The Problem With Personal Income Tax Rates

Genuine fairness doesn't come easily

This post contains an important correction

A short while back I wrote about the Problem of Corporate Tax Rates. That’s where I presented data strongly suggesting that higher provincial corporate tax rates are likely to produce negative economic and social outcomes.

While researching the “rich-corporations-don’t-pay-their-share” thinking that inspired that post, my mind drifted to the closely related “rich-people-don’t-pay-their-share” claim. Since this is a question that should be easy to answer, I figured I’d add my own $0.02 to the conversation. But then things got weird.

Canada Revenue Agency data covering the 2021 tax year provides total income tax payments broken down by income brackets. The data also gives us the number of taxpayers in each bracket and how much tax all members of each bracket were required to pay. The (updated) chart below summarizes some of that data.

As we’d expect, we can see that the total payments from all taxpayers who earned less than $70,000 in 2021 were less than their numeric proportion of all taxpayers. As an example, those earning between $55,000 and $59,999 represented 5.23 percent of the population but, as a group, paid only 3.85 percent of all income tax.

The next few brackets are also predictable: those earning between $70,000 and $249,999 are contributing considerably more than their proportion of all taxpayers.

Now take a look at the top bracket. The lucky 2.14 percent of the population who earn more than $250,000 are paying 29.44 percent of the total.

I guess that should answer claims that - and least in the context of reported income - the rich don’t pay their share.

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What follows is, after the major correction, no longer strictly relevant to this post. But there are some ideas that might have value anyway.

We’re not talking about tax fraud, here. The vast majority of frauds happen long before people settle on the numbers they’d use to fill out their T1 forms. For the most part, the lucky 2.14 percent we’re seeing in these numbers took advantage of perfectly legal tax strategies like income deferral, registered shelters, and optimizing capital gains income. The question is whether the tax code could be updated to limit access to some of those strategies.

Actually, that’s not quite correct. The question is really whether the tax code should be updated to limit access to some of those strategies. You see, fairness is certainly important. But hacking away at tax policy too aggressively can lead to unexpected consequences - as the federal Liberals are discovering after changing the rules for capital gains.

High-income business owners, investors, or professionals, for instance, could respond to unfavorable changes by relocating their assets or operations to countries with more friendly tax regimes. This could lead to what’s known as capital flight. The subsequent departure of high-skill workers can weaken Canada’s competitiveness and shrink the domestic talent pool - along with its potential for innovation.

Tightening tax regulations could also make the tax code even more complex. This, of course, will lead to higher compliance costs for both the government and taxpayers. The resources required to enforce stricter rules could strain the CRA’s already anemic operational capacity.

And speaking of unintended consequences, playing around with well-established tax rules could end up harming middle-class taxpayers who might also rely on these methods.

So I agree that it doesn’t feel right that Canada’s highest earners are also among its most reluctant taxpayers. But given the government’s track record on change management, we’re probably best off cutting our losses and maintaining the status quo.