Posted on November 24, 2015

Taxing The Rich Is Counter-Productive

Taxing The Rich Is Counter-ProductiveAs politically popular as it is to spew “soak-the-rich” rhetoric during an election campaign, the reality is that it is a very inefficient way to raise revenues or to address income inequality. Indeed, it will actually shrink the economic pie. It provides a disincentive to entrepreneurial spirit and work effort and it will make it more difficult for Canada to attract and keep its most productive talent, particularly in light of the much lower tax regime in the United States.

Our tax system is already highly progressive and it will be more so when the federal government reduces tax rates for the middle class. The reduction in middle-class tax rates is desirable because it will increase disposable income and spending for a group that has experienced little income growth in recent years.

The proposed tax hike for high-income earners is not desirable. The higher the tax rates, the higher the incentive to avoid them. There is already a good deal of planning going on by affluent taxpayers to adjust their finances in such a way as to avoid or at least minimize the effect of the proposed tax increases on people earning $200,000 and above. In consequence, the actual revenue gain associated with such a move will likely be far lower than the government has predicted. Tax planning can involve such things as rearranging sources of income, changing jurisdictions, legally using foreign trusts or changing the timing of the sale of capital assets. These actions will line the pockets of the accountants, tax lawyers and financial planners, but will do little to increase tax revenues or reduce income inequality.

Several provinces have already imposed heavier tax rates on higher-income earners, so that if the federal proposal to raise top marginal tax rates by four percentage points is implemented, marginal tax rates for these individuals will be above 50% in many jurisdictions (Table 1, from C.D.Howe Institute E-Brief, November 19, 2015).

Targeting High-Income Earners Will Backfire

Not only are these proposed top marginal income tax rates high enough to dampen potential growth rates, but dividend tax rates and capital gains tax rates will rise as well. For example, top marginal dividend tax rates in Ontario will rise from 33.8% to nearly 40% and top marginal capital gains tax rates will rise from 24.8% to 26.8%. In contrast, the top dividend tax rate in the U.S. is 28.6% and only 23% in the OECD. The average capital gains tax rate in the OECD is 18.4%. This will discourage business and personal investment in Canada and provide an enormous disincentive for innovation and job growth.

The market for top talent is global and raising Canadian taxation will make it more difficult for Canada to compete.We run the risk of a brain drain and it will be more difficult to attract foreign talent, particularly given the depreciation in the Canadian dollar. Thus, excessive taxation is self defeating and does not generate the tax revenue that some expect.

According to a recent study by the C.D. Howe Institute,” the proposed 4 percentage points tax increase on incomes above $200,000 could result in those affected taxpayers reporting approximately 4.5 percent less taxable income, costing the personal income tax base $7.3 billion in 2016. This erosion of the tax base could reduce projected tax receipts from the hike by about 70 percent; delivering to the government only about $1.0 billion of a potential $3.3 billion. The erosion of the tax base also means that provincial governments could also suffer from lower-than-otherwise personal income tax revenues – a non-negligible shortfall of $1.4 billion in 2016″.

The best way to reduce income inequality is to provide the necessary training and relocation assistance to disadvantaged workers and to remove barriers to opportunity.

The Canadian economy is under performing, damaged by the dramatic decline in oil and other commodity prices. The Bank of Canada has reduced interest rates twice this year, but now it is time for real fiscal stimulus–government spending increases and tax cuts. Our government debt-to-income levels are among the lowest in the OECD. We can afford to invest in our future by creating the environment necessary to boost innovation and technological prowess that assures Canadian prosperity in the future.