How Governments Raise Revenue

Background Knowledge For Smarter Business Planning

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By L.Kenway BComm CPB Retired
This is the year you get all your ducks in a row! Start by starting.

Published February 20, 2026

WHAT'S IN THIS ARTICLE
The Three Ways Governments Raise Revenue | How Provincial Governments Fund Services | The Global Shift: Taxing Consumption Over Income | Strategic Implications for Small Business Owners | Practical Takeaways

Puzzle PiecesUnderstanding how things fit together


The Three Ways Governments Raise Revenue

To do Canadian bookkeeping requires some basic knowledge of taxes so you can properly record sales tax, payroll tax, employee taxable benefits, or allowable income tax deductions. 

Let me say that again. To do Canadian bookkeeping requires some basic knowledge of taxes so you can properly record sales tax, payroll tax, employee taxable benefits, or allowable income tax deductions. 

I think ... no, I know... it helps YOU to keep a better set of books if YOU understand a little bit about the kinds of taxes there are in Canada ... and the reason governments use one type of tax over another.

Governments use taxes not only to raise revenues but also to direct social policy. The trend in the world today is to tax consumption more than income.

David Robertson, a Canadian tax lawyer explains ... in a paper entitled Sales Tax Harmonization: The Facts & Nothing But The Facts ... that there are only three ways for a government to raise revenues:

  1. When money is earned by a taxpayer - for example income taxes, payroll taxes and profit taxes.
  2. When money is spent by a taxpayer - for example consumption taxes, sales taxes, land and property transfer taxes.
  3. On the value of a taxpayer's assets - for example property and estate taxes.

How Provincial Governments Fund Services

Provincial governments have four sources of revenue:

  1. provincial taxes - for example personal income taxes, corporate income taxes and sales taxes;
  2. federal government transfers;
  3. income from investments and government businesses - for example the liquor board;
  4. other income - for example natural resources, fines and permit fees.

Mr. Robertson [1] points out that "the choice between which of these taxes to impose and when is generally driven by not only the need to raise revenues for government purposes, but also the behaviours the particular government wishes to encourage or discourage.

The Global Shift: Taxing Consumption Over Income

Amongst OECD member countries, the trend, at the beginning of the twenty first century, was to place more emphasis on taxing consumption and to reduce taxes on business profits and investments.

The policy reasons for this are clear. Taxation of income and profits provides a disincentive for citizens to earn more.

By reducing income taxes, government place more after-tax dollars into taxpayers’ hands, allowing them more flexibility to choose to invest that money in further income-earning activities or to use it for personal consumption.

If the taxpayer chooses the former, no further taxation is imposed. If the taxpayer chooses the latter, a consumption tax applies. In this way, the tax system provides an incentive to taxpayers to invest in further income-earning activities with the added benefit of discouraging excess consumption."

Strategic Implications for Small Business Owners

Understanding how governments raise revenue isn't just academic. It influences smart business decisions in four key areas.

  • Business Structure Decisions
    Knowing that Canada shifted toward consumption taxes and away from heavy profit taxation in the 1990s can inform your incorporation timing. If you're earning significant income as a sole proprietor, understanding how different business structures are taxed helps you plan strategically.
  • Compensation Planning
    Owner-managers who understand tax policy can, with the help of their accountant, make informed decisions about salary versus dividends, knowing how each is taxed and why.
  • Major Purchase Timing
    Understanding consumption taxes helps you plan when to make significant business purchases. Should you buy that equipment before or after a fiscal year-end? The answer often lies in understanding how sales tax and income tax interact. Your accountant can help you with this type of decision.
  • Investment Decisions
    Tax policy often encourages reinvestment over consumption. When you understand this principle, you can align your business growth strategy with tax advantages ... reinvesting profits into equipment, training, or expansion rather than taking everything as personal income.

Practical Takeaways

Keep these principles in mind. You don't need to become a tax expert, but understanding the 'why' behind tax policy helps you ask better questions when planning your business future.

Questions to discuss with your accountant as your business grows ...

  • Should I be setting aside money differently knowing consumption taxes work this way?
  • When I'm ready to hire, how will payroll taxes affect my costs?
  • If I'm thinking about buying expensive equipment, what's the tax advantage of reinvesting versus taking the money personally?
  • As my income grows, at what point should I talk to my accountant about different business structures?

Tax policy shapes the business landscape you operate in. While it won't affect your daily bookkeeping tasks, this background knowledge helps you make informed strategic decisions as your business grows.

🦆 Remember: These are general principles. Always consult with a qualified tax professional for advice specific to your situation.


Reference

[1] Mr. Robertson is a partner with the firm EY Law LLP. His paper was presented in September 2005 at the CICA Commodity Tax Symposium. The article is no longer available online. The 75 page paper is written in a user friendly way ... which means it didn't sound "legalize" to me. I could actually follow what he was saying ... and it was really interesting and informative ... so I thought I'd share just a piece with you. I hope you enjoyed it. 

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