The smart way to cut federal income tax

What if middle- and uppermiddle-income earners in Canada got a massive break on their federal income tax — something in the order of 30 to 70 per cent — on most of the money they make?

And what if this could be done without affecting federal revenue in an unmanageable way?

If this idea appeals, you will like a new Fraser Institute study suggesting just such a cut — eliminating Ottawa’s middle- and upper-middle-income tax rates of 22 and 26 per cent, and dinging all taxable income up to $136,000 a year at no more than the basic rate of 15 per cent. Of course, any income over this amount would still be taxed at 29 per cent, but only one tax filer in 50 earns this much, so why would most of us care?

Some of us — although, significantly, not all of us — are apt to care more when we contemplate how the Fraser Institute suggests paying for this big cut. The study proposes that most of the cost be covered by pulling the plug on many of those “boutique” tax cuts I have often carped about — the often-trivial, but collectively huge sops that various politically motivated finance ministers have given to a huge range of interest groups over the years.

These kinds of breaks — along with many not-at-all-trivial and much-easier-to-justify breaks such as basic personal exemptions and deductions for qualified retirement savings plans — are collectively known as tax expenditures. And the Fraser Institute doesn’t recommend giving them all up.

The authors divide the long list of federal tax expenditures — five full pages in the report — into those measures that they have judged to reward consumption and those that don’t — in other words, those that encourage saving. The result, it recommends, is that 68 tax measures worth $20 billion could and should be on the cutting block — a little over half the number that are on the books, but worth only about one-sixth of the total value.

Not recommended for elimination are those personal exemptions and retirement savings deductions, along with things like EI premiums, TFSA earnings, an income-splitting provision for seniors (and promised for other families), capital loss carry-overs, lifetime exemptions for farmers and small business owners, alimony, and more.

On the chopping block should be a whole range of employment deductions, including dues for union or professional association members, medical and disability tax credits, charitable and political donation credits, tuition and student loan interest credits, children’s arts and fitness credits, flow-through share credits, labour-sponsored venture capital credits, and much, much more.

The point that has always got my goat about these kinds of deductions is that most, if not all, arbitrarily advantage one group of taxpayers over another.

A telling further point underlined by the authors is that, although they really do lower tax bills for some taxpayers, they do nothing to reduce what economists call the marginal tax rate — that is, the rate that applies to the next dollar of income a taxpayer earns.

To cite an example, the existing rules that provide tax shelters for retirement savings and some other investments mean that, effectively, Canadians pay no tax on earnings from as much as 75 per cent of the money they have invested. Yet if a Canadian who has already taken full advantage of these kinds of breaks were to invest additional money, it would be taxed at a very high rate. It is this dampening effect of existing tax rates on investment that concerns the Fraser Institute researchers.

As tax policy stands, the analysis notes, “If two individuals have the same lifetime earnings, but one saves some earnings for future consumption and the other spends all his or her earnings on current consumption, the saver pays more tax than the immediate consumer does over a lifetime.”

The authors think this makes no sense. It’s hard to disagree.