Every once in a while, budget day brings something truly big that people fail to appreciate until much later.
Something big happened with Canadians' savings in the 2009 budget, when tax-free savings accounts appeared. The change has repercussions that will reverberate, mostly to the good, for generations to come and will make Canada a world leader in the savings and tax field.
From a standing start, the number of Canadians holding TFSAs has jumped from zero to about nine million, or about one-third of taxpayers. If you had said about a decade ago, when Rhys Kesselman of Simon Fraser University and I first proposed the Canadian TFSA model, that after just three years the annual contributions to TFSAs would be as large as those to registered retirement savings plans – and they now are – we might not have believed you.
The numbers are truly large. In 2011, Canadians contributed more than $30-billion to TFSAs, and the aggregate savings in them exceeded $60-billion. Now, after a dodgy couple of years, markets have rebounded, and I estimate 2013 total TFSA savings well north of $100-billion – about one-ninth the size of total amount in RRSPs, to which Canadians have contributed since 1957.
Participation is across the board. Among those 18 to 29 years old, about one in four contribute to TFSAs. Among those older than 65, it's four in 10. Yes, folks with high incomes are more likely than others to hold the tax-free accounts – but half of TFSAs are held by low- or modest-income earners, from low-income households. More women than men hold TFSAs.
These numbers do not really capture how big a deal this is. Assuming no change in policy from Finance Minister Jim Flaherty or his successors, most ordinary Canadians, over the next couple of decades and on into the future, will be able to do all of their desired saving on a tax-free basis. Yes – all of it.
Over time, the growth rate of TFSAs will slow, as it steadies out and reflects more new saving, rather than people shifting money from taxable accounts to TFSAs. And this is how the long-term sea change is going to show itself.
Suppose you're graduating from college in May, 2013, at the age of 22, and have never contributed to a TFSA or an RRSP. You will enter the work force with $25,500 in TFSA contribution room, which will grow by at least $5,500 a year – and double that if Mr. Flaherty keeps his 2011 commitment to expand annual TFSA room. In addition, you can contribute 18 per cent of your earned income every year, to a current maximum of $24,000, to an RRSP. Can't afford to save that much? All the room can be carried forward to later years.
What's more, if you choose to buy a house, your investment in it is like a TFSA. You pay for your house out of after-tax income, but any gains on the sale of a principal residence are tax-free.
Taken together, anyone entering the work force or has done so in recent years, and who arranges affairs to save anything near the allowable maximums, can contemplate arriving near retirement age with significant savings on which the tax bill has already been paid. For a typical middle-income couple, this would or could be comfortably in seven figures.
The economic implications are big, and fascinating.
First, Canadians will have the capacity – if not necessarily the willpower – to generate savings in such meaningful quantities that pressure for late-in-life government transfer support will wane.
Second, Canada is well on its way to transforming its tax system to an entirely consumption-based system. We still call it a personal income tax, but if for most of us all our savings, interest and dividends and other capital income accumulate tax-free, then the money we're taxed on is what we spend.
Governments need to plan around this. Pressure for old age low-income supports may shrink – but government income from taxing personal savings and investments will also shrink, to just about zero. Time for some long-term thinking by federal and provincial governments.
Meanwhile, if today's federal budget or the next one honours Jim Flaherty's promise to double TFSA contribution room, Canada's tax and savings transformation will be nearly complete. I look forward to finding how it all turns out.
Finn Poschmann is vice-president, research, at the C.D. Howe Institute in Toronto.