New federal polices worsen old problem of discouraging work in Canada

Last month the federal government’s new Canada Child Benefit program came into force, replacing and consolidating an assortment of previous programs. However, little attention has been given to how this policy change, along with others from the Trudeau government (i.e. expansion of the Canada Pension Plan), will exacerbate a longstanding economic problem in Canada: high marginal effective tax rates and the resulting work disincentives faced by some moderate and middle-income Canadians.

The marginal effective tax rate is simply the amount of money you lose to taxes, including the reduction of government benefits, when earning an additional dollar of income.

Economists worry about high marginal effective tax rates because they weaken the incentives for people to earn extra money by working additional hours or investing in their skills—actions that increase a person’s current and likely future earnings. If you consider working and earning more income but can only keep a portion of each additional dollar, you will assess the costs and benefits of doing so. If the amount you keep is small enough, you may decide not to expend the extra effort.

Policies that discourage work effort have wide-ranging economic consequences. They discourage Canadians from engaging in productive economic activity, ultimately hindering economic growth and prosperity—things the Trudeau government wants to encourage.

There’s a popular misperception that only “rich” Canadians face very high marginal effective tax rates. Not true. Due to the combination of taxes and benefits that are “clawed back” as income rises, those of more modest means also face high effective marginal tax rates.

This is not a new problem in Canada. But recent federal policy changes will magnify this problem for some Canadians, despite the federal government’s signature personal tax cut on middle-income Canadians.

Consider an Ontario couple with two children. Let’s call them the Millers. In the Miller family, Sally financially supports the family, earning $50,000 in labour income, while Jim stays home and looks after the kids. Even before the federal policy changes, Sally faced a high effective tax rate on an additional income. After accounting for federal and provincial income taxes, CPP and EI payroll taxes, and the claw-back of various federal and provincial transfers, the Millers would lose 61 cents for every additional dollar Sally earned beyond $50,000. This marginal effective tax rate was a disincentive for Sally to earn more.

But it’s getting worse. With the new Canada Child Benefit, and assuming the CPP payroll tax hike is implemented today, the Millers would lose 70 cents of an extra dollar Sally earned. If they decided to have another child, that would increase to 75 cents.

And these numbers actually underestimate the work disincentives facing the Millers. They exclude the employer portion of CPP and EI payroll taxes, although evidence shows these taxes will be passed on to the Millers through lower wages and/or benefits for Sally. Nor do they factor in the fact that any consumption activity with the little money the Millers keep from an additional dollar earned will be taxed at the HST rate of 13 per cent.

It’s easy to see why the Millers might determine that working harder to earn more money just isn’t worth it.

Of course, not every Canadian family will face the same marginal effective tax rate as the Millers. The precise rate for each family will depend on their number of children, their income level, and the number of household earners. But there are multiple scenarios in which changes to child benefits and CPP have increased the barrier to working more and earning a higher income for Canadian families.

The Canada Child Benefit and the proposed CPP expansion make a longstanding problem worse for some Canadian families and should not be overlooked if the Liberal government is serious about growing the economy and encouraging Canadians to move up the income ladder.