Canada's Tax Policies and Inequality
Inequality has arisen as a significant issue around the world.
People's understanding of inequality differs:
- Is the issue about a small group of super-rich individuals whose fortunes have arisen because of political control over a country's assets (e.g. royal families in the gulf states, oligarchs in corrupt political systems, corrupt government officials and politicians ), or because of the development of digital applications that have achieved universal use in a global economy. or through employment in large corporations whose management has taken over the corporations to pay management salaries out of line with market values.
- Is the issue about economic inequality, and if so, is it about income, wealth, some combination of the two, or some other economic variable? Is it political inequality? Is it about legal inequality? Is it about social inequality (gender, race, religion)?
- How unequal is unequal? Should everyone be equal?
The typical Canadian attitude is that Canada is a country based on ideas of justice and fairness, with a Constitution and Charter of Rights that supports equality. This attitude may be based on a less than comprehensive understanding of ways in which Canadian policies and practices are unequal. The goal here is to summarize some of the policies and practices that may be considered unequal.
A common view is that tax breaks are universally beneficial. Those that hold this view miss the point that taxes are a zero-sum game. Their purpose is to raise revenue, and if someone gets a tax break, someone else is paying more.
The Policies and Practices
The tax treatment of inheritance
In the absence of inheritance taxes, those with assets can pass those assets on to whoever they like. This would not create inequality if the recipient is a spouse. However, if the recipient is a child, the inheritance would give the child an unequal and undeserved advantage over children who did not receive inheritances. The inheritance would be in addition to the advantages the child would have received growing up in a household with sufficient assets to leave an inheritance. If the recipient is neither a child nor spouse, but some other person, there is also an unequal and undeserved advantage being passed on.
Canada imposes minimal taxes on inheritances. These are imposed by provinces, and they amount to at most a few percentage points of the inheritance to be conferred.
Other countries, including the United States, impose inheritance taxes.
Inheritance taxes can take many forms. There can be threshold levels at which taxes start. The amount of tax can be at a fixed rate or at progressive rates. The taxes can be imposed on the recipients of the inheritance rather than the estate of the person making the inheritance. From an inequality perspective, this would be fairest.
The personal tax system
The absence of a tax on wealth
Canada does not impose a tax based on wealth. According to Wikipedia, countries that have a wealth tax include France, Spain, India, Netherlands, Norway, Switzerland and Italy. In practice, a wealth tax can be designed in a variety of ways, including determinations of the assets to be included or excluded from consideration, the methods in which the assets are valued, whether liabilities would be deducted from assets to determine net wealth, the level of wealth after which the tax would be payable, the tax rate, the phase-in process for the tax, and administrative procedures related to the tax.
Wealth is the most obvious way in which individuals are economically unequal.
Wealth taxes are often justified on the basis of fairness: those that have benefitted the most from the economic system, including the laws, regulations and tax reguirements, should pay a premium for these benefits.
Not all income is equal
In Canada, the personal tax system is based on income. It treats income from employment, commissions, self employment, pensions, interest, retirement on one basis, and income from dividends and capital gains completely differently.
Income from dividends is grossed up (i.e. actual dividends are multiplied by a specified amount), included in the calculation of income for purposes are determining taxes, and then used to deduct a fixed amount from taxes payable. The ultimate result is that dividend income is taxed at a fraction of the rate of wage incomes, as the table below indicates
Income from certain types of capital gain are excluded from taxation. For example, the capital gain on the disposition of a principle residence is not taxed. Those that cannot afford home ownership do not get an opportunity to benefit from this exclusion. Even if one accepts the utility of some form of capital gain protection related to one's principle residence,there remains the problem that the protection is not capped at an upper limit of, for example, $1 million, or related to time over which the capital gain occurred. A considerable amount of money can be made tax free by utilizing the capital gains exclusion, particularly in hot real estate markets.
In addition, investors in shares of qualified small businesses receive a lifetime capital gain exemption of over $800,000 on the disposition of these shares.
where capital gains are in fact taxed, income from capital gains is cut in half for tax purposes. The amount of tax paid on capital gains is also a fraction of the amount paid on most other forms of income. Not only is income from capital gains not fully taxed, net capital losses in previous years are deductible from current capital gains. If logic behind the partial taxation of capital gains is based on some notion of a reward for risk, the ability to deduct capital losses from previous years mitigates this risk.
The table below outlines the relationship between income from employment, dividends and capital gains for various amounts of taxable income. In this case, "employment" includes not just salaries and wages, but commissions income, as well as small business, fishing and farming income. Clearly, income from dividends and capital gains are taxed at a much lower rate than income from work.
|Income ($)||Taxes Paid (2014)|
|Tax Payable ($)||Tax Rate (%)||Tax Payable ($)||Tax Rate (%)||Tax Payable ($)||Tax Rate (%)|
|Table Notes: Data is based on a single, male in Ontario born on January 1, 1980. Actual dividends have been grossed up by 38 percent. Data comes from a popular tax software package.|
Who benefits? Let us start with the dividend tax credit. Only 13.7 percent of tax filers claimed a dividend tax credit in 2012. Among those with incomes less than $50,000, only 7.5 percent claimed a dividend tax credit. Their average dividend tax credit was $473. Among those with incomes $250,000 and over, 68.0 percent claimed a dividend tax credit, and for them, the average dividend tax credit was $21,622. As the table below indicates, the more income, the greater the benefits from the dividend tax credit.
|Item||Tax filer income|
|Grand Total||0 - $49,000||$50,000 - $99,999||$100,000 - $149,999||$150,000 - $249,999||$250,000 and over|
|Total number of returns||26,700,250||18,869,180||5,918,100||1,223,950||463,610||225,430|
|Number of returns claiming federal dividend tax credit||3,658,110||1,422,500||1,403,800||442,240||236,270||153,310|
|Returns claiming federal dividends tax credits as a percent of total returns||13.7%||7.5%||23.7%||36.1%||51.0%||68.0%|
|Total amount of federal dividend tax credits ($000)||8,476,479||673,230||1,990,363||1,257,919||1,240,089||3,314,879|
|Average federal dividend tax credit per return ($)||2,317||473||1,418||2,844||5,249||21,622|
What about the taxable capital gains? Only 7.7 percent of tax filers claimed a taxable capital gain. For incomes less than $50,000, only 5.1 percent had a taxable capital gain, with an average taxable capital gain of $1,584. For incomes $250,000 and over, 41.2 percent reported a taxable capital gain, with an average taxable gain of $98,344, and an equal tax exempt capital gain. As with the dividend tax credit, the more income, the greater the benefits from the capital gains provisions of Canada's income tax law.
|Item||Tax filer income|
|Grand total||0 - $49,999||$50,000 - $99,999||$100,000 - $149,999||$150,000 - $249,999||$250,000 and over|
|Total number of returns||26,700,250||18,869,180||5,918,100||1,223,950||463,610||225,430|
|Number of returns reporting taxable capital gains||2,055,300||963,700||662,420||213,900||122,430||92,880|
|Returns reporting taxable capital gains as a percent of total returns||7.7%||5.1%||11.2%||17.5%||26.4%||41.2%|
|Total amount of taxable capital gains ($000)||17,245,600||1,526,773||2,537,320||1,792,798||2,254,497||9,134,214|
|Average taxable capital gain per return ($)||8,391||1,584||3,830||8,381||18,415||98,344|
The Unprogressive Progressive Personal Tax System.
Canada has a progressive tax system. In a progressive tax system, higher taxable incomes are taxed at higher rates than lower taxable incomes.
Canadian tax rates are a combination of federal and provincial rates.
Canada's progressiveness stops at a relatively low amount. In 2014, the federal amount was $136,270, at which the federal tax rate 29 percent. The Ontario rate was $220,000. The table below provides the rates that apply for various levels of taxable income for Ontario.
|Taxable Income Range||Tax Rate (%)|
|Federal Rate (%)||Ontario Rate (%)||Combined Rate (%)|
|up to $40,120||15||5.05||20.05|
|$40,120 - $43,953||15||9.15||24.15|
|$43,953 - $80,242||22||9.15||31.15|
|$80,242 - $87,907||22||11.16||33.16|
|$87,907 - $136,270||26||11.16||37.16|
|$136,270 - $150,000||29||11.16||40.16|
|$150,000 - $220,000||29||12.16||41.16|
|$220,000 and over||29||13.16||42.16|
Much of the progressiveness occurs at income levels typical of the middle class. The federal rate jumps 7 percent at $43,953, a further 4 percent at $87,907 and a final 3 percent at $136,270. The provincial rate jumps 4.1 percent at $40,420. The remaining jumps are marginal. The following graph illustrates the progressiveness of the combined rates. It appears as if both levels of government are reluctant to tax the high income earners.
Unrestricted Deductions from Total Income
The personal income tax system first determines total assessed income, and then allows a number of deductions from the total before the "progressive" tax rates are applied. These deductions include registered pension plan contributions; RRSP deductions; deductions for elected split-pension amounts; annual union, professional, or like dues; child care expenses; business investment losses; moving expenses; support payments made; carrying charges and interest expenses; deductions for CPP/QPP contributions on self-employment and other earnings; deductions for provincial parental insurance plan (PPIP) premiums on self-employment income; exploration and development expenses; other employment expenses; clergy residence deduction; Canadian Forces personnel and police deductions; security options deductions; other payments deductions; non-capital losses of other years; net capital losses of other years; capital gains deduction; northern residents deductions; additional deductions; and farming/fishing losses of prior years.
These deductions lower the tax payable for the tax filer by lowering the taxable income. An individual with $10,000 in income and $10,000 deductions has no taxable income. An individual with $20,000 in income and $10,000 in deductions would get to keep 79.95 percent of the deductions and pay tax of ($10,000 x 20.05% = ) $2,005. A person with $250,000 in income would get to keep 57.84 percent of the deductions and pay tax of ($10,000 x 42.16 = ) $4,216.
The point to note is that those with high incomes qualify for the deductions in the first place. In a progressive tax system, these deductions could be phased out for those with higher incomes. For example, those with incomes over $150,000 in income could get to use only 50 percent of their deductions. Those with $250,000 in income would not be able to use their deductions.
The lack of progressiveness in Canada's "progressive" tax system strengthens the case for income related restriction to deductions that can be used.
The unprogressive tax credit system
Canada's tax system includes a number of tax credits. Tax credits are different from tax deductions. With tax credits, the tax rate depends on the taxable income, and is "progressive", in that higher incomes face higher tax rates. Once the amount of tax is determined, tax credit are used to reduce tax payable. The amount of benefit from the tax credit is the same for high and low income earners.
The system would be more progressive and foster more equality if most of the tax credits became tax deductions.
The system would also be more effective. Many tax credits were established as incentives to achieve a public purpose by changing individual behaviour. The likelihood that modest financial tax incentives would change the behaviour of high income earners is small.
Here are items for which tax credits are currently given: basic personal amount; age amount; spouse or common-law partner amount; amount for eligible dependant; amount for children 17 and under; amount for infirm dependants age 18 or older; CPP or QPP contributions through employment; CPP or QPP contributions on self-employment and other earnings; Employment Insurance premiums; PPIP premiums paid; PPIP premiums payable on employment income; PPIP premiums payable on self-employment income; volunteer firefighters' amount; Canada employment amount; public transit amount; children's fitness amount; children's arts amount; home buyers' amount; pension income amount; caregiver amount; disability amount; disability amount transferred from a dependant; interest paid on student loans; tuition, education, and textbook amounts; tuition, education, and textbook amounts transferred from a child; amounts transferred from spouse or common-law partner; medical expenses; allowable charitable donations and government gifts; eligible cultural and ecological gifts.
Tax Free Savings Accounts (TFSAs)
Canada allows the creation of tax free savings accounts. If one puts money into the account, the earnings on the account are never taxed. Under current rules, one is allowed to put $10,000 per year into the account. By putting $10,000 in a tax free savings account and with a return of 3 percent on the return, one would make $300 per year. At the maximum Ontario tax rate of 42 percent, this would amount to a benefit of about $120 per year. By itself, a $120 tax benefit is not a big deal.
The cumulative impact over many years is a big deal. The table below shows the cumulative effects of annual $10,000 contributions to a tax free savings account over 25 years, at different interest rates. These tax fee benefits are not insubstantial.
|Interest Rate (%)||TFSA Return ($)||Taxed Return ($)||Tax Free Benefit ($)|
Who is going to be able to make annual $10,000 contributions to their tax free savings account? The answer is the well to do. Most Canadians are stuggling with debt, and will not be able to make annual contributions to their tax free savings accounts. One can get a sense of this by looking at Canadian behaviour toward a similar savings vehicle - the Registered Retirement Rension plan (RRSP). Only 22.9 percent of all tax filers in 2012 claimed an RRSP deduction. Among those with incomes less than $50,000, 11.5 percent claimed an RRSP deduction.
A number of Canadian policies and practices promote inequality, yet most political processes do not address the issues raised here. There are several explanations.
- A well to do, economic elite controls the political agenda in Canada that policies and practices that promote their interests do not reach the political agenda.
- Canadians accept inequality.
- Canadians do not accept inequality in principle, but do not believe inequality exists in Canada to a significant degree.
- Canadians are not familiar with measures that would reduce inequality and promote equality in Canada.