The Liberal government’s tax on Canada’s top 1 per cent failed to produce the promised billions in new revenue in its first year, as high-income earners actually paid $4.6-billion less in federal taxes.
The Liberal Party’s campaign platform said a new top tax bracket would raise nearly $3-billion a year, but an analysis of recently released data from the Canada Revenue Agency (CRA) shows the expected benefit didn’t materialize.
The latest available tax records show that revenue from Canadians earning about $140,000 or more – which had previously been the fourth and highest tax bracket – dropped by $4.6-billion in 2016, the first full year that the Liberal tax changes were in effect. Further, 30,340 fewer Canadians reported incomes in that range for 2016 compared with the year before.
Finance Minister Bill Morneau’s office told The Globe and Mail that the drop in revenue from high-income earners appears to have been a one-time event. Because the changes were announced in late 2015, before the year was done, taxpayers had the opportunity to shift income into the 2015 tax year, sheltering those funds from the higher 2016 taxes. As a result, the government says tax revenue was higher in 2015 and lower in 2016. A spokesperson for Mr. Morneau said early indications are that 2017 will show “a substantial rebound” in revenue from high-income earners.
The decline in Alberta’s energy sector also appears to have been a key factor. More than 90 per cent of the $4.6-billion decline in revenue from high-income earners is attributable to that province.
The Liberal Party won the fall 2015 federal election by promising a middle-class tax cut that would be paid for by imposing a new, fifth tax bracket on income over $200,000. According to the party’s campaign documents, the two measures would offset each other perfectly. The new top bracket with a 33-per-cent tax rate was predicted to raise about $3-billion a year in new revenue, which would offset the $3-billion in expected lost annual revenue from lowering the rate on the second income tax bracket from 22 per cent to 20.5 per cent.
Shortly after forming government, Mr. Morneau’s department released revised forecasts in late 2015 that said the tax hike would not pay for the tax cut. The department estimated the tax cut would cost $3.4-billion in its first full fiscal year while the tax hike would only raise $2-billion.
However, actual results for the first calendar year of the tax changes varied considerably from the projections of both the Liberal Party and the Finance Department.
While tax revenue was down among high-income earners, the impact of the new tax cut on income between $45,282 and $90,563 – the second tax bracket – is harder to quantify based on the available data because the cut also benefits taxpayers with income in higher tax brackets, because of Canada’s progressive tax system. For context, tax revenue from the second and third brackets decreased by a combined $817-million in 2016. A Finance official said that for taxpayers in the new fifth bracket, the tax hike would offset the benefit of the tax cut “for almost all of them.”
The Minister’s office said future revenue changes resulting from the tax cut are expected to be “in line with projections.”
The CRA data show combined revenue from all tax brackets declined by nearly $5-billion, from a total of $139.3-billion in 2015 to $134.3-billion in 2016.
Critics of the Liberal plan say the CRA’s 2016 numbers justify their concern that a new top tax bracket hurts Canadian efforts to boost competitiveness and attract top talent. They also say the CRA figures prove the theory that raising top tax rates encourages behavioural changes to avoid paying the highest rates.
“This really shouldn’t be surprising. This is basic economic theory. If you increase tax rates, it creates an incentive to try and lower the amount of tax that you’re paying,” said Brian Kingston, a former federal government economist who is now vice-president of international and fiscal issues with the Business Council of Canada.
Mr. Morneau is currently consulting business leaders across the country with the goal of releasing measures this fall aimed at helping Canadian businesses stay competitive in response to a package of tax cuts and regulatory changes that were adopted by the United States earlier this year. While much of the debate has focused on the fact that the changes have eliminated Canada’s corporate tax advantage with the United States, the U.S. package also included personal income tax cuts.
Tax experts caution that establishing a clear link between one policy change and federal revenues is a challenge because so many other factors are at play, such as the sharp downturn in Alberta’s energy sector.
Pierre-Olivier Herbert, a spokesperson for the Finance Minister, said the 2017 results will tell a different story.
“Preliminary aggregate statistics for the 2017 tax year are broadly indicative of a substantial rebound in taxable income reported by high-income taxpayers, but it is too early to quantify this effect,” he said.
Mr. Herbert said the Minister is listening to business leaders about their concerns regarding U.S. tax cuts. However, the government appears to be ruling out tax cuts for individuals.
“There are currently no plans to change personal income taxes,” Mr. Herbert said.
Fred O’Riordan, a former CRA assistant commissioner who is now the national leader for tax policy with Ernst & Young LLP, noted that the new federal rate pushed the highest combined federal-personal tax rate to over 50 per cent in seven of Canada’s 10 provinces.
Such a top rate is high by international standards and can encourage high-income earners to take advantage of more aggressive strategies to pay less tax, he said.
Mr. O’Riordan said the U.S. tax changes should inspire Mr. Morneau to launch a wide-ranging review of Canada’s tax system, which many experts say is long overdue.
“I would hope that everything is on the table and open to consideration,” he said. “The time has come for the government to undertake a comprehensive tax policy review.”