A flat personal income tax would do more for B.C.'s economy than Campbell's now mothballed income tax cut

The unexpected departure of Premier Gordon Campbell left the fate of his announced personal income tax cut in a cloud of uncertainty. Its subsequent cancellation has removed that doubt. But the real question British Columbians need to ask is: what’s best for the economy?

While a personal income tax cut provides good economic bang for the tax cut buck, Campbell’s 15% reduction to the bottom two rates would not have been the best move for the province. What B.C. really needs is a single rate personal income tax system.

Before delving into the details of a single rate tax, it’s important to understand that the recently mothballed income tax cut is not compensation for a perceived tax increase under the HST. The HST was brought in with tax reductions that more than offset the increased sales taxes that would be paid by low- and middle-income families. Those tax reductions included an increase in the basic personal income tax exemption to $11,000 from $9,373, which reduces the amount of tax individuals pay, and a new B.C. HST credit ($230 per family member) to help roughly 1.1 million lower-income British Columbians.

Campbell’s proposed income tax cut should be judged on its own merit, separate and distinct from the HST. And the best way to judge tax relief is based on whether it improves the incentives for work effort, saving, investment, innovation and entrepreneurship. These activities form the backbone of a strong and prosperous economy.

Currently, B.C. has five personal income tax brackets, starting at 5.06% for income up to $35,859 and increasing to 14.7% for income over $99,987. In other words, B.C. has “progressive” personal income tax rates. But progressive income tax rates create strong disincentives for people to engage in productive economic activities.

To understand how progressive tax rates act as a disincentive, think of progressive fines used to discourage fast driving. Speeding tickets are higher depending on how much above the posted limit we drive. While certainly not the intention, progressive income tax rates have the same effect in that they discourage hard work and success.

When people make decisions to increase their incomes by working harder or longer, increasing their savings and investments or starting their own company, their marginal tax rate influences behaviour (the marginal tax rate is the rate paid on the next dollar of earned income). If governments take more of an additional dollar in income, people are less likely to make the effort to earn more.

Although Campbell’s 15% income tax cut would have reduced the provincial government’s cut from your income (which is good for incentives), the economic impact would be minor. Since the tax cut only applied to the bottom two personal income tax rates (5.06% and 7.70%), it would do little to encourage savings and investment because lower-income individuals undertake little savings and investment. In addition, the tax cut would have a minor impact on work effort, because low-income workers already face very low statutory tax rates.

A single rate tax would remove a significant barrier to success and drastically improve economic incentives. To date, Alberta is the only Canadian province that maintains a single rate on personal income (10% on income over $16,825).

Unfortunately, reducing only the bottom two rates moves B.C. further away from a single rate system and makes it more difficult to adopt such a system in the future.

When Campbell significantly reduced personal and corporate income tax rates after first coming to power, he helped set the stage for B.C.’s economic recovery. Now his successor can prime the B.C. economy for its next stage of growth by embracing a flat personal income tax.