I'd like to thank the finance committee for inviting me to this hearing.
Before I get started, just some background. From what I saw with the previous panellists and from this panel, I think what you're mostly going to get from them is micro-analysis of the individual proposals. I'm going to bring you some macro-analysis about the broad trends and the tax and transfer system that might help put these changes in context. The overview is based on a detailed report I wrote for the Macdonald-Laurier Institute called “Giving and Taking Away: How Taxes and Transfers Address Inequality in Canada”, which members can refer to for more details.
The main conclusion is that the tax and transfer system became markedly more progressive between 1976 and 2011. The progressivity of transfer payments had a much greater impact than taxes on the redistribution of income. The greater role of transfers partly reflects that cutting income taxes does little to help low-income people, as the lowest income quintile effectively pays no income tax, with an effective rate of 2.4%. Instead, it is transfers and government that provide over half of their tax income.
As we move up the income quintiles, taxes progressively increase and transfers steadily decrease up to the highest quintile for whom transfers are as negligible, at 3%, as taxes are for the lowest quintile, while the effective tax rate for the highest quintile reaches an average of 22%.
Looking at combining the impact of tax and transfers, it shows that only the highest two income quintiles pay more into the tax and transfer system than take out, while the other three lowest quintiles are net beneficiaries. The highest income quintile pays 80% of the total net redistribution going on within the tax and transfer system. So the system is quite progressive, even if it's not completely offsetting the growing inequality of market incomes over the last 35 years.
Despite rising incomes earned in the marketplace, net transfers to the middle class have increased. This was particularly the case for the second-lowest income quintile, where net transfers rose from 2% to 17%. Only the highest quintiles saw a net contribution increase. So overall, the tax and transfer system has become more progressive in redistributing income from the highest income earners to the lowest and middle incomes.
For 35 years Canada has moved to a system of higher transfers and lower tax rates for 80% of the population being paid for by the highest 20% of earners. We may be nearing the limits of the amount of resources that can be transferred from one quintile to the other four. As noted by Professor Kevin Milligan in a recent study for the C.D. Howe Institute, raising the marginal tax rate further on high-income earners risks reducing their labour supply and may even lead to lower tax revenues. Advocates of higher tax rates for upper-income earners should take note of the growing contribution of the tax and transfer system over the longer term. Critics of the benefit that income splitting may give to some of the highest quintiles should also be aware of this trend.
Finally, the focus of all parties on aiding the middle class at some point risks becoming either a transfer from some parts of the middle class to other parts of the middle class, or worse, from the left pocket to the right pocket of the same person.
Thank you.