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tax policy

To some, income inequality isn't a problem. It's the natural byproduct of a healthy free-market economy that rewards some for their ambition, hard work and risk-taking.

But that isn't the way most Canadians see it. Polls consistently show that we worry a lot about the gap between rich and poor, and our angst is growing.

That reality may help to explain the Conservative government's sudden unease about one of its signature promises from the previous election – income splitting. Under the plan, families with children would be able to transfer up to $50,000 of income from a high-earning spouse to another earning less, or even nothing, such as a stay-at-home father or mother.

The Conservatives pitched income splitting as a middle-class "family" tax cut, and vowed to introduce it as soon as the budget deficit was eliminated.

But recent studies suggest income splitting isn't broad-based tax relief, and few of its benefits would flow to the middle class. A recent C.D. Howe Institute report, for example, concluded that the benefits of income splitting would go overwhelmingly to upper-income earners. Three-quarters of the benefits would go to families earning more than $125,000 a year, with the greatest payoff to those with incomes over $200,000.

There would be nothing at all for 85 per cent of taxpayers.

More troubling for the Conservatives, the proposal would almost certainly worsen income inequality.

Even before Jim Flaherty delivered a budget last week, showing a surplus is just around the corner, the Finance Minister was already wavering. "I'm not sure that, over all, it benefits our society," he said, echoing the conclusions of many experts.

Mr. Flaherty's apparently offside comments suggested a rare schism in the Conservative ranks. A more likely scenario is that Mr. Flaherty's misgivings are part of an orchestrated effort by Prime Minister Stephen Harper to start backtracking on a promise that has become inconvenient.

Income splitting has troubling political optics. It seemed like a brilliant idea in the heat of the 2011 election campaign – a stark contrast to the NDP and Liberals, who were offering no tax relief at all.

But portrayed as a gift to the rich, income splitting risks becoming a noose for the Conservatives in the next election.

"The studies are coming out that [show] it's not going to benefit the people they say it's geared to," said Peter Devries, a former director of fiscal policy at Department of Finance Canada. "It's not going to help those people at all, or very little."

Directing a huge chunk of the surplus – $2.5-billion or more from an estimated surplus of $6.4-billion next year – to mainly wealthy Canadians could provide an opportunity for rival parties to lay out more appealing plans. The Liberals could pitch tax-rate reductions for middle-income earners. The New Democratic Party might target families with enhancements to the child tax benefit for lower-income earners. Both parties might also pump money back into health care, innovation or infrastructure.

Also potentially awkward for the Conservatives is that Mr. Flaherty's main argument against income splitting – that the benefits are not broadly shared – applies to many of the 160 targeted tax breaks the Conservatives have proudly introduced since 2006, Mr. Devries pointed out. These include breaks for parents of children playing sports or taking art classes. The government says these and other measures have delivered $160-billion in tax relief to Canadians over the past six years.

Polls suggest the Conservatives may be dangerously out of sync with the national mood on this one. Sixty-four per cent of Canadians said reducing the gap between the rich and the middle class should be a high or moderate budget priority for the government, according to a February Ipsos Reid poll.

The results confirm what pollsters have been seeing for some time. A 2013 study by the Washington-based Pew Center found that 76 per cent of Canadians believe income inequality is worsening in the country. And in 2012, separate surveys by Ekos and Environics similarly showed high levels of concern about the negative effects of income inequality.

Look out, Mr. Harper: Income splitting has become an income-gap trap.

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