The federal Liberals introduced massive tax increases for many of the self-employed this week, with marginal rates soaring to as high as 81 per cent.
Of course, the government wouldn’t quite choose those words to describe the launch of the Canada Recovery Benefit, the new program designed to buttress the incomes of workers not covered by Employment Insurance.
But a high clawback rate for benefits, combined with a relatively high threshold at which those clawbacks begin, means that CRB recipients with moderate incomes wanting to supplement their benefits face a hefty bite from their earnings – and a significant disincentive to taking on additional work, economists say.
In an analysis posted on FinancesoftheNation.ca, Robin Boadway, professor emeritus of economics at Queen’s University, laid out how the CRB increases the effective tax burden of recipients once they earn more than $38,000 in a given tax year. At that point, CRB benefits are reduced, or clawed back, by 50 cents for every additional dollar of earnings.
That 50-per-cent clawback, when added on top of personal income taxes, pushes the effective marginal tax rate to "fairly punitive” levels, Prof. Boadway said in an interview. (Effective marginal tax rates include not only income tax rates that appear on annual forms, but the implicit tax represented by the clawback in benefits that are tied to income.)
Prof. Boadway says the CRB will push effective tax rates high enough to become a disincentive to work, particularly since recipients will largely be the self-employed with a greater ability to fine-tune their hours and income.
As the chart below shows, an individual who is part of a two-income family of four in Alberta would see a steep increase of their effective tax rate from 52 per cent (which already includes the effect of other clawbacks) to 81 per cent once annual income rose to a relatively modest $43,400. At that level, the family is only 19 cents better off for every additional dollar of the CRB received. Once the recipient’s income hits $52,000, the effective marginal tax rate falls sharply, to 58 per cent.
An individual in the same kind of family in Ontario faces an even higher effective marginal tax burden, with a peak rate of 119 per cent when income hits $61,000.
The broad pattern of a spike in effective marginal tax rates holds true in other provinces, and for other kinds of CRB recipients.
Two facets of the CRB design are driving that spike. The first is simply the rate of the clawback: the higher that rate, the greater the impact on effective marginal tax rates. The second is the earnings threshold at which the clawback kicks in. As that threshold rises, the cost of any income support program rises.
And the main way to rein in costs is to increase the clawback rate. So, a program with a low clawback threshold can have a low clawback rate. But a program with a high threshold will need to have a high clawback rate, or else see costs rise.
In the case of the CRB, the clawback is quite high, at 50 per cent. By contrast, a one-time payment that the BC NDP are proposing in that province’s election campaign has just a 2-per-cent clawback rate.
The clawback rate of the Employment Insurance system is similar to that of the CRB, starting out at 50 per cent and eventually rising to 100 per cent of earnings. But the 50-per-cent clawback for EI recipients kicks in at the very first dollar of earnings, leaving CRB beneficiaries with lower incomes significantly better off.
Prof. Boadway said that if the CRB clawback were to begin at the first dollar of earnings, the rate could be set much lower, around 30 per cent. That would reduce the top effective marginal tax rates below 100 per cent – still high but allowing middle-income recipients to benefit from the CRB. That and other changes are needed before the CRB can be used as a foundation for permanent income support for the self-employed, or for a wider basic-income program, he argued.
There is one other major difference between the clawback systems of the CRB and EI: timing. Under EI rules, benefits are reduced shortly after recipients earn wages. But under the CRB, that clawback doesn’t happen until tax season, in part because recipients need to know their annual income. At a minimum, that raises a question of whether recipients will respond to clawbacks that will happen months in the future in the way they would to immediate reductions in earnings. A 10-per-cent withholding tax is deducted from CRB payments, but that could still leave recipients saddled with a substantial tax liability.
There is also a question of whether the clawbacks will happen at all, says University of Toronto economics professor Michael Smart. “This could be hard for Canadians who maybe thought that would be money in the bank and now find in some cases they are being asked to repay it through the tax system," he said. "It’s going to be hard for the government to make that happen.”
Prof. Smart said the federal government may have to change clawback rules in the spring, particularly if economic weakness persists into 2021, making it unpalatable to weaken consumer spending.
Tammy Schirle, professor of economics at Wilfrid Laurier University, cautioned that the CRB’s increase in effective tax rates may have limited impact because the self-employed tend to have low earnings, and may end up not hitting the clawback threshold at all. According to 2016 census data, median annual income for self-employed workers in the service sector without paid help was $23,000, meaning half of workers made less than that amount, and half made more. Prof. Schirle said that means that a very large proportion of self-employed workers would fall below the CRB’s $38,000 earnings threshold in a normal year.
But 2020 is anything but a normal year. Prof. Schirle said it is difficult to say how the economic downturn of the past seven months has changed the earnings profile of the self-employed and therefore hard to gauge how big of an impact the CRB clawback will have.
Tax and Spend is a weekly series that examines the intricacies and oddities of taxation and government spending.
Editor’s note: An earlier version of this article contained incorrect figures from FinancesoftheNation.ca on the impact of the Canada Recovery Benefit on effective marginal tax rates. FinancesoftheNation.ca recalculated and corrected those figures, which were used to amend the Globe’s story and graphic.