On Wednesday, the day after delivering the 2014 federal budget, Finance Minister Jim Flaherty set off a firestorm by offering his view on income-splitting, a platform commitment the Conservatives made for when the government returns to a balanced budget (likely next year). I'm not sure that, overall, it [income-splitting] benefits our society, Minister Flaherty stated, preferring instead to, reduce taxes more.

While readers of this page will know we haven't always agreed with Minister Flaherty over the years, he is right on the money with respect to income-splitting.

Indeed, contrary to the opinion of some, Minister Flaherty should be congratulated for both recognizing the weakness of the current proposal for income splitting and the need for a much deeper and involved discussion about how best to improve our tax system.

There is general agreement that a distortion exists in Canada's tax system between households. That is, households with similar incomes can face very different income tax bills depending on who earns the income. If a Canadian household has two earners with similar incomes they would ultimately pay lower income taxes than a one-earner household with the same amount of income.

A central tenet of tax policy is that households with similar incomes should face similar tax burdens. The distortion between dual-income households and those where most of the income is earned by one of the spouses is due to Canada's progressive personal income tax system - tax rates increase significantly as income increases (see table for federal income tax rates). Since the income tax rates apply to individual earnings, rather than family income, single earner families are taxed at higher rates than dual-income families with the same family income.

15% on first $43,953 of taxable income
22% on income between $43,954 and $87,907
26% on income between $87,908 and $136,270
29% on income over $136,270

The idea of income splitting is one method by which to fix this largely agreed upon problem. It basically allows households to combine and then split their income for tax purposes, thus moving some income from higher rates when it is earned by one spouse to the other spouse who faces lower tax rates because of their lower earnings.

Critically, and what one hopes motivated the Minister of Finance to raise concerns about income splitting is that it does almost nothing to improve economic incentives or Canada's competitiveness. A robust discussion about tax policy would ask whether there are other policies and reforms available that could allow us to both fix this distortion between single-earner and dual-income households while at the same time improving the incentives for work effort, savings, investment, and entrepreneurship, and improving our competitiveness.

A recent study published by the Fraser Institute evaluated the existing research on marginal tax rates and confirmed that the weight of the available evidence indicates that high and increasing marginal personal income taxes discourage productive behaviour like investment and entrepreneurship, which form the basis for a thriving economy.

In addition, and central to the emerging debate, is that the study found that Canada's personal income tax rates were generally high and effective at comparably low levels of income relative to our main trading partners, particularly when compared with the U.S.

The destructive impact of Canada's personal income tax rates has been identified by consecutive federal governments, both Liberal and Conservative. In 2005, then-prime minister Paul Martin's economic plan, A Plan for Growth and Prosperity, stated that: Lower personal taxes would  provide greater rewards and incentives for middle- and high-income Canadians to work, save and invest.

Similarly, Prime Minister Stephen Harper's original economic plan, Advantage Canada, stressed that Canada needs lower personal income tax rates to encourage more Canadians to realize their full potential. Indeed, the need to reduce personal income tax rates was highlighted years before the Conservatives mentioned income-splitting.

Given the economic research and Canada's relatively high personal income tax rates, any proposed tax reduction should focus on tax competitiveness and economic incentives. As such, we suggest eliminating the two middle-income tax brackets leaving one tax bracket (15%) for the majority of Canadians and a single high-income bracket, which would only affect 2 percent of taxpayers. In other words, the overwhelming majority of Canadians would face a single federal tax rate of 15%.

This would eliminate the distortion causing the need for income splitting for almost all households. Recall that the reason for the distortion between the different households was based on different marginal tax rates, which would be eliminated for most households under this proposal.

Our estimate is that such a change, fully implemented, would cost $20.6 billion. Thankfully, it could be implemented incrementally so as to manage the costs. For instance, we estimate the cost of a one-percentage point cut in the two middle-income tax brackets at $2.6 billion.

The current budget plan provides an estimated surplus of $6.4 billion in 2015-16 and $8.1 billion in each of the next two years. These expected surpluses would finance part of the proposal to eliminate the two middle-income tax brackets but not all of it.

The remainder would have to be financed through the elimination or reduction of many of the special privileges imbedded in the tax code, which are known as tax expenditures.

We shouldn't ignore the enormous benefits available from simplifying the tax code. Professor Francois Vaillancourt recently estimated that Canadians spent up to $24.8 billion simply complying with the tax code and another $6.6 billion was spent by governments administering the tax system. Simplifying the tax code would reduce these costs.

Consider that the totality of resources consumed by tax expenditures is actually quite large. For example, in 2012, the most recent year for which data is available for tax expenditures, the federal government spent $167.9 billion on personal income tax expenditures while collecting $125.7 billion in personal income taxes. Yes, the federal government spent more money providing carve-outs and special treatment than it collected in personal income taxes.

The $167.9 billion incurred in personal income tax expenditures is in addition to the $28.6 billion spent on corporate tax expenditures. Surely the remaining costs of the tax reform outlined above can be found within these tax expenditure amounts that total almost $197 billion.

Our proposal would provide broader-based tax relief and an enormous improvement in our tax competitiveness while strengthening the incentives for work effort, savings, investment, and entrepreneurship. Put simply, Canadians would get far bigger bang for their buck through this type of reform than income splitting.