax avoidance. I think there's an obligation on the part of individuals and organizations to take advantage of the tax laws as we have them and to avoid paying taxes if they can. Tax evasion is a totally different matter and I just wanted to make sure that this was understood, that we weren't talking about tax avoidance; we're talking about tax evasion.

The other thing that I'd like to raise is that this morning Mr Spiro was mentioning to us his monetary methodologies, and he was taking exception to the fact that some of the models that were being used show that the size of the underground economy was somewhere in the 15% range, where he felt that somewhere between the 8% to 15% range was more in line.

In an article that appeared in the Toronto Sun today, a university professor of economics in Montreal claims that the total is about 16% of Canada's official $700-billion economy. Then, at the very end, they estimate that maybe it's somewhere between 8% and 13%.

This other article in the Toronto Star on October 18 just appeared on our desks. It referred to Professor Smith at the University of Alberta. He has been studying the underground economy for more than a decade, and he estimated that in 1990 the size of the underground economy was between 15% and 20%.

We have this wide range of estimates of the size of the problem. I don't think it's going to make much difference. As you said earlier this morning, whatever the number is, it's a huge number, but on the other hand, it would be important to know if the problem is twice what we think it is or half what some people think it is. I'd be interested in having some comments on that.

One last thing I'd like to have comments on is the article in Maclean's magazine where it is reported you said -- and we mentioned it this morning -- "I hesitate to talk about this subject because the data show that the more people become aware that other people cheat, the more they cheat." You talk about some of the things you're doing to address the problem. One of the things you suggested you'll be doing is putting out this non-compliance bulletin or whatever you call it, and you're going to talk about some of the more unusual ways people have been trying to evade or are evading taxes.

I would suggest that, notwithstanding that you caught them, the more you talk about them, the more ideas you give to people because, given the constraints on your personnel, it's impossible to audit everybody. The more you talk about it, the more people will get ideas as to just how they can circumvent your particular laws. I'd like to have some comments on that.

Mr Spiro: You should go first.

Mr Lawrie: Dealing with your last comment first, in our bulletins and press releases we're obviously not going to provide a road map for tax evaders. The press release doesn't guarantee publicity. There has to be something unusual about the case for it to hit the newspapers. We look for unusual things. For example, a good quote from the presiding judge in passing sentence would take it into the realm of newsworthy. It can be something as simple as that.

Particular kinds of evasion would be a concern, particularly if we feel we were lucky in discovering them and have not taken precautions to look for any others or prevent them from recurring. On the other hand, the bad gas scam, for example, which was investigated by a joint force of the OPP and ourselves and a couple of other ministries, where unstable solvents were mixed and sold as gasoline -- and there's a safety issue as well -- got a great deal of publicity.

That's the sort of thing I'm talking about. It's unlikely, when something like that gets a lot of publicity, that it's going to recur.

Mr Spiro: As to the measurement, I haven't seen today's Sun, but I presume it's Professor Vaillancourt who's being quoted there.

Mr Kwinter: Yes.

Mr Spiro: That's right. He was also quoted in yesterday's Star. I don't know if it appears in the Sun quotation, but in the Star quotation he gives a range for the dollar value of the underground economy in so many billions, from $50 billion to $100 billion, something like that. If you work out those numbers, his range as a percentage of GDP is very similar to the 8% to 15% range that I put here. Again, Professor Smith is the same Smith of Mirus and Smith I referred to on page 18. In their latest study, they carried the estimation up to 1990 and they have 15%. Then I suppose it makes sense for him to say 15% to 20%, because there is a perception that the underground economy has grown further since 1990.


But again I reiterate what I said before. Mirus and Smith are assuming that the cash in the underground economy recirculates as rapidly as it does in the legal economy. I suppose one can't rule that out, since we have no data on it, but it does strike me as implausible because of the fact that the people there cannot take their savings from their underground income and invest it in other financial assets, as a person earning legal income could. I think it's virtually certain that the velocity of circulation of money in the underground economy is lower.

So while generally I find Professor Smith's estimation methodology plausible in terms of his estimation of how various factors lead to the growth in cash, and that's identified with the underground economy, I think nevertheless that by not taking into account this difference between the use of cash in the underground economy and the aboveground economy, he does tend to exaggerate the size. But again I'd have to admit there's absolutely no way of knowing what that differential rate of recirculation of cash is in the underground economy, so that's why I attach such a wide range to it.

Mr Kwinter: Do I have time for another one?

The Chair: Your colleague Mr Phillips wanted to ask a question.

Mr Phillips: Go ahead.

Mr Kwinter: There's another thing I'd like to ask, if I could. When you do your audits, is the way you evaluate your auditors on the amount of money they generate? I notice in your reporting, on page 23, you talk about your audit recoveries per audit. I'm just concerned that when the auditors go out, they know what the average return should be on their audit and that determines who gets audited. In other words, there's no sense auditing somebody if you haven't got a hope of meeting your average, because then you're going to be evaluated as an auditor or a collector on the basis, "You're not generating enough money for our coffers and you're wasting your time when you could be out getting a lot more money if you chose some other people to audit."

Mr Lawrie: The answer to that is of course no; auditors are not judged on the revenue they bring in. But there's a slight other side to that, which is that for corporations tax in particular, we concentrate on larger corporations for our audits in file selection. The reason is that Revenue Canada, which also does corporations audits for income tax, has a very much wider coverage than we do. They've got a lot more auditors in Ontario. We get the benefit of their audit adjustments. Although they're quite heavy on larger corporations as well, they spread their coverage quite well among the smaller corporations. We feel that our resources in corporations tax therefore are better spent where they can get the largest recovery, which has proven to be basically corporations over about $50 million in annual sales and we concentrate on corporations like that. We do occasionally do corporations that are smaller in size. But individual auditors are not rated on the revenue they bring in.

These figures were simply put together to show a trend because, as my colleagues have pointed out, it's very difficult to size the underground economy. A lot of the information one gets is anecdotal because of its very nature. The figures I gave were simply to show why I personally feel in tax administration that, yes, non-compliance with tax statutes is growing and has been growing for two or three years now, quite steadily. It was in that context that the figures were given.

Mr Cousens: Mr Kwinter raised the issue of tax avoidance versus tax evasion. Would you treat anyone any differently? How would you treat someone who has a deficiency under either case? Are they treated any differently under the law or by yourselves? I'd just like to stay on that one a little bit, because I think it's an interesting question for me.

Mr Lawrie: Tax evasion requires mens rea, or criminal intent. In tax avoidance, there is no criminal intent. It's often said there's a thin line between tax avoidance and tax evasion. Personally, I disagree with that. If you cannot prove that there was criminal intent from the evidence you get, it was not evasion; it was obviously tax avoidance at best.

The remedies are different. Tax evasion obviously can result in prosecution in court and fines, and in certain circumstances jail sentences being imposed, as well as substantial civil penalties in many instances. Tax avoidance, if it's actionable -- and sometimes it is not; if it's not, I would term it tax planning rather than tax avoidance. At least, in my experience, tax avoidance is usually used to mean the type of thing that is going a little further than the Legislature intended when it passed the relevant statute. In other words, it doesn't pass the smell test, but it is not criminal activity. I don't know if that helps.

Mr Cousens: That's very helpful. I just wanted to chase on it. I don't know if you have anything further on that, but I think you've answered it for me. I want to go back. One of the things that was said in the first presentation had to do with the fact that even if Ontario had a lower tax on tobacco -- on page 8 is the diagram where we were talking about it -- there'd still possibly be profit for the underground economy to benefit from it. That's a fact I'm having trouble with.

If you look at different things within the underground economy, I guess there's a certain percentage that varies. As long as it's above a certain amount, then it becomes worthwhile for the underground to prosper in it. Could you expand on that whole thing, because it's a theorem that I don't think the public would accept. I'd say we're at the point now where it's been exacerbated by the high taxes and the tax wall and other things, but most people would believe it's an integral part of the underground economy, that both the federal and the provincial taxes are all so high.

Mr Wallace: I'm not sure I disagree with your point. I don't think there's any question that the level of tobacco taxation, the increases in the late 1980s and the early 1990s, particularly at the federal level, but joint federal and provincial for sure, have created a situation in which there's a substantial price differential between the price of cigarettes in Canada and the price of cigarettes exported to the United States and brought back into Canada, so there is in some sense a substantial incentive there. The main point on the slide is that the incentive is not solely a function of provincial taxes. There's no question that provincial taxes contribute to that incentive.

The incentive now is sufficiently large, quite frankly, that it's our guess, it's our understanding that even if provincial taxes were eliminated from the picture, there would still be some financial incentive to carry out smuggling, certainly to Quebec where taxes may remain the same, but also to Ontario even if the Ontario taxes were reduced to nothing. I think that gives you some sense of the magnitude of the price differential. It depends of course on smugglers' costs and things like that, which are going to be highly variable due to a whole bunch of factors: level of enforcement, all sorts of other things that will have an impact on that. But the basic point I think is quite obvious there, that it's not something Ontario policy alone can adequately compensate for.

Mr Cousens: The final thing is the matter of the cooperation among other levels to make sure that you're into it, because the tobacco is certainly cross-border. You're in a position then where you must have high cooperation between our Ministry of Finance and police forces at all levels.

Mr Wallace: Yes, and the other thing is simply that the situation is different now that there seems to be a network established. Whereas previously it may have required a substantial ramping up of taxes and a number of years for a network to be established, once that network is in place, they have their own costs in place etc and are used to it. That may alter the situation substantially and it may alter their own internal cost structures.


Mr Drummond White (Durham Centre): I would like to pursue a couple of questions, Mr Spiro. In regard to your excellent examination of the research, the issues behind the subterranean economy, there were a number of things that I found to be quite striking. If I could turn your attention to the two charts on pages 16 and 17, many of which have the same statistical background, it seems clear from the chart on page 16 that if we exclude the Mediterranean countries -- or even if we include them; it doesn't really matter. If we look at this chart there seems to be very little consistent relationship between the top marginal personal tax rate and the presence, or the degree to which there is a presence, of a subterranean economy.

However, when I turn this page to the next one, with the exception of the Mediterranean countries, I've drawn a little line here. I think that's about as close to a perfect relationship as you can get: a direct correlation between one factor and another, pretty close, especially given the uncertainty of the figures and the variation in the report. I would conclude from this that the personal income tax rate is not necessarily directly related, but the overall tax rate is.

Mr Spiro: That's right, although of course the structure of personal income tax rates in general forms part of the overall taxes as a percentage of GDP. But yes, your general comments are quite right.

Mr White: If one makes that distinction between the personal income tax, the top marginal rate, and the overall taxes, the difference between those two tax rates essentially is founded within the consumer-based taxes such as the GST, the PST, the property taxes etc, and particularly what we refer to often as a regressive tax, one which is not based on one's ability to pay.

I find that striking, particularly when I compared it with the other chart, which is on page 6, "Nominal GDP and Tax Revenue Growth." The tax revenue dropped dramatically in 1991-92 and has stayed down since. Now, there are two things that happened in that period. We had a recession, and on January 1, 1991, we had this thing called the GST which went from a tax base on corporations which really couldn't avoid paying the tax, as you've very clearly mentioned, to that tax being spread out across the general population in a regressive form, hitting people across the board, and as you've indicated, promoting a climate wherein tax avoidance and tax evasion became as popular a sport as baseball, perhaps even more so.

It seemed to me from those factors that there's a direct relationship between the incidence of regressive taxes that affect working people more significantly than upper-income people, and small businesses and small business people more significantly than large corporations.

Mr Spiro: That's right. As we discussed this morning, we haven't been able to carry out a complete study of the factors underlying chart 6. As best as I've been able to establish, there has been growth in the underground economy coinciding with this period. It would be hard to attribute all of this or even the majority of this decline in revenue to the underground economy. There's a substantial portion, but when we see a 10% drop in revenue, it doesn't seem possible that even the majority of it could've been due to the underground economy. It's something we do intend to study. In a general sense, I guess the evidence does support what you're saying.

It should also be remembered that this is just one aspect of what underlies tax policy and one of the considerations behind tax policy. It may be true that this type of tax increase does add to the underground economy, but there are pros and cons of all different taxes. Some taxes have a greater impact on the incentive to work, on the incentive to investment and so on, so there are a variety of factors. In fact, one of the studies I alluded to this morning by Clotfelter mentions the effects of taxes on evasion but suggests that this is one of a number of factors you have to take into account when you evaluate the validity of different kinds of taxes.

Mr White: I appreciate that, but I would wonder if a consumer-based tax, such as a GST or a PST or taxes such as that, would be more likely to be evaded or avoided than an income tax or a corporate tax.

Mr Spiro: It's hard to generalize. It depends also on the types of taxation. In its latest budget, the Ontario government imposed a provincial sales tax on insurance services, and there we have a reasonable expectation that there will not be much evasion because of the nature of those companies: They're highly regulated, highly visible companies. Insurance by its very nature is not something that you're going -- well, maybe some people do buy it in the underground economy when they're forced to, but it's not ordinarily the kind of thing you get there.

Mr Wallace: And it's called protection.

Mr Spiro: That's right. There are some types of general consumer-type taxes where you can feel reasonably confident that they won't be evaded, and then there are others where there's a high degree of likelihood that they will be, so when you're setting tax policy you do have to look on a case-by-case basis.

Mr Wallace: Two very quick points on that: One is just an economic point, which is that Peter's graph does show taxes as share of GDP and the apparent correlation between that. We should be aware that over the last couple of years, taxes to GDP, the ratio is falling, with taxes as a share of GDP actually declining at the same time that we're supposing the underground economy increases. That relationship is, as we talked about earlier, likely to be substantially influenced by major economic factors as well. I'll leave it at that.

Mrs Haslam: I apologize if I was asking you to give me some profile of people when you are more interested in the figures on paper. I'm just trying to get my mind around the facts and figures about it so that when we have other people come before the committee and we talk about the mindset and talk about how they perceive what they're doing and some of the underlying reasons regarding corporations versus little guy, small versus large and that kind of thing -- that's what I was trying to get at, getting a more factual picture of what a corporation does so that when we look at the mindset, we have the facts and figures. I'm stymied because I don't have those facts and figures to look at.

I know it's a complex issue. I know you've said it's not a result of the tax system. We're talking about the underground economy not being a result of the taxes, either federally or provincially, that are being charged, but I wanted to do one more question.

On page 24, you talked about non-filers and you said you were talking about people who have never filed income tax. Is that true? Are there people who have never filed income tax?

Mr Lawrie: Yes.


Mrs Haslam: Let's say next year I decided not to file my income tax. Can I get away with that?

Mr Lawrie: I think it's true of most tax administrations that once you've filed a return once, your chances of being detected --


Mrs Haslam: Mr Phillips, you've already filed, have you?

Mr Lawrie: -- when not filing subsequently are much higher than if you had never filed that first return, because the presumption is that no one knows about you if you never filed a first return.

Yes, there are people who have never filed income tax returns. The most common example is illegal immigrants, where there is no work permit. If they're discovered they fear being deported and, obviously, they don't want to bring the attention of any part of government to their existence.

Mrs Haslam: That's just a clarification for me, and that's all I have for now.

Mr Norm Jamison (Norfolk): I find it interesting to look on page 14 at the percentage of medium and small businesses out there that, under certain surveys, simply don't -- 52% of income was unreported by sole proprietors and 40% of income was unreported by small corporations.

I had an interesting experience just a couple of weeks ago talking to a contractor, a person who subcontracted out his work. I asked him about the underground economy, and he smiled, of course, and didn't really know who I was. I said, "What would happen?" He said, "Well, with competition being so tough in the market, of course sometimes you present two prices: You'd present one that would be paid in full by cheque or you would present one that would be paid in full in cash, and those prices would be significantly different." I said, "How would you hide doing the job?" Of course he kept referring to "people," but he said people would do that by issuing a receipt valued at far less than the job was actually done for, and the contractor would consistently put enough money in his pocket, at that point, to pay the groceries and maybe the hydro bill and some other things, his ongoing bills. I said, "Is this an isolated, infrequent instance?" He said, "It used to be, but it's not any more."

I think people initially looking at these figures would be shocked at seeing the percentages. What I'm trying to say is that the underground economy is not just in cigarettes and the alcohol. The underground economy is out there in everyday business practice at this point, and it's becoming more and more. I think all of us, as representatives, are very concerned about this, that it's becoming a common practice, one that almost receives some back-handed credibility from within the community itself. Listening to Drummond White's concerns over the upward climb of the underground economy, he has indicated that certain things happened at certain times that seemed to have at least helped spur that along.

As auditors, how is it we deal with that particular type of situation, when you're having contractors, small business people, dealing in cash rather than otherwise and reporting and writing bills out for less than the job could actually be done?

Mr Lawrie: A number of things could be done by the federal government if it really wanted to attack the underground economy; for example, increasing the amount of third-party information return reporting. There is, I believe, information reporting on stock exchange transactions in the US. Presumably an act could be required in Canada.

It would also be possible to increase the use of deduction at source. For example, there's no standard rate of tax deducted from dividends from interest income from subcontractor payments. Such a system could be devised. It does work in other countries. It would serve to give a cross-check on income reported voluntarily from sectors that otherwise are known as being centres of non-compliance. But they have to be done at the federal level, things like that, and not at the provincial level, because I think most of the examples you've given are personal income tax.

My personal view is that the biggest loss of tax revenue in the underground economy is personal income tax, the reason being that the rates are very high across Canada compared to other forms of taxation; therefore, not declaring income that's supposed to be subject to personal income tax gives you a bigger return. If you combine that with, in certain instances, a very low risk of detection because of low audit coverage, obviously it's going to result in an increase in non-reporting of income in areas like that. Basically, what I'm talking about is the self-employed and personal income tax.

Mr Phillips: All this is very, very interesting. The chart on page 6 is fascinating, and I wonder if the staff can be helpful to us. There used to be a bunch of formulae you used in Finance or Treasury or whatever to project revenue. It used to be 9% of nominal GDP growth, as I recall. It seems to me that in the last couple of years those formulae have kind of gone out the window and that the money doesn't come in in the relationship it used to. The reason I'm raising the question is that it may be helpful to us in defining the size of the problem and the growth of it if there's any way we can get a three- or four-year projection of revenues that you would have expected under normal conditions and what revenue has actually come in. Is that possible for the staff to provide us with that?

Mr Wallace: It's an excellent question and one we're considering. What we'd like to do is in some sense take that as notice, not to evade the question, in the language of the day, but to come back to it. It's one we're really very, very interested in, and we'll give every consideration to that and let you know.

Mr Phillips: I am too. My own view is that the weak economy has hurt it, and I happen to think low inflation has had some impact and the underground economy, those three things.

Mr Wallace: But on the relative ratio of those things and how they apply to the different taxes and things like that, in order to give you any kind of a credible answer at all, those things need to be considered, and we'll give it a shot.

Mr Phillips: If you can do it, it will be very helpful to us, I think.

I thought Mr White had a good comment in that while we may not be able to change it, I do suspect that different types of taxes have different impacts on the underground economy and that we should at least be aware of that to the extent we can on our report. You've been helpful today on that. Just to alert the committee, I think we should be thinking about that. As I say, we may not be able to change the taxes. Someone made the point earlier about the way you introduced the tax on insurance. It sounds to me like at least you had a secondary, if not primary, consideration of the underground economy; at least that was an added benefit of that, the way you did that.

Mr Wallace: Another point I'd make along the same lines is that both federal and provincial governments have refrained from raising tobacco and alcohol commodity taxes over the past few years. I think there is a broad recognition, in some sense, of the issues and the need to avoid exacerbating some issues as well.


Mr Phillips: I have two more questions, if I might, in terms of our report. A comment I often get from the business community and businesses is that their view is that there is an overlap of audit responsibilities and that they feel like they have four or five different branches of government coming to it. Should this committee be considering ways of better coordination among levels of government, and maybe within government, so we can use our scarce resources more effectively? Is that a worthwhile area for us to pursue?

Mr Wallace: Let me take a stab at the question generally, which is, absolutely. I think that's an area we've really highlighted in the presentation. It's an area of considerable interest and concern to the ministry. I'll pass it over to Roy.

Mr Lawrie: There's also the government's Clearing the Path for Business Success initiative, which is more or less concerned with the same thing: looking at ways of reducing the paper burden for small business and looking at a combination of various reports that are necessary for small business to file; whether there is any real need for the filing requirements to be so diverse and whether they could be combined in some way, along those general lines. There is a lot of work being done. In fact our re-engineering project for our systems is regarded as a possible vehicle, platform, for our Clearing the Path initiative for small business.

Mr Phillips: That may be an area in which the committee can be helpful in encouraging that along.

My last question is on barter. I recall a presentation this morning -- maybe I can't remember it clearly -- indicating that in your opinion barter may not be a significant issue. Just to help me at least to understand, where barter kind of moves from legitimate barter to barter that is subject to taxes that may not be paid on it -- what I'm getting at here is that anecdotally, as you say, I have a feeling that more and more people are looking at barter and that they perhaps quite legitimately say: "I'm not participating in the underground economy. I'm just finding a better way to buy cheaper." I'm in this business and I go to somebody and they say, "You take your margin out, I'll take my margin out," whatever it is. "I'll sell you a computer and you renovate my office." We both take our margins right down to the bare bone.

My question really is this: This morning, I thought the presentation was that barter, in your opinion, wasn't a huge problem. Secondly, where is the legal line you draw on barter in terms of what's permissible and what isn't?

Mr Spiro: I was the one who made the comment on that. There are a number of barter organizations, organizations that are trying to promote barter. Legally, as I understand it, the fact that you are bartering has no effect on the tax that's owed. There's a dollar value of the transaction, and if that represents income for you, for example, if you're a plumber and you do a certain value of plumbing and get something else in exchange for it, there's a dollar value that can be imputed to that and you have to include that in your income tax. In fact, the organizations that are promoting barter are quite clearly saying that they're not trying to evade tax, that they encourage their members to pay the legal amount of tax.

Apart from that, we don't really have a lot of data on the amount of barter going on. My point was mainly a logical one, that if someone is interested in being in the underground economy for the purpose of evading tax, there's not much additional advantage to them to engage in bartering. Bartering is always difficult because, just by its nature, you have to find exactly another person who wants exactly what you have and you want exactly what he has. That takes a lot of time and trouble to arrange that transaction.

If you want to evade taxes, to be in the underground economy, it's much easier to sell your services for cash and buy the other person's services for cash. Then you've evaded the taxes and made your life much simpler by buying wherever you choose, or at least having a much larger range of choice in which to trade rather than trading with one specific person who has exactly what you want and who wants exactly what you have.

The Chair: If the committee would allow me, could I make a comment about bartering? I happen to be from rural Ontario and lived in a place for a long time where I witnessed bartering. I think it's something that takes place in close families quite frequently, not because there's a want to avoid tax but because there's a need, probably because of very low rates of income, to meet some of the needs of the family, if I can put it that way. Therefore, a family member will call up another family member and say: "Do you want to get some work done on your house? You're a farmer; I could sure use a freezer full of beef," or whatever. These things happen with, I would suspect, great frequency.

I don't think there's a deliberate plan to avoid paying of taxes; however, there is certainly the understanding that both people are going to benefit in some way, because their limited resources do go further for them in that circumstance. Again, I want to emphasize that I don't think it's done deliberately to avoid taxation; it's done deliberately because there are limited resources within the families themselves. So they work cooperatively in order to make some accomplishments that they might otherwise not be able to afford.

Mr Wallace: I wanted to make a very similar point but more in economic terms. We've talked a lot about the relationship, and I think the nature of the questioning has focused a lot on the nature of the relationship between tax and taxation levels and the underground economy. I think it's always worth remembering that the underground economy has an awful lot of activities that don't have anything to do with tax.

The other thing I'd just like to emphasize is that I think at least part of the underground economy, in something like barter or in something like Mr Jamison's question, in the home-building industry for example -- I know you'll be having them as witnesses -- is that all of a sudden you have an increase in the level of unemployed resources, both human resources and capital resources, out there in the community, especially in some sectors, and I think people have a reasonable sense of what those are. I think as that becomes available, you have all sorts of people who would have preferred otherwise to work at ordinary jobs, to be drawing income, to be paying income tax at source, etc, looking, both for economy reasons and to try to get any income they can, for various ways, and they may well find that through some type of cash economy or through barter.

The primary thing again that is driving it may not be a desire to evade tax per se, but simply that this is the only mechanism that happens to be available to them in terms of their non-standard work situation. This would mimic in many cases what has been the practice in rural areas for a very, very long time or in any type of extended community situation as well. So I think we have to be careful about imputing all of this to the tax environment, although it's clearly an important factor, and remember that there are going to be some underlying economic and cultural factors as well.

Mr Cousens: I had a letter from Edgar Korea in my riding, after I'd written a letter about the fraud going on within social assistance and health. He came back with a number of points to suggest how we deal with it.

In my view, when we're dealing with the underground economy, part of that has to be seen as what is done that is fraudulent and wrong in dealing with government ministries. I would assume when we're looking at this as a larger subject, and that is my assumption, that we're looking at it as not just something that's out there in the business world but that there are many sections within government where it should well be considered. Assuming that is the case, to what degree have your ministries considered or dealt with other areas within the government where there are known needs? An example will be those people who are getting social assistance, two or three different cheques, getting them together. Is that something you have had a chance to assess or is it part of your considerations?

Mr Lawrie: The only thing that I'm aware of at the moment is that we are looking at possible participation in the government's recently announced Ontario child income program to replace certain benefits under the current welfare system.

The province of Quebec has done a great deal of work in trying to integrate its social benefits system with personal income tax. When we don't administer personal income tax ourselves, there are a lot of obstacles to doing that in Ontario, but perhaps with the new Ontario child income program we'll be taking the first steps towards some form of integration.


Mr Cousens: I'd strongly support it, and it's the kind of thing that this gentleman --

Mr Sutherland: You support our own income tax system in Ontario?

Mr Cousens: No, the point that was being raised by the ministry shows ways in which we can then identify those people who should be captured within the computer system and then apprehended by our own police force. But it's kind of like no benefits to an address that shows "in care of." There are so many things that are going on within other levels of the government, but obviously we're not too prepared to dig into that kind of exercise within this. Maybe it's something our own committee at some point could look at.

I had one final question. That has to do with the publicity, on page 25, when you started looking at the efforts by the ministries to publicize convictions and the enforcement bulletin. In my view, it's not an area in which you've exhibited much success. If so, maybe you could tell me why you think it's so, but I don't think you've publicized convictions worth a hoot. I guess your new forms that you're trying to get into will promote a little bit more understanding by the public at large that you're alive and well. Maybe you can expand a little bit more to make yourself look better.

Mr Lawrie: Prior to March this year, there was no active publicity sought on any conviction for tax evasion in Ontario.

Mr Cousens: None?

Mr Lawrie: None whatsoever. In fact, if by chance a reporter was in court and wanted to ask questions, he was directed to the prosecuting counsel. The ministry's position for a number of years, the long-standing position, was that no publicity be sought for evasion cases.

There has been quite a reaction since we started press releases in selected cases, which was only in March of this year. My impression, from special investigations branch and through the minister's office and through reporter calls, some of which I've taken myself, is that the reaction has been almost entirely positive -- the opposite, I guess, of what you suggest -- even from some of the more cynical members of the press, which is rather surprising. Perhaps the time is right for the message that cheaters cheat us all; we all have to pay if people evade taxes. Perhaps there's a dawning recognition that social programs have to be paid for somehow, and obviously taxes are the way that most of them are paid for.

Mr Cousens: Have you ever used the Gazette for the listing of certain cases that have been passed through the court? Is that a way you could use?

Mr Lawrie: You mean publish the names and addresses?

Mr Cousens: Sure.

Mr Lawrie: I think the theory is that the newspaper people, and television and radio too, in some instances, know best how to get the message across and are more effective at doing it than simply publishing lists of names and addresses.

The Chair: I've noticed from time to time over maybe 10 or 15 years that there is a report in our local paper about someone who has gone to court for evading taxes. I wouldn't say it was a headline, but it's certainly noted in the tabloid. But that's not what you're talking about. You're talking about automatically bringing it to the attention of the media that someone has evaded?

Mr Lawrie: Yes. As I said, the new policy consists of factual statements of tax evasion cases, including names, and addresses in some instances, and the sentence given and details of the offence. They're sent to newspapers and put on the wire services. Our target always is the same day as the conviction, because a day later it's usually old news; no one wants to print it. It's not simply a question of the ministry publishing names and addresses; it's trying to provide enough information for an interesting article for a newspaper in particular to pick up.

Revenue Canada, for a while, used to do the same thing but for a number of years now has only provided information if newspapers ask directly or if television or radio reporters ask directly. Of course the big problem there is it's actually quite seldom, unless it's a very big case, that there's any kind of reporter in court at the time of conviction. So how do they know about the case to ask about it? The answer is, usually they don't.

The Chair: The reports that I've seen, and these aren't recent, these may be five or 10 years ago, in my local paper were certainly -- the results of those court proceedings with regard to those people who had tried to evade paying their taxes were such that I certainly would think that it would be a deterrent to anyone to try to not pay or try to undertake not paying their taxes.

Mr Sutherland: I guess I wanted to deal with a bit of a theoretical situation -- well, maybe not theoretical. But dealing with the GST: When the GST was brought in, the view was that you need to make it visible: People need to see the taxes and where they are and you're replacing, as we heard, the much narrower but invisible manufacturers' tax. I sometimes have wondered since the GST has come in as to whether the concept of making a tax such as that more visible has been more effective or has had a negative impact in terms of the fact that it is so visible. People see it so tangibly. I understand the desire for that, and certainly I think consumers' groups and all that would say that it should be that way.

I am just wondering in terms of the impact it has on people, whether visible taxes are better than those such as the manufacturers' tax that some would call hidden tax.

Mr Spiro: Certainly from the point of view of transparency and being open with the public, one would say that it's desirable and preferable to have a tax visible and to let people know how much they're paying.

There were a variety of elements surrounding the GST, partly that it was introduced at the beginning of a recession. There was also a perception by some people that while the total amount of revenue raised by the GST might be the same as had been raised by the old manufacturers' sales tax, that it was distributed quite differently: a shift in the short term, at least, of the burden of taxation away from corporations on to consumers. Some theorists will argue that corporations eventually pass all their tax on to consumers in any case. That may or may not be true; it's probably not true in the short term. In this case, since we're talking corporations involved in international trade, some of it would never come back to Canadian consumers in any case.

So, there were a variety of elements in it, I think, beyond the issue of transparency. A lot of people did immediately criticize it as a shift in the tax burden, and that probably contributed to the controversy and the unpopularity of the GST.

Mr Sutherland: I think that's it for now.


Mr Lawrie: At this point in time, one little thing on that. I think if it's a question of showing sales tax separately added on to a basic price, whether it's RST or GST, I think it does concern a lot of consumers. I think the average person would prefer to have it one way or the other and not a mixture, because a mixture's confusing. You don't always look at the very small print at the bottom of the label to see if it includes the magic words "including RST, including GST." I think, obviously, value added tax is very similar in Europe to GST and there I think the practice is almost universal, that it's not shown separately at all; it's included in the price.

Mr Sutherland: It's incorporated into the sales price?

Mr Lawrie: Yes.

Mr Sutherland: My understanding is you can't do that with the GST, is that correct, you have to show it separately?

Mr Lawrie: You have an option. You can either show it separately or include it and post a notice, whichever one you use.

The Chair: Are there are further questions from committee members?

Mr Phillips: Maybe this was asked this morning, but from my perspective, if the staff have any studies you think we would find useful -- I'm sure you've read every study that's probably been done -- you might let the committee know about that and forward them, I guess, to the clerk. Perhaps it's already been done.

Mr Spiro: We already discussed that with some of the staff from this morning.

Mr Phillips: Okay, I'm sorry. The other is, as we go through this exercise, and I think we've got a good overview of the problem today, if you've any suggestions for solutions -- and I'm not sure how you can do that and what role you can play for us. I'm sure the committee would be interested in that, even if it's not recommendations, but just things you may want to consider, because I'm looking forward to this being a useful report for us.

The Chair: Mr Sutherland?

Mr Sutherland: No, that's fine.

The Chair: Okay, if there are no further questions, I'm not certain if there were any questions the committee members wanted to ask the representatives from the ministry in camera, but we can certainly do that, if it's necessary. Does anyone have any request for that? No? Okay, then that's not necessary. Mr Jamison did want to ask you a question. He's not here; he responded to the quorum call.

I'd like to thank you, on behalf of the committee, very much, Messrs Lawrie, Spiro and Wallace, for attending today and making, indeed, a very comprehensive and fine presentation before the committee and following that up by answering all of the questions that were posed to you. Thank you very much.

Mr Spiro: You're quite welcome.

The Chair: To the committee members, our research officer has indicated by a paper you received that there is a list of reports. Some of them are quite thick and substantial in size. I just thought it might be important to let you know that the clerk will certainly have a copy of all of these available, but I think it would be appropriate that, if you had a specific request for those reports, you make it known to the clerk.

Mrs Haslam: I would be interested to see the list in that way.

Mr Sutherland: She distributed it before.

Mrs Haslam: Oh, I haven't seen it. I'm sorry.

The Chair: It was distributed this morning.

Mrs Haslam: Excuse me, Mr Chair, I thought you meant she had added or had some other ones, because we had asked for some additional ones and I thought you were saying, because she had that new list, if we wanted something off it, we should ask.

The Chair: No, the list that was handed out this morning, those reports are available. Rather than give everyone a copy -- that may not be necessary. What I'm saying is that the clerk will certainly have a copy of all of them available for your perusal. However, if you have a request for any of those individual copies for yourself, I would suggest you make those to the clerk and she will make sure you get a copy.

Mr Sutherland: I'm just wondering, without putting an excessive burden on our legislative research officer, maybe if we had a little summary, some type of a one- or two-page summary, depending on how lengthy they are, of each of them, then that would give each of us a better idea if we wanted to study the entire report in depth.

The Chair: Ms Campbell, the research officer, will make a comment on that.

Ms Elaine Campbell: That was requested by the subcommittee last week and the memo makes reference to that. We'll try to get a summary of each report together as soon as possible.

Mr Sutherland: Great. Thank you.

The Chair: If there are no further issues to be raised today, then this committee is adjourned until 10 o'clock next Thursday.

The committee adjourned at 1655.