NDP leadership hopeful Brian Topp launched the latest salvo in the clash between rich and poor Monday. Declaring growing income inequality to be today’s central economic issue, Topp detailed a series of proposed tax hikes on corporations and the wealthy aimed at narrowing the earnings gap.
Topp's proposals would see a rollback of some $18 billion in tax breaks enacted under successive Liberal and Conservative governments. His ideas come as many on the left in Canada have begun to question the direction in which Ottawa's tax policies have taken the country. Pointing to the income gap, they argue tax policy simply isn't as good at alleviating income inequality as it used to be. And new tax breaks — Tax-Free Savings Accounts and the proposed expansion of income-splitting to families— may only make things worse.
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Though the ideas are timely, they are part of a wider, generations-long ideological conflict.
In 1896, William Jennings Bryan declared that “There are those who believe that if you just legislate to make the well-to-do prosperous, that their prosperity will leak through on those below. The Democratic idea has been that if you legislate to make the masses prosperous their prosperity will find its way up and through every class that rests upon it.”
More than 110 years later, the struggle continues between those who believe lower taxes will lead to increased investment and greater prosperity and those who argue the wealthiest in society should pay for measures to help lift the least fortunate out of poverty. Proponents of low taxes, however, are getting their way in Canada.
Those who argue against the tax-cutting agenda point to the fact that wealth in Canada is increasingly concentrated among the wealthiest few.
During the period from the late 1950s to the late 1960s, the richest one per cent took home just 8 per cent of growth in total income. Between 1997 and 2007, before the financial crisis cooled the nation’s hot economy, the richest one per cent of Canadians took home 31.8 per cent of the growth.
The wealthy aren’t just taking more of the growth, they are taking more of the total income pie as well.
“[From] 1980 to the present, the top one per cent’s share changed from about 8 per cent of all income to about 14 per cent of all income,” says McMaster University economist Michael Veall.
While those at the top are taking home more than they have in 100 years, real wages are actually falling at the bottom of the income spectrum. Between 1980 and 2006, according to Statistics Canada, median income for the bottom 20 per cent fell by $4000, or around 20 per cent once adjusted for inflation. During the same period, the top 20 per cent saw their median income grow by $12,000, or more than 16 per cent.
But this trend isn’t swaying the Conservative government’s steadfast belief in low taxes as the way to stimulate the economy.
“We’ve got one of the lowest tax regimes in the world now and we have businesses coming to Canada specifically saying ‘We came here to open a business because it’s a low-tax environment.’ When they come here they hire people. It’s simple,” says Minister of State for Finance Ted Menzies, pointing to the “120 different taxes” the Tories have reduced since 2006.
And not everyone agrees that income inequality really is growing -- or that it should be seen as a problem.
“The whole notion of income inequality and that it’s growing is a complete myth,” says Neils Veldhuis, senior economist at the Fraser Institute.
“When you think about income inequality you’ve got to bring in mobility. Most of us at one point in time … were in the bottom 10 per cent or 20 per cent of income earners. So we were going to school, trying to make ends meet, working one or two jobs. We get out of school … you have a low paying job, you get some experience, you save some money. Twenty years from now you’re no longer in the bottom 20 per cent of income earners.”
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Yet there is no doubt wealthy Canadians are paying less tax than they did in the past. In 1948, the top marginal tax rate was 80 per cent on incomes over $250,000, or $2.37 million in today’s dollars. The top rate in 2009, averaged across Canada to account for different provincial rates of taxation, was 42.9 per cent for incomes above $126,264. The last time wealthy Canadians faced a tax burden this light was in the roaring 1920s.
The income tax system has become less progressive over time. In 1948 we had 19 tax brackets, we now have four, says Armine Yalnizyan, senior economist at the Canadian Centre For Policy Alternatives (CCPA).
Today, the top federal income tax bracket of 29 per cent kicks in at $128,800. There are no further brackets for higher earners. The United States’ system is actually more progressive, with six federal income tax brackets and a top rate of 35 per cent, kicking in it at $379,151.
“We’ve turned a progressive income tax system more and more into one that is becoming increasingly regressive,” says Peter Julian, the NDP’s finance critic. Taking into account all taxes, Julian argues a lower-middle class secretary can now end up paying a higher percentage of income in taxes than her wealthy boss. “I mean that’s an absurd situation.”
CORRECTION: A previous version of this story indicated there were 17 tax brackets in 1948. There were actually 19.
CORRELATION IS NOT CAUSATION
While decreases in taxation may correlate with increases in inequality, most economists agree that changes in tax law aren’t the cause of the widening gulf between rich and poor.
“I don't think tax policy has created inequality, I think that has happened through the marketplace and how people in different types of occupations have had their work valued over time,” offers Yalnizyan. “But I don't think recent trends in tax policy have worked to minimize the gap as much as it could.”
Critics of current policy point to the decline of the welfare state as an explanation for rising inequality.
“Through the gradual gutting of social programs and the cutbacks that we’ve seen and massive corporate tax cuts, we’ve now turned back the clock on income inequality to where it was prior to the Great Depression,” argues the NDP’s Julian.
The Conservatives maintain low taxes are the best way to stimulate the economy.
“Forbes Magazine put us number one as best place to invest, lowest tax environment for the world. So that’s what grows the economy,” says Menzies.
One of the most controversial, and popular, of these low-tax initiatives is the Tax-Free Savings Account, which some critics suggest contributes to the growing income gap.
STORY CONTINUES BELOW SLIDESHOWS
The Tax-Free Savings Account (TFSA) came into effect on January 1, 2009. Any Canadian aged 18 or older can invest $5,000 each year in the account and any capital gains earned on the money will not be taxed. Money can be withdrawn from the account at any time.
The measure has been popular, but who is benefitting most has become a matter of fierce debate. In just under three years, 41 per cent of eligible Canadians have opened a TFSA. Nearly half, 46 per cent, of those who earn more than $100,000 per year have opened one, more than in any other income group, according to a survey recently conducted by Angus Reid for ING Direct. How much money has been deposited by each earnings group remains a mystery. "I think the evidence shows that that's the kind of tax change, that while it's sold to the public as providing more choice and opportunities and everything else, really the only people who can benefit from it are the ones that have enough disposable income," says Charles Beach, an economist at Queen's University. "Someone who's unemployed or living on low income, they simply don't benefit from that. So that's the kind of tax cut that I think favours those with the higher income."
The Fraser Institute's Niels Veldhuis points out data on the TFSA remains scarce and that we shouldn't rush to judgment. That said, he argues that any vehicle which leads to more savings must be good for the economy. "It is positive regardless who is using it. The more savings we get, the more investment we get, the better off we all are." It's a matter of "fundamental economics," asserts Conservative Minister of State for Finance Ted Menzies. "Investments put in a bank are utilized by the banks to lend out to grow other businesses."
Armine Yalnizyan, senior economist at the Canadian Centre For Policy Alternatives (CCPA), questions the supply-side argument that savings will translate into investment and investment into jobs and economic growth, especially since the TFSA was introduced during the "nadir of the economic meltdown." She argues consumer demand is more important than investment for stimulating growth. "In the middle of this economic calamity, the federal government introduces a measure that does the opposite of what every other nation around the world is trying to do, which is to stimulate aggregate demand. Instead the government is favouring a program that tells people to pull money out of the economy. Stop spending, start saving. That is lunacy, there is no other word for it."
Soon, Canadians will likely get the chance to put away even more money into their TFSAs. The Conservatives promised during the last election campaign to increase the annual contribution limit to $10,000 per year once there is a return to balanced budgets.
The increase in the TFSA limit isn’t the only tax shelter expansion the Tories are planning to introduce once deficits are a thing of the past. They also plan to extend income splitting — a measure currently only available to pensioners — to parents:
In 2007, the Conservative government introduced pension-income splitting for seniors. The measure allows a senior to combine his or her pension income with their spouse or common-law partner and then divide incomes equally for tax purposes. It benefits couples in which one partner is taxed at a higher rate than the other.
The expansion of the program to families -- which the Conservatives have promised to introduce once the country returns to balanced budgets -- would allow parents with children under 18 years of age to split their incomes, up to a maximum of $50,000 each year, for tax purposes. According to the Tories, this would allow one parent to stay home or work part-time in order to help raise children. There is a strong element of family values in the Tory plan. "Call me old fashioned, but I think [it's] wonderful ... if one of the parents is able to stay home and raise the kids, even if it's just in their early ages. So it's not high-income earners, it's actually middle-income earners that have chosen quality of life, that want to spend time raising their kids, those are the people that I see using income splitting," says Minister of State for Finance Ted Menzies.
Estimates made by the Library of Parliament on the effects of income splitting for families found the relatively well-off would get the lion's share of the benefits. In 2007, it estimated the total cost of the program to be roughly $2.16 billion. Of that money, around $1.33 billion, or nearly 62 per cent, would go to families making more than $90,001 per year before taxes. Families earning $60,001 - $90,000 would get $661 million in breaks, those making $30,001 - $60,000 would collect $166 million and those making less than $30,000 would receive $12 million. A C.D. Howe study released last month concluded 40 per cent of total benefits from the measure would go to families with incomes above $125,000. According to StatsCan, the median family income in Canada in 2009 was $68,410. The authors of the study have argued in The Globe and Mail that the measure is "irremediably flawed."
Minister of State for Finance Ted Menzies denies that income-splitting will largely benefit the wealthy. "A lot of those families tend to have two high-income earners, so there's no benefit to splitting," he says. "It's the ones where there's a great deviation, maybe one of the parents is only working a very part-time job two days a week and the other one is working full-time, it allows them to split that and spend more time with their family."
TAX THE DEAD … AND THE LIVING
With the Occupy Movement making headlines around the world, the debate about what measures should be implemented to address income inequality is heating up.
While increasing taxes on the rich is perhaps the most talked about proposal for mitigating the effects of the income gap, it is only one among many.
Another idea is to bring back an estate tax, or, as critics often call it, a “death tax.” The measure could come in many different forms, but the essential idea is for the government to tax inheritance at a very steep rate, perhaps as much as 100 per cent, above a certain threshold.
“The only people that are complaining are the people that didn’t make the money in the first place. So you could put a limit on an estate of a million or million and a half dollars and tax above that," says Yalnizyan. "We’re looking at trillions of dollars passing between the generations as the Boomers die, we’ve got to get that sucker in place if we want to be able to fund a decent world for the next generation."
The CCPA economist isn’t alone in supporting such a measure. Queen’s University economist Robin Boadway argues an estate tax would help to make Canada’s system more progressive overall. “The only element of progressivity in the system is the income tax … We don’t have an inheritance tax which even the U.S. has, although it’s a bit moribund.”
Estate taxes traditionally face vehement opposition from the super-rich, and the lengths some wealthy people have considered to escape them are shocking.
In 2009, a fumble by the U.S. Senate allowed the estate tax to lapse. As of January 2010, it ceased to exist in the United States. However, due to a sunset provision, it was set to return at the start of 2011. This gave a temporary incentive for the wealthy to commit suicide before the tax came back, a potential strategy made famous in an article in The Wall Street Journal.
Besides an estate tax, Boadway points to an expansion of Canada’s existing system of refundable tax credits as a way to mitigate inequality. Currently, Canada has three such credits: the Working Income Tax Benefit, the Child Tax Benefit and the GST/HST tax credit.
Because the poorest Canadians often pay no income tax at all, these credits are a way to help the poor in the simplest way possible: by giving them money.
"Even if you don’t owe any taxes … you get a refund from the government,” Boadway explains. “Making all credits refundable would effectively turn the tax system into a negative income tax system … I would really emphasize people at the bottom end of the income distribution and not make transfers to people in the middle that don’t need it.”
Another suggestion for mitigating income inequality which has picked up steam since the financial crisis is a global tax on financial transactions, a proposal which was opposed by Canada’s Finance Minister Jim Flaherty at the G20.
Minister Menzies argues such a tax would be passed onto consumers. “I think you know as well as I do who pays the tax. It’ll be you and I.” Citing the strength of Canada’s banks compared to their U.S. counterparts, Menzies asks why we should “punish the good.”
The NDP’s Julian says it’s these sorts of regulations that allowed Canada’s banks to escape relatively unscathed in the first place.
“For the Conservatives to then go overseas and say ‘No, we don’t want to see any sort of regulations or any sort of braking system in place for international financial speculation,’ it is just highly irresponsible and it shows they just don’t understand what kinds of policies need to be in place to support ordinary working families.”
While there are numerous proposals for mitigating inequality through taxation, it's the notion of raising income and capital gains taxes on the rich that has recently captured the imagination of the press, protesters and politicians around the world.
In a recent paper, picked up on by Paul Krugman, economists Peter Diamond and Emmanuel Saez suggest 76 per cent is the optimal marginal income tax rate for top earners to maximize government revenues. Any higher and behavioural responses, such as avoiding taxes or working less, actually reduce revenue.
It is these behavioural responses which some economists point to as a reason not to increase taxes on the wealthy.
“The most damaging impact of raising taxes on high income earners is not on current high income earners … the biggest damage is on incentives,” assert the Fraser Institute’s Veldhuis. “Doing that you create a disincentive for young Canadians to become the top income earners in this country. If you increasingly take away the profits from the hard work, from the investment, from entrepreneurialism, you’re going to get less of it.”
Charles Beach, an economist at Queen’s University, argues tax avoidance is a more pronounced effect when raising taxes on the wealthy. “It’s not so much they will suddenly become lazy and slovenly. It’s more that in a small, open economy, people at the very top end who can afford fancy tax lawyers will find ways to evade the taxes.”
Rather than increase the progressivity of the tax system, Veldhuis maintains we should flatten it outright. Asked what tax policy would be best for creating broad-based prosperity, he says “There’s no question that it would be to move to a flat tax, single rate income tax to remove the disincentive that’s in the current tax system.” While it wouldn’t happen overnight, he says such a system would stimulate economic activity and ultimately lead to higher government revenues.
Lowering taxes on the rich is an argument Armine Yalmizyan disagrees with fiercely. “We’ve tried every rate of exemption under the sun on capital gains under the assumption that if you let rich people keep their money they’ll invest and create jobs. Well, we’ve had … 40 years of trickle-down theory when it comes to capital gains and at the end of those 40 years the evidence points to one undeniable conclusion: Trickle-down is a joke. Sadly, the punch line goes something like this: Trickle-down would work if it wasn’t for the sponges at the top.”
Raising taxes on the wealthy seems destined to remain a hypothetical as long as the Conservatives remain in power.
“I know you’re going to be shocked by this, but I’m not a fan of raising taxes,” says Menzies. “We think we’ve been very successful with the low tax plan that we’ve put in place.”
LAST WORD: WHY PAYING TAXES CAN BE GOOD FOR BUSINESS
The argument that economic prosperity rises from investment in social programs, education and infrastructure, rather than tax cuts, went viral earlier this year when a video of Elizabeth Warren, the former head of the panel which oversaw the implementation of the Troubled Asset Relief Program (TARP), hit the Internet. Watch as Warren explains why paying taxes is good for business.