Is Canadian Income Tax Unconstitutional? (Hint: No)

One thing that seems to cheer up my American skeptical friends is when they discover Canadians have their fair share of wingnuts and loonies. I gather many Americans view Canadians as reasonable people and not given to the nastiness that has emerged from the so-called Culture War. So when Americans find out Canadians are as bonkers, it gives them hope that maybe the inmates are not in charge of the insane asylum.

One of the odder claims by some is the idea that income tax is unconstitutional. Wesley Snipes’ problems with the IRS have brought some larger media attention to the notion that some people have the odd view they can ditch out on paying income tax by simply asserting income tax is unconstitutional. This ghost-shirt type tax dodge strikes me as wholly silly. Sure you can direct people to things like the 16th Amendment but at the end of the day I think the most powerful argument that there is nothing to this claim is the fact that no major law firm has ever, ever, ever taken up a class action lawsuit. You would think if the unconstitutionality was so obvious and clear cut to a B-list movie actor and people who mint their own gold currency that it would be as clear cut to big time law firms always hungry for the next big money class action suit. That no group of powerful lawyers have ever, ever, ever taken up such a suit in the last 40 years, won, collected a 40% cut, and then bought France with the proceeds indicates to me that most sane, rational legal minds fully understand income tax passes constitutional muster.

The idea some form of taxation is unconstitutional crops up from time to time in Canada when a new tax is introduced. Ontario (Canada’s biggest province and Canada’s industrial heartland) is about to introduce something called the HST. This combines Ontario’s sales tax (PST) with the Federal government’s GST (a value added tax). Unlike most VATs, the GST and now the HST are typically not hidden in the posted price. You pay the posted price plus the HST at the cash register (or previous to July 1, 2010, you paid the posted price plus the GST and the PST).

The notion that, in Canada, Federal income tax is illegal seems to be mostly championed by western separatists and members of a strange anti-New World Order Catholic fringe political party called Social Credit (a party that roughly believes the government should just print money as needed). See. We really do have those types in Canada.

What’s the basis for the claim Canada’s Federal income tax is illegal? Well, it stems from a portion of our constitution called the British North America act. Two sections outline the exclusive powers of the federal government (section 91) and the exclusive powers of the provinces (section 92).

Both sections give the Federal government and the provincial governments the power to tax.

Section 91 (federal powers) states:

The raising of Money by any Mode or System of Taxation.

Income tax seems to fall under the idea of “any system of taxation”.

The income-tax-is-unconstitutional peope say “hold on, check Section 92″. Section 92 (the provincial powers) states:

In each Province the Legislature may exclusively make Laws in relation to Matters coming within the Classes of Subjects next hereinafter enumerated; that is to say…

Direct Taxation within the Province in order to the raising of a Revenue for Provincial Purposes.

The “direct taxation” line is meant to keep the provinces from imposing their own value added taxes, production taxes, manufacturing tax, excise taxes, etc. The tax-is-unconstitutional people think “income tax is direct taxation” (which it is) and the federal section did not specify direct taxation (just that troublesome “any tax” thingy). Further, they note section 92 appears to give provinces the EXCLUSIVE right to direct taxation. Therefore, the Federal government may impose any kind of tax except DIRECT taxes, as this power is exclusive to the provinces.

However, the tax-is-unconstitutional people have to ignore the rest of the sentence in Section 92 that says “in order to the raising of a Revenue for Provincial Purposes” (it would seem 19th century constitution writers write like my Korean ESL students). So the meaning is a province has the exclusive right only to raise a direct tax for its own internal purposes. A province cannot raise a tax and then hand that money over to someone else, like the province next door or the UN or something. Conversely, the Federal government cannot impose a direct tax for the purposes of funding Ontario hospitals (hospitals are an exclusive provincial responsibility).

At least twice, as best I can figure, this notion the Federal government can’t impose a direct tax because of Section 92 has been challenged in court. Both times the courts have ruled against the plaintiff. The most relevant seems to be Mueller v. Canada. Another, Winterhaven Stables Ltd. v. Canada (Attorney General), seems to be a clever one. In Canada the Federal government ultimately gives some of the Federal income tax back to the provinces. The intent is to help them fund hospitals and education. We call these “transfer payments”. When the British North America act was written hospitals and education were not big ticket items. Now healthcare and education are HUGE public expenditures the provinces have to bear. The Federal government helps the poorer provinces by transferring some Federal tax revenue. This way you don’t get Third World medical treatment in Nova Scotia and First World treatment in Ontario. As I noted in the paragraph above, the federal government funding hospitals straight out of Federal income tax dollars seems to be contrary to the notion the Federal government can’t raise a direct tax to fund a provincial responsibility. The court seems to have ruled the money transferred to the provinces doesn’t come specifically from income tax. It comes from, you know, various sources, like excise taxes, pop bottle collection drives, etc.

It took me about two days of research to figure this all out. Oddly Canada’s version of the IRS gives the whole “income tax is unconstitutional myth” a very shallow treatment:

This myth is based on the faulty argument that the Canadian Constitution gives the power of direct taxation exclusively to the provinces. Section 91 of the Constitution says the federal government can raise money “by any mode or system of taxation.” Section 92 says the provinces can impose “direct taxes within a province” to raise revenue for provincial purposes. As a result, while federal and provincial taxing powers overlap, the federal government can levy both indirect and direct taxes, including income tax.
The courts have confirmed the power of the federal government to levy direct taxes including income tax. No court in Canada has ever agreed with the idea that the federal government cannot levy income taxes. The often-cited 1950 Supreme Court decision concerning the Lord Nelson Hotel in Nova Scotia dealt with the issue of whether the federal government and a provincial government could delegate authority to each other on specific issues of labour and taxation. The Court did not address the issue of imposing direct taxes or their constitutionality.

Okay. So no court, but which courts? You’d think they’d list the cases. The only case they cite is this rather cryptic Lord Nelson Hotel decision and it doesn’t seem to make sense in context. Digging deeper it seems to work like this:

Nova Scotia in 1950 wanted to impose a sales tax. Although sales taxes are common today, the provinces only started to levy them at the start of the 1960s. Nova Scotia in 1950 seems to have feared a sales tax was an indirect tax, not a direct tax. As noted, Section 92 only allows a province to collect a direct tax. A direct tax is a tax you pay directly. An indirect tax is generally defined as a tax collected by another and then passed onto the government. Several authorities include sales taxes as meeting the definition of an indirect tax. But more about this later.

So Nova Scotia had this plan that the Federal government would lend them their Section 91 power to impose indirect taxes and if that power was so offered, the province would graciously accept it. The Lord Nelson Hotel case ruled the Federal government could not delegate federal powers to the provinces and vice versa. So the Federal government can’t say “okay, Quebec, you can print your own currency.” And Ontario can’t say, “okay Federal government you can open Federally controlled hospitals and schools in Ontario”.

How this case seems to help the anti-taxxers is beyond me. The case is about provinces gaining federal powers, not about the Federal government supposedly gaining a provincial direct taxation power.

Anyway, this raises the question of whether or not sales tax is a direct tax or indirect tax. If it’s indirect, then provincial sales taxes are illegal. For example the Farlex Financial Dictionary defines an indirect tax as

A tax that is shifted to another person or entity. For example, sales taxes are levied on a seller but are paid by buyers; that is, the government expects sellers to pay the sales tax, but they pass the cost on to their customers.

So the retailer has to collect the tax and pass it on. I don’t submit all my receipts for the insane crap I buy every year and then pay tax on it. However, it would appear the Canadian federal government defined an indirect tax as a tax levied on a producer and simply built into the final price of the product:

An indirect tax is that which is demanded from one person in the expectation and with the intention that he shall indemnify himself at the expense of another.

That part about building it into the final price of the product is key. All prices in Ontario are posted pre-tax. Compare that to, say, a manufacturer tax. The manufacturer pays the tax for every dongle it builds. Whether it sells the dongle or not is immaterial. It still owes a tax. Naturally, the manufacturer passes on the total cost of building stuff. So to keep a PST all direct tax like, retailers cannot build the PST into the posted price. Further, provincial retailers are designated as agents of the province; much like an employer may deduct income tax from your pay and send it to the government.

– Karl Mamer