Federal tax relief for low income people
Discussion Paper Prepared for the National Anti-Poverty Organization
by Andrew Mitchell and Richard Shillington
November 2004
The federal surplus and tax cuts
The federal finance minister has announced a surplus of approximately
$9 billion, and has speculated that some portion of that might be devoted
to tax cuts. However, the chart below demonstrates that past income tax
reductions have provided disproportionate benefits to those with middle
and upper incomes.
Our rough estimate is half the benefits over the last decade have gone
to those 10% of families with incomes over $100,000.
Hell and High
Water; An assessment of Paul Martin’s record and implications
for the future; Edited by Todd Scarth; Chapter 3 - Taxation: The Martin
Record by Hugh Mackenzie
There are several good arguments for directing tax cuts to low-income
people. Low-income people have suffered serious erosion in real income.
Tax cuts directed at low-income persons will increase their spending immediately
(to ‘Pay the Rent’, ‘Feed the Kids’ and purchase necessities). This fuels
the local and Canadian economy directly and immediately – none of the
money would be used for investment, foreign vacations, or luxury vehicles.
What federal taxes do low-income people pay? (1)
Everyone is a taxpayer. Even a child buying a chocolate bar pays a consumption
tax. People employed at very low wages also pay consumption taxes but
also make social insurance contributions to EI and CPP/QPP.
Table 1 shows that low-income people will pay over $4 billion dollars
in federal taxes in 2004. Of this, approximately 70 percent, comes from
federal commodity taxes. The remainder comes from income taxes (12%),
CPP/QPP contributions (12%) and EI contributions (5%). This amounts to
approximately $1,400 per low-income family, of which about $1,000 comes
from commodity taxes, $172 comes from federal income taxes, $169 from
CPP/QPP premiums and $66 comes from EI premiums. Recall, these are federal
taxes only. Low-income families still have to pay provincial income, sales
and property taxes.
Table 1: Federal taxes paid by low-income and non-low-income people
|
Canada 2004 |
Economic family income |
Population |
Total Federal taxes |
Federal income taxes |
CPP/QPP contributions |
EI contributions |
Federal commodity taxes |
|
(000’s) |
($millions estimated) |
Poor * |
4,900 |
$ 4,200 |
$ 500 |
$ 500 |
$ 200 |
$ 3,000 |
Near-Poor ** |
2,300 |
$ 3,500 |
$ 1,000 |
$ 600 |
$ 200 |
$ 2,000 |
Not poor nor near poor*** |
24,200 |
$ 145,000 |
$ 88,000 |
$ 19,000 |
$ 7,700 |
$ 30,000 |
All |
31,400 |
$ 152,000 |
$ 89,000 |
$ 20,000 |
$ 8,200 |
$ 35,000 |
*pre-tax LICO Statistic Canada’s Low-Income
Cut-Off
** Above pre-tax LICO, <=125% of LICO
*** Above 125% of pre-tax LICO |
It is also important to consider taxation from a life-cycle perspective.
Most low-income people do not remain low-income for their entire lives.
As their income status changes over their lives so too will their tax
contributions. So, from a life-cycle perspective, as well as an ability-to-pay
perspective it is appropriate for low-income people to pay very low, or
no, taxes.
An important way of looking at personal taxes is to examine vertical
equity, that is, what fraction of a person’s income is paid in taxes,
as income rises. Figure 1 shows that federal taxes, as a percentage of
income, rise gradually until the $40,000 - $50,000 range (2)
at which point effective tax rates level off. The exception is at the
low end of the range where effective federal tax rates are about 18% at
the lowest income levels, due to commodity taxes, and some income taxes
and social security contributions.(3)
When you include provincial taxes, the poorest people are paying 35% of
their income in taxes, tax rates that are comparable to those at the upper
end because of consumption taxes. This includes just federal and provincial
taxes and not CPP or EI contributions.
The most detailed and exhaustive research has demonstrated that o Once
local property and corporate taxes are included , the overall tax system
in Canada is not progressive. It is virtually proportional – all people
pay similar percentages of income in tax, regardless of income.(4)
Options for tax reductions directed to low-income people
Many proposals for tax reductions are promoted, but not all have the
same effects on everyone. To illustrate we compare four options for reducing
taxes and the efficiency of each – that is, how much of the net
benefit would end up in the hands of low-income families. The five options
are to: reduce the GST rate from 7% to 6%; restore the value of GST credit
for erosion in real value that took place between 1992 and 1999; increase
the basic personal exemption from $8,000 to $12,000; and to reduce all
tax rates by 1%. Table 2 shows the estimated impacts.
Since most of the federal taxes paid by low-income people are commodity
taxes it makes sense to look at ways of reducing these taxes. The easiest
route would be to simply cut the rate at which the GST is levied, currently
7%. This would cost approximately $5 billion in lost federal revenue,
of which only about 9% would go to low-income families who, on average,
would end up with $143 more disposable income.
Table 2: Impact of tax measures on low-income families |
Canada, 2004 (estimated) |
Tax measure |
Total Cost ($millions) 1 |
Share of benefit for low-income families
2 |
Average benefit for low-income families
|
Reduce GST rate by 1% |
$ 4,996.5 |
8.5% |
$ 143 |
Index GST credit to previous purchasing power |
$ 601.1 |
19.0% |
$ 40 |
Increase personal credit to $12,000 |
$ 8,973.8 |
3.5% |
$ 111 |
Reduce all income tax rates by 1% point. |
$ 1,230.4 |
7.7% |
$ 33 |
Reduce all income taxes by 10%. |
$ 8,93500 |
0.5 % |
$ 17 |
1 Total cost is the change to the net
federal balance. |
|
|
2 Benefits are defined as the change
in disposable income. |
|
The GST credit was introduced with the GST to reduce its inherent regressive
impact and is targeted to lower income families. But the value of the
credit was fixed at the same nominal value between 1992 and 1999. A simple
alternative is to increase the GST credit amounts and associated thresholds
by the amount lost due to this erosion. Table 2 shows that this would
cost the federal treasury about $600 million annually. A higher proportion
of the net benefits (19%) would flow to low-income families. However the
average benefit to low-income families is only about $40.
An increase in the basic personal exemption is often raised as a way
to “remove low income people from the tax roles”. Indeed, this has the
effect of raising the income threshold at which a person begins to pay
federal income taxes. But because everyone can claim the personal exemption
this benefits everyone who pays taxes, regardless of income. In fact,
Table 2 shows that of raising the basic personal exemption from $8,000
to $12,000 would cost nearly $9 billion and deliver only 3.5% of the benefits
to low-income families.
The reason that increasing the personal credit yields fewer benefits
to lower-income families than cutting the GST rate is that many lower-income
families already pay little or no income taxes ( many seniors as well
as many of those on welfare ).
If instead the tax rates for each bracket were reduced by 1% the overall
cost would be $1.2 billion of which nearly 8% would go to low-income families.
On average low-income families would receive about $33 in increased disposable
income.
Conclusion
Consumption taxes make up the largest part of the taxes paid by low-income
people, with income taxes and social insurance contributions a distant
second and third place. Changes to the income tax system will have limited
benefits for low-income families. It is logical to look for changes in
the consumption tax regime if the goal is to deliver benefits to low-income
Canadians.
However, it would require much larger increases in the GST credit to
deliver substantial benefits to low-income Canadians, and to offset the
heavy consumption taxes they pay. Also, even though the GST credit was
the option that delivered the highest proportion of benefits to low-income
people it is important to recognise that a large increase in the credit
would raise the income level at which families receive some benefit.
1. This analysis is
based on Statistics Canada's Social Policy Simulation Database and Model.
The assumptions and calculations underlying the simulation results were
prepared by Andrew Mitchell and Richard Shillington and the responsibility
for the use and interpretation of these data is entirely that of the authors.
2. This includes approximately
80% of individuals with incomes.
3. The situation of
this group should not be dismissed as an anomaly as they represent about
20% of all individuals with incomes.
4. Frank Bermaeten,
W. Irwin Gillespie and Arndt Vermaeten, “The incidence of tax in Canada”
(1994), Canadian Tax Journal, vol. 42, no. 2, 348-416.
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