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Children Financial security Taxation

Family Tax Cut: A potentially helpful tax policy, undermined by politics (or This is why we can’t have nice things)

Primarily single income, middle-class families, whether by choice or by chance, shouldn’t be penalised relative to their two income counterparts when paying taxes on the same earnings. Framed as such and designed solely to address this income disparity, the federal Family Tax Cut (FTC) would not be terribly controversial. But that’s not how it was designed, and the fallout has been all too typical of the increasingly hyper-partisan political environment in Ottawa.

According to the federal government’s Economic Action Plan, the FTC allows a higher-income spouse to notionally transfer up to $50,000 of taxable income to a spouse in a lower income tax bracket for federal tax purposes, up to a maximum benefit of $2,000.

An insightful analysis published recently by the Office of the Parliamentary Budget Officer (PBO) points to the real problem with the FTC: While the maximum benefit cap is reached by relatively middle-income families with total taxable earnings as low as $60,000, there’s no cap on combined (two income) family earnings to qualify for benefits.

Since a discrepancy between primary and secondary family earners of ‘up to $50,000’ is more likely to occur in families where at least one earner has a relatively high income in general, the lack of a cap on total family earnings to qualify for FTC benefits renders this otherwise potentially progressive family tax relief measure remarkably regressive.

As the PBO report points out, a third ($750 million) of all ($2.2 billion) FTC benefits would accrue to households where the primary earner makes in excess of $100,000 annually. Looking at combined family earnings, two thirds ($1.4 billion) of all FTC benefits would accrue to families with combined earnings in excess of $90,000 annually.

The solution seems readily apparent: Either supplement or substitute the FTC benefits cap with a combined family earnings cap – say $90,000.

The tables provided in the PBO report allow for a rough estimate of such a supplemental cap on family earnings, as illustrated in the tables above. It would decrease total FTC benefits to just $835 million for all families with a combined income below the suggested earnings cap. This would render the income tax schedule below the referenced income threshold relatively flatter – and, arguably, more ‘progressive’.

Targeting the FTC squarely at middle-low to middle income families – as opposed to mostly middle-high to high income households, as the PBO report notes it does – could also address the two theoretical  concerns raised in the Budget Officer’s report: The potential impact on government revenues and labour substitution effects.

Government revenues could decline if the balance of FTC benefits payments went to savings, although not by the full balance of benefits payments. The PBO analysis assumes a static model and does not factor for changes in household savings and consumption patterns, which would require making assumptions with a high degree of uncertainty.

The propensity to save is higher for higher income households. As it’s currently designed, families with middle-high to high incomes receive the lion’s share of FTC benefits. A hypothetical cap on combined family income effectively directing benefits toward low-middle to middle income families, with a lower propensity to save / higher propensity to consume out of disposable income, would direct most of those benefits back into the economy (household consumption accounts for more than half of expenditure-based GDP) and ultimately the government tax base (which level of government is topical).

In terms of labour substitution effects, the PBO estimates a relatively modest 0.04% change in total hours of labour supplied. Here again, the static model used does not account for broader labour supply and demand changes in the economy. For example, if a lower-income spouse reduces their hours due to the FTC, as the computed elasticity from the static model suggests they may, the model does not factor for whether an un- or under-employed individual would supply those hours. Nor does the static model factor for whether any reduced hours supplied are in line with reduced labour demand.

Given strong, persistent slack in the Canadian labour market, where the labour underutilisation rate according to the latest (February 2015) LFS release is still 14.2% –  i.e. 1 in 7 working age Canadians is either unemployed, under-employed or wants work but has given up looking – there’s no shortage of labour supply. Labour demand also happens to be at or near a record low, as the recently reported record number of consecutive months below 1 per cent year-over-year employment growth suggests.1

And that’s assuming there is any significant potential labour substitution effect to be had. As the PBO report notes, the substitution effect is hypothetical, based on uncompensated wage elasticity, i.e. the change in hours worked corresponding to a 1 per cent change in the marginal effective wage.

If the FTC were designed to address the disparity in income tax treatment of primarily single income, middle-class families, either these families’ have pre-determined their labour market participation (to spend more time on child, elderly, personal or other care), or they find their participation limited by labour market demand. Again, either by choice or by chance, labour substitution is more a notional than real choice today for many Canadian families.

With the right design, the FTC could have been (still could be) a relatively low-cost, revenue neutral tax measure that helps many Canadian families. In addition to providing tax relief for primarily single income families, the nearly $1.4 billion potentially saved by restricting FTC benefits to low-middle to middle income earning families could be directed to helping families who would not directly benefit from it. For example, the savings could be directed to changing the income level on which the Child Care Expense Deduction could be made  (currently, with limited exceptions, the expense can only be deducted from the lower-income earner, limiting its potential benefit).

But the FTC was never debated as such. Instead, Canadians have been subjected to perpetual political pandering, with the federal government accusing opponents of its regressive tax scheme of being ‘anti-family’, and the opposition responding with equally inane ‘anti-feminist’ accusations, demanding the FTC be scrapped entirely in favour of a far costlier national child daycare scheme2 it endorses – one that would neither benefit parents with children above pre-school (0-4 years) age nor primarily single-income parents who care for their children at home.

The result: An otherwise helpful family tax measure has become a social wedge issue in an increasingly hyper-partisan political climate that leaves all Canadians worse off.

Notes:

1. Regarding medium to long-term labour supply effects, it’s worth recalling that Finance’s (Kijiji) Jobs Report last February didn’t project any significant uptick in labour demand until 2025, projecting it to remain well below 1% for the foreseeable future. While labour force participation was projected to drop significantly as baby boomers retired, a number of recent reports suggest the majority of seniors can’t afford to. While Statscan’s reference (M1) demographic projections foresee a drop in the proportion of the working age (15-64 years) population, it’s projected to level out by 2031. While the demographic shift is a concern in many policy areas, the labour supply impact appears overstated.

2. Like the FTC, the Quebec child daycare programme some wish to see expanded nationally did not restrict benefits by family income. Recent research has suggested the Quebec programme has likewise been primarily subsidising higher income families, which has in turn prompted its provincial government to introduce a (far too limited) redesign in an effort to control spiralling costs. Contrary to some rather flawed analysis supporting such programmes, government subsidised child daycare is not revenue neutral.

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