Tax ideas for a federal budget

Jamie Golombek looks at some proposals offered by the C.D. Howe Institute.

While the speculation around when and what will be contained in Finance Minister Bill Morneau’s second federal budget continues unabated, some interesting ideas — some old, some new — were floated this week with the release of the C.D. Howe Institute’s annual “shadow budget” for 2017, co-authored by William Robson, Alexandre Laurin and Rosalie Wyonch. Here are some of the proposed changes the Institute has put forward for discussion.

TAX RATES

Last year saw the introduction of the middle-income tax cut (the rate drop to 20.5 per cent from 22 per cent for 2017 income between $45,916 to $91,831) coupled with the launch of the new 33 per cent high-income bracket (for 2017 income above $202,800). The top combined federal/provincial marginal tax rate for high-income earners in Canada is now more than 50 per cent in seven provinces, a rate the report calls “punitive.”

Echoing earlier research by Mr. Laurin, the authors write that “in the short term, highincome taxpayers respond to tax-rate increases by trying to realize their income in different forms, at different times and in different jurisdictions. These responses shrink the tax base and reduce tax receipts… Excessively taxing the talent that fuels a more innovative, creative and successful economy is ultimately self-defeating.”

The report therefore recommends that the threshold at which the top rate applies be increased to $402,800 from the current $202,800. By comparison, the current U.S. top rate of 39.6% only applies to income above US$418,400. This measure would reduce the number of people subject to the highest tax rate, “helping Canada to remain competitive and fiscally attractive for the world’s best talents.”

TAX CREDITS

The report also recommended the elimination of more “boutique” tax credits, sometimes known as “tax expenditures.” Last year’s federal budget announced the elimination of four of the credits: the children’s fitness and arts credits as well as the education and textbook credits for students.

The report singled out the tax credit for first-time home buyers as a “problematic subsidy” and would have it phased out. Similarly, it recommended that the public transit tax credit, which “subsidizes an activity that already receives substantial tax support and, thanks to the ramping up of federal support for infrastructure, will soon receive more,” also be eliminated after 2018.

At the same time, it urged the government to lower the income threshold for being able to claim medical expenses. For the 2017 tax year, valid medical expenses qualify for a 15 per cent federal medical expense tax credit (METC) as well as a provincial credit, provided they exceed a minimum threshold equal to the lesser of 3 per cent of your net income or $2,268. The justification for a tax break on medical expenses is that they are generally non-discretionary — most people incur them because they are sick and thus the income used to cover them is not available for consumption.

The report feels that METC “is not generous enough” and recommends that the government lower the threshold for a tax break on such expenses to 1.5 per cent of net income, or $1,120, whichever is lower.

INCREASING AGE LIMITS FOR TAX- DEFERRED SAVING

With life expectancy in Canada rising at a rate of more than two years per decade since the 1960s, Canada’s retirement system’s age limits don’t reflect this change. For example, we can’t contribute to our RRSPs beyond age 71 and after this age, we’re required to draw down a minimum prescribed amount each year from our RRIFs (or annuitize our RRSP).

The report recommends that, starting on Jan. 1, 2018, the age at which contributions to tax-deferred retirement saving schemes must end should be increased to 72 and, every six months after that date, the contribution time frame would be further increased by one month.

INCREASE TAX- DEFERRED SAVING LIMITS

Our tax rules also limit the amount of retirement wealth Canadians can accumulate on a tax-sheltered basis. Because people are living longer and yields on safe, fixed income investment savings are now extremely low, the cost of being able to save for a given level of retirement income has increased in recent years. Moreover, the existing rules for calculating equivalency between defined benefit and defined contribution pension plans or limits for RRSPs are “badly out of date, putting people with DC plans and/or RRSPs at a major disadvantage relative to those in DB plans.”

To help fix this, the report calls for the government to update the assumptions underlying the equivalency factor to reflect current economic and demographic realities. As a result, the amount you would be able to contribute to your RRSP would increase to 30 per cent of earned income from the current level of 18 per cent. The cost of this measure is relatively small on a present value basis since the tax owing on higher RRSP contributions is simply deferred until the invested funds and related income/ gains are withdrawn.

REDUCING/ ELIMINATING MANDATORY RRIF WITHDRAWALS

You’ll recall that the 2015 federal budget reduced mandatory minimum RRIF withdrawals to help reduce the risk that Canadians might outlive their savings by being forced to deregister and pay tax on their retirement savings prematurely — in other words, before they need to for consumption purposes. But given our low-interest rate environment, where the yields on (relatively) risk-free investments are paltry, coupled with increased longevity, the risk is still material.

The 2015 adjustments to the RRIF minimums assumed real investment returns of 3 per cent. If these projections were to be rerun today with real returns on safe investments, “seniors still face a material risk of outliving their tax-deferred savings.” The Institute is therefore recommending that the government consider either regular adjustments to the RRIF minimums to keep the withdrawals aligned with real returns and longevity or eliminating minimum withdrawals entirely.

PRE- AGE 65 PENSION SPLITTING

With family income splitting (known formally as the “Family Tax Cut”) now gone, seniors still have the ability to split pension income, but only from an annuitized defined benefit or defined contribution pension plan. Recipients of funds from other retirement saving vehicles, such as life-income funds or RRIFs can only income split their pension income from age 65. The report suggests making pension income splitting, and at the same time the $2,000 pension income credit, available to all such income, regardless of the recipient’s age.