Ottawa’s ‘luxury tax’ will hurt the economy and Canadians

The Trudeau government’s “luxury tax” came into effect this fall. Such a tax, which applies to luxury goods (cars, boats, planes), supposedly will help ensure high-income Canadians pay their “fair share” of taxes. The sentiment is popular but not very sensible in the context of Canada’s current tax system, and the policy itself is downright harmful. And unfortunately, like the space between Boardwalk and Park Place, the federal luxury tax imposes financial costs not only on the wealthy but on everyone.

One of the pithiest rejoinders to this “fair share” talk was given by American economist Thomas Sowell. “What is your ‘fair share,’” Sowell asked, “of what someone else has worked for?” In Canada, data from 2017 show the top one per cent of earners paid 18 per cent of the income tax—double the combined income tax payments of the bottom 50 per cent of earners. Put another way, the average income tax bill for the top one per cent of earners is about 100 times higher than the average in the bottom 50 per cent.

Yet more evidence that Canada’s top earners are already over-taxed. The last time the federal government tried to make them pay more, the economic effect was unquestionably harmful and even the effect on government revenues likely negative. A study in 2018 by Alexandre Laurin found the federal government’s income tax hike on the top one per cent of earners in 2016 resulted in $1.2 billion in increased revenue for Ottawa, but by discouraging top earners from generating taxable income, cost provincial treasures $1.3 billion, for a net fiscal loss.

A study in 2019 by economist Ergete Ferede found similarly pessimistic results of the tax on federal revenues in the short term, with its fiscal harm growing in the long run. Thus even if the goal of tax policy is to maximize government revenues—which it should not be in the first place—reducing the income tax rate on top earners is probably a better idea than increasing it. A luxury goods tax functions differently than a top marginal income tax hike, but the effect is not all that dissimilar.

Taxing consumption (as a luxury goods tax does) is preferable to taxing income because a consumption tax tends to be less economically harmful, but an offsetting disadvantage of a luxury goods tax is its uneven application. As a general principle of sensible tax policy, a tax should be broadly applied to minimize its “distortionary” effects on the economy. In contrast, a luxury goods tax is narrowly applied, the goods to which it applies arbitrarily selected, and the price points at which it comes into effect arbitrarily decided.

Importantly, taxes on top earners, whether on income or consumption, discourages them from supplying work effort and distorts economic activity. This is true whether those earners are entrepreneurs, corporate executives, heart surgeons or in other professions. The effect of such taxes is therefore a weaker economy for all. For example, discouraging work effort among corporate executives will mean large companies will be less efficiently run, which is worse for ordinary workers, consumers and shareholders, not just “the rich.”

Thus taxes that are said to be paid for by “the rich” in fact impose costs on everyone. The federal luxury goods tax, which yields little or nothing in the way of compensating benefits, is a cost all Canadians should be unhappy to bear.