The Cost of Tax-Free Savings Accounts
Supporters of various American wars have sometimes proclaimed, “Freedom isnâ€™t free.” This idiom could also be applied to Tax-Free Savings Accounts, which entail a cost in terms of lostÂ federal and provincial revenues.
When Budget 2008 unveiled TFSAs, several writers on this blog pointed out that their initially low fiscal cost would grow exponentially over time. At least one high-profile TFSA supporterÂ agreed.
New numbers from Finance Canada suggest that even the initial cost of TFSAs may be significantly higher than Budget 2008 projected. The 2008 Tax Expenditures and Evaluations (released Friday, January 2, for maximum exposure)Â project that TFSAs will cost $45 million in 2009 and $155 million in 2010.
If these costs are evenly spread over the calendar year, they imply costs of $11 million in the 2008-09 fiscal year and $73 million in the 2009-10 fiscal year. By comparison, Budget 2008 estimated $5 million in 2008-09 and $50 million in 2009-10. (Of course, none of these figures include the corresponding loss of provincial income tax revenue.)
In reality, not everyone who will use a TFSA deposited the full $5,000 on January 1. Since people will contribute more to TFSAs over the course of the year, the costs are probably skewed toward the latter half of the year. While this dynamic might explain the apparent discrepancy for 2008-09, it could not do so for 2009-10.
Another possibility is that, with the stock-market collapse since Budget 2008, Finance Canada is nowÂ assuming higher capital gains (and hence forgone tax revenue) on funds invested in 2009 and 2010 as the market recovers. However, half the value of capital gains is already tax free. (Indeed, to the extent that investors have incurred capital losses, capital gains are fully tax free.)
Presumably, many investors will instead use TFSAs for the portion of their portfolio that collects interest income, which is normally fully taxable. If so, the decline in interest rates since Budget 2008 should actually have reduced the estimated fiscal cost of TFSAs.
Since neither of these possible explanations is satisfactory, one must also consider the possibility that Budget 2008 simply understated the likely cost of TFSAs.