Expect tweaks to Liberals’ income tax reforms, expert says

Steve Mertl
National Affairs Contributor
Daily Brew
Canada's Finance Minister Bill Morneau speaks during Question Period in the House of Commons on Parliament Hill in Ottawa, Canada, December 8, 2015. REUTERS/Chris Wattie

The Liberal government is apparently heeding warnings that its plan to pay for a middle-class tax cut by soaking the rich a little more does not add up.

Citing a senior federal source, the Globe and Mail reports Finance Minister Bill Morneau will acknowledge the party’s revenue projections from a tax hike on high-income earners won’t make up for the 1.5-percentage-point cut for middle-income earners.

“There are going to have to be some adjustments around the margins,” a senior federal official told the Globe.

Economists had questioned whether introducing a new 33-per cent tax rate (up from 29 per cent) for income of more than $200,000 would raise enough revenue to offset the $3-billion estimated cost of the middle-class cut to 20.5 per cent from 22 per cent.

The C.D. Howe Institute, an Ottawa economic think tank, warned in a report last week the high-income tax increase could raise as little as $1 billion, well short of the roughly $2.8 billion the Liberals’ election platform projected.

The author of that report, institute research director Alexandre Laurin, was not surprised by the signal Morneau will modify his reforms but doubts it will be enough to close the revenue gap entirely.

“I think they will announce they will close many tax-avoidance opportunities for high-income earners,” Laurin said in an interview with Yahoo Canada.

Closing tax loopholes in addition to the rate increase should boost anticipated revenues to between $2 billion and $2.5 billion, he said.

“On top of that they will announce another few tweaks, elimination of a few tax provisions or something of some sort that affects disproportionately high income tax payers that will raise a little bit more revenue to make the things balance,” Laurin said.

Read more:

Liberal government would introduce middle-class tax cut in first bill

Don’t let expected TFSA change stop you from putting money in, experts say

Liberal tax-switch plan could mean $4B in lost revenue, study suggests

The problem is, when it comes to tax loopholes, there is no low-hanging fruit, said Laurin, who before joining the institute in 2008 worked for Parliament’s information and research arm providing non-partisan policy analysis for MPs and senators.

Governments were attacking loopholes when he began in public service 18 years ago, closing some every year, he said. The result is an increasingly complex Income Tax Act and more work for tax accountants and lawyers as high earners look for other ways to avoid paying the maximum tax.

Closing loopholes likely will have small impact, economist says

“There are still some opportunities out there but the marginal impact of closing the next tax-avoidance opportunity has to be small when you’ve been at that for that many years,” Laurin said.

The Liberals also promised to reduce the maximum annual contribution to the popular Tax Free Savings Account (TFSA) program to $5,500 from the $10,000 limit introduced by the previous Conservative government last spring. Reducing it further, say to $5,000, would not yield any revenue improvement as contributions are made in after-tax dollars,

“Any significant improvement [from the TFSA change] is for the long-term future,” Laurin said.

Asked if reducing the size of the planned middle-class tax cut might help, Laurin agreed cutting the tax rate by just one percentage point instead of 1.5 would reduce the cost by one third. But he said there’s no sign the Liberals are prepared to bend that election promise.

The average family with two income earners pulling down between $44,701 and $89,401 in taxable income – the second lowest tax bracket – could potentially save up to $1,200 a year, he said. But that assumes both are earning at near the top of the range. More likely, one spouse probably earns significantly less.

“For that kind of average family it’s going to be a few hundred dollars,” Laurin said. “But for other average families with $150,000 income [of] one or two earners, depending on how their earning is split it could be much more, in the range of $800-$900.”

Laurin’s report pointed out the top combined federal-provincial tax rate would climb above 50 per cent in every province east of Saskatchewan except for Newfoundland and Labrador – the others are all in the high 40-per cent range. That makes it more likely high income earners will look change their behaviour.

“They always seem to adjust,” he said, adding it creates a diminishing return. “Every time you go higher you still get a bit less and less for every increase.”

Liberals could find other ways to make up tax shortfall

The Liberals could move forward with other tax measures from their platform, Laurin said, such as eliminating certain tax preferences, credits and allowances that disproportionately benefit high earners. They would be inherently progressive without needing to boost the overall tax rate, he said.

His report also recommended reforming the small-business tax deduction used by high-income professionals to shield themselves from personal income taxes.

“One way they avoid to pay the high marginal tax rate is they incorporate,” Laurin explained.

“They become a small business and they pay the small business tax rate, which is very low. But then they leave the income in the corporation and spend it on themselves as a corporation.”

Laurin suggested capping the small-business tax deduction at a set total amount accumulated over a period of years. That would allow a new business to establish itself without the government providing a continuing subsidy. It’s not perfect, though, because it could also punish businesses not earning high incomes.

Morneau is expected to announce details of his tax reforms in the coming days, in time for them to take effect Jan. 1. By convention, tax changes become enforceable when the government states its intention to pass the necessary legislation.