Tax Cut for the Wealthy?

The 1999 federal budget was sold on two fronts: the restoration of health care funding for the provinces, and tax cuts for all income earners. Rhetoric aside, the reality is somewhat different.

Yes, the budget partially restored health care spending previously cut, but only partially.

Yes, the federal budget moderately decreased taxes for low-income Canadians by further increasing the basic exemption by $175.

Yes, the federal budget moderately decreased taxes for middle-income earners by completely eliminating the 3 percent surcharge and increasing the basic exemption by $675.

Yes, taxes were moderately reduced for high-income earners in the same way they were for middle-income earners, namely, the elimination of the 3 percent surcharge and an increase in the basic exemption. However, the budget speech failed to mention that the 5 percent surcharge assessed on high-income earners would be maintained. Thus, high-income earners still pay a tax penalty in the form of both higher rates and additional surcharges.

The fact that we define high-income earners at roughly $65,000, while the US defines high-income at roughly $270,000 (US) is indicative of a larger negative Canadian attitude towards wealth generation and success.

Taxes were actually increased for many Canadians because of bracket creep. Bracket creep occurs when individuals are pushed into higher tax brackets because of inflation, rather than any real increase in their income.

An important signal was also included in the federal budget, sent to Canada’s top income earners. The budget stated that “changes are being proposed that would prevent high-income individuals from being able to reduce their taxes by income splitting with their minor children.”

This proposed change pertains to family trusts wherein wealthy professionals establish trusts that own shares in the individual’s business. The trust can remit dividends up to approximately $23,000 tax-free due to the basic exemption and dividend tax credit to the children of the professional. This income-splitting technique allows high-income earners to reduce their taxable income, and thus their tax bill, by remitting income to their children. The professionals’ children are therefore able to claim income that the parent actually generated, and thus reduce the amount of taxable income claimed by the parent without necessarily reducing the income of the household. The proposal discussed in the federal budget signals to high-income earners that the federal government is preparing to eliminate this income-splitting technique.

Does it matter? These people are already rich, says the usual chorus of the government and those supportive of progressive tax regimes. Canada is facing an increasingly troublesome brain drain problem wherein many of the best and brightest Canadians are emigrating south of the border. Statistics from 1996 indicate that as many as 52,000 Canadians emigrated to the US and elsewhere. The importance of high-income earners for tax collection is illustrated by how much each group contributes to total taxes. In 1996, Canadians earning more than $70,000 represented 4 percent of tax filers and 19 percent of total income assessed, but contributed 31 percent of total federal taxes. David Stewart-Patterson of the Business Council on National Issues estimates that the government lost up to $1 billion in tax revenue in 1996 due to the brain drain.¹ More alarming is the cost of replacing those who have left Canada, which, according to Prof. Don Devoretz, is estimated at $11.8 billion between 1982 and 1996.²

Equally alarming is the long-term effect on the Canadian economy if the brightest Canadians continue to leave the country. Who will fill the gaps as current professionals retire? Who will create new companies if a large number of the most talented Canadians leave? Who will produce the future innovations that must characterize the Canadian economy if it is to advance?

The brain drain is not occurring in the low- and middle-income brackets, but at the higher income levels. If we truly want to stop exporting our brightest young people, then we must deal with the egregious tax system that penalizes our most successful citizens as well as diligence and hard work.

Instead of allocating tax revenues to Mr. Martin’s favourite projects, the federal government could, and should move immediately to eliminate the 5 percent surcharge on “wealthy” Canadians, and rethink any change in the family trust provisions in order to ensure that they are not exacerbating the brain drain. No, it is not a perfect plan, but we know the problem, we know the general solution, and now we must act to stem the brain drain.

Notes

1 Don DeVoretz, “Facts, Policy and Politics of Canada’s Recent Brain Drain Experience,” presented at The Fraser Institute conference, The Brain Drain: Causes, Consequences, and Policy Response, Vancouver, Canada, Nov. 13, 1998.

2 David Stewart-Patterson, “Brain Drain Cuts Tax Take, Too,” Fraser Forum, January 1999, pp. 5-6.