Questioned repeatedly about rising inflation during her appearance last week before the Commons finance committee, Finance Minister Chrystia Freeland acknowledged there is indeed “an affordability challenge, especially for the most vulnerable Canadians.”
The minister went on to extol the fact that benefits such as the Guaranteed Income Supplement for seniors, the Canada Child Benefit and GST credits for low-income households are indexed to inflation. “So, I think one piece of assurance that we can collectively offer to the most vulnerable Canadians is the benefits they depend on are actually going to be linked to the costs that they face in their lives,” she concluded.
That will be true eventually – but not this year or in 2022, when those on fixed or otherwise modest incomes will be dealing with rising prices.
Ms. Freeland is correct to point out that benefits are indexed, as are the income brackets used to calculate when higher rates of income tax kick in. Each fall, the Canada Revenue Agency determines how much benefits, and those brackets, will rise. For the most part, those increases apply of Jan. 1. For benefits such as the CCB and the GST credit, inflation-indexed increases kick in as of July 1. So for Canadians receiving those kind of benefits, any inflation relief is more than a half-year away.
But the much bigger issue is how quickly the indexation system responds to inflation. Broadly speaking, it works well in a world where inflation moves up or down gradually – as opposed to the current situation of a sudden surge in the consumer price index. In 2021, as inflation started to pick up, the indexed increase was just 1 per cent. For 2022, the increase is 2.4 per cent, a jump from the previous year to be sure, but still far below the 4.7-per-cent increase in CPI in October.
Why the gap? It has to do with the formula for calculating the indexation increase, spelled out in the Income Tax Act (Section 117.1, for those who are curious). That formula calculates the percentage change in the average of the CPI over the 12 months ended Sept. 30 compared with the average CPI for the preceding 12 months.
So, this year’s figure would use the average CPI from Oct. 1, 2020, through to Sept. 30, 2021, and then the average CPI for Oct. 1, 2019, through to Sept. 30, 2020. The result, a change of 2.4 per cent, is the indexation increase.
A key part of that formula is that it includes each month’s CPI level as a data point. So if there is a sudden surge at the end of that period, as is the case this year, earlier months, when CPI was stable, mute any uptick. The formula is akin to how a vehicle computes average fuel efficiency: Any sudden increase in the rate of fuel consumed takes a considerable time to change the average, which has been calculated over many kilometres.
The vagaries of the indexation formula explain why the increase for 2021 was just 1 per cent – the CPI dipped in 2020 in the initial stages of the pandemic, depressing the 12-month average.
And that is also the reason why the adjustment arriving on Jan. 1, and for some benefits, July 1, seems modest compared to the current inflation rate. Next year’s adjustment is depressed by relatively sluggish growth in the CPI in the fall and winter of 2020-21. By contrast, the September-to-September change in the CPI, which lands in news headlines, was 4.4 per cent.
The indexation increase will eventually close that gap, assuming inflation does not accelerate further and worsen the problem. But for next year, at the very least, the vulnerable Canadians that Ms. Freeland mentioned will face an inflation-driven erosion in the purchasing power of their government benefits. Other Canadians, assuming their income rises in step with inflation, will temporarily shift into higher tax brackets.
All of them can take comfort that Ms. Freeland’s assurances will come to pass, eventually. Just not in 2022.
Taxing questions
Left unanswered at that finance committee hearing was a question from Conservative finance critic Pierre Poilievre about the effect of a one percentage point increase in interest rates on federal finances. Ms. Freeland declined to directly respond to Mr. Poilievre, instead saying there will be information made available in Tuesday’s economic and fiscal update.
But Page 347 of April’s federal budget answers that question precisely, if from a slightly outdated fiscal framework. A sustained increase of 100 basis points (or one percentage point) in all interest rates decreases the budgetary balance by $1-billion in the first year, $2.5-billion in the second year and $4.6-billion in the third. Public debt charges (presumably the nub of Mr. Poilievre’s query) do rise, jumping a not-insubstantial $8.2-billion by the third year.
The increase in the cost of debt is offset somewhat by higher payments from the government’s interest-bearing investments. The budget goes on to note that the sensitivity estimates for interest rates don’t include the downward adjustments in public-sector pension obligations that higher rates would trigger. Nor do they include any revenue upside from stronger economic activity, often the spur for higher rates.
Line Item
The 1 per cent lose a little ground: The Parliamentary Budget Officer has updated its figures for wealth distribution in Canada, with its numbers showing that wealth inequality has diminished, oh so slightly, since 2019. Two years ago, the 1 per cent richest families held 24.8 of Canada’s net wealth. The bottom 40 per cent of families, by net worth, accounted for just 1.1 per cent of national net wealth. Fast forward to the second quarter of 2021 and that yawning gap has closed a titch. Now, the top 1 per cent are having to make do with just 24.3 per cent of net national wealth (although the dollar amount collectively held has risen). The bottom 40 per cent, meanwhile, have seen their share of net wealth skyrocket to 1.7 per cent.
Follow me on Twitter, @PatrickBrethour or ask your Taxing Question here.
Sign up for the Tax and Spend newsletter here
Patrick Brethour