Does Revenue Canada Play Matchmaker?

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Martin Zelder and Patrick Basham

Talk of tax reform almost inevitably leads to discussions about whether or not capital gains should be included, what the rate structure should be, and whether the tax should be based on income or consumption. Rarely do we talk about the tax system's implications for marriage and divorce. But perhaps we should.

On February 10, the US House of Representatives passed legislation which would revise the tax code and eliminate the marriage "penalty" incurred by approximately 25 million US couples. Under existing law, they suffer this penalty in that they pay higher taxes as a married couple than if they were single cohabitants (unlike Canada, most US states maintain fairly stringent requirements for cohabitants to be regarded as de facto married).

Does Canadian tax law also impinge on married couples? It does, but with an important difference. To assess this impact, it is crucial to understand the differential consequences of US tax law for married couples.1 Tax law creates marriage "penalties" or "subsidies" if it increases or decreases, respectively, the tax bill faced by a couple if they are married rather than unmarried. The underlying characteristics of the tax code which generate these penalties or subsidies are lump-sum credits triggered by income (e.g., the Canadian spousal tax credit) and marginal tax rates which vary with income (e.g., the progressivity - higher marginal rates with higher income - found in both the Canadian and US tax systems).

In the US, these two features of the tax system combine to penalize some married couples and subsidize others. Specifically, the US system penalizes couples with similar incomes, and subsidizes couples with dissimilar incomes. For example, in one hypothetical calculation, a couple in which each spouse earned $40,000 suffered a penalty of $1,477, while a couple with a single earner at $80,000 and the second spouse at $0 received a subsidy of $4,113.2 This means that were the dual-$40,000 couple to divorce and cohabit, their tax burden would fall by $1,477; on the other hand, the single-earner couple lessens its tax burden by $4,113 by marrying rather than remaining legally single cohabitants.

Such disparate treatment of married and unmarried couples by the tax system becomes of interest to policy reformers if it affects choice. The choice in question here is of marital status: does the tax system influence the decision to get married or get divorced? The American evidence indicates that it does.

As the size of the marriage penalty increases, economists Alm and Whittington (1999) find that the marriage rate declines. In particular, they discern that a 10 percent rise in the average size of the penalty has led to a 2.3 percent decrease in the marriage rate. Furthermore, a larger marriage penalty has also been found to make couples more likely to divorce (Whittington and Alm, 1997; Dickert-Conlin, 1999).

Consequently, if the tax system has such effects in the US, it is worth investigating whether the Canadian tax system embodies penalties or subsidies. Little has been written on the Canadian version of this phenomenon. In fact, a thorough search of the economics literature yielded only two articles which address the marriage penalties or subsidies created by the Canadian tax system. Pechman and Engelhardt (1990) calculate the tax burden for a single individual relative to a married couple, holding income constant, for a variety of countries, including Canada. This calculation effectively generates the marriage penalty or subsidy for a single-earner couple. Pechman and Engelhardt found that in Canada (as in all other countries examined), the single individual's tax burden exceeded that for the married couple with equal income. The implication is that at the time of their analysis (1989), the Canadian tax system provided a marriage subsidy for single-earner couples.

Further Canadian evidence, albeit less direct, is found in Gelardi (1996). He analyzed the impact of the 1986 Canadian tax law change which eliminated the advantage to late-in-year (e.g., December) marriages. Gelardi found that there was a significant decrease in the proportion of marriages occurring in December from 1986 onward, compared to the period 1960-1985.

Due to the dearth of evidence, we calculated the tax consequences of marriage for 9 hypothetical married couples, using the QuickTax software program. We assumed that no special deductions, credits, or exceptions were claimed except personal and spousal tax credits. The 9 hypothetical childless couples consist of three groups of three, where each group corresponds to a different combined pretax income: $20,000, $40,000, and $80,000. For each of these combined incomes, income was split between the male and female partner in three different ways, involving varying degrees of inequality. The income splits are listed in the first column of table 1.

We discovered that the Canadian income tax system provides a subsidy to particular couples - those with the most unequal incomes. That is, in our simulations, couples with one spouse who earned no income received marriage subsidies, as did the couple for which $15,000 of its joint $20,000 were earned by one person. The other five hypothetical couples - three with equal spousal earnings, and two with somewhat unequal spousal earnings - received no subsidy from the tax system, but also were not burdened with a marriage penalty.

This result - that the couples with the most unequal earnings receive subsidies - is the same as that for the US. The only difference is that Canadian couples with equal earnings do not face a marriage penalty. The largest subsidy is received by the couple that earns $80,000 from a single income earner.

Given this intervention, and the evidence in the US (and to a lesser extent in Canada) that similar interventions affect marriage and divorce decisions, the remaining question is whether the Canadian marriage subsidy is appropriate. While economists have assessed the effects of such interventions (as described above), they have largely avoided the issue of the appropriateness of penalties or subsidies on marriage. As a general economic matter, a subsidy is appropriate if the additional activity it encourages confers external (spillover) benefits on other members of society. The benefits of marriage are essentially private, and thus solely enjoyed by the two spouses. Only if a compelling argument can be made that the rest of society benefits when those who otherwise would not marry are induced to do so by the subsidy could the current disparate tax treatment of unmarried and married couples be justified.

References

Alm, James, Stacy Dickert-Conlin, and Leslie A. Whittington (1999). "Policy Watch: The Marriage Penalty." Journal of Economic Perspectives 13:193-204.

Alm, James, and Leslie A. Whittington (1999). "For Love or Money? The Impact of Income Taxes on Marriage." Economica 66:297-316.

Dickert-Conlin, Stacy (1999). "Taxes and Transfers: Their Effect on the Decision to End a Marriage." Journal of Public Economics 73:217-240.

Gelardi, Alexander M.G. (1996). "The Influences of Tax Law Changes on the Timing of Marriages: A Two-Country Analysis." National Tax Journal 49:17-30.

Pechman, Joseph A., and Gary V. Engelhardt (1990). "The Income Tax Treatment of the Family: An International Perspective." National Tax Journal 43:1-22.

Whittington, Leslie A., and James Alm (1997). "'Til Death or Taxes Do Us Part: The Effect of Income Taxation on Divorce." Journal of Human Resources 32:388-412.

Notes

1. As with many public policy questions, the academic literature is more extensive for the US than for Canada.
2. These calculations are found in Alm, Dickert-Conlin, and Whittington (1999).

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