Longstanding problem of discouraging work made worse
The federal government’s new Canada Child Benefit program recently replaced and consolidated an assortment of previous programs. Yet little attention has been given to how this policy change, along with others, will exacerbate a longstanding economic problem in Canada: high marginal effective tax rates and the resulting work disincentives faced by some moderate and middle-income Canadians.
The marginal effective tax rate is simply the amount of money you lose to taxes, including the reduction of government benefits, when earning an additional dollar of income.
High marginal effective tax rates weaken the incentives for people to earn extra money by working additional hours or investing in their skills. If you consider working and earning more income but can only keep a portion of each additional dollar, you will assess the costs and benefits of doing so. If the amount you keep is small enough, you may decide not to expend the extra effort.
It’s not just “rich” Canadians who face very high marginal effective tax rates. Due to the combination of taxes and benefits that are “clawed back” as income rises, those of more modest means also face high effective marginal tax rates.
Although not a new problem in Canada, recent federal policy changes will magnify this problem for some Canadians, despite the federal government’s signature personal tax cut on middle-income Canadians.
Consider an Ontario couple with two children. Let’s call them the Millers. In the Miller family, Sally financially supports the family, earning $50,000 in labour income, while Jim stays home and looks after the kids. Even before the federal policy changes, Sally faced a high effective tax rate on an additional income. After accounting for federal and provincial income taxes, CPP and EI payroll taxes, and the claw-back of various federal and provincial transfers, the Millers would lose 61 cents for every additional dollar Sally earned beyond $50,000. This marginal effective tax rate was a disincentive for Sally to earn more.
But it’s getting worse. With the new Canada Child Benefit, and assuming the CPP payroll tax hike is implemented today, the Millers would lose 70 cents of an extra dollar Sally earned. If they decided to have another child, that would increase to 75 cents. It’s easy to see why the Millers might determine that working harder to earn more money just isn’t worth it.
Of course, not every Canadian family will face the same marginal effective tax rate as the Millers. The precise rate for each family will depend on their number of children, their income level, and the number of household earners. But there are multiple scenarios in which the changes to child benefits and the CPP have increased the barrier to working more and earning a higher income for Canadian families.