Tax incidence in Canada, 1990-2005

The CCPA today released my paper, Eroding Tax Fairness: Tax Incidence in Canada, 1990-2005. The Toronto Star ran a front-page story on it that is quite good. This paper was a long time in the making – while it might seem fairly straightforward to calculate the share of taxes in income for different groups, there are many tricky data and methodology issues to sort out when you add all income sources (including inheritances, employer-provided benefits and capital gains) and taxes (including corporate and property taxes), rather than just the narrower slices produced by Statscan. I followed the general methodology of tax incidence pioneered by Irwin Gillespie in his work for the Carter Royal Commission back in the late 1960s, and updated last in a couple of mid-1990s papers co-authored with the Vermaeten brothers (aka VGV, with estimates going up to 1988).

My study starts in 1990, which benchmarked well against VGV, then looks at 1995, 2000 and 2005. I stuck to the literature in making my assumptions, and as a result the findings may even be conservative – for example, if you assume greater capital mobility the top tax rates would be even lower and the system more regressive. But even if some may quibble with specific methodological choices I made, this does not change the basic trend over time to a less progressive tax system.

Unfortunately, the choice of dates means that the most recent federal tax cuts for 2006 and 2007 are not in the paper. The coverage is up to the end of the Liberal government’s time in government federally. The GST cuts will lower rates at the bottom, but perhaps more importantly the corporate income tax cuts when fully phased in will be of huge benefit to top income earners (and by 2012 the corporate income tax cuts are actually larger in fiscal impact than both GST cuts combined) since ownership is fairly concentrated in the top decile.

The summary of the paper:

Eroding Tax Fairness: Tax Incidence in Canada, 1990 to 2005 is the first major study of tax incidence in Canada in well over a decade. It examines the many changes to Canada’s provincial and federal tax system over this 15-year period and shows that Canada’s tax system was far more fair in 1990 than it is today.

The tax rates of the richest 1% of Canadians have dropped dramatically since 1990, while poorer Canadians have seen their tax rates rise steadily. The tax system is still progressive for middle-income earners in Canada, but not for upper-income earners. Not only do the top 1% pay a lower tax rate than they did in 1990, their rate is actually slightly lower than that paid by the poorest 10%.

The principal finding of this study is that the overall tax system no longer meets the test of fairness across income groups. It finds Canada’s upper income earners are not paying their fair share in taxes compared to 15 years ago. This study is unique among recent analyses of taxes in Canada in that it includes all sources of income (including inheritances, employer-provided benefits and capital gains) and all taxes (including property taxes and corporate taxes).

Tax cuts were the major factor behind the erosion of Canada’s tax fairness, with personal income tax cuts leading the reduction in rates at the top. This has reinforced adverse inequality trends driven by the labour market. The tax cut agenda unfurled precisely when inequality in pre-tax incomes surged, disproportionately benefiting those with the highest incomes, while doing little for low-income Canadians.

This study also finds that the provinces have led the way in introducing regressive tax changes. Provincial taxes were relatively flat in 1990, but had become more uniformly regressive by 2005. Provincial income tax cuts are the major culprit behind Canada’s eroding tax fairness, an important consideration given allegations by the provinces of a “fiscal imbalance” in Canadian federalism.

By 2005, federal tax cuts had exacerbated the problem. Higher payroll taxes have offset the impact of income tax cuts for the middle of the distribution. At the top of the distribution, income tax cuts have contributed a a regressive pattern.

The study works through federal and provincial changes to Canada’s tax system, unearthing a series of changes that disproportionately benefited higher income earners in Canada. Among these changes:

•    For most Canadians, tax rates fell by roughly two percentage points or more between 1990 and 2005.
•    Canadians in the top 1% of the income distribution saw their total tax rate fall by almost 4 percentage points between 1990 and 2005.
•    In contrast, Canadians in the bottom 10% of the income distribution saw their tax rate increase by more than five percentage points between 1990 and 2005, with an increase of three percentage points for the next 10% (D2), with almost all of the change occurring by 2000.
•    A number of small changes in regressive taxes account for about half of the change for income earners in the bottom two deciles. These include consumption, payroll and property taxes and other provincial taxes and fees.
•    Income taxes are the principal source of progressive taxation, although this had eroded for the top 5% by 2005.

The study concludes that there is scope for raising income taxes at the top of Canada’s income distribution so that tax incidence becomes, minimally, proportional and, ideally, progressive. Such changes would help to ensure those who can afford to contribute more for public goods and services valued by all Canadians do so.

While there may be some theoretical limit to how progressive upper rates can be, Canada is nowhere close to hitting tax rates that would have adverse economic consequences. The study finds there is still ample room for raising income taxes on the most affluent by raising the top rate or through the addition of new top tax brackets. Similarly, the study finds Canada’s preferential treatment of capital gains is unwarranted, and they should be taxed fully as any other form of income. These measures would go a long way towards restoring tax fairness to Canada’s tax system.

4 comments

  • Good work. When I looked at the VGV (1988) study awhile ago, my impression was that trends since then were more likely to tilt the tax system away from being essentially flat towards being regressive. I was hoping someone would take the time and do the update.

  • Congratulations on a great study, Marc. I am just dimly aware of how much work must have gone into this. It really moves us foward in terms of the argument that governments are worsening rather than correcting for market driven inequality.

  • Great job, Marc. CBC Newsworld broadcast a good piece on your study on Saturday morning. Some “food for thought” regarding corporate taxes, the fiscal imbalance, and resource royalties follows.

    To me, Table 1 (pages 16-17) confirms that significant corporate taxes are integral to progressive taxation. Personal income taxes (PIT) are progressive for most of the distribution, but become regressive among the richest 10%. Corporate income taxes are flat over most of the distribution, but become sharply progressive for the richest 10%, where business ownership is concentrated.

    Taken together, PIT and corporate income taxes are progressive over the whole distribution, although other taxes and fees offset this progressivity. The only alternative to robust corporate taxes would be to remove PIT preferences for capital gains and dividends while raising top PIT rates, as Marc recommends.

    I completely agree that the “fiscal imbalance” mainly resulted from unsustainably large provincial tax cuts. The question is whether this fact undermines the concept of a fiscal imbalance or whether it confirms that a severe fiscal imbalance exists due to inter-provincial tax competition. Even before the emergence of modern tax-cut ideology, inter-provincial mobility eliminated estate taxes.

    One might argue that the federal government has a greater capacity, and hence a greater responsibility, than provincial governments to maintain a highly progressive tax system. Although this argument does not excuse misguided provincial tax cuts, the federal government also has significant influence over provincial tax policy.

    It was, after all, a federal decision that facilitated provincial governments setting their own PIT brackets/rates (as outlined on page 18) rather than piggy-backing on the relatively progressive federal structure. The current federal government is providing political pressure and fiscal incentives for provincial governments to eliminate corporate capital taxes, exempt business inputs from sales taxes, and cut corporate income taxes.

    A final issue, which is probably inevitable in a study on this scale, is that “other provincial taxes and fees” (page 20) includes at least two quite different types of “taxes”. User fees, which I suspect dominate the category, are highly regressive. Natural resource royalties, which are very important in a few provinces, would presumably be as progressive as corporate taxes.

  • It’s good to see that a few of us try to stand up for true democracy. Those in the upper income levels have people to lobbyfor them. Those lobbiests do a great job. I have been fightig the regressive propert tax set up for years. I may never succeed but I’ll continue.
    The big landlords, and corporations get it all back in the end. The taxes they have to pay are all simply added into the cost of the products and services that we produce for them and then must buy. Still they convince the people in the goverments that we the people elect to edge up the taxes of the little people and shave down their taxes. There are times when one wonders how this thing we call democracy fell prey to rampant capitalism.

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