On Tax-Transfer Integration: Let Us Return to the Ability-To-Pay Principle

Similar documents
e-brief What s My METR? Marginal Effective Tax Rates Are Down But Not for Everyone: The Ontario Case April 27, 2011

The Personal Income Tax : e Tax Rate Structure

Caledon Response to Liberal Poverty Strategy

A Proposal for Restructuring the Universal Child Care Benefit

Regressing Towards Proportionality: Personal Income Tax Reform in New Brunswick

Reforming the Tax Cut Agenda

Challenges in Shifting Canadian Taxation toward Consumption

Aging and taxation: Retirement income and age-related tax issues

Optimize RRSP Contribution Strategy Summary

Blinded by the Refund : Why TFSAs may beat RRSPs as better retirement savings vehicle for some Canadians by Jamie Golombek

THE ULTIMATE END-ALL-BE-ALL DEFINITIVE GUIDE TO. RRSP or TFSA WHICH WAY SHOULD YOU GO?

Making the most of your TFSA dollars

Ontario s Fiscal Competitiveness in 2004

Pension Income Splitting

Personal Income Tax. July 16, 2014

Submission to the House of Commons Standing Committee

2017 Provincial Budget Commentary. PARTNERS LLP Chartered Professional Accountants. April 27, and

Re: Tax and Retirement Savings Innovations to Promote Retirement Income

consider allowing a sample logbook to determine business use for a taxation year, and would consult on this issue with various small business groups.

Passive Income: Historical and Legislative Context and Comments

Like many other countries, Canada has a

e-brief September 30, 2008

newsletter Distribution of tax burden in Croatia ivica urban Institute of Public Finance

Securing Canada s Retirement Income System

PUBLIC POSITION. Meeting the Needs of Canada s Future Retirees A CALL TO TIMELY ACTION: NOVEMBER 10, 2015 SUMMARY OF CIA POSITION

Understanding Income Distribution and Poverty

Top Ten Tax Filing Tips 2009 Returns

Would the Senate Democrats proposed excise tax on highcost employer-paid health insurance benefits be progressive?

Income Splitting in Retirement

Federal Income Tax Treatment of the Family

October 2017 Tax Newsletter

Tax & Retirement Planning Guide

Cover Text for French Translation: Macroeconomic Aspects of Retirement Savings. April David A. Dodge and. Richard Dion, Bennett Jones, LLP

2013 Year End Tax Tips

RDSP, HENSON TRUST OR TFSA?

Canadian Centre for Policy Alternatives Ontario August Losing Ground. Income Inequality in Ontario, Sheila Block

the debate concerning whether policymakers should try to stabilize the economy.

Inequality and Redistribution

In assessing the benefits of incorporation the following four items represent the most significant tax benefits of incorporation:

2013 Year End Tax Tips by Jamie Golombek

How the world s best financial plans are made

Sole proprietorships vs. corporations

Payroll Deductions Supplementary Tables

Navigator. Withdrawing surplus cash from a corporation. The. Please contact us for more information about the topics discussed in this article.

Kurt Rosentreter 2017 Year-End Tax Planning Tips

Perspective. Cautious Optimism. In this issue

Budget 2015 More splash than cash

Module 5 - Saving HANDOUT 5-7

CORPORATE TAXATION: WHAT YOU NEED TO KNOW

ECONOMIC SURVEY OF NEW ZEALAND 2007: TWO BROAD APPROACHES FOR TAX REFORM

Registered Retirement Savings Plan

TAX FACTS & FIGURES. April 2018

A B.I.G. Typology and what we might be able to afford. David Zhang and Mike Moffatt Lawrence National Centre for Policy and Management

A Recipe for Reform: Comments on the Paper by Satya Poddar and Morley D. English

IFS. Options for a UK 'flat tax' Some simple simulations. The Institute for Fiscal Studies. Stuart Adam James Browne. IFS Briefing Note No.

How the Tax System Could Help to Reduce Poverty and Inequality

Ontario Marginal Tax Rates 2012 Calculator

Navigator Federal Budget. The. Key tax measures that may have a direct impact on you

Public Pensions. Economics 325 Martin Farnham

2016 Federal Budget Federal Budget March 22, RBC Wealth Management Services

created by provisions in the taxpayer s Will;

Tax Incentives for Charitable Giving. Jamie Golombek Managing Director, Tax and Estate Planning CIBC Wealth Strategies Group

TAX FACTS & FIGURES. April 2017

2013 Edition. Ontario Health Tax

An Agenda for Tax Reform in Canada

Top 10 Tax Tips. Tax Season Top 10 Tax Tips. By Jamie Golombek. Tips for your 2008 Return

DRAFT. A microsimulation analysis of public and private policies aimed at increasing the age of retirement 1. April Jeff Carr and André Léonard

PENSION REFORM IN CANADA

HARPER. Edited by Teresa Healy. Photo: Tom Hanson/THE CANADIAN PRESS

Retiring Right: Understanding the Taxation of Retirement Income

A PRIMER ON WILL AND ESTATE PLANNING

Navigator. Incorporate or not? The. Is incorporating your business right for you?

The Flypaper Effect. Does equalization really contribute to better public services, or does it just stick to politicians and civil servants?

DETAILED CONTENTS OF CHAPTER 3

The Power of Dividends. by Douglas M. Parker CA CFP Partner Director of Taxation Wilkinson & Company LLP

Update on the CCPC tax proposals December 2017

2012 Year End Tax Tips

Conservatives plan to cut public spending to cut National Insurance

TAX REFORM, DEMOGRAPHIC CHANGE AND RISING INEQUALITY

S T E P. S o c i e t y o f T r u s t a n d E s t a t e P r a c t i t i o n e r s

Kevin Milligan, Vancouver School of Economics and NBER Tammy Schirle, Wilfrid Laurier University

Fiscal Needs and the CHST Per Capita Division Rule

The National Child Benefit. Progress Report SP E

Private Corporation Tax Proposals: In the right direction?

POLICY BRIEF. A Stronger Foundation. Pension Reform and Old Age Security. By Monica Townson. November 2009

Pension income splitting

DETAILED CONTENTS OF CHAPTER 6

Tax-Free Savings Accounts

Taxation of Business Income and Methods of Withdrawing Cash from a Corporation

What is incorporation?

How Do the Presidential Candidates Tax Plans Affect Taxpayers Marginal Tax Rates?

The impact of tax and benefit reforms by sex: some simple analysis

RRSP Checklist. To qualify as a 2010 deduction, contributions to your personal or spousal RRSP must be made on or before March 1, 2011.

Welfare: Women, Poverty and the Charter

Tax Tips & Traps. In this edition: TAX TICKLERS TAX TICKLERS some quick points to consider

Canadian income tax system. For the purposes of this article, we assume you are a tax resident of Canada.

No Taxation Without Indexation

Tax & Retirement Planning Guide

Expanding the Social Security Benefit Exemption Under the Iowa Income Tax

Payroll Deductions Supplementary Tables

Transcription:

On Tax-Transfer Integration: Let Us Return to the Ability-To-Pay Principle Thomas A. Wilson* The attempt to replace the type of welfare or means-tested support for the poor with a much simpler system through the extended child tax system is all to the good. And I would agree that we need to provide more support for poor families with children. But in this commentary on the preceding paper by Ken Battle many of my remarks are quite critical. I think the real problem with the child tax benefit (CTB) as currently structured is that it has introduced distortions of the personal income tax system. Let me begin by reviewing two basic principles of taxation. The first is the benefit taxation principle that is, taxes that are based on a user-pay principle whereby the beneficiaries of a program pay for it through taxes or user charges. Now this principle, of course, is not relevant, for any kind of tax has an income redistribution objective. The second principle, and the one that was heavily emphasized in the Carter report 1 many years ago, is the ability-to-pay principle. That principle provides the main justification for a broad-based tax on income, or indeed for broad-based taxes on other sources, such as consumption or wealth. The ability-to-pay principle involves two derivative objectives: horizontal equity, which is equal taxation of people in equal circumstances, and vertical equity, which is appropriate differentiation across people with different circumstances. I argue that our present personal income tax (PIT) system has wandered far away from the ability-to-pay principle. This drift has been due not so much to the changes in the base 2 that have occurred, but rather (among several other changes) to the failure to adequately recognize the family unit. Despite the strong arguments of the Carter commission for recognition of the family unit, we have left our tax system largely on an individual basis. The failure to recognize that children reduce discretionary income, even for families with above-average income, creates inequities. When a couple with two children has double the average industrial wage, they * Director, Policy and Economics Analysis Program, Institute for Policy Analysis, University of Toronto. 1 Canada, Report of the Royal Commission on Taxation (Ottawa: Queen s Printer, 1966). 2 Our current system remains a hybrid, but it has been moved away from the consumption base and is now much more of an income tax and much less of a consumption tax than it was years ago. 1258

TAX-TRANSFER INTEGRATION: THE ABILITY-TO-PAY PRINCIPLE 1259 approach the income level at which they completely lose the CTB. And there is no other deduction or credit for the children. 3 The inappropriate use of credits in place of deductions also distorts net income 4 as a measure of the ability to pay. Examples include the medical expense credit and the replacement of Canada Pension Plan (CPP) and employment insurance (EI) deductions with credits. 5 The latter is becoming particularly important now that EI benefits are clawed back from some taxpayers and a portion of the EI has effectively become a general payroll tax, so it is no longer a tax that has a rough correspondence to benefits. The other problem is the clawback of transfer payment benefits. These are typically clawed back on the basis of family income, whereas taxation remains primarily on an individual basis. As a result, there is an interaction of clawbacks and PIT marginal rates that is potentially quite serious in terms of adverse incentive effects. 6 Some of these measures reflect a confusion of the objective of vertical equity, and how to achieve it, with the proper measurement of the tax base under an income tax system based on the ability to pay. If we examine a particular measure let us say, the former exemption for children naturally in a progressive system if you multiply such a deduction by the progressive marginal rate, it looks like it provides a greater benefit for high-income than for middle-income and lower-income people. 7 But that is not the right way to view it. We have to view the subsistence level of children as an expense representing non-discretionary spending, and then the only way to recognize that appropriately is through a deduction. 8 3 The child expense deduction represents an expense of earning income, rather than a deduction for children s subsistence. 4 Battle goes so far as to argue that gross income is a better measure than net income of the ability to pay. While the issue of deductions for registered retirement savings plans (RRSPs) and pension contributions depends on the choice of base (income versus consumption), most of the deductions Battle cites clearly represent expenses of earning or deriving income, and are quite properly deductible in measuring ability to pay. See Ken Battle, Child Benefit Reform: A Case Study in Tax-Transfer Integration (1999), vol. 47, no. 5 Canadian Tax Journal 1219-57, at 1251. 5 There is also, I might add, the threat of further switches of deductions to credits. The Globe and Mail persistently gets it wrong with respect to the child expense deduction. This is properly a deduction because it is an expense of earning income. 6 Battle argues (supra footnote 4, at 1242) that the higher marginal rates due to the clawback are effectively invisible and hence will not affect behaviour. My reply is that you can t fool all the people all the time. Once a family experiences the effects of the clawback, it will make the connection. 7 For example, Battle (supra footnote 4, at 1249) cites the child care expense deduction as delivering its largest benefit to affluent families. But if child care expenses are viewed as a cost of earning income, they are properly deductible in arriving at net income. 8 Another factor that has pushed us away from the ability-to-pay principle is the almost total elimination of averaging from our system. Farmers and fisherman can still average, but the only other averaging allowed is through the use of RRSPs; that is a very limited base of averaging and one that involves a severe penalty. If savings are withdrawn from an RRSP during low-income years, that retirement savings room is lost forever.

126 CANADIAN TAX JOURNAL / REVUE FISCALE CANADIENNE Let us consider two examples of problems with the existing PIT system. The first example is the treatment of a family. A single-earner family of four with an income level of $8, would pay roughly $24, in tax (assuming a 5 percent provincial tax rate on federal tax and ignoring surtaxes). A two-earner couple without children, with their income divided 6/, would pay tax of about $18,. So the family of four with, I would argue, increased requirements for subsistence pays more than the couple without children. In fact, to make that couple without children pay the same amount of tax, they would have to receive an income above $95,. I submit that we cannot defend this inequity on the basis of ability to pay. 9 The second example concerns the irrational marginal rate structure under the current tax-transfer system. Figure 1 (taken from David Perry s Canadian Tax Journal article) 1 shows the effective marginal rates for a single-earner family of four with two children. I argue that there is no rationality to that particular rate schedule, and that when provincial taxes are included, we get an even more extreme schedule. Figure 2 (taken from the recent study by Jack Mintz and Finn Poschmann, 11 published by the C.D. Howe Institute) shows combined federal and provincial marginal rates going above 6 percent. This is for Ontario; in higher-tax provinces, the picture would be even worse. 12 This type of erratic rate schedule comes as no surprise to me; in a recent paper 13 on the proposed seniors benefit, I discovered that we have an irrational marginal rate schedule for seniors under the current guaranteed income supplement and old age security (GIS/OAS) system. There is a substantial range of incomes for the elderly within which the GIS clawback overlaps with the first bracket of PIT, imposing on them effective marginal rates of 75 percent! 14 9 Perhaps one can defend it on some efficiency argument about incentives for the lowincome spouse to go to work, but there are other measures such as earned income credits that can maintain incentives. 1 David Perry, Federal Marginal Income Tax Rates (1998), vol. 46, no. 2 Canadian Tax Journal 477-85. 11 Jack M. Mintz and Finn Poschmann, Tax Reform, Tax Reduction: The Missing Framework, Commentary no. 121 (Toronto: C.D. Howe Institute, February 1999). 12 For a detailed review of how and why effective and statutory marginal rates differ, see Alan Macnaughton, Thomas Matthews, and Jeffrey Pittman, Stealth Tax Rates : Effective Versus Statutory Personal Marginal Tax Rates (1998), vol. 46, no. 5 Canadian Tax Journal 129-66. 13 T.A. Wilson, The Proposed Seniors Benefit: An Evaluation, in Report of Proceedings of the Forty-Ninth Tax Conference, 1997 Conference Report (Toronto: Canadian Tax Foundation, 1998), 26:1-25. 14 This overlap has largely been generated by the indexing of the GIS coupled with the partial deindexing of the PIT system. As Battle notes (supra footnote 4, at 1249) partial deindexing has also worsened horizontal equity among non-poor families that is, families above the (deindexed) clawback threshold.

TAX-TRANSFER INTEGRATION: THE ABILITY-TO-PAY PRINCIPLE 1261 45 Figure 1 Federal Tax Rates for a Family of Two Adults and Two Children Aged Between 7 and 16 35 3 Rate, percent 25 15 1 5 Marginal rate Average rate 5 15 25 35 45 55 65 75 85 95 15 Income, thousands of dollars Source: David B. Perry, Federal Marginal Income Tax Rates (1998), vol. 46, no. 2 Canadian Tax Journal 477-85, at 485. Other objectives may temper the attainment of vertical equity. One is efficiency. And another is international competitiveness, particularly relative to the United States. High effective marginal tax rates can affect labourleisure decisions, savings decisions, and risk-taking decisions. Regarding Canada-US comparisons, whether we are looking at marginal rates or average rates (and I note that for migration decisions it is the average rates that matter), the biggest gaps are for upper- and upper-middle-income families with children, and this is particularly the case where the distribution of income within the family is highly unequal. In the limiting case of the single-earner family, the tax gap is the largest. So it is apparent that measures to adjust the tax treatment of families, and in particular families with children, would help to close that largest gap. To correct the inequities of the tax treatment of children and of the family, the family unit should be recognized through a separate rate schedule (we need not go all the way to the American approach of full income splitting, but we should go a long way). Children should be recognized, preferably by deductions. And those deductions should be related to what may be viewed as basic subsistence amounts.

1262 CANADIAN TAX JOURNAL / REVUE FISCALE CANADIENNE 8 Figure 2 Marginal and Average Tax Rates in Ontario for a Single Earner with Two Children, 1999 6 Federal and provincial marginal rate Marginal tax rate, percent Federal marginal rate Federal and provincial average 6 8 Income, thousands of dollars Source: Adapted from Jack M. Mintz and Finn Poschmann, Tax Reform, Tax Reduction: The Missing Framework, Commentary No. 121 (Toronto: C.D. Howe Institute, February 1999), at 15. 1 1 Finally, clawbacks of transfer payments, where appropriate, need to be designed carefully. 15 There should be full provincial-federal cooperation to design the various clawbacks in order to take into account how they interact with the PIT system. Erratic effective marginal rates, such as those shown in figures 1 and 2, must be avoided. I would argue that we should always make sure that nobody pays a higher effective marginal rate than that paid by the richest Canadian. 15 As Battle points out, targeted programs inevitably raise effective marginal rates. Indeed, traditional welfare programs and in-kind support can generate effective marginal rates above 1 percent. My concern is that, at present, the tax-transfer system imposes higher effective marginal rates on families with moderate incomes than it does on the richest Canadians.