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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.


 

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