Reading the latest federal budget, a hard-pressed taxpayer might be tempted to give Jim Flaherty a hug.
The only Finance Minister the current government has ever known delivered his 10th budget this week, and inside the document is a claim that an average family of four is paying $3,400 a year less in taxes than in 2006. The figure was calculated by adding up cuts to the Goods and Services Tax, personal income tax reductions and various tax credits the Conservatives introduced after coming to power eight years ago.
“Canadian families keep more of their hard-earned dollars as a result of the government’s actions to reduce the tax burden,” the 419-page document points out.
So it might come as a bit of a surprise to many Canadians that the government’s long road back to a balanced budget is as much a story about rapidly growing tax revenues as it is about more widely discussed spending cuts.
In the wake of cuts to the GST and corporate income tax rates, personal income taxes are carrying a growing and outsized share of the load of paying for government. By 2018, personal income taxes will account for 50 per cent of total federal revenue – far and away the largest source of money for Ottawa.
And the share has been steadily climbing for at least two decades. In 1993, when Jean Chrétien became Prime Minister, personal income taxes represented 44 per cent of government revenue. By the time Stephen Harper took over in 2006, the share was up to 46 per cent.
“The message from the government is that most taxes have been going down,” said Peter Devries, a former director of fiscal policy at the Finance Department. “I don’t think people realize that, as a share of what the government takes in, the average Joe is paying more.”
The Conservatives have naturally played up their fiscal credentials now that the federal Treasury is poised to move back into surplus next year and beyond. On many measures, spending restraint is a key part of the narrative. Program expenses as a percentage of gross domestic product – the broadest measure of economic activity – are now projected to fall to less than 13 per cent in 2015 and beyond, from nearly 16 per cent in 2010. That is the result of thousands of civil service job cuts and freezes to departmental budgets.
But the remarkable turnaround from red ink to black is just as importantly being driven by revenues. Ottawa’s projections say the government will move from a $19-billion deficit in 2013 to a $10-billion surplus in 2019. Higher revenues from a recovering economy are expected to make up two-thirds of that $29-billion swing.
“It is true that revenues play an assist here, and that runs counter to some of the messaging around the budget. In fact, revenues are rising as a share of GDP,” said Douglas Porter, chief economist at the Bank of Montreal.
Total budgetary revenues, which include employment insurance premiums, are projected to grow to 14.5 per cent of GDP by 2019 from 14.1 per cent now.
Even more apparent is the growing contribution of individual Canadians. Based on the government’s own models, the total take from personal income taxes will grow by about 5 per cent a year over a six-year period – to $167.7-billion in 2018-19 from $125.7-billion in 2012-13.
More revenue is the natural consequence of an improving economy. “Economic tailwinds are leading to improved revenue intake, which is certainly helping the government’s bottom line,” Toronto-Dominion Bank senior economist Sonya Gulati said.
Taxes collected from individuals typically grow faster than the overall economy. That’s because of the progressive features embedded in the tax system, which force higher-income earners to pay higher rates. When the economy grows, people move more quickly up the income scale and through the four income tax brackets, which start at 15 per cent (for income of $43,953 in 2014) and top out at 29 per cent (for income over $136,270).
The income tax base also grows as the labour market expands. There are about 870,000 more people working in Canada than there were four years ago, most of them full-time.
“It’s probably an underplayed story that the revenue side will be doing some of the heavy lifting. And it’s very subtle,” BMO’s Mr. Porter pointed out. “It’s not like tax rates are being increased, other than on tobacco.”
Corporate taxes currently make up 14 per cent of total revenue. Other taxes, including the GST and tariffs, account for 17 per cent.
Part of the reason for shifting the burden to individuals is the Conservatives’ decision to cut the GST from 7 per cent to 5 per cent between 2006 and 2008.
But the drift started long before that – the result of lower tariffs from free trade, lower corporate tax rates and other policies that have shifted more of the load of government onto individuals.
The Conservatives will soon have an opportunity to reverse the trend, and truly lighten the load for Canadians. Barring a major setback for the global economy, by this time next year, Mr. Flaherty will be at the centre of a fierce debate about how to spend a growing surplus.
The party – and the Reform Party from which it emerged – has long espoused broad-based tax cuts for individuals. But what it has delivered up to now has been mainly targeted relief to very specific groups, for often political reasons. The budget touts 160 tax measures that have saved Canadians $160-billion since 2006, including breaks for children’s sports, art lessons and firefighters.
“It’s fair to say that tax relief has been targeted, not broad, and it’s been targeted at the 905 [area code, in the Greater Toronto Area] and other suburban voters,” said Finn Poschmann, vice-president of research at the C.D. Howe Institute in Toronto. “Broad-based tax changes provide small benefits to a large number of people, as opposed to significant and visible benefits to a small number of people. That political calculation leads to targeted credits.”
Already the Conservatives appear to be backing off a bit from a signature promise made in the last election campaign – income splitting. The pledge, estimated to cost $2.5-billion a year, was pitched as broad middle-class tax break that would allow working parents to transfer income to a lower-income or stay-at-home spouse.
However, experts say income splitting looks like another targeted tax cut whose benefits will flow mainly to higher income-earners.
The problem with broad tax cuts is that they are expensive because they go to many. “If you want to do anything of significance, it costs you a lot of money,” said Mr. Devries, the former Finance official.
The best and simplest way to give broad tax relief is to reduce income tax rates – rather than, say, raising the thresholds for moving into a higher tax bracket. But a reduction of just one percentage point in each tax bracket would cost $10-billion a year – coincidentally, the estimated size of the surplus at the end of the budget forecast period in 2019.
So that’s not likely to happen, given that the government will be facing demands to spend more from just about every interest group in the country.
The C.D. Howe Institute’s Mr. Poschmann suggests instead that the government should broaden the tax base by scrapping all the special-interest tax breaks that have been added in recent years. That way, Mr. Harper and Mr. Flaherty would have money to spend on cutting tax rates.
“You expand the base by getting rid of all the things that shrink it – all the things that put holes like Swiss cheese in the tax base,” Mr. Poschmann said.