Thank you very much.
I particularly wish to address the issue around dropping the personal marginal tax rate from 22% to 20.5% and raising the top rate from 29% to 33%. This is a reform with both good and bad consequences.
The good consequences are associated with the modest reduction in personal income tax rates between $45,000 and $90,000, roughly, which will benefit many middle-income households. It will create some incentive to work and save, but as economic studies suggest, the impacts will be relatively modest. Reductions will also help offset higher marginal tax rates for families with the introduction of the new child tax plan, which is income-tested, and provide some offset to single-earner families who benefited from the income splitting that was cancelled.
On the other hand, the increase in the top rate is less justified as a source of revenue. Canada's top rate, an average of 53%, once combined with provincial rates, will be fourth highest in the industrialized world, slightly below France's. The top rate hits at roughly $140,000 U.S. dollars, a level that is one third of that in the United States, where the top rate is 46.3%. Of course, we know from experience in the past, that when the United Kingdom and France raised their marginal tax rates—quite significantly, in the case of France—both retracted those decisions when they saw that they had a very significant reduction in the amount of income that was collected.
As economists have pointed out in various studies, there are some important consequences to raising the top rate. A high top rate will deter talent from staying in Canada or being attracted to Canada, and this comes at a time when the Canadian dollar has returned to less than 80 cents U.S., similar to the years when we experienced the brain drain. In fact, I have talked to a number of businesses, and they are already finding that this is becoming an issue in terms of compensation to attract the very best people around the world to come to Canada. Studies on the migratory effects on the wealthy are few, but we know anecdotally of cases, including a very public one recently in Canada. It is not so much the loss of the tax base that is important, as much as the loss of the talent needed to improve Canada's productivity.
The consequences of high marginal tax rates are to particularly discourage entrepreneurial effort by the so-called job creators. The marginal effective tax rate on small businesses, now that the small business tax rate will no longer be reduced, increases by two percentage points due to the higher personal income tax rate contained in the federal budget.
The discouragement of talent and entrepreneurship can affect economic growth. In an excellent survey published by William McBride of the Tax Foundation in the United States, 21 of 23 studies show that higher taxes reduce growth. The two studies showing no relationship were written before 1993. While growth in the United States and Canada was accompanied by high marginal tax rates 50 years ago, the typical analysis of those arguing that taxes do not affect growth is poorly done, by mismeasuring effective tax rates that depend on the tax base. For example, Canada did not tax capital gains before 1972. These types of studies also fail to include other factors that explain growth, and by confounding causality, whereby growth itself can lead to higher tax rates due to the progressivity of the tax system, they should be dismissed.
Almost all studies using good statistical analysis have shown that increases in marginal tax rates or the top rates reduce growth rates. In a well-known paper, Robert Barro shows that the increase in the average marginal tax rate results in reducing per capita GDP by 0.5%. Gemmell, Kneller, and Sanz estimate that taxes on income and profit are the most damaging to growth, followed by deficits and then consumption taxes. There have also been people who have estimated the marginal costs of taxation. Bev Dahlby, from the School of Public Policy at the University of Calgary, who is one of the international experts in this area, has found that corporate taxes are the most damaging taxes to levy in Canada, as well as many other countries, followed by the top rate of the personal income tax.
Recent studies have also estimated the sensitivity of the income tax base to changes in marginal tax rates. Michael Veall is one of those individuals who have done some excellent work. Some sensitivity can result from longer-run impacts, such as less effort in investment as well as migration effects. What we don't know very well is migration effects, as there have been very few studies to analyze them.
The tax base can also decline in the short run because of tax planning and timing of receipts, whereby taxpayers—high-income ones particularly—are able to do these things in a relatively robust manner according to the law. Certainly many taxpayers in 2015 arranged their affairs to report income in 2015 that should lead to a decline in reported income in 2016. There have been various techniques to do this, as many people know.
The C.D. Howe Institute, surveying various Canadian and American studies, suggested that a one-percentage-point increase in the top rate would lead to a reduction in after-tax income of about 0.69%. The institute estimated that the federal government will only receive $1 billion from the hike in the top rate, while falling well short of the revenue cost of reducing the middle tax bracket. The parliamentary budget office, as Michael Veall mentioned, estimates a higher revenue gain from raising the top rate—$1.8 billion in 2016-17—using a much lower responsiveness of about 0.38%, which is well below that of most studies that have currently been published. The provinces will also lose tax revenue as the base shrinks at the top end.
Overall, my belief is that raising the top rate in Canada above 50% to a level similar to that in 1993 was an error in public policy. It might have been good politics to hit higher-income Canadians with higher tax rates, but a far more effective approach could have been used to fund the middle class tax cut. As I've argued in several pieces, several tax incentives benefit higher-income Canadians but have narrowed the tax base unduly. Instead of raising marginal tax rates, we should have reduced tax preferences; that would have improved both tax efficiency and fairness.
I hope that one day the government will find, just as the United Kingdom and France have, that what it did was a mistake and will reverse it.