Income inequality in Canada is more pronounced than previously believed, a new report reveals, because many of the country's wealthiest people are funnelling their income through private companies that are not included in standard measures of individual earnings.
A study by three leading academics says Canada's top 1 per cent of income earners took home an average of $500,200 in 2011 – including income from private corporations they control directly or indirectly through holding companies. That is 39 per cent more than the $359,000 figure calculated when traditional individual income tax data are used.
The new report says the top 1 per cent accounted for 13.3 per cent of all reported individual income in 2011, an increase from 12 per cent a decade earlier. Previous statistics that looked only at individual tax returns showed the top 1 per cent earned 10 per cent of all income in Canada in 2011, a number unchanged from 10 per cent in 2001.
The study, entitled Piercing the Veil, was completed by three of Canada's leading researchers on income and inequality issues: Dr. Michael Wolfson of the University of Ottawa, and professors Mike Veall of McMaster University, and Neil Brooks of York University.
Dr. Wolfson, a former assistant chief statistician at Statistics Canada, said he realized years ago when he worked for the federal Finance Department that many individuals were setting up private companies – known in tax parlance as Canadian-controlled private corporations (CCPCs) – because there were numerous tax advantages to the structure.
As a result, he said income data has been understated because income earned by these private companies was not included in published material derived from personal income tax returns.
"For the first time, we're trying to make public the role that these private corporations are playing in our income distribution statistics," Dr. Wolfson said in an interview.
Since the economic downturn, there has been a debate about whether income inequality is increasing in Canada. The new data including CCPC income shows that the top 1 per cent earned almost 15 per cent of all income in Canada in 2007. But that group took a big income hit when stock markets cratered in 2008, dropping to earning about 12 per cent of all income by 2009.
Since then, however, incomes for the top 1 per cent have started to recover, climbing to 13.3 per cent of all income in Canada by 2011 (the most recent year for which data are available), suggesting there has been an increase in income inequality in recent years.
Using data that includes CCPCs changes the picture of Canada's top income earners because these are the people most likely to set them up. Only 5 per cent of people in the bottom half of income earners own a stake in a CCPC, and the study shows that, over the past decade, up to 80 per cent of those in the top 0.01 per cent of income earners owned a stake in a CCPC. Some people own stakes in four or more CCPCs, the report shows.
CCPCs are typically used to hold a private business, so they could be created by the owner of a store or restaurant to incorporate the business. Dr. Wolfson said they are also legally used by doctors, lawyers, accountants and other professionals as a way to incorporate their business activities, allowing the corporation to be paid income rather than having the individuals paid in the form of salaries.
There can be many advantages to having income go into a corporation rather than receiving it as a salary, including the ability to defer income, split income with a spouse, and reduce capital gains tax.
Researchers have long found it difficult to measure income for top earners and that has led to an inaccurate picture of the degree of income inequality between the rich and the poor. Including CCPCs has given a better portrait of high income earners and revealed the sizeable impact of these private holdings.
The report shows that income for the top 10 per cent of earners increased an average of 16 per cent when CCPCs were included in the income data. The increase was even more dramatic for those in the top 0.1 per cent. Their average income rose to $2.1-million when CCPCs were taken into account, compared with $1.3-million if CCPCs were excluded. That's a difference of 55 per cent.
And for the ultra-elite 0.01 per cent; their average income in 2011 was 71 per cent higher when CCPC's were included, rising to $8-million from $4.7-million.
Dr. Wolfson said the researchers plan to dig further into the data because it is likely that top incomes are still being underestimated because some income from CCPCs is missed.