Federal Income tax is regressive, not progressive


Tonington
#1
Please forgive the lengthy cut and paste, but I don't think I could condense this material much without losing too much of the context.

Federal Taxation of Labour Income in Canada is Regressive (in Terms of Marginal Rates) (external - login to view)

Or at least, it is for some ranges of income. Don't believe me that marginal tax rates are regressive? Follow me:


For this analysis, I will need to do the following:
  • Ignore provincial income taxes since the tax system differs from province to province.
  • Assume that the person does not live in Québec (for reasons we will discuss later).
  • Ignore industry specific insurance premiums on income, such as WSIB (external - login to view) premiums since these vary from industry to industry (and, as it turns out, do not change our story in any fundamental way.
Federal Income Taxes

If we include the Federal Basic Personal Amount as a separate tax bracket (it's the amount of money a person needs to earn before they start paying federal income taxes), Canada has five marginal income tax brackets which are as follows:
  • 0%: $0 - $10,382
  • 15%: $10,383 - $40,970
  • 22%: $40,971 - $81,941
  • 26%: $81,942 - $127,021
  • 29%: $127,022 - inf
(all tax rate data from Taxtips.ca (external - login to view)) So far this looks pretty progressive, with low-income earners paying no income tax. Interestingly, the first tax bracket starts up well before Statistics Canada's Low-Income Cut-Off (LICO) which is a widely used (but far from universally accepted) definition of poverty. In 2004 the LICO for a single person was between $14,000 and $20,337, depending on where the person lived (source: CCSD (external - login to view)).
Payroll Taxes on Employees


There are two payroll taxes paid by the majority of working Canadians: Canada Pension Plan (CPP) contributions and Employment Insurance (EI) premiums, both of which are proportional to labour income. There are some exceptions:
  • People can be exempt from either CPP or EI, for a variety of reasons. For instance, individuals who own 40% or more of the companies they work for are exempt from EI premiums.
  • Québec has their own version of CPP (QPP). Currently the marginal tax rates are identical, but the plan is administered by the province rather than the federal government.
CPP Employee Contribution Rates

  • 0%: $0 - $3500
  • 4.95%: $3501 - $47,200
EI Employee Premium Rates

  • 1.73%: $0 - $43,200
Note, there is no basic exemption level for EI and both EI and CPP payments kick in well before LICO.
Adding it Together

For a person who is eligible to pay both EI and CPP along with income taxes, there are now eight effective tax brackets on labor income:
  • 1.73%: $0 - $3,500
  • 6.68%: $3,501 - $10,382
  • 21.68%: $10,383 - $40,970
  • 28.68%: $40,970-$43,200
  • 26.95%: $43,201-$47,200
  • 22%: $47,201-$81,941
  • 26%: $81,942-$127,021
  • 29%: $127,022-inf
Note that marginal tax rates are declining from $40,970 to $127,021, and a person earning $41,000 a year faces almost the same marginal tax rate as someone making $410,000. And it gets worse from here.
Payroll Taxes on Employers

Employers are required to pay EI premiums and CPP contributions for their employees as well. Canadian law requires employers to match CPP contributions dollar-for-dollar, and EI contributions 1.4-to-1 (that is, for every dollar employees pay, employers pay $1.40).

Thus the tax rates for employers are as follows:
CPP Employer Contribution Rates

  • 0%: $0 - $3,500
  • 4.95%: $3,501 - $47,200
EI Employer Premium Rates

  • 2.422%: $0 - $43,200
As such, 50% of the legal incidence of CPP Contributions falls on employees along with 41% of the legal incidence for EI premiums.
But Who Really Pays Payroll Taxes

Stephen Gordon examined this question a few weeks ago in The economics of tax incidence: paying the tax is not the same as bearing the burden (external - login to view):
Payroll taxes. These include employer contributions to EI and C/QPP as well as Worker's Compensation premiums. But as a HRCD survey (external - login to view) notes, long-run labour demand is more elastic than labour supply, so the ultimate effect of payroll taxes is to reduce wages: "labour's share of the payroll tax burden in the long run is in the range of 87 to 100 percent."
Additional evidence to this point - The Incidence of Payroll Taxation: Evidence for Chile (Jonathan Gruber, Journal of Labor Economics, July 1997) has a useful literature survey which includes the following:
More recent work in the United States has examined the effects of changes in the costs of government mandated employer benefits within different states over time, controlling for correlated time-series and fixed location effects. These studies have found that the incidence of mandated employer benefits is fully on wages, with little to no disemployment effect.
Meaning that the incidence falls on employees. Gruber's study of Chile came to the conclusion, but this is not a universal finding in the literature. Holmlund's 1983 study of Sweden found that only half of the employer's share was paid by employees in reduced wages.

Given all of this evidence, it is difficult to imagine that less than 75% of payroll taxes are ultimately paid by employees. We will use this figure as a lower bound, though HRDC's figure of 87-100 percent is likely more accurate.

If employees are paying 75% of payroll taxes, then their tax rates on EI and CPP are roughly 3% and 7.5% respectively. Using these figures along with income tax rates leads to the following marginal tax rate schedule:
  • 3%: $0 - $3,500
  • 10.5%: $3,501 - $10,382
  • 25.5%: $10,383 - $40,970
  • 32.5%: $40,970-$43,200
  • 29.5%: $43,201-$47,200
  • 22%: $47,201-$81,941
  • 26%: $81,942-$127,021
  • 29%: $127,022-inf
Now the highest marginal tax rates are on people making around $41,000 a year. Marginal tax rates are regressive from income levels of $40,970 to $81,941, and people under the LICO 'poverty level' making $11,000 face roughly the same marginal tax rate as those earning $110,000 a year.
Complications and Considerations

There are at least three additional factors we may want to consider:

1. Are Payroll Taxes Equivalent to Income Taxes


They potentially could differ in one significant aspect. If a person pays additional income taxes, they do not receive any additional services from the government. However, if a worker pays higher EI or CPP contributions, they may receive additional benefits. From Gruber:
However,Summers (1989) noted that this analysis missed an important of feature of payroll taxation: tax revenues are often used to finance programs which benefit workers only, such as retirement benefits under Social Security or compensation for workplace injuries.This restriction of benefits to workers creates an important tax/benefit linkage...
If workers believe that EI and CPP payments benefit them directly, while income taxes do not, the behavioural response to changes in each will be different. Specifically, we would expect that higher income taxes would lead to sharper reductions in labour supplied than higher payroll taxes.

The question then is, "Do workers perceive payroll taxes as being fundamentally different than income taxes?" I am not aware of much research in this area. It would be very difficult to argue that for EI, there is a close relationship between tax and benefit. Premiums are not based on expected benefits, as the rates for people with almost no chance of finding themselves unemployed are the same as for higher risk persons. Secondly, since EI premium revenues were incorporated into general government revenues in the 1990s, there is not necessarily a close link between overall EI revenue received and EI payments made. This distinction is discussed in great length in Economics versus Politics in Canadian Payroll Tax Policies (Jonathan R. Kesselman, Canadian Public Policy, September 1998. The link between a person's taxes paid and expected benefit is quite weak in the case of EI.

The case for CPP is much less clear, as there is a closer (but far from one-to-one) link between taxes paid. Younger workers also have an additional concern - will the system still be in place when they retire? There is not much data for Canada, but there is a significant body of evidence that suggests that young Americans believe Social Security is important, though they will not be able to collect it. From the New York Times (external - login to view):
Yet here’s the odd part: only a third of the younger respondents, and only a third of all respondents, expressed confidence in the program’s future. How do you square these opinions that Social Security is crucial, that you want it to be available decades hence, with the belief that it probably won’t be?
Think tanks (external - login to view) and life insurance companies (external - login to view) are recommending to young workers not to count on a young social security system - to the point which the Social Security Administration felt the need to respond (external - login to view). Whether or not the claims of the demise of Social Security are valid or overblown is somewhat irrelevant - if young workers believe they will receive no personal benefits from their contributions, then the behavioural response is the same as an income tax.

In the previous analysis, I have treated CPP contributions as a straight tax. That may be excessive, though I am not convinced. However, it may make more sense to treat it as 75% tax and 25% forced saving, or 50% tax and 50% forced saving. The latter would drop the CPP tax burden by workers down from 7.5% to around 4% - which does not look too much different than the marginal tax rate figures that did not take into account employer contributions, which were still regressive. The tax/benefit linkage may reduce the regressivity of labour income taxes, but it does not eliminate it.

2. Provincial Income Taxes

We have only considered federal income taxes. Perhaps once we take into account provincial income taxes, the labour income tax system ceases to be regressive.

The difficulty: Provincial income tax systems are not progressive enough to swing the pendulum back to an overall progressive tax system. Alberta has a flat tax on income, so it does not make the overall situation more progressive. Ontario, on the other hand, has a progressive income tax regime which is as follows:
  • 0%: $0-$8,943
  • 5.05%: $8,944-$37,106
  • 9.15%: $37,107-$74,214
  • 11.16%: $74,215-inf
If we add this to the marginal tax rate schedule that includes both employer and employee contributions, we get a rather lengthy marginal tax rate schedule that looks as follows:
  • 3%: $0 - $3,500
  • 10.5%: $3,501 - $8,943
  • 15.55%: $8,948-$10,382
  • 30.55%: $10,383 - $37,106
  • 34.15%: $37,107-$40,970
  • 41.65%: $40,971-$43,200
  • 38.65%: $43,201-$47,200
  • 31.15%: $47,201-$74,214
  • 33.16%: $74,215-$81,941
  • 37.16%: $81,942-$127,021
  • 40.16%: $127,022-inf
Once again, we see the highest marginal labour tax rates paid by individuals earning roughly $41,000 a year, with the system being highly regressive between the income range of $41,000 and $74,000.

3. Tax Incidence of Income Taxes

One assumption we have made through this entire discussion is that the incidence of labour income tax rates fall wholly on those earning the income. What if, instead, some of the incidence falls on firms or customers?

Remember, though, that the income tax portion is the progressive part of the whole labour income tax system. The higher the level we assume is paid for by non-workers, the more regressive the system actually is. The only way this consideration would make the system more progressive is to assume that the tax incidence faced by workers is greater than 100%. That is theoretically possible, but in reality unlikely.

Labour Income Tax System - Conclusion

When payroll taxes and tax incidence is taken into consideration, the Canadian labour income tax system is highly regressive in the income range of $40,000-$70,000. Taking into consideration the benefit/tax linkages of payroll taxes mitigates this, but only partly.

Given that both EI premiums and CPP contribution rates (external - login to view) are both likely to rise in the near future, expect an even more regressive Canadian tax system soon.
 
SineQuaNon
#2
Very good piece.
The rest of the tax system, the expenditure side, does include means tested benefits via the gst rfunds, policy benefits for childcare, benefits and deductions for disability support which tend to transfer funds more to the centre then either end of the schedule.
Secondly, the popularity the Austrian school of eonomics espoused from Thatcher throughout most modern economies has cut non-labour taxes increasing the burden on the middle while increasing the debts. Hopefully, Canada will follow Obama and roll back all tax cuts to earnings above $100,000.
Third, labour will always pay a higher total pool of taxes because wages of labour constitute the largest expense and income pool in the economy.
 
JLM
No Party Affiliation
#3
Quote: Originally Posted by ToningtonView Post

Please forgive the lengthy cut and paste, but I don't think I could condense this material much without losing too much of the context.

Federal Taxation of Labour Income in Canada is Regressive (in Terms of Marginal Rates) (external - login to view)


Given that both EI premiums and CPP contribution rates (external - login to view) are both likely to rise in the near future, expect an even more regressive Canadian tax system soon.

Too bad the recent departee from the forum is gone- he'd justify all this for you in a flash.
 
Bar Sinister
No Party Affiliation
#4
No argument from me about the inequities of the Canadian tax structure, but given the fact that those who can afford to pay more are those who most strongly support the current party in power what are the chances that anything is going to change?
 
petros
#5
Is the word "progressive" being used in the socialist sense?
 
Walter
#6
The most efficient and fairest way to tax is by consumption only; no income, property, capital gains, corporate, gasoline, cigarette, booze, etc. taxes; just a flat consumption(sales) tax on everything.
 
JLM
No Party Affiliation
#7
Quote: Originally Posted by WalterView Post

The most efficient and fairest way to tax is by consumption only; no income, property, capital gains, corporate, gasoline, cigarette, booze, etc. taxes; just a flat consumption(sales) tax on everything.

Wonders never cease, Walter, I think you are on to something. Never thought I'd agree with you.
 
Bar Sinister
No Party Affiliation
#8
Quote: Originally Posted by WalterView Post

The most efficient and fairest way to tax is by consumption only; no income, property, capital gains, corporate, gasoline, cigarette, booze, etc. taxes; just a flat consumption(sales) tax on everything.


You are going to have to explain how a sales tax on everything in any way fairly taxes those who are most able to pay such as the the very wealthy; or the very poor who cannot afford to pay any tax.
 
Bcool
#9
Quote: Originally Posted by WalterView Post

The most efficient and fairest way to tax is by consumption only; no income, property, capital gains, corporate, gasoline, cigarette, booze, etc. taxes; just a flat consumption(sales) tax on everything.

Couldn't agree more, Walter.

Quote: Originally Posted by JLMView Post

Wonders never cease, Walter, I think you are on to something. Never thought I'd agree with you.

Good heavens! What would ::koff:: someone have to say about this I wonder? LOL

Quote: Originally Posted by Bar SinisterView Post

You are going to have to explain how a sales tax on everything in any way fairly taxes those who are most able to pay such as the the very wealthy; or the very poor who cannot afford to pay any tax.

I think you just answered your own question, IMHO of course.

Quote:

Tonington elucidated: Please forgive the lengthy cut and paste, but I don't think I could condense this material much without losing too much of the context.

Thank you for such a wealth of information presented in such a way that even I am beginning to get my head wrapped round most of it. I think I'm going to be very annoyed when I actually get it, right?
 
Liberalman
#10
Quote: Originally Posted by WalterView Post

The most efficient and fairest way to tax is by consumption only; no income, property, capital gains, corporate, gasoline, cigarette, booze, etc. taxes; just a flat consumption(sales) tax on everything.

I totally agree
 
TenPenny
#11
Quote: Originally Posted by Bar SinisterView Post

You are going to have to explain how a sales tax on everything in any way fairly taxes those who are most able to pay such as the the very wealthy; or the very poor who cannot afford to pay any tax.

People with more money buy more stuff.
Buying more stuff = paying more taxes.

Can you follow that?
 
Bar Sinister
No Party Affiliation
#12
Quote: Originally Posted by TenPennyView Post

People with more money buy more stuff.
Buying more stuff = paying more taxes.

Can you follow that?

Unfortunately, the very wealthy do not buy enough to make up the difference that lower paid citizens would consume given the same spending power.

Try a little spending exercise based on equal incomes. On the one hand you have a single earner making ten million a year. On the other hand you have 200 average income earners spending 10 million collectively. Work out how much they spend on household furnishings, automobiles, restaurants, clothing, and so on in one year and you will easily see that the 200 average income earners are far more important to the economy than the single wealthy person.

As for the really wealthy person he may or may not spend all of his cash in his country or residence. He is just as likely to spend it in a second or third residence in another country or on expensive foreign vacations.

The wealthy person may also spend some of it to expand his business provided there is any demand from the masses for whatever he is producing. If there is no demand he will put it somewhere else including investments that may have little immediate or direct benefit to his country.

If I was an economic planner trying to give the economy a boost I would far rather have 200 average citizens buying new houses that one millionaire building a mansion.

Can you follow that?
 
JLM
No Party Affiliation
#13
Quote: Originally Posted by Bar SinisterView Post

Unfortunately, the very wealthy do not buy enough to make up the difference that lower paid citizens would consume given the same spending power.
Try a little spending exercise based on equal incomes. On the one hand you have a single earner making ten million a year. On the other hand you have 200 average income earners spending 10 million collectively. Work out how much they spend on household furnishings, automobiles, restaurants, clothing, and so on in one year and you will easily see that the 200 average income earners are far more important to the economy than the single wealthy person.
As for the really wealthy person he may or may not spend all of his cash in his country or residence. He is just as likely to spend it in a second or third residence in another country or on expensive foreign vacations.
The wealthy person may also spend some of it to expand his business provided there is any demand from the masses for whatever he is producing. If there is no demand he will put it somewhere else including investments that may have little immediate or direct benefit to his country.
If I was an economic planner trying to give the economy a boost I would far rather have 200 average citizens buying new houses that one millionaire building a mansion.

Quote has been trimmed, See full post: View Post
Yep, what the 200 spend is the "meat and potatoes", what the millionaire spends is the "gravy".
 
Tonington
#14
Quote: Originally Posted by petrosView Post

Is the word "progressive" being used in the socialist sense?

No. A progressive tax would mean that as earnings increase, or progress, the tax rate follows.

Quote: Originally Posted by WalterView Post

The most efficient and fairest way to tax is by consumption only; no income, property, capital gains, corporate, gasoline, cigarette, booze, etc. taxes; just a flat consumption(sales) tax on everything.

Except that lower income earners disposable income is almost entirely used by purchasing necessities, while higher income earners have much more income that is saved. So consumption taxes end up impacting the lower income earners the largest, which again is regressive.
 

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