Finance Minister Morneau, please take note of research from your old think-tank
The C.D. Howe Institute, where federal Finance Minister Bill Morneau (pictured above) recently served as Chair, recently released a report calculating the revenue impact of the Liberals’ proposed tax changes. Morneau might want to take note of the results, and reconsider the plan to increase the top rate, given that the policy will cause economic damage and bring in much less revenue than expected.
The Liberals propose to reduce the marginal tax rate for individuals earning between approximately $45,000 and $90,000 from 22 per cent to 20.5 per cent, and raise the top marginal rate on those earning more than $200,000. Their campaign platform estimates that the new revenue coming from the tax hike would roughly cover the revenue lost from the tax reduction (about $2.8 billion in each in case). The C.D. Howe report challenges these findings.
In fact, the report estimates that the tax cut will cost more than what the Liberals anticipated ($3.5 billion) and the tax hike will bring in much less revenue than expected (only $1.0 billion). In addition, the report estimates that the proposed tax changes would create a $1.4 billion hole in provincial budgets by shrinking the tax base across the country, leading to lower provincial government revenue.
As a recent Fraser Institute study described, tax hikes—particularly on upper earners—tend to bring in less revenue for governments than expected because they encourage people to change their behaviour in ways that reduce the impact of the tax increases on their tax bill. This can come in many forms: taking more leisure time, accepting more compensation as fringe benefits, incorporating as a business to take advantage of lower tax rates, and shifting income to, or perhaps even physically leaving to, a lower tax jurisdiction.
Upper-income earners are especially well-positioned to take advantage of a variety of tax-saving mechanisms already available in the tax code. This is why a 2010 federal Department of Finance study found that tax-filers in the top one per cent reduced their reported incomes by 0.72 per cent for every one per cent increase in income taxes.
It’s critical to understand that tax revenue depends on two components: the base, which is the income derived from the activity being taxed, and the rate. Multiplying the two together gives us the “tax take” or the revenue the government receives from a specific tax. Unfortunately, governments often fail to realize that the base and the rate aren’t entirely independent of each other. Tax rate increases change people’s behaviour, which can reduce the tax base. Multiplying a lower tax base by a higher tax rate won’t necessarily lead to an overall increase in revenue—or it could generate less additional revenue than expected.
Moreover, a robust body of research shows that high and increasing personal income tax rates are harmful to economic performance as they discourage people from working, saving, investing and taking entrepreneurial risks.
Canada’s personal income tax system already compares poorly to a number of other industrialized countries in terms of both tax rates and the income levels at which they apply. With the new proposed top tax rate of 33 per cent, Canada’s competitive standing will worsen, bringing the top federal and provincial combined rate to more than 50 per cent and making it the fourth highest among industrialized countries, according to OECD data. Critically, the federal tax increase will exacerbate recent rate increases in several provinces including Ontario and Alberta.
Thankfully, there is a much better option for providing tax relief for middle-income families while improving, rather than harming, the economic competitiveness of Canada’s personal income tax system: simply eliminate the two middle personal income tax brackets, leaving one tax bracket (15 per cent) for the overwhelming majority of Canadians and a single high-income bracket of 29 per cent, affecting approximately two per cent of taxpayers. To help finance this tax change, the government could eliminate or reduce ineffective tax expenditures—one of the priorities outlined by the new Liberal government.
Mr. Morneau may want to carefully review the recent research from his old think-tank and others, and form tax policy that is informed by this evidence.
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