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Taxation

Abolish the Income Tax!
Part 3:
The Solution

Originally published at About.com - April 26, 2001
This article is also available at
Towards a Tax Free Canada

There is tremendous force in the power of compounding. And there are three factors that contribute to the power of compounding - the amount invested, the rate of return, and the length of time the money is invested.

There are some interesting anomalies from this. A person investing $1000 at age 20 and adding $1000 a year for ten years will have accumulated well over a million dollars by age 65 (12.5% annual rate of return). Yet a person starting later - at age 30 with a $1000 investment and adding $1000 every year until retirement at 65, will accumulate less than half that.

Now here's a truly amazing fact. A one-time investment of a mere $500 in an account for a baby when it is born, compounding at 12.5% a year, will accumulate to over a million dollars when that babe reaches age 65. Amazing but true. $1000 invested needs a return of only 11.5% to accomplish the same thing.

By the government's information in Paul Martin's mini-budget of October 2000, the federal government expects to take in $175 billion in fiscal 2001 and will increase its take by about 3% a year. It ran a surplus of $12.3 billion in fiscal 2000 and expects to run an average surplus of over $10 billion for the next six years.

According to Statistics Canada data, income taxes made up about 62.8% of revenues in fiscal 2000.

For the sake of argument, we assume the government's revenues will continue to grow at 3% a year into the future and the percentage taken by income tax is actually 65% of total needs and continues at that rate.

If $10 billion of last year's surplus is invested in carefully selected mutual funds we have the following result:

At a 20% rate of return, the $10 billion fund will have grown large enough to generate enough money each year to replace the income tax in 2027. If we want to be conservative and only use half the revenue generated to replace the income tax, the balance being reinvested for further growth, we could eliminate the income tax by 2031 - just four years later.

But, you say, a 20% rate of return is unrealistic. Okay, let's consider a variety of rates. The table below summarizes the results.

Rate of Return Rate of Withdrawal to Replace Income Tax Year Income Tax Eliminated
20% 10% 2031
15% 10% 2043
12.5% 10% 2054
10% 8% 2075

Now some may think these rates of return, even 10%, are unattainable. But consider the following: As of Dec. 31, 2000, six Canadian mutual funds had a rate of return better than 15% over 15 years. 22 returned better than 12.5% for that period. And a whopping 69 have done better than 10%

And if we look at a shorter time frame, say ten years or five years, the results are even better. The table below summarizes the number of Canadian mutual funds generating different rates of return over various time horizons. And remember that these figures are as of December 31, 2000, after a year in which many mutual funds suffered horrendous losses.

Time Frame 20% Return 15% Return 12.5% Return 10% Return
15 Years 0 6 22 69
10 Years 6 51 119 256
5 Years 39 179 324 494

In fact, the shorter the time frame, the more funds there will be with higher returns. There are 87 funds returning 20% over 3 years and 237 returning better than 20% for the year 2000. Not bad for a year in which indexes crumbled and stock markets collapsed.

With a judicious method of fund allocation - setting certain performance requirements for the government to keep invested in a particular fund, it is sure to be able to generate at least a 12.5% return. And that's just looking at Canadian mutual funds. If the government invested in U.S. funds, the number of available investment choices would be that much greater, and, delicious irony, profits from American industry would pay for the Canadian government - not a penny out of Canadian taxpayers' pockets!

One last scenario: If the government, instead of plunking down $10 billion now and leaving it there opted to divide its surplus into four - a quarter for tax relief, a quarter for debt retirement, a quarter for new spending and a quarter into the income tax elimination fund, in other words, investing $2.5 billion a year into the fund, the timetable would be delayed by four years, But if it continued beyond the fourth year adding $2.5 billion to the fund - guess what?

With only a 10% return, the income tax would be eliminated in 2060 instead of 2075. At 12.5% the tax would go in 2045. At 15% - goodbye tax in 2037. And with a 20% return - no more income tax in 2029.

The government is, in fact, already invested in the stock market. It has a $1.7 billion stake in Petro-Canada and further hundreds of millions in Hibernia. Some have urged the government to divest itself of these holdings. I disagree. If the government sells off these holdings, it should be to diversify, not to get out of the market. Earmark those funds for an income tax elimination fund, and the government is already 20% of the way towards the goal I set out in this article!

These figures look at just eliminating the income tax. But each scenario allows for continued growth of the investment pot. Eventually, adopting such a plan, Canada could become - oh wonder of wonders - a tax-free nation!

Now isn't that something to strive for?

Note to Ralph Klein: Alberta is well on its way to eliminating its provincial debt in the next few years, making it Canada's only debt free province. It is already the only province without a provincial sales tax. You should grab the brass ring, Ralph, and implement the ideas in this article to make Alberta the only tax-free province. Now that would be leadership!

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