The Cost of Tax-Free Savings Accounts

Supporters of various American wars have sometimes proclaimed, “Freedom isn’t free.” This idiom could also be applied to Tax-Free Savings Accounts, which entail a cost in terms of lost 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 supporter 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) 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 now 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.

19 comments

  • oopsie, great plan. Almost right up there with off-shore tax shelters. A legal place to stanch one’s money, if one has disposable income.

  • I think TFSA are a great idea. It is great for short to medium term savings, and in some cases long term savings depending on your marginal tax rate. Low income people who don’t earn enough to benefit from deductions for RRSP’s, or for those with lower marginal tax rates in their early working years are likely to benefit. I realize that TFSA’s will cost the government revenue, but don’t you think that it is a great incentive for people to save?

  • Chris said:

    “don’t you think that it is a great incentive for people to save?”

    When your wages are shit and you have to live pay-to-pay (or even just a couple of weeks ahead of bankruptcy), what’s the point of saving?

    As usual, a tiny minority of people will use these to shift wealth ownership away from the poorer majority.

  • “As usual, a tiny minority of people will use these to shift wealth ownership away from the poorer majority.”

    I strongly disagree. I work for a bank and the TFSA is very popular. I’m seeing edlerly people to young people opening TFSA’s for their savings needs. The response has been very supportive toward the TFSA. But on to your point of those who are low income and won’t have savings anyway so they will not benefit. I don’t believe in your extremely poloarized world view of a tiny wealthy class and a mass majority of poor people who simply can’t afford to save. That is no longer the reality of our economy. Yes there are low income people, but the mass majority of workers earn more then the minimum wage and I see people who earn the minimum wage saving all the time. Low income-moderate income people won’t benefit from RRSP’s, but they will benefit from TFSA account by getting income tax relief on their investments. Why is it a bad thing to offer incentive’s for people to save? Savings give people the opporunity to purchase their first home and build credit. I think it is a good thing. That is my opinion.

  • Andrew and Marc posted extensive critiques of TFSAs when they were announced. I will make a couple of quick points here.

    First, the tax exemption is worth about twice as much to rich savers as to poor savers. Someone with less than $37,885 of taxable income (in the bottom federal tax bracket) retains 15 cents of unpaid federal tax on every dollar of investment income generated inside a TFSA. Someone with more than $123,184 (in the top bracket) saves 29 cents of unpaid federal tax on every dollar.

    If we want more public incentives for private saving, why not instead establish savings accounts that provide a tax credit for investment income? TCSAs, if you will, would give everyone 15 cents on the dollar regardless of their marginal tax rate.

    Second, the $5,000 TFSA provided this year might be used by a broad range of ordinary Canadians who have some savings outside of their RRSPs. But the addition of a further $5,000 every year will outstrip the capacity of most Canadians to save (over and above RRSPs) while allowing the affluent to accumulate large additional pools of tax-exempt investments at considerable public expense.

  • Chris said:

    “The response has been very supportive toward the TFSA.”

    By whom? People whose economic education is limited to right-wing newspaper economists?

    “I don’t believe . . . .”

    Well, what can I say to that? At some point in your life, may you not get a first-hand education in how the world really works.

    “Yes there are low income people, but the mass majority of workers earn more then the minimum wage”

    Did I say they didn’t?

    “I see people who earn the minimum wage saving all the time.”

    Are they still living with their parents? Can they afford a family?

    “they will benefit from TFSA account by getting income tax relief on their investments.”

    What investments? And how does that income tax relief compare to the relative “relief” someone at the top-end of the scale gets?

    “Why is it a bad thing to offer incentive’s for people to save?”

    Where did I say this?

    The accounts are little more than a right-wing populist nostrum that will benefit the wealthier section of society _far_ more than most.

    “Savings give people the opporunity to purchase their first home and build credit.”

    I had zero savings, and I could easily get credit (probably not in times like these now); for the longest time, there was a massive disconnect between saving and giving credit: the housing bust in the US that was the straw, remember that?

  • In reponse to your questions Todd I will anwser:
    The TFSA has recieved positive feedback from the majority of clients regardless of income or amount of services they have had with the bank, and I have no idea what newspapers they read, so I can’t anwser the last part of that question. I guess you will probably assume that anyone who has an account with a bank is a populist right winger. I assume that people are seeing a greater incentive to save and invest for whatever purposes they choose.
    Onto Erin’s point of tax credits, are you speaking of refundable tax credits for low income people to encourage saving? I think that would be a great idea as a public incentive for low income earners. But what I was praising was the private incentives of the TFSA. There is more flexability with the TFSA then what you have with the RRSP. Also, many people in my view, seem to be responding well to the notion of having some of their investment income tax free, and this appears regardless of their income level.

  • What a chuckle,

    Here is why it is popular.

    Joe the plumber walks in and says: ” I have been thinking about saving.”

    Chris the banker responds: ” that is great times are tough good time to start saving. ”

    Joe says: “but not for retirement, I don’t want some RSSP where I get penalized for taking out my money before retirement.”

    Chris the banker replies: “thats great because the government has a new program whereby you can save your money and the interest earned is tax free!!!”

    Joe says: “freekin awesome I am generally predisposed to that idea.”

    Joe goes home delighted.

    Then Bob comes over and asks: “how much you gonna save a year Joe?

    “oh I don’t know maybe 2500$.”

    Bob says: “well lets assume you find an investment vehicle that returns 10% a year. That equals 250$. Had you been taxed on that you would have payed assuming 30%) 75$ to the government. So you have saved the cost of your digital cable package for one month! But had you invested in equities and realized a capital gain of 250$ you would have been taxed 30% on 125$ which = 37.50$.”

    “Thieving bastards; the government,” replies Joe.

    Keep on shilling Chris.

  • I would not be surprised if you ate alone in the faculty cafeteria at Laval Travis. Judging from many of your posts, I would guess my assumption would be true.

  • Chris said:

    “I guess you will probably assume that anyone who has an account with a bank is a populist right winger.”

    Don’t be stupid: you need an account at a bank to hold down a good-paying (and even most crappy-paying) jobs.

    “The TFSA has recieved positive feedback from the majority of clients regardless of income or amount of services they have had with the bank”

    People no doubt thought quite highly of Thalidomide as well, but they weren’t exactly in the best of positions to make informed choices, were they?

  • I do not, generally, eat at the university but I never drink alone:), But your implicit premise is correct: I do not care about being popular. To my mind, that, is a dangerous preoccupation for an academic. d

  • Todd,

    I think you got this one backwards:

    “Don’t be stupid: you need an account at a bank to hold down a good-paying (and even most crappy-paying) jobs.”

    You in fact need a job to get a poor paying account at the bank!

  • The top third of this post on exponential growth implicitly provides a good illustration of why TFSAs could end up being extremely costly to the public treasury. However, if financial markets perform as badly as the bottom third suggests, there may be little investment income to tax, with or without TFSAs.

  • I read on http://www.celi.ca a lot of things about TFSA (CELI in french). It’s seems the banks try to push their clients into Lock-in Gic’s strategy. Not especially for their goals but for THEIR own needs (cash flows). In fact there is absolutely no emergency with the TFSA. Better make a plan before anything!

  • I cant believe Some of these comments. Simply put, the government is only loosing the proposed chance to tax future income.

    It doesn’t cost them a sent, @Erin Wiers Comment. in terms of appropriations A tax credit would physically require our government too go into debt or use tax dollars to supply that credit.

    Second This Tax Free Savings accounts supports small business, which need lower taxes to compete with corporations that love it when government raises taxes, drives small competitors out.

    Also In Lumby BC individuals used their TFSA accounts to Buy an XRay machine, Something Lumby was promised for years from the provincial govt. So these TFSA account allowed a small community to support itself When Government could not take care of it. The government physically cant do everything, So they do not need every last dime.

    Also any Income they loose will be still be there. That compound interest will work better then any Current BAILOUT program in the world.

  • “A tax credit would physically require our government too go into debt or use tax dollars to supply that credit.”

    You may be envisioning a tax credit on investment income that is already tax-exempt. I am proposing to eliminate the exemption and replace it with a credit, which would cost the government less in forgone revenue.

    Investment income from a TCSA (Tax-Credit Savings Account) would be taxable, but the investor would get a 15% federal tax credit for this taxable amount. For low-income taxpayers, who face a 15% federal income tax rate, a TCSA would produce exactly the same result as a TFSA. For high-income people, who face a 29% tax rate, a TCSA would only be half as lucrative as a TFSA.

  • Yes that would work but I had assumed the Tax credit you envisioned would be similar to the Cash for Clunkers Tax credit in the US which Makes the Broken Window theory I learned in college turn on its head, in some cases you could go into the showroom buy a car no money down, Tax credit with a rebate so you also walked out with a 1000 in cash, they also appropriated 3 billion tax dollars to be given out in said TaxCredits. Many Tax credits just further put the Canadian government and US In debt

    Lets break every Window and have a cash for glass program, and cash for rags program, we have a lot of old clothing good idea? and push a nation further into debt but to be on point. You are now, targeting Income level, the success of this program lies in the fact that it does not differentiate between income levels, this will allow the money to flow to all parts of the economy low income individual will spend his money from differently TFSA’s then high or middle income individuals.

    Your plan may even be better but it doesn’t allow for what I see to occur, which a tax exempt money from all income level floating to the economy. The multiplier effect of this forgone revenue will be great. One thing John Maynard Keynes suggested would occur from deficit spending is his theory which was wrong.

    His theory was based on what is called the “consumption function”. Consumers who enjoyed increased incomes would consume a fixed proportion of the increase , he reasoned. Profs. Milton Friedman and Franco Modigliana showed that consumers based their consumption on permanent or expected lifetime income.

    The economic stimulus package will have very little multiplier effect because the workers will know that their jobs are temporary. The multiplier effect of TFSA accounts will be great. Since people will save & use this money based on expected lifetime income

    Also I argue that the money is being forgone to the public, a bailout in a sense. I believe the compounded interest, the money saved will serve Canada better if its citizens decide where the money goes instead of government and our government supports this and they will be still be responsible, they will still be collecting other sources of revenue and this wont sufficiently harm us either, I just think there so much upside to this program if we let it work for a few years, and if we live in a more vibrant economy, TFSA will have played a part

    If in a small town of Lumby Brittish Columbia, Nova Scotia voluntarily asked its clients if they wanted to have one, months later now and enough people donated for a xray machine, the biggest donors were people with TFSA accounts, there pretty viral here. This a first hand account eye witness testimonial, I think Canadians are smarter then the government or even individual or groups of people give credit for

  • “As usual, a tiny minority of people will use these to shift wealth ownership away from the poorer majority”

    Could you please tell me how individuals saving their own personal income are “shifting” wealth ownership away from the “poorer majority”? Is this just another way of saying that the wealth cannot be confiscated through taxation (although it can still be confiscated by inflation)?

    I’d also like to know how only a “tiny majority” benefits. Every university graduate and employed worker I know has opened one. Does that make us a “tiny majority”?

    “But the addition of a further $5,000 every year will outstrip the capacity of most Canadians to save (over and above RRSPs) while allowing the affluent to accumulate large additional pools of tax-exempt investments at considerable public expense.”

    Yes, it is difficult to save an additional $5,000 every year when a very significant part of even a middle class worker’s wealth is confiscated every day through taxation and inflation. I laugh at your suggestion that the fact that people can save some money without one form of confiscation (taxation) are somehow doing it at the public’s expense. How is it at their expense? Because they can’t confiscate the wealth through force? I suppose you feel sad for the big corporations and well-connected politicians who can no longer benefit from the small guy when they are unable to steal a part of his wealth by force.

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