Clawed back from working harder
Last month the federal government’s new Canada Child Benefit program came into force, replacing and consolidating an assortment of previous programs. However, little attention has been given to how this policy change, along with others from the Trudeau government — including the expansion of the Canada Pension Plan — will exacerbate a long- standing economic problem in Canada: high marginal effective tax rates and the resulting work disincentives faced by some moderate- and middleincome Canadians.
The marginal effective tax rate is simply the amount of money you lose to taxes, including the reduction of government benefits, when earning an additional dollar of income.
Economists worry about high marginal effective tax rates because they weaken the incentives for people to earn extra money by working additional hours or investing in their skills — actions that increase a person’s current and likely future earnings. If you consider working and earning more income but you will only keep a portion of each additional dollar earned, you will assess the costs and benefits of doing so. If the amount you keep is too small, you may decide not to expend the extra effort.
Policies t hat discourage work effort have wideranging economic consequences. They discourage Canadians from engaging in productive economic activity, ultimately hindering economic growth and prosperity — things the Trudeau government wants to en- courage.
There’s a popular misperception that only “rich” Canadians face very high marginal effective tax rates. Not true. Due to the combination of taxes and benefits that are “clawed back” as income rises, those of more modest means also face high effective marginal tax rates.
This is not a new problem in Canada. But recent federal policy changes will magnify this problem for some Canadians, despite the federal government’s signature personal tax cut for middle- income Canadians.
Consider an Ontario couple with two children. Let’s call them the Millers. In the Miller family, Sally financially supports the family, earning $ 50,000 in labour income, while Jim stays home and looks after the kids. Even before the federal policy changes, Sally faced a high effective tax rate on an additional income. After accounting for federal and provincial income taxes, CPP and EI payroll taxes, and the clawback of various federal and provincial trans- fers, the Millers would lose 61 cents for every additional dollar Sally earned beyond $ 50,000. This marginal effective tax rate would be a disincentive for Sally to earn more.
But i t’s getting worse. With the new Canada Child Benefit, and assuming the CPP payroll tax hike is implemented today, the Millers would lose 70 cents of each extra dollar Sally earned. If they decided to have another child, that loss would increase to 75 cents for every extra dollar Sally earned.
And these numbers actually underestimate the work disincentives facing the Millers. They exclude the employer portion of CPP and EI payroll taxes, although evidence shows these taxes will be passed on to the Millers through lower wages and/or benefits for Sally. Nor do they factor in the fact that virtually any consumption activity with the little money the Millers keep from an additional dollar earned will be taxed at Ontario’s HST rate of 13 per cent.
It’s easy to see why the Millers might determine that working harder to earn more money just isn’t worth it.
Of course, not every Canadian family will face the same marginal effective tax rate as the Millers. The precise rate for each family will depend on their number of children, their income level, and the number of household earners. But there are multiple scenarios in which changes to child benefits and CPP have increased the barrier to working more and earning a higher income for Canadian families.
The Canada Child Benefit and the proposed CPP expansion make a long- standing problem worse for some Canadian families. These are setbacks that should not be overlooked if the Liberal government is serious about growing the economy and encouraging Canadians to move up the income ladder.
NEW CHILD BENEFITS AND CPP COULD SEE A MIDDLE-CLASS FAMILY LOSE 70 CENTS OF EACH EXTRA DOLLAR EARNED.