Low income. Middle income. Regressive taxation. It’s election time, so these words are being thrown around like cheap candy at a small town parade. Whenever some new benefit or tax is proposed, an argument pops up faster than the new Massey Bridge – how does this impact the ‘rich’ compared to the ‘not-so-rich,’ with scorn for policies that appear to give greater benefits to the well off.
Income testing is often proposed as a solution to these issues, a way of distributing taxes and benefits in a more equitable manner. Both the NDP and Green party platforms include new or expanded use of income testing for various measures, such as
- Climate action rebate
- Expanding rental assistance
- Student loan interest
- Education grants
- Homeowner grant
- Progressive property tax
- Low income benefit
The Liberal platform doesn’t speak of many particulars on this matter, but their platform document mostly consists of “holy crap, we’re awesome” and “bewaaaaare the 1990’s…..” so, we’ll just leave it aside.
The challenge with income tested programs is they effectively increase the tax rate on low-income earners earnings. So what’s meant to provide a progressive distribution of taxes and benefits can end up asserting itself in a very regressive manner.
If you are a high income earner and earn an additional dollar, you pay your marginal tax rate on it. If you’re a low income earner and you earn an additional dollar, you pay your (lower) marginal tax rate on it, but you also lose various benefits due to having a higher income. Those losses of benefits are effectively a tax on low income earners.
A few years ago the CD Howe institute looked at this and put out a study of the marginal effective tax rate for families in the western provinces. It was a good look, but some of the various benefits have changed (e.g. Canada Child Benefit) and they didn’t include certain costs and benefits, such as MSP premiums. So I figured I’d take a crack at it using the latest tax rates and benefits for BC.
I looked at a single parent of two school age children, as they have more potential benefits available to them (and to be clawed back) and are often the type of people we are concerned with when talking about low income families. I considered looking at a dual parent family, but things get crazier than Miley Cyrus’s hair, and the numbers for a single parent are enough to get the point across.
I wanted to estimate a taxpayer’s average and marginal tax rates across various income levels, accounting not only for income tax, but all the various additional taxes, fees, and income tested benefits to assess just how much income is taxed back as you increase your wages. So I looked at a Costco warehouse pack of various taxes and benefits.
- Taxable income (wages, EI, interest on savings, whatever)
- GST/HST Credit
- BC Low Income Climate Credit
- Canada Pension Plan contributions (employee only)
- Employment Insurance contributions (employee only)
- Working Income Tax Benefit
- Canada Child Benefit
- BC Family Bonus
- BC Rental Assistance Program
- BC Childcare subsidy
- Medical Services Plan premiums
- Federal and Provincial Income Tax (incl. basic exemption, CPP, EI, BC Tax Reduction, and $5000/yr in childcare costs)
Basically, I assumed that the taxpayer was going to pay all their obligations personally, and that they would claim any benefits they are eligible for. Various tax rates came from taxtips.ca, Canada Child Benefit, WITB, and BC Family bonus from the CRA benefits estimator, BC Rental Assistance from their estimator (assuming renting in Metro Vancouver), and MSP from the BC government website. Estimating BC childcare subsidies was a pain in the ass, and calculated by hand using the formulae and tables in the regulations. All were done using current or 2017 rates, except for the CRA benefits estimator as it only goes to 2016.
I then estimated the various taxes and benefits for someone earning wages of $0 to $50,000 in $5,000 increments. For each wage level, I calculated the total income including all benefits, the total taxes, including MSP and payroll taxes, and determined the average tax rate at that income level.
For each increment of $5,000 in wages, I calculated the additional gross income (easy, exactly $5,000 in each case), the additional net income (additional income after taxes and benefits are adjusted) and calculated the marginal tax rate on that $5,000 of additional earning. This marginal tax rate was based on the amount of after tax income gained compared to the gain in gross earnings, and accounted for increases in taxes payed and reductions in benefits received. For example, if you earned an extra $5000 in wages, but payed an extra $500 in taxes and lost $1000 in benefits, the marginal tax rate would be 30%.
The CD Howe study I mentioned above found BC dual income families face a marginal effective tax rate that was slightly negative up until about $15,000 of income, at which point it shot up to between 20% and 60%, before levelling off around 35%.
When you add in more income tested benefits, the numbers gets worse. However, the general pattern I found is very similar to that in the CD Howe study. Plotting it out, we see many interesting things.
Firstly, with zero taxable income, a single parent can get over $27,000 in various forms of income/government benefits. And this is not including social services such as CPP, EI, or income assistance (though those would all be taxable income, and thus move the person up the chart).
Secondly, going from $5,000 to $10,000 in taxable income, there is a negative marginal tax rate, that is after tax income rises faster than gross income, hooray! This is due to the Working Income Tax Benefit, which is a refundable tax credit. Sadly, once we get past $15,000 in taxable income, things turn very not hooray.
Moving from $15,000 to $25,000, there is actually an effective marginal tax rate that is greater than 100%. I always harp on people who say “I don’t want to earn more, it’ll put me in a higher tax bracket,” because the way income taxes work, you never lose more in taxes than you gain in income. Well, apparently you can. If you are a single parent earning in the $15,000 to $25,000 range and claiming all these benefits, earning an extra dollar of taxable income will mean you take home 20 cents less than you did before.
I know everyone likes to harp on MSP as being regressive, but MSP has barely even started at this point. The key drivers here are the loss of rental assistance and childcare subsidies.
Moving up in income from $30,000, the marginal tax rate drops off from 80% down to 50% as various benefits are lost (and thus no longer clawed back) and MSP premiums climbe and then level out. Side note since I know someone will ask – I ran this with the 2016 MSP premiums as well, when they were twice as much. It shifted things around a bit, slightly higher marginal tax rates in the $20-30k range, slightly lower in the $30k+, but the numbers were all within 5-10 points. Likewise, eliminating MSP entirely makes an equivalent impact in the other direct. The chart below shows where the taxes and clawbacks are coming from for two of the higher marginal effective tax rates.
Out of curiosity, I also did the analysis for a single adult, with far fewer benefits available. While the magnitude of the marginal rates were much smaller due to this, the pattern was still the same – negative rates until $10,000, peaking at around 44% at $20,000, then dropping down and levelling off at 32%.
Also out of curiosity I looked at the marginal rate of increasing a single parent’s income from $100,000 to $105,000. Since your MSP, CPP and EI are already maxed out, and the only benefit still remaining is a small amount of the Canada Child Benefit, despite having much higher marginal income tax rates, the effective marginal tax rate at this level is only (only!) 43%.
None of this is to say income testing is good or bad, or the alternatives are necessarily better or worse. Different hammers for cracking different skulls and all that. Since apparently mullets are a thing again this election, all this is to say that while income testing is progressive business up front, it has a regressive party going on in the back. What's the incentive to earn more if you're only going to keep 20% of it or worse.
Compounding this is the un-coordinated nature of the various benefits from different levels of government, and we end up with the situation where a single parent can take more money home by earning less. I struggle to see anything progressive in that.