Last week, Jamie Golombek wrote a great article in the Financial Post about the progressivity of our personal income tax.  In short, the article discussed the fact that many provinces in Canada have combined federal – provincial personal income tax rates at the highest rate that exceeds 50%. For example, Ontario, BC, Quebec and many of the Maritime provinces all have their highest personal tax rates that are in the 54% range. In addition, he briefly compared our rates to the U.S. and how Canada’s highest rates are reached at much lower levels of income and discussed some possible solutions recently put forward by another tax practitioner: income averaging and family taxation.

I’d like to expand on Jamie’s points regarding high personal rates and family taxation and defer on income averaging but I totally agree with his points.

First, the fact that it is acceptable to have marginal personal tax rates that exceed 50% is something that needs a re-think.  Historians of tax might rebut me, and state that Canada used to have marginal tax rates in the 1940s and 50s that were over 80%, with the high being 97.8%!

But that needs some context:  first, Canada’s personal income tax system was relatively young back then.  The number of actual taxpaying individuals, compared to the population as a whole, was much lower than it is today.  In addition, capital gains were not taxable (capital gains did not become taxable in Canada until 1972).  So, of course, there was no shortage of gamesmanship for the small number of high-income taxpayers to convert their income into non-taxable capital gains.

Fast forward to 1966 and the release of the Royal Commission on Taxation’s landmark recommendations.  Volume 3, Chapter 15 of the Report says the following:

“When marginal rates of tax exceed 50 per cent, the taxpayer receives less than half of any increase in income he earns. At such levels, taxation becomes a powerful deterrent to additional effort, savings, and investment.

…

We recommend that marginal rates of personal income tax should not exceed 50 per cent.

These are timeless quotes and are just as relevant today as they were in 1966. There is no doubt that personal tax rates need to come down across Canada.  However, given our country’s huge reliance on personal tax revenues and massive spending, that is much easier said than done.

Personal tax revenues for the 2024 fiscal year for the federal government was $217.7 billion out of total revenues of $459.5 billion.  That’s 47.4% of revenues.  Accordingly, any reduction in personal tax rates have a big impact on those total revenues.  For example, the recently proposed 1% reduction of the lowest personal rate, not yet passed by Parliament but being administered as if it were – is estimated to cost the government roughly $6 billion in lost revenues every year.

This means that any significant reduction in personal tax rates would need to be covered by corresponding cost-cutting (something that needs to occur regardless) and / or additional revenues from other sources.

It’s my contention that the GST should play a bigger role in Canada’s taxing system given its efficiency and fairness.  And especially since the hard edges of the regressiveness of a traditional consumption tax have been reduced with the GST given the exemptions for health care, basic groceries, rents for housing, and other basic necessities (combined with basic rebates for low-income households). Unfortunately, doing so would likely come at a significant political cost.

High personal tax rates are only part of the story. Equally troubling is how we treat the economic unit that bears the brunt of these policies: the family. I’ve long been an advocate for family taxation.  Good taxation policies should always follow the economic realities of life and/or business. The reality is that the family is the basic economic unit for most and will continue to be for hundreds if not thousands of years into the future. Canada’s taxation policies should mirror those economic realities. The government has recognized that basic premise for purposes of calculating various credits – like GST credits and for the Canada Child Benefit.  But for calculating income tax? Nope. And that’s wrong. The result is increased administrative complexity and income tax burdens.

And strange results.  For example, the tax burden of a married couple with $100,000 of combined income is very different if, say, one spouse earns all of the $100,000 vs both spouses earning $50,000 each.  Should it?  In my view, no.

Critics of family taxation, usually certain left-leaning academics and bureaucrats have often voiced that family taxation has been proven to prevent women from entering the workforce. When I first heard that argument years ago, I was surprised at such assertions. Sure enough, there are academic papers written on that topic, but, with respect, such papers and conclusions lack practicality, substance and common sense. Especially since the combination of incomes for various credits doesn’t seem to bother such critics nor does it appear to impact women from entering the workforce in the U.S. (who have had a form of family taxation for decades).

In most families I know, taxation policies — whether they are positive or negative — do not materially influence the decision for a parent to enter or stay in the workforce once children enter the scene.

To quote the 1966 Royal Commission on Taxation:

“Taxation of the individual in almost total disregard for his … economic ties with … the family … is … another striking instance of the lack of a comprehensive and rational pattern in the present tax system.”

Again, this critique remains true.

When we tax individuals as isolated units, we ignore the real-world financial dynamics within families. Add to that our willful tolerance of punitive personal tax rates, and it’s clear our tax architecture is outdated. Comprehensive tax reform / review is a must.

Do we have the political courage to build a tax system that truly reflects how Canadians live, work, and contribute? I hope so.