Lindsay Tedds is an associate professor of economics in the School of Public Administration at the University of Victoria, and visiting professor at the School of Public Policy at the University of Calgary.
The New Brunswick government just announced that it is reconsidering its proposed income-tax increase on high-income earners, as reported Friday in The Globe and Mail. If prime-minister-designate Justin Trudeau's election promise comes to fruition, high-income earners will be taxed more federally. When combined with New Brunswick's own proposed tax increase on high-income earners, it would make the province the highest-taxed in Canada.
Once the federal and provincial proposed tax increases are implemented, the combined tax rates for high-income earners in New Brunswick would rise to 54 per cent for those with incomes between $200,000 and $250,000, and 58.75 per cent for those with income above $250,000.
This had led some to cite that there is a psychological barrier to tax rates rising above 50 per cent. The threshold is a bit of an urban legend in tax circles, a legend that has only recently made its way back into the tax discussion. As outlined in this piece for the Mowat Centre, the origins of this 50-per-cent psychological tax barrier seem to date back to the 1966 Royal Commission on Taxation, but there exists little actual evidence for either the existence of the barrier or the rate at which the barrier would occur.
Equally in these discussions, it has been noted that combined tax rates in Canada have been much higher in the past. In 1948, the top tax bracket peaked at 84 per cent. By 1973, after the Carter Commission report, the top combined bracket was reduced to 61.34 per cent.
As a result, those promoting the psychological-barrier lore suggest that rates on high-income taxpayers are too high, whereas those looking into our past are using that information to suggest that tax rates on high-income earners are too low. But these views are not rested in any evidence and represent heavily normative views about how much income tax high-income individuals should pay.
To escape normative debates, we need to consider the evidence. What evidence do we have regarding high-income tax rates? The Canadian Centre for Policy Alternatives recently published a piece by Lars Osberg of Dalhouse University entitled "How Much Income Tax could Canada's Top 1 per cent Pay." The piece summarizes nicely the existing work in this area and concludes that "65 per cent is the average estimate of the revenue-maximizing top marginal tax rate found in recent economics literature." This evidence suggests that New Brunswick can safely proceed with its proposed tax increases.
On the other hand, Michael Veall of McMaster University urges caution in pursing tax increases on high-income earners. He notes that there is a great degree of uncertainty regarding the assumptions underlying the estimates of the revenue-maximizing top marginal tax rate. As a result, the revenue generated from such tax increases may likely fall quite short of expectations. Instead, he argues that before we pursue such increases, we should instead broaden the tax receipts from this group by "eliminating special tax preferences, concentrating on those that differentially benefit those with high income."
Our tax system includes a number of deductions, exemptions, tax credits and preferential treatments that disproportionately benefit high-income individuals and that serve little or no benefit to the economy or society and that defeat the underlying progressiveness of the tax system. In addition, the complexity that these special tax preferences create in our tax system results in high compliance costs that serve to reduce economic growth.
Before we move to increase tax rates, we should first remove the features of a tax system that impeded the "overall efficiency and the progressivity of our tax system." After all, the special tax preferences only serve to undo any policy objectives of raising tax rates on high-income individuals.
It is important to note that the newly elected Liberal government has committed to reviewing tax expenditures that "unfairly help those with individual incomes in excess of $200,000 per year." While this is a step in the right direction, the logic of doing so after increasing tax rates and while also committing to bringing back some preferential tax expenditures like the LSVCC tax credit is questionable. In addition, this does not address similar tax preferences that exist at the provincial level and suggests a path forward for the New Brunswick government.