Why TFSA doubling will exacerbate income inequality

The tax change would ‘impose a fiscal straightjacket on future administrations’

Chris Young/CP

Chris Young/CP

The federal government’s other tax shoe is about to drop—or is it? The Conservative Party’s 2011 election platform promised two major tax policy changes. Income splitting for families with children is already being implemented, albeit with changes made to blunt the charge that the policy is of overwhelming benefit to high-income couples.

Their other campaign pledge—to double the contribution limits for Tax-Free Savings Accounts—has recently been critiqued in reports from the Broadbent Institute (which I wrote) and the Parliamentary Budget Office. This proposal’s long-run impacts are found to be even more sharply tilted in favour of the well off and much more costly to both federal and provincial revenues than income splitting.

How will the government proceed with its remaining unfulfilled tax policy commitment? In light of the serious deficiencies now uncovered by two independent sources, will it modify the TFSA hike to reduce the distributional tilt? Will it drop the proposal entirely? Will it confirm but delay the increase until 2016 to garner some marginal votes? Or will it feel obliged to proceed at once regardless of the adverse economic consequences?

The TFSA has proven widely popular among Canadians, who are eligible to contribute to an account beginning at age 18. Nearly 11 million individuals have opened a TFSA since the Tories introduced them in 2009. Yet, three out of every five eligible people have chosen not to open a TFSA, so it is hardly, as some of its proponents have heralded, the account that benefits everyone.

Finance Minister Joe Oliver sought to defend the TFSA against charges of a pro-rich bias by describing “the vast majority of accounts [as] belonging to low and middle-income earners.” Other supporters of TFSA expansion have similarly noted that individuals with incomes below $60,000 hold two-thirds of TFSAs. Canada Revenue Agency’s TFSA statistics for 2012 support that figure.

However, these figures overlook an important fact: Many TFSA holders with modest incomes have a spouse with higher income. Their family’s total income can be much higher, and TFSA rules permit a high-earning spouse to contribute to both their own and their lower-income spouse’s TFSA-each up to the $5,500 annual limit, for a total of $11,000 per couple.

If we draw on custom tabulations using Statistics Canada’s Survey of Financial Security for 2012, a radically different picture emerges of the TFSA’s tilt toward higher incomes. This survey provides a revealing view of TFSA patterns at the level of family incomes rather than individual incomes, and it also reflects the increasing size of account balances with family income.

While households including unattached persons with total incomes below $60,000 constituted 52 percent of all families, they held only 31 percent of all TFSA balances in late 2012-less than half the share of TFSAs based on individual incomes. At the other end of the income spectrum, only 4.4 percent of families had incomes of $200,000 and higher-but they held more than triple that share of all TFSA balances at 15 percent.

Upper-income families enjoy TFSA tax savings to an even more unbalanced degree than those statistics might suggest: they typically generate higher investment returns on their TFSA assets than lower earners, and they avoid the higher personal tax rates that would otherwise apply on the income from assets shifted into their tax-free accounts.

Even without any hike in the TFSA contribution limits, this tilt toward higher income families will increase over time as more moderate-to-middle income families exhaust their holdings of taxable assets available for transfer into TFSAs. A doubling of the TFSA limits would accelerate and exacerbate this tilt by favouring high earners with substantial taxable assets to continue shifting into their TFSAs far into the future.

Data on behaviour from 2009 through 2012 suggests that TFSA contributions are mainly a shift of taxable assets into accounts rather than new saving. Even the Department of Finance Canada cites the phenomenon of individuals “redirect[ing] their stock of existing savings to tax-assisted accounts such as the TFSA.” Thus, doubling the TFSA limits has not produced any tangible benefits for the overall economy.

Some TFSA-doubling proponents note that account contributions have already been taxed once as labour income. They assert that taxing any investment income stemming from those savings is unfair “double taxation.” They ignore the fact that a personal income tax has as its base both labour income and capital income. Limited tax relief for capital income-which is highly concentrated among the wealthy-is afforded through employer pensions, RRSPs, and TFSAs, but was never meant to be open-ended.

As both recent reports forecast, the existing TFSA provision will deprive the federal and provincial governments of many billions in revenues when the scheme matures decades from now. Doubling the contribution limits would raise those revenue losses by further billions at a time when governments will be strapped for income to cover the costs of supporting a bulge of seniors with a shrinking pool of taxpaying workers.

Before dropping the second shoe, the government should reconsider its pledge to initiate a tax change that would impose a fiscal straightjacket on future administrations that undercuts tax progressivity and increases income inequality.

Rhys Kesselman holds the Canada Research Chair in Public Finance at Simon Fraser University’s School of Public Policy. He co-authored 2001 research that led to the original TFSA, and he authored the recent Broadbent Institute study on TFSAs.


Why TFSA doubling will exacerbate income inequality

  1. Some other things to consider when looking at who has TFSAs:

    1) What are the balances like, compared to incomes?
    2) Why do people have them?

    In my own case, I have a TFSA because the bank offered me a deal on my monthly fees if I opened one. There’s next to nothing in it; if I have money to sock away, it goes to my RRSP or my daughter’s RESP (neither of which ever reach their ceilings).

    If my experience is fairly typical of the 11 million (and I really have no idea if it is or not), then in all odds the only people who are hitting their ceilings and want more room are the very well off.

    • You choose to put your money into an RRSP, you could just easily put that money into the TFSA, RESP, or split it up. There many advantages of a TFSA over an RRSP. Maybe not in your personal situation, but for some TFSA’s are a better investment.

      Nor does the fact that many people aren’t hitting the TFSA ceiling today, doesn’t mean they won’t in the future.

      Seems that you believe Canada’s tax policies should all be geared to benefit you, and anything else is somehow questionable.

      • I’m agreeing with the author – the doubling is largely a sop for the wealthy. For most of us with median incomes or below, the direct impact will minimal to nil – but the wealthier will get more tax breaks (which, as this means less money for the government, will mean fewer services &/or higher taxes).

        So I’ll throw your statement right back at you: Seems that you believe Canada’s tax policies should all be geared to benefit you, and anything else is somehow questionable.

        Just more of the inequity that seems to be the bread & butter of this government’s policies.

  2. ” the government should reconsider its pledge to initiate a tax change that would impose a fiscal straightjacket on future administrations…”

    I absolutely agree.

    However, the Conservatives probably see that as a benefit, or even the real reason to do this. Starve the beast. Remember Harper’s quote: “You won’t recognize this place when I’m through with it.”

    Let’s hope he’s through with it soon, I barely recognize my own country.

  3. Why do the leftist elites complain about the TFSA, but don’t complain about RRSP’s, the unlimited capital gains exemption, whole life insurance, individual incorporation?

    Because the TFSA is the only tax preference that the working poor can actually use. The others cost far more in lost and deferred tax revenue, and benefit only the upper middle class and wealthy.

    So instead of limiting the ones that only the wealthy can use to pay for the only one that the working poor can use, they attack the only one, the TFSA, that is useful to the working poor.

    To talk about the TFSA and its cost in isolation, without considering the entire spectrum of tax preferences and their costs is grossly dishonest.

    • Because the TFSA is the only tax preference that the working poor can actually use.

      That seems rather counter-intuitive. Care to explain how that works?

      And even if true, how many working poor are hitting the cap and need more room?

    • “Because the TFSA is the only tax preference that the working poor can actually use.”

      Yeah, I don’t get this either. If I put money in an RRSP, I see a near-term benefit on my income tax statement. If I put it into a TFSA, I might see a tax advantage in the future. Who in the working poor would choose TFSA over an RRSP?

      As for the “leftist elites” vs. the working poor, you need some fresh air – try some new sources of news and opinion.

      • The working poor are paying taxes at the lowest rate. That means they get little benefit from an RRSP, because they will likely be paying taxes at a higher rate when they withdraw funds from the RRSP. And since probably don’t have one of those gold-plated defined benefit pensions, when they withdraw funds as seniors from the RRSP, it will be added to their income, which will likely disqualify them from a whole host of government programs. The RRSP room is also lost if they have to make a withdrawal for an emergency. The rules of the TFSA are ideal to encourage savings by the working poor. They can paid tax on their income at a low rate, and then put it in a TFSA where it can grow tax free, and still be available for an emergency, penalty free.

        Meanwhile, the wealthy likely have unrealized capital gains on their principle residence, which will be tax free, and won’t count against their income.

  4. I’ve got one I’m retired $40K a yr in earnings and I couldn’t care less………….

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