Liberals’ new high-income bracket may encourage tax avoidance, economists warn

The Liberal proposal for a new tax bracket would push the top combined tax rate in most provinces to nearly 50 per cent or more, a psychological threshold that economists have long warned will encourage tax avoidance and disappoint government expectations for extra cash.

Liberal Leader Justin Trudeau is counting on an additional $3-billion in revenue from a new 33-per-cent federal tax rate for Canadians earning $200,000 or more. But several provinces have also brought in tax-the-rich hikes in recent budgets, meaning an additional move by Ottawa would push the combined top tax brackets to levels that could raise concerns about Canada's international competitiveness.

New Brunswick would be affected the most. The combined top tax rate in New Brunswick would increase to 58.75 per cent, including an increase announced in this year's provincial budget that raises the rate on incomes above $250,000. Nova Scotia would have the second-highest combined rate at 54 per cent, followed by Ontario at 53.53 per cent, including the provincial surcharge. Quebec's combined top rate would be 53.3 per cent, followed by 51.37 per cent in PEI,  50.4 per cent in Manitoba and 49.8 per cent in British Columbia.

"What's worrisome is the combined effects … It could affect the brand," warns Michel Kelly-Gagnon, president and CEO of the Montreal Economic Institute, who says Quebec's current top combined rate is already a problem for Quebec firms seeking to attract international talent.

The top marginal personal income-tax rate is often used as a measure of international tax competitiveness. The fact that the proposed top rate would not kick in until income reaches $200,000 is a level of detail that is not obvious when countries are listed using this measure by organizations like the Organization for Economic Co-operation and Development.

According to the OECD, Canada's average top personal income-tax rate of 49.5 per cent is already higher than the 46.3-per-cent rate in the United States.

Mr. Kelly-Gagnon said Canadians should keep these issues in mind as they debate taxing the rich.

"Rich people sign paycheques," he said.

After months of criticism that his party was light on policy, Mr. Trudeau announced two major campaign planks Monday. The party is proposing to reduce the tax rate on income between $44,701 to $89,401 from 22 per cent to 20.5 per cent, a $3-billion tax cut that would be paid for by the new tax bracket on income above $200,000.

The Liberals also propose replacing the monthly Universal Child Care Benefit with a similar Canada Child Benefit that promises more money to families tax free than the Conservative plan, provided family income is $150,000 or less. The Liberals promise to pay for this in part by eliminating the increase in the Tax Free Savings Account annual contribution limit and by eliminating income splitting for couples who are in different income-tax brackets.

Governments have been warned for years not to let personal tax rates climb above 50 per cent.

The 1966 Carter Commission, a Royal Commission report that made recommendations on the most effective ways of taxing Canadians, said the tax rate should not go above 50 per cent.

"We think there is a psychological barrier to greater effort, saving and profitable investment when the state can take more than one half of the potential gain," the report stated.

A detailed analysis conducted by Finance Canada decades later in 2010 examined the specific scenario of a tax increase on the top 1 per cent of income earners. It found that group is significantly more likely to change behaviour to avoid the tax than taxpayers in lower income brackets. The study said examples of these changes include switching the form of remuneration to stock options or boosting investment and using that as a tax deduction.

Liberal MP John McCallum said his party did take that into account by using a model from Statistics Canada that estimates the potential behavioural changes. He also noted that a Liberal government would crack down on tax enforcement to limit aggressive tax avoidance.

"In general, we have been prudent in our costing assumptions," he said.

Philip Cross, a former chief economic analyst at Statistics Canada who is now with the Macdonald-Laurier Institute, questioned whether the new bracket will actually raise $3-billion.

"Not a chance," he said. "These are the people who are best positioned to take advantage of loopholes in the system. The idea of soaking the rich to pay for benefits for other people never works out."

Editor's note: An earlier version of this story contained estimated tax rates that did not take into account the Ontario and Prince Edward Island provincial surtaxes or the Quebec abatement. Taking those into account, a new top federal tax bracket of 33 per cent would bring the combined tax rate in Ontario to 53.53 instead of 46.16 per cent as originally stated, and to 53.3 per cent in Quebec, compared to 58.75 per cent as originally stated. Including the PEI surtax would bring the combined rate to 51.37 per cent, rather than 49.7. This version has been corrected.