federal personal income taxes

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Effect of Federal Income Tax Changes on Canadian Families Who Are in the Bottom 20 Percent of Earners

Summary

  • Since coming into office in 2015, Prime Minister Justin Trudeau’s government has made several major changes to the federal personal income tax system. This report examines how those tax changes affect Canadian families with children, focusing particularly on families who are in the bottom 20 percent of income earners.
  • Specifically, the report measures the number and percentage of families in this income group who are paying higher personal income taxes due to the federal government’s changes— and how much more they are paying.
  • Among the bottom 20 percent of income earning families with children, 406,000 (of a total 660,000) are paying more federal income tax following the changes. Specifically, 61 percent of families who are the bottom 20 percent of earners are paying more—$269 more on average.
  • Families in the bottom 20 percent of earners benefitted very little from the federal government’s reduction to the second lowest personal income rate. This is because most of the individuals in lower income families earn too little income to qualify for the tax reduction, which starts at incomes of $45,916.
  • However, many families in this group pay more income tax because they no longer benefit from income splitting and other tax provisions (including tax credits for children’s fitness, public transit, and education and textbooks) which were eliminated by the Trudeau government.
  • For the 61 percent of families in the bottom 20 percent who are paying more overall income tax due to federal changes, the tax rate cut amounts to an average tax reduction of just $22. By contrast, the elimination of income splitting represents an average increase of $154, while the elimination of other tax credits amounts to an average tax increase of $148.
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Measuring the Impact of Federal Personal Income Tax Changes on Middle Income Canadian Families

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  • During the 2015 federal election campaign, the Liberals pledged to cut income taxes on Canada’s middle class. Since coming into office, the government has repeatedly claimed that it has delivered on this commitment. While the federal government did reduce the second lowest federal personal income tax rate, it also simultaneously introduced several other broader changes to the federal personal income tax system.
  • For instance, it introduced a new, higher top income tax rate and eliminated several tax credits, which had the effect of increasing taxes on Canadian families who previously claimed those credits. In fact, the elimination of many tax credits may partially, or even completely, offset the tax rate reduction targeted at middle class families.
  • This paper measures the net overall effect that the federal government’s changes to the personal income tax system have had on the amount of tax that Canadian families with children pay. It finds the federal government’s income tax changes have resulted in 60 percent of the 3.88 million families with children covered in this paper (representing 13.9 million individuals), paying more in taxes. The average tax increase amounts to $1,151 each year.
  • Among middle income families—the group of families the federal government claims to want to help—81 percent are paying more in taxes as a result of the federal income tax changes. The average income tax increase for this group of middle income families is $840.
  • For the subset of middle income families consisting of couples with children, an even greater share (89 percent) pays higher income taxes ($919 on average).
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Reforming Federal Personal Income Taxes

After seven years of consecutive budgetary deficits, the federal government appears poised to balance its budget in 2015 and has signalled that its top, post-deficit priority is “examining ways to provide further tax relief for Canadians.” Reductions in marginal tax rates could provide a considerable boost to the economy by increasing incentives for Canadians to work, save, invest, and engage in entrepreneurial activity.

How should tax relief be delivered? One way is a major tax reform initiative that eliminates tax expenditures to broaden the tax base and uses the fiscal room to offset the costs of broad-based personal income tax reductions. The federal personal income tax system has also gone largely unreformed for nearly 30 years. A proliferation of tax expenditures—credits, deductions, exemptions, exclusions, and other tax preferences—in the intervening time has added complexity and in turn increased tax compliance costs for Canadian taxpayers, provided few behavioural incentives, and shrunk the tax base upon which taxes are levied, thereby requiring higher tax rates than would otherwise be necessary to generate the same level of government revenue. As a result, the Canadian personal income tax system—above all its marginal tax rates and the income thresholds at which they apply—is decidedly uncompetitive compared to that of the United States and other industrialized countries.

While there has been progress in shifting the federal income tax base towards consumption, a number of tax expenditures remain that retard progress in this direction. Eliminating these tax expenditures would continue the shift to a consumption-based tax and also be a great help in offsetting significant reductions in marginal tax rates. It is estimated that eliminating these tax expenditures would produce $20.2 billion in new fiscal room. This could form the basis of substantial broad-based tax reductions.

The new resources available from eliminating the tax expenditures would essentially offset the elimination of the two middle income tax rates of 22% and 26% and create a new tax landscape with just two personal income tax rates—15% for almost all Canadians and 29% for top earners (roughly 2% of tax-filers). More ambitious options could include increasing the income threshold at which the top rate applies from $136,271 to $250,000 and lowering the top rate from 29% to 25%.

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