Thank you, Mr. Chair and members of the committee. It's a pleasure to be part of your consultations this morning.
I was invited to talk about the impact of the tax and transfer system on work decisions by low-income families. What I'll be presenting is based on a publication that I published earlier this year. It's entitled “The High Cost of Getting Ahead: How Effective Tax Rates Affect Work Decisions by Lower-Income Families”. Due to the short notice for this appearance, I did not have enough time to have it translated for distribution, but it is available on our C.D. Howe website. Basically, I will simply make the following points today.
First, geared-to-income fiscal benefit programs provide valuable financial assistance to families. However, these benefits might come at the expense of effective tax rates for secondary earners in two-earner families, especially at the lower-income levels, with higher tax rates, thus reducing the gains from working. Policy-makers must be aware of this effect when they contemplate further expansion of the targeted financial assistance system.
Let's start with every year. Canadians file tax returns and calculate how much tax they owe to federal and provincial governments. On top of that, tax filing also serves another purpose. It serves to determine family entitlements to fiscal benefit programs such as the Canada child benefit, the GST tax credit, provincial programs such as the Ontario trillium benefit and the Quebec's social solidarity program, and many others. Those are payments from governments to taxpayers.
To determine the full impact of the tax system on households' take-home pay, we must therefore take into account the combined effect of fiscal benefit entitlement and taxes. It is not unusual for families at the lower end of the income scale to receive more in fiscal benefits than they pay in personal income tax. As families earn more income, fiscal benefits are reduced at various phase-out rates, and these phase-out rates pile up on top of each other because there are many such programs.
Benefit reductions act like hidden tax rates. Just like a normal tax, they reduce the gains from work. From having tax liability to fiscal benefits lost, we can estimate what we call an effective tax rate, and that's what I have done in my research paper.
There are two types of rates that I calculated. The first is a tax disincentive to earn a little more for employed workers, and this is known as the marginal effective tax rate. It's a tax rate on the next dollar of earnings. There's the disincentive to participate in the labour market at all, and that is measured through what we call the participation tax rate. Basically, a high marginal rate matters because it affects family incentives to work more, for instance, by working overtime or taking a second job, and a high participation rate matters because it affects the incentive to look for a job at all.
Let's take quickly, for example, a two-parent family with two children, with a working mother considering whether to earn extra income. One factor she must consider in her decision is how much of this extra income she will get to keep after deducting income taxes and lost fiscal benefits for her family. At a family income ranging from $36,000 to $42,000 in Ontario in 2015, she might lose more than 70¢ per extra dollar of earning. That means her METR, marginal effective tax rate, would be 70%. METRs for working families are generally in excess of 50% or 60% at income levels ranging between $25,000 and $45,000. This is family income. Looking at all families with children in Canada, about one in 12—for some people it's a lot, for others it's not much—are at METRs in excess of 50%.
Let's take another example. This time let's pretend the mother is currently unemployed, so she's not working but she's contemplating whether to take a job earning just less than about $30,000 a year, which is the average income for secondary earners.
How much of her work earnings would her family get to spend after taking into consideration the additional taxes paid and the reductions in fiscal benefits? These sums, or what we call our participation tax rate, will depend on her spouse's income. If her spouse earns a relatively low income, about $25,000 a year, her participation tax rate will be 50%, or greater, in seven of Canada's 10 provinces.
In 2015, about one in five stay-at-home spouses had a participation tax rate greater than 45%.
In these examples I have given you, I am looking at effective tax rates for secondary earners and families with children, because empirical studies of paid work behaviour estimate that the secondary earner in a family, as well as the low-skilled workers, are much more responsive to wage and tax rates. This means that high METRs or participation tax rates for a child-caring spouse are likely to have an impact on incentives to work longer, to seek part-time work, or to re-enter the workforce, leading to fewer paid work hours than people otherwise might choose.
Therefore, in contemplating new, targeted income support programs, federal and provincial policy-makers should pay special attention to work disincentives stemming from high effective tax rates. They should ensure that any new financial assistance programs do not contribute to increasing already high effective tax rates by adding another layer of geared-to-income benefit phase-out rates at lower income levels.
That's a simple message: just pay attention to the problem.
Thank you for your attention. I am open to questions.