Finance Minister Bill Morneau recently announced proposals to make changes to small business tax rules to stop high-income Canadians from taking “unfair” advantage of the tax system—all in the name of “fairness” to the middle class. But is this really about fairness to the middle class? Or is it actually about making up revenue lost to an eroding tax base as taxpayers seek legal ways to avoid what they see as punitive tax rates? Sadly, it seems more like the latter than the former. Too bad the minister wasn’t serious about tax fairness.
Fairness, like beauty, is in the eye of the beholder. Economists are loath to make fairness comparisons except to say that people with the same income should be treated similarly by the government. The tax changes contemplated by the minister are aimed mostly at incorporated small business owners, so any “unfairness” will be in the comparison of salary earners and small business owners, not different income classes.
Economic theory does not tell us anything about how much tax and transfer rates should vary as incomes rise. That is a political judgment. Unfortunately, few finance ministers are brave enough to talk plainly about what people actually pay in taxes and receive in government transfers or what they think is a “fair” distribution of the tax/transfer burden we all share. The reason is that many people might be surprised and unhappy with the level of taxation and the amount of redistribution built into our system.
What would the finance minister tell taxpayers if he was really interested in tax fairness? He would begin by being transparent about what we pay now in taxes and what we receive in transfers from the government. To date, he has not. Fortunately, a recent research paper based on 2008 data by Crisan, McKenzie and Mintz (CMM) tells us a lot about what we need to know.
The authors used tax and transfer data from 2008 to examine what people paid in taxes and received in transfers from the government. They repeated the same analysis to show how age affected taxes and transfers. We focus on income differences, since that is how lower-, middle- and upper-income classes are defined for tax purposes.
In their careful analysis, the authors work with total income, which includes wages and salaries, interest and dividends and government transfers to individuals. They look at statutory tax rates as well as the benefits individuals receive in government transfers to calculate net tax rates by income class. The results for five income classes are presented below.
In this first chart we see that average tax rates range from 17.3 per cent for the lowest income 20 per cent of adults (those 20 years and older) to 34.9 per cent for the highest income 20 percent of adults. If average tax rates rise with income, we say the tax system is “progressive”. Thus, as income rises, individuals not only pay more tax, but an increasing share of their income in tax. In sum, in 2008, tax rates for the highest income group were about double what they were for the lowest income group, with the highest income group paying about one-third of their total income in tax.
In this second chart we see the impact of government transfers on the progressiveness of the Canadian tax system. Net tax rates (treating transfers as negative taxes) are -47.7 per cent for the lowest income group and 34 per cent for the highest income group. In other words, when net taxes are compared, the lowest income group receives a boost equal to almost half of their earned income and the highest income group pays about one-third of their earned income in tax. Thus the progressiveness of the tax system rises dramatically. Whether this amount of progressiveness in the tax system is “fair” is for politicians to defend and voters to decide.
We are told that the incorporation of professionals like doctors, lawyers and consultants has risen significantly in recent years and that this has caused a significant erosion of the personal tax base. Incorporating a business costs money, and there are additional costs associated with preparing corporate tax returns and filing reports to the government. So why is the incorporation of professionals rising? Perhaps because federal and provincial governments have increased taxes on high-income earners to the point that those taxpayers no longer think the system is fair.
The data examined by the authors of that research paper was for the year 2008. Consider what has happened to income taxes since then. Using Ontario as an example, in 2008 the marginal tax rate (the tax owed on the last dollar of income) was 21.1 per cent for the lowest tax bracket (up to $40,700 of taxable income) and 46.4 per cent for the highest tax bracket (above $126,300 of taxable income). Ten years later in 2017, the marginal tax rate for the lowest tax bracket (up to $42,200 of taxable income) has fallen to 20.1 per cent, while the marginal tax rate on highest tax bracket (above $220,000 of taxable income) has risen to 53.5 per cent. Thus today, Ontario taxpayers in the highest bracket pay more of their marginal earnings to the government than they keep themselves. It is perhaps not surprising that they are increasingly seeking legal means to reduce their tax burden.
Political rhetoric about tax fairness is rarely accompanied by a genuine effort to communicate with taxpayers about what they actually pay and whether or not it is fair. If the minister of finance were serious about tax fairness, he would undertake comprehensive reform. A good starting place would be some transparency about the changes that have occurred to the tax system over the past decade and how the measures he is proposing will address both the overall fairness and efficiency of our fiscal system.
Paul Boothe is a former senior provincial and federal finance official and a Fellow of the Institute for Competitiveness and Prosperity.