Evidence of meeting #16 for Finance in the 42nd Parliament, 1st Session. (The original version is on Parliament’s site, as are the minutes.) The winning word was rate.
A video is available from Parliament.
Liberal
Steven MacKinnon Liberal Gatineau, QC
I would like us to focus on the report of the subcommittee. We can work with as much energy and efficiency as possible during that week. Let's accomplish what we can on the budget implementation bill.
I suggest we pass the motion. And as for the report of the committee, we will do our best.
Liberal
The Chair Liberal Wayne Easter
Could I just give a further explanation, Mr. Caron and Mr. Liepert?
We don't know how many witnesses will show interest and want to appear, but the week of May 9 to 13 could be for witnesses. Then the next week we are already booked up with other issues, KPMG and CRA issues. Then there is the break week the last of May. Then May 30 or 31 would be really our first available time to go to clause-by-clause if we finish the witnesses that week.
The report won't lock us in to May 9 to 13. It's just if it's doable, based on what happens in the House, and then we'd go from there.
NDP
Guy Caron NDP Rimouski-Neigette—Témiscouata—Les Basques, QC
The committee met before it had received the bill. I'm looking at how thick it is and the scope of the clauses in it. I know I was cautious in what I said to the subcommittee. I did not say that we should finish the study in a week. I suggested that we leave one week open for this study, but we did not set any specific date for completing our report and the clause-by-clause study.
That is why I agree on the possibility of continuing the study during the last week, not to delay anything, but so that in the month of June, in a reasonable time period, the bill can be referred to the House.
Liberal
Steven MacKinnon Liberal Gatineau, QC
We will proceed in that way if need be, but we don't necessarily have to conclude that it will take us all that time.
Conservative
Ron Liepert Conservative Calgary Signal Hill, AB
I'm supportive, but I don't want to go through another harangue of having 90-some witnesses parading through this committee. We did that once, and let's be honest, it had zero impact on what was delivered in the budget. If we're going to parade a bunch of witnesses through here again who have zero impact on changing the budget, I don't want to have people coming here just to show up so that this committee can look like it's listening to people when in fact it really won't be listening to people.
Liberal
The Chair Liberal Wayne Easter
As chair, I don't want to disagree with you, but I will. I don't agree that we had no impact. I think some of the witnesses did. Be as it may, the question is on the floor.
All those in favour of supporting the subcommittee's report?
(Motion agreed to)
Liberal
The Chair Liberal Wayne Easter
Thank you witnesses, for your indulgence.
Pursuant to the order of reference of Monday, May 21, 2016, we are studying Bill C-2, An Act to amend the Income Tax Act.
From the Institut du Nouveau Monde, we have Nicolas Zorn, policy analyst. From the Institute for Research on Public Policy, we have France St-Hilaire, vice-president, research.
Via video conference, we have Michael Veall, professor, department of economics, McMaster University.
On the telephone at the moment, we have Jack Mintz, who is with the school of public policy at the University of Calgary. Those are our witnesses for the first hour of our session.
The floor is yours, Mr. Zorn.
Nicolas Zorn Policy Analyst, Institut du Nouveau Monde
Good morning. My name is Nicolas Zorn. I am a policy analyst at the Institut du Nouveau Monde. I thank you for your welcome.
For a few years now, our institute has studied economic and social inequalities in Quebec and Canada.
We know that income inequality has increased significantly since the 1980s: the average income has not really increased, while the richest 1% have seen their income increase considerably, much more so than the rest of the population. Thanks to the work of hundreds of researchers in international organizations such as the IMF or the OECD, we now know that significant inequalities, in addition to impeding economic growth, undermine the well-being of the population, social mobility, life expectancy, and the health of our democracy.
It is in that context that the three tax measures in Bill C-2 are going to affect income distribution and inequalities generally. The purpose of my presentation and the brief I submitted to the committee is to assess the impact of those measures on income distribution, in two ways.
First, the Institut du Nouveau Monde produced two budget bulletins, last year and this year, a non-partisan exercise for the purpose of assessing how the measures in the federal and Quebec budgets will affect inequality.
This year, we asked 33 economists and recognized public policy experts, from the left, the right and the centre, to assess the main measures in the last federal budget. Basically, we summarized the experts' replies, we examined the level of consensus among them, and we present their comments, which confirm or nuance the results.
In the opinion of the participants, the three fiscal changes in Bill C-2 could potentially reduce income inequalities. The results, the methodology and the names of the expert panellists are provided in the brief.
That being said, the overall effect of the rate cut in the second tax bracket—one of the three measures in Bill C-2—is that the overall impact on inequalities is weaker than in the case of the other two measures. However, the experts we consulted had more differences of opinion on this measure than on the other two. The first half of the specialists considered that this measure would reduce inequalities, but the other half felt that the measure would have no effect, or, worse, that it would increase income inequality in Canada.
When you look at the details of this measure presented as a tax cut for the middle class, you can see that it will be most beneficial for the richest members of the population, in particular those with taxable incomes in excess of $90,000. For instance, for an individual with a taxable income of $50,000, who would be considered by some as being in the middle class, this tax cut represents around $70 in savings. For someone who has taxable income of $100,000 or $200,000, the tax gain is 10 times higher. In other words, people with incomes of more than $90,000 will have tax savings of approximately $700 per person.
If the objective of parliamentarians and the Government of Canada is to reduce income inequalities and lower the amount of income tax paid by the middle class, there could be more targeted measures that would allow them to reach that objective.
If you have questions, I will be pleased to answer them.
I will now move on to my second and last point.
We estimated that adding a fifth tax bracket for those who earn $200,000 or more would have a significant effect on inequalities. This is also shown in the brief. Essentially, the richest 1% have seen their incomes go up because their incomes have increased four times faster than the rest of the population.
This measure will slow the growth of the income of the richest 1% just enough so that the income of the poorer 99% will increase at approximately the same rate. In other words, this measure will check the growth in inequalities we have seen over the past 30 years. However, inequalities will remain at a historically high level despite that. To bring the inequality back to a historically lower level, for instance the level that prevailed in 1985, the tax rate of the new bracket would have to increase from 33% to 39%. To get back to the ratio that existed 25 years ago, that would have to be the case for the next 25 years.
In conclusion, if the government and Parliament want to reduce the inequality between the richest 1% and the poorer 99%, and if they want to help the middle class more, the introduction of additional tax brackets for higher incomes and a review of the entire tax system would be more effective, according to several experts, than simply increasing the tax rate in that fifth tax bracket.
To the extent that there are many tax credits that increase opportunities for tax avoidance, abolishing deductions that mainly benefit the wealthiest people might be more appropriate.
Thank you for your attention. Do not hesitate if you have questions.
Liberal
France St-Hilaire Vice-President, Research, Institute for Research on Public Policy
Good morning, Mr. Chair.
First I'd like to thank the committee for inviting me to appear today.
If I may, I will be making my presentation in English, but I would be very happy to answer your questions in the language of your choice.
My remarks this morning are based on the results of a two-year research initiative that the Institute for Research on Public Policy led, and just completed, to look at income inequality trends in Canada, the factors driving its marked increase since the early 1980s, and the role of policy in addressing this problem.
We found that income inequality has increased significantly over the past 35 years. This was primarily due to the dramatic rise in the incomes of the top earners and the anemic income growth of the middle class.
Given this diagnosis, we would expect that many of the tax measures announced in the recent budget and, in particular, the rate increase on the taxable income in excess of $200,000, should provide a substantial policy response to this problem.
In the few minutes that I have, I would like to focus on the issues related to top income taxation and the reasons why this might not be as straightforward, or as effective a solution, as it may appear.
First, it's important to point out that it is transfers that do the heavy lifting in offsetting market income inequality in Canada. For instance, in 2011, the tax and transfer system managed to reduce inequality by 28%, and of that, two-thirds was due to transfers and one-third to taxes. That one-third contribution is not negligible, but it does put into perspective what can be accomplished through the tax system on the inequality front.
Second, increasing taxes on top earners will reduce their share of income, but that effect is likely to be limited for two reasons. First, the increase in the marginal rate applies only to the share of income that is above the top bracket threshold, and second, top earners can and do respond to tax increases by reducing their reported incomes through tax shelters and income shifting. I refer you to the work of Kevin Milligan and Michael Smart on this issue.
There's considerable debate on the size of that behavioural response and the limit to real income taxation—that is, how far can you raise the top marginal rate before the revenue loss due to the taxpayer response exceeds the revenue gained from the income rate increase. It's a fine balance that is difficult to find.
Third, the taxation of top income also has an important federalism dimension, which all governments need to consider. Although the provinces share the same income tax base, the reduction in reported income, due to a top rate increase by one level of government, can reduce the revenue of the other level of government. In some scenarios, the result may be a net loss of revenue overall.
Experts seem to agree the potential for income shifting is larger at the provincial level than at the federal level. In a sense, that's the situation we have now. Most provinces have increased their top marginal rate substantially in recent years, and the new federal top rate brings the combined federal and provincial rate in the 48% to 54% range for most provinces. Rates at these levels increase the potential for tax competition among provinces and raise concerns about the loss of mobile labour and income. That's probably the reason why the Government of New Brunswick decided to reverse its recent tax increase on top incomes.
This raises two questions. First, does it matter whether top rate increases are at the federal or provincial level? Second, is there still room for further increases?
In our book we argue that progressive taxation should take place primarily at the federal level. Milligan and Smart's estimates show that provinces' capacity to raise revenue from the same top rate increase varies widely from one region to another. They find that poorer provinces, which already have higher tax rates, stand to gain the least, whereas the opposite is the case for richer provinces because they have a higher share of top earners.
The advantages of progressive taxation at the federal level are that it does not engender inefficient tax competition between provinces, since the same rate applies across the country; it entails less scope for income shifting to other jurisdictions; and it means that more revenue from progressive taxation is raised nationally to help fund redistributive federal transfer programs, not only for individuals, but also for provinces to fund health and social services. All this makes redistribution through the tax transfer system more effective and equitable across the country.
As for further increases in the top rate, we think it would be preferable to first let the dust settle on the important policy changes implemented since last fall's election. Notwithstanding important reservations regarding the middle-class tax cut, the top rate increase, combined with other measures relating to TFSAs, income splitting and the Canada child benefit, are expected to make the tax-and-transfer system more progressive. It would be wise to let these reforms filter through the system and then to assess their overall impact.
I'll finish on this. Beyond this, we also argue, as have others—Mike Veall and several others—that the tax system is in need of a major review to reassess the purpose and the incidence of a litany of tax preferences, many of which disproportionately benefit top earners. Until these issues are addressed, further rate increases will only serve to increase the efficiency costs and the inequities of the income tax system.
Thank you, Mr. Chair.
Liberal
The Chair Liberal Wayne Easter
Thank you very much, Ms. St-Hilaire. Your last paragraph picked up the ears of Mr. MacKinnon, because he's been pushing that point.
We'll turn to Mr. Veall, who is with the department of economics at McMaster.
The floor is yours. Welcome.
Dr. Michael R. Veall Professor, Department of Economics, McMaster University, As an Individual
Thanks very much for this opportunity. I'm sorry I can't be there in person, as I normally can.
I have three points.
First, the question is raised of how much revenue will be increased for the high-income taxpayers' rates. I'm not going to repeat what France said. I agree with what she said. There is the issue of the erosion of the tax base that is a consequence of that increase. I think, as she correctly said, there should be some emphasis that this has an effect on the provinces as well. While economists are well known for disagreeing, I agree with the C.D. Howe Institute, the Department of Finance, and the parliamentary budget office that the federal revenue increase from this measure will likely be in the neighbourhood of somewhere between $1 billion and $1.8 billion. It used to be that I would have guessed more towards the low end of that range, but my more recent calculations suggest that it may be towards the upper. Nonetheless, as these things go, that's a fairly narrow range.
There is one wild card here. There is a recent suggestion in the economics literature that the effects of the tax increase on top-income individuals could perhaps also—
Liberal
The Chair Liberal Wayne Easter
Mr. Veall, could you slow down a bit? Our translators are having a little difficulty in keeping up.
Professor, Department of Economics, McMaster University, As an Individual
Okay.
I do not dismiss the possibility that there could be this effect on other income tax brackets that would have raised some additional revenue that isn't in the usual calculation, but I do not think that approach yet has sufficient support to use for current tax policy.
My second point is also in support of the Department of Finance and the PBO estimates of the revenue effect on the income taxes for the $45,000 to $91,000 bracket increase. I think those estimates are also solid.
Finally, I will get to my third point, which pertains to TFSAs.
As an aside, if you know anyone who is 64 with a low enough income to be on the guaranteed income supplement, when they turn age 65, please tell them not to make an RRSP contribution but to use TFSAs. The RRSP contribution will likely have a strong negative return, because it will be subject to the guaranteed income supplement clawback. In fact, if they take their money in out the next year, it's pretty much sure that they will lose half their money, or perhaps even more in some cases. It's a terrible investment in that case.
So there is a good thing about TFSAs, but the flip side of this is that it's also a serious policy problem. There are many ways to put it, but if you think about a $10,000 limit—if that limit were to stay—there will likely be a significant number of individuals who would be reaching the age of 65 with perhaps half a million dollars or a million dollars or more in assets but who would still be eligible for the full guaranteed income supplement, a program that is intended to help poor seniors.
So more generally, TFSAs have this time bomb aspect. The problems they can create will get worse and worse over time, with the revenue impact almost 10 times greater as a fraction of GDP in 2050 as compared to now. Their effects will get worse. My own view is that the TFSA problem needs to be slowed down while there is a reform that better integrates the taxation of returns to saving and to the pension system, because if we expect Canadians to plan 20, 30, or 40 years ahead, we need the government to do it too.
Thank you very much.
Liberal
The Chair Liberal Wayne Easter
We will now turn to Mr. Mintz, on the phone. Welcome. The floor is yours.
Dr. Jack Mintz President's Fellow, School of Public Policy, University of Calgary, As an Individual
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.
Liberal
The Chair Liberal Wayne Easter
Turning to questions, because of our restricted time, let's go to five minutes instead of the seven minutes. We can get more in.
Mr. MacKinnon.
Liberal
Steven MacKinnon Liberal Gatineau, QC
Thank you, Mr. Chair.
I thank all of the witnesses for being here, those who are here in Ottawa, or participating by video conference or by telephone.
The main finding that emerges from most if not all of your comments is that Bill C-2 largely meets with the government's objective to reduce inequalities. This can be compared to the first act of a play, the second one being the 2016 budget tabled in the House by the Minister of Finance. With that in mind, I would like you all to comment.
You also pointed out in your respective presentations that the tax system needs to be reviewed.
I know, Mr. Mintz, that you've written about this as well, in your comments in The Globe and Mail on April 18, saying that it's time to look at the Income Tax Act. Other witnesses here today have mentioned that this is probably a necessary exercise, because there are a number of distortions in the act; that whether you look through an inequality lens, a tax-simplification lens, or a proper-incentives lens, tax reform is something that is more or less urgently needed in Canada.
I'd like you to briefly address both of those points, the inequality point and the tax reform point.
Liberal
The Chair Liberal Wayne Easter
Mr. Zorn, do you want to start? If you don't have a comment, that's fine, too.
Policy Analyst, Institut du Nouveau Monde
As for the tax system, we regularly hear it said that such a review could decrease the capacity of taxing those with the highest incomes, among other things. People also say that this could discourage work and savings.
I am going to take Steve Jobs and Bill Gates as examples, two individuals about whom it may be said that they succeeded in business. They launched their businesses in the 1970s, when the tax rates were particularly high. Over the past 100 years, the glorious 30 years were those decades where economic growth was the most sustained and where there were the fewest economic crises. It was also the period when tax rates were the highest.
I simply want to point out that that effect will not exist if you broaden the tax base, and as we advocate, reduce the opportunities for tax avoidance, that is to say the opportunities for those with the highest incomes to reduce their tax bill.
Moreover, the fact of reducing inequalities has a concrete impact. Here's an example. In Montreal, there is a 10-year gap in life expectancy between the Hochelaga-Maisonneuve neighbourhood and the Westmount neighbourhood. I am not talking about dollars here, but years of life expectancy, an extremely concrete indicator. This 10-year gap is also the same as the one between Bangladesh and Germany.
Reducing inequalities is a desirable goal. As our budget bulletin pointed out, it is a first step. However, it only stops the growth in inequalities. If they remain high, the negative consequences will persist.
Thank you.
Liberal
The Chair Liberal Wayne Easter
Ms. St-Hilaire, and we'll have to try to tighten the answers a little, too. Thank you.