Jack Mintz: Ottawa can’t keep squeezing Crazy Rich Canadians. Or barely rich ones.
January 10, 2019
Over half the population support proposals to raise taxes on the wealthy, but the wealthy will just move their income elsewhere
Why is it so hard for governments to reduce personal income taxes? Every time a politician proposes that income taxes should be cut, a typical reaction is to call it unfair since high earners are better off and so they supposedly don’t deserve any tax breaks. But tax reductions necessarily favour higher-income Canadians: with our highly distributive income-tax-transfer system, high earners already pay a majority of the personal income tax, so they will also get the most out of any income tax cut. And while redistribution to help the poor is laudable, it also comes at a cost to the economy, resulting in less growth, a lack of competitiveness and distorted consumption patterns that favour public over private spending.
According to the Canada Revenue Agency’s recent preliminary statistics for 2016, individuals earning $100,000 or more in annual income (8.7 per cent of all taxpayers), pay 51 per cent of federal income taxes. The one-per-centers (with more than $250,000 in annual income) pay 20.4 per cent of federal income taxes.
Going a bit further down the income scale, the top 15 per cent of tax filers (those with individual income more than $80,000) pay almost two-thirds of federal income tax. So cutting personal taxes obviously makes higher-income Canadians better off.
Indeed, very little tax is paid at low-income levels given our system’s concessionary marginal tax rates and credits. Statistics Canada reported that households at the 50th-percentile income level in 2016 received an average market income of $52,300, paid $6,600 in federal and provincial income taxes and received money transfers equal to $7,400. That means that federal and provincial income taxes comprised just 12.6 per cent of their market income compared to transfers at 14.6 per cent and that, effectively, the median Canadian household is receiving a transfer, net of income taxes, of $800 a year — or a two-per-cent bonus over their income.
But that’s just for income taxes: Once we take into account all levies and transfer programs, as my co-authors and I showed in a 2015 paper, the lowest income groups, representing 40 per cent of the population, pay fewer taxes than they receive in money transfers.
So when it comes to federal elections, the parties know that over half the population will likely support proposals to raise taxes on the rich to fund more transfers to the non-rich masses. This has been referred to as the “tyranny of the majority.” Because a greater number of people make moderate or low incomes, they can use their votes to effectively expropriate income from the fewer high-income taxpayers to support the rest of us.
It’s no surprise, then, that the federal Liberals won sufficient voter support for their promise to “ask the wealthiest one per cent of Canadians to give a little more” to pay for their “middle-class tax cut.” Truthfully, once in power in 2015, the Liberals didn’t really “ask”: They raised the federal top rate to 33 per cent from 29 per cent while offering a smaller tax cut of 1.5 percentage points to income roughly between $45,000 and $90,000.
Even conservative politicians tend to focus on income tax cuts for the more heavily populated middle income bracket, rather than for high incomes. But it’s even easier for politicians to get away with promises to cut broad-based taxes like those on sales and payrolls, since pretty much all adults pay those. The Harper government made itself more popular by lowering the federal GST rate — more popular except among members of the Economist Party, who kept reminding people that consumption taxes are less harmful than the income taxes.
Yet, there gets a point that governments can’t keep hitting those Crazy Rich Canadians — or just barely rich Canadians — with ever-higher taxes to fund public expenditures, which now account for more than two-fifths of the economy. The rich are usually able to shift assets and income outside of Canada or move themselves to countries with lower taxes (such as the U.S., the U.K. or the Cayman Islands). Or they may simply work less and retire early. Few studies have looked at the long-run impact of tax-rate hikes on mobile taxpayers in the highest brackets, but we do know that high-income earners in the short run react much more to high taxes, by using avoidance manoeuvres, than the rest of the population does.
We also know from various economic studies that high marginal personal tax rates reduce economic growth. They discourage work effort, investment and risk-taking by entrepreneurs and highly paid skilled labour. As seen in the accompanying table, Canada’s top marginal income tax rate is now the seventh-highest among 33 OECD countries (about seven points higher than the top U.S. rate, after recent tax reforms there). Moreover, unlike France, Japan, Portugal and United States, Canada defines someone to be a high earner at a much lower income level relative to the average national wage.
To lighten the tax burden on the rich facing high marginal tax rates in ways that avoid unpopular income tax cuts, governments often introduce various tax preferences targeted at high earners, such as venture-capital credits, flow-through share credits, capital gains exemptions and electric-car credits, among many others, ostensibly to encourage government-favoured activities. Whether the various tax expenditures are effective in encouraging certain behaviour is less important. It’s just easier, politically, to offer relief to high earners indirectly.
Still, the more we rely on a highly progressive income tax, the more we reduce growth, even if the money is redistributed to growth-enhancing programs, like education and infrastructure. To fund large spending outlays, governments must also rely on taxes on payroll, sales, property, excise and other non-income sources. And those taxes are much more heavily borne by lower- and middle-income Canadians. The result is a system that taxes income in ways that hampers growth, but is now reaching the limit of how hard it can squeeze upper-income earners. So, if the public sector continues to expand, then what will be left is governments relying disproportionately on taxing money away from middle-income families. None of this is a formula for prosperity and growth.
Going back to the argument in the famous 1967 Carter Report, comprehensive tax reform would lead to a better tax system with lower rates, a lot fewer of those special credits and exemptions, and broader tax bases. But given the way political decision-making works, don’t hold your breath for that. It would take a brave government to lead the way to reforming our tax system for the better. It’s hard to name any leaders right now who have the right stuff for it.