The so-called “middle class” tax cut promised by the newly elected Liberal government in the name of promoting greater fairness seems set to be quickly implemented for the 2016 tax year. Yet the distributional and revenue consequences of this measure are often misunderstood, and the proposed change merits reconsideration.
Currently there are four federal tax brackets: 15% on taxable incomes of less than $44,701; 22% on further income up to $89,401; 26% on further income up to $138,586; and 29% on income above that amount.
The promise is to cut the federal income tax rate from 22% to 20.5% on taxable incomes between $44,701 and $89,401, which yields a maximum tax saving per individual filer of $670, and more for many families with more than one income.
The threshold is almost exactly the same as average taxable income, so anyone with a below average income fails to qualify.
In fact, this measure fails to benefit the great majority of Canadians since well under one half of tax filers have an above average income. Canada Revenue Agency data (for 2012) show that only one in three individual tax filers (8.5 million out of 25.5 million) had taxable incomes above $45,000 in that year, roughly the income threshold needed to benefit from the new tax break.
Further, it is not always appreciated that a cut in the rate in any one tax bracket benefits all tax filers in higher brackets. The maximum tax saving of $670 is phased in between taxable income of $44,701 and $89,401, and then benefits everyone with incomes above $89,401.
It can be calculated from Statistics Canada data on high income taxpayers that fully one half of the $3 billion in savings flowing from the “middle class” tax cut will in fact go to the top 10% of individual tax filers who had taxable incomes of more than $89,200 in 2012. Beneficiaries include the top 1% with incomes of more than $222,000, though this elite group will face a new top tax rate of 33%, up from 29% today.
To summarize, the major gains from the “middle class” tax cut will go to individuals with incomes between $89,200 and $200,000, roughly the top 10%, minus the top 1% who will pay higher taxes to pay for the tax cut for those below them on the income ladder.
As is well known, the incomes of the top 1% have grown much faster than those of ordinary Canadians in recent years, with their share of all income rising from 8.1% to 10.3% from 1990 to 2012. Meanwhile, the income share of the bottom 50% of Canadians fell from 19.3% to 16.7% over the same period.
While the top 1% did extremely well, especially those with ultra high incomes, the data show that the income share of the top 10% minus the top 1% has also risen significantly since 1990, from 22.7% to 24.8%.
The real losers over the past fifteen years and more have been the middle and lower income earners who will not benefit much if at all from the new “middle class” tax cut. While the higher tax rate on the top 1% promised by the new government, as well as the new system of child benefits, will certainly promote greater income equality, the same cannot be said of this measure.
Further, rather little has been said about the revenue consequences of the new tax bracket beyond the calculation that it will cost about $3 billion per year on implementation. But this overlooks the fact that a lowering of the tax rate will reduce the growth of income tax revenues relative to the growth in taxable incomes. Typically, income tax revenues rise faster than incomes since earnings growth pushes some taxpayers into higher tax brackets, even though these are indexed to inflation.
It also remains to be seen if the new top tax rate on very high income earners will bring in enough new revenues to fund the middle-class tax cut or will create a hole in revenues.
The new government is to be applauded for promising a higher tax rate on the top 1%. But the cause of equality and inclusiveness would be better served by devoting the new revenues to programs and services which benefit middle and lower income Canadians rather than to a so-called “middle-class” tax cut.
Andrew Jackson is Adjunct Research Professor in the Institute of Political Economy at Carleton University, and senior policy adviser to the Broadbent Institute.
Photo: Phillip Ingham. Used under a Creative Commons License.