It’s time to pay more at­ten­tion to mar­ginal ef­fec­tive tax rates

National Post (Latest Edition) - - FINANCIAL POST - Jamie Golombek Fi­nan­cial Post Jamie. Golombek@ cibc. com Jamie Golombek, CPA, CA, CFP, CLU, TEP is the Man­ag­ing Direc­tor, Tax & Es­tate Plan­ning with CIBC Fi­nan­cial Plan­ning & Ad­vice in Toronto.

There may not be much sym­pa­thy out there for the top one per cent high­in­come earner who, in 2018, will face a mar­ginal tax rate of over 50 per cent in more than half the prov­inces in Canada. But there should be some at­ten­tion given as to why a lower-earn­ing par­ent of a dual-earn­ing cou­ple, with two kids and a com­bined fam­ily in­come of $ 50,000, can face a mar­ginal ef­fec­tive tax rate of over 70 per cent.

To bet­ter un­der­stand what’s go­ing on here, we first need to re­visit the con­cept of a statu­tory tax rate and com­pare that to your mar­ginal and av­er­age tax rates. Then we can look at your mar­ginal ef­fec­tive tax rate ( METR) and par­tic­i­pa­tion tax rates ( PTR), two con­cepts high­lighted in a new re­port out this week from the C. D. Howe In­sti­tute en­ti­tled, “Two-Par­ent Fam­i­lies with Chil­dren: How Ef­fec­tive Tax Rates Af­fect Work De­ci­sions.”

In the re­port, re­searcher Alexan­dre Lau­rin finds that work­ing par­ents with chil­dren — par­tic­u­larly low-in­come fam­i­lies — “face pro­hib­i­tive tax rates that dis­cour­age tak­ing on ex­tra em­ploy­ment to get ahead … (with) moth­ers and poorer fam­i­lies … the most ad­versely af­fected by this tax trap.”

Be­fore we look at Mr. Lau­rin’s find­ings and po­ten­tial fixes, let’s take a look at the different types of tax rates.


The statu­tory tax rate is the rate of tax ap­plied to a given level of in­come. Cana­dian in­di­vid­u­als ( but not cor­po­ra­tions) pay taxes at grad­u­ated rates, mean­ing that your rate of tax gets pro­gres­sively higher as your tax­able in­come in­creases.

Last year, the fed­eral govern­ment an­nounced that the in­fla­tion rate used to in­dex the 2018 brack­ets and amounts would be 1.5 per cent. Thus, for 2018, the five fed­eral tax brack­ets are: zero to $ 46,605 ( 15 per cent), $ 46,605 to $ 93,208 ( 20.5 per cent), $ 93,208 to $ 144,489 ( 26 per cent), $ 144,489 to $ 205,842 ( 29 per cent), with any­thing above that taxed at 33 per cent. On top of this we add pro­vin­cial or ter­ri­to­rial tax ( and in at least a cou­ple of prov­inces, pro­vin­cial sur­taxes), to get our com­bined fed­eral/ pro­vin­cial statu­tory tax rate, which ranges from about 20 per cent to over 50 per cent, de­pend­ing on your in­come and province of res­i­dence.


Your mar­ginal tax rate is the amount of tax you would pay on an ad­di­tional dol­lar of in­come. Your av­er­age rate is cal­cu­lated by tak­ing the to­tal amount of in­come tax you pay and di­vid­ing it by your to­tal in­come. For most Cana­di­ans, your av­er­age rate is sig­nif­i­cantly be­low your mar­ginal rate, due to the pro­gres­sive, grad­u­ated rates dis­cussed above.


But per­haps the most im­por­tant tax rates we should be con­sid­er­ing is our METR and PTR. The “mar­ginal” ef­fec­tive tax rate ( METR) con­veys the fi­nan­cial loss, through ad­di­tional taxes and di­min­ished ben­e­fits, as­so­ci­ated with an ad­di­tional dol­lar of earn­ings. For a work­ing par­ent, it rep­re­sents the fi­nan­cial penalty that must be paid from any small ad­di­tion to their in­come.

The “par­tic­i­pa­tion” tax rate ( PTR) is the cu­mu­la­tive ef­fect of all taxes, fis­cal con­tri­bu­tions, pay­roll de­duc­tions and loss of fis­cal ben­e­fits on the en­tire earn­ings from work. For a stayat- home par­ent, it rep­re­sents the fi­nan­cial penalty that must be paid out of the to­tal in­come de­rived from en­ter­ing the work­force.


The C. D. Howe re­port ex­am­ines how Canada’s fed­eral and pro­vin­cial tax and ben­e­fit sys­tem im­pacts take- home pay by com­bin­ing the ef­fects of both taxes paid and loss of govern­ment ben­e­fits to pro­duce METRs that show the tax bite from each dol­lar of ex­tra in­come.

Be­cause ben­e­fit pro­grams are tar­geted at the lower end of the in­come scale, low- and mid­dle- in­come fam­i­lies’ ef­fec­tive tax rates are gen­er­ally higher than those of higher- in­come fam­i­lies.

Mr. Lau­rin finds that METRs gen­er­ally peak at fam­ily in­comes be­tween $ 35,000 and $ 50,000. For ex­am­ple, in On­tario, the fam­ily METR on ex­tra earned in­come peaks at 64 per cent while in Que­bec, it peaks at 73 per cent.

The study showed that in 2017, about 9 per cent of em­ployed par­ents con­tem­plat­ing earn­ing a few ex­tra dol­lars, and about 13 per cent of stay- ath­ome par­ents con­tem­plat­ing get­ting a job, faced an ef­fec­tive tax rate higher than 50 per cent.

The re­port pro­poses a cou­ple of fixes. First, the govern­ment could sub­si­dize child care. Un­der our cur­rent tax sys­tem, child­care ex­penses are tax de­ductible, but only on the tax re­turn of the lower- earn­ing spouse or part­ner. In ad­di­tion, the max­i­mum claim is lim­ited ei­ther by a dol­lar amount ( gen­er­ally $ 8,000 for kids up to age 6 and $ 5,000 for chil­dren age 7 through 16) or by two- thirds of the in­come of the spouse, which­ever is l ower. Due to these re­stric­tions, up to onethird of fam­i­lies can­not fully deduct their child­care ex­penses be­cause of the two- thirds- ofin­come limit ( mostly among those at lower in­come lev­els) or the max­i­mum claim lim­its ( mostly among those at higher in­come lev­els).

Mr. Lau­rin pro­poses a fed­eral re­fund­able credit for child­care costs with very gen­er­ous rates for lower- earn­ing fam­i­lies, de­signed along the lines of the Que­bec child­care ex­penses credit.

“Par­ents, es­pe­cially moth­ers, have been shown to be par­tic­u­larly sen­si­tive to changes in child­care costs,” says Lau­rin. “A more gen­er­ous tax treat­ment would likely en­cour­age about 15 to 22 per cent of stay- ath­ome moth­ers to join the work­force and stay em­ployed over the long term.”

An­other so­lu­tion pro­posed by Mr. Lau­rin and one I’ ve touched on in a pre­vi­ous col­umn is in­come av­er­ag­ing. If work­ers were al­lowed to av­er­age their in­come over a num­ber of years, it would lessen the im­pact of fluc­tu­at­ing in­come on their tax li­a­bil­ity and thus, their govern­ment ben­e­fits.

That way, any sin­gle large earn­ing year wouldn’t lead to higher tax pay­ments along with a dis­pro­por­tion­ate loss of fis­cal ben­e­fits.

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