Troubled waters—Incentive-damaging tax hikes
On the eve of the new Liberal government’s first federal budget, as Canada’s economy struggles amidst a global slowdown coupled with depressed commodity prices, the key for governments across the country is to focus on what they can influence directly: namely getting the incentives right at home. That means implementing sound, pro-growth economic policies. However, the federal and many provincial governments have taken some backwards steps in recent years when it comes to tax policy.
On personal income taxes, a key pillar of the overall economic policy climate, the federal and several provincial governments have increased rates in recent years. High and increasing marginal tax rates discourage people from engaging in productive economic activity (working hard, expanding skills, investing, and being entrepreneurial), ultimately hindering economic growth and prosperity.
This year, the federal Liberals added a new income tax bracket, raising the top tax rate from 29 per cent to 33 per cent. Here, context is important. The increase in the federal tax rate is layered on top of numerous recent provincial increases including significant increases in Ontario and Alberta. Since 2009, seven out of 10 provincial governments increased tax rates on upper-income earners. With the federal hike this year, the combined federal and provincial top personal income-tax rate is higher today in every province than in 2009.
In Ontario, the top combined federal-provincial personal income tax rate has increased from 46.4 per cent to 53.5 per cent. The top combined rate is now above 50 per cent in six of the 10 provinces.
The federal and provincial increases to Canada’s personal income-tax rates have put the country at a greater competitive disadvantage for attracting and retaining skilled workers and entrepreneurs. This is especially ironic since several governments talk frequently about the importance of attracting such individuals. Even before the changes, the country’s combined federal and provincial top personal income tax rates compared unfavourably to those in the United States and other industrialized countries. The recent increases have simply made things worse.
Canada’s top combined personal income tax rates are now among the highest in the industrialized world. In 2014, the latest year of available international data, Canada had the 13th-highest combined top personal income tax rate out of 34 OECD countries (using Ontario’s provincial rate). The new 2016 Canadian top tax rate (53.5 per cent) is sixth highest relative to the 2014 international rates and second highest among G7 countries, behind only France.
The fact that Canada’s top tax rates are often applied to lower levels of income than in other countries further erodes our tax competiveness. Consider that at an annual income level of $150,000 (Cdn), every province’s combined federal/provincial marginal tax rate is higher than the combined federal/state tax rate in every U.S. state.
Unfortunately, there are signs that the federal government may compound this mistake—raising the top tax rate—by pursuing additional policies that will make it harder for Canada to attract and retain top talent. Specifically, there have been musings about capping stock options and increasing capital gains taxes. Both policies would directly contradict the government’s stated commitment to spurring innovation and entrepreneurship.
Stock options are often used by cash-starved start-ups to increase the potential compensation of employees if the companies are successful. Caps would mean that Canadian companies will be at a disadvantage to attract and retain engineers, computer programmers and other professionals who can help drive innovation. This would be particularly harmful given that the high-tech industry is more mobile than traditional industries, which means firms are more likely to relocate in the face of an uncompetitive tax structure.
When it comes to capital gains taxes, it’s important to understand that financiers assume great risk when investing in unproven ventures. And entrepreneurs help drive innovation by taking risks, often accepting lower wages for a period in hopes of future benefits. Capital gains taxes reduce those potential benefits and the attractiveness of entrepreneurship and economic risk-taking.
Canada is going through a difficult economic period, thanks partly to factors outside of any government’s direct control. However, these challenges make it all the more important to get policy choices right. Smart, pro-growth economic policies can help make Canada’s economy more resilient in the face of external shocks and better position our economy to rebound quickly when circumstances improve. Unfortunately, personal income tax policy is one area where many Canadian governments are getting it wrong. Simply put, the country needs to stop penalizing economically beneficial behaviour through incentive-damaging tax hikes.
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