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.