Key policy areas for the new finance minister: Part 2—top tax rate

The appointment of Bill Morneau as minister of finance is particularly interesting because of his involvement in the world of public policy think-tanks. In recent years, the Fraser Institute and the C.D. Howe Institute (where Mr. Morneau recently served as Chair) have both produced important research that provides insights that can help guide the policy decisions of the new finance minister on a number of different files. This series of blog posts will highlight a number of key policy areas where Mr. Morneau’s think-tank experience can be especially useful. In this post, we examine the Liberal election promise to raise the top marginal personal income tax rate.

During the campaign, the Liberals promised to increase the top marginal personal income tax rate. Recent research from the C.D. Howe Institute as well as the Fraser Institute suggests that following through on this commitment would harm the Canadian economy.

A robust body of economic research shows that high personal income tax rates are harmful to economic performance. One of those studies, which examined the tax rate increases in Ontario under Premier Wynne, was published by the C.D. Howe Institute in 2012. It concluded that the tax rate increases in Ontario would “likely create more economic costs than benefits” because of the negative incentives such tax rate increases impose on investors, entrepreneurs, business professionals and skilled labour. Indeed, the study further stated that behavioural responses to the tax rates would likely reduce government revenue in the long-term by more than the province would collect.

Although the behavioural response to a federal tax increase would not be as strong as a provincial tax increase (because it is harder to change the country you report income in than the province), the C.D. Howe paper correctly observed that higher-income taxpayers respond to higher taxes by reducing their labour supply. This would be equally true for a federal tax increase as a provincial one, with the consequences of reduced economic growth and weaker-than-expected revenue gains from higher personal income taxes.

Our own work in this area buttresses the conclusions of the C.D. Howe report. For example, a recent paper on personal income taxes showed that Canada fared poorly compared to the United States and a number of other industrialized countries in terms of both our tax rates and the income levels at which they apply. In other words, our personal income tax rates were judged to be comparatively high and effective at relatively low levels of income. This research strongly suggests that further increases to personal income tax rates would make Canada less competitive, negatively influencing investment, savings, entrepreneurship and overall economic growth.

Increasing the top marginal income tax rate would hurt the economy and could bring in a disappointing amount of new revenue. Mr. Morneau should carefully review the recent research from his own think-tank and others and form tax policy that is informed by this evidence.