The trouble with the TFSA
TheStar.com – news/Canada
Published On Sat Apr 30 2011. By Linda McQuaig, Columnist
While corporate tax cuts have been fiercely attacked in recent weeks as giveaways to big business, the Conservatives have managed to avoid controversy over another costly election promise that seems poised to deliver an even bigger windfall to the Bay Street crowd.
The promise involves Tax Free Savings Accounts (TFSA), which the Conservatives introduced in 2009 and now plan to greatly expand. The opposition parties have avoided attacking the program, which the Conservatives have carefully pitched as a way to help moderate earners build their savings.
But Neil Brooks, a professor of tax law at Osgoode Hall Law School, says the program does little for moderate earners, and is really about eliminating taxes on capital gains and other income from capital – something the financial community has long lobbied for but been unable to achieve.
Brooks argues that the TFSA program has far-reaching implications, moving Canada away from the income tax – which taxes income from both capital and wages – towards a system that taxes only wages.
That will shift the tax burden away from investors, and increasingly onto the backs of wage earners, he notes.
This is well understood in financial circles, which pushed for the TFSA program and is cheering it on. However, the shift is largely invisible to the wage-earning public, according to Allister Young, a tax professor at Brock University.
“The Conservatives’ philosophy is that they want to move away from taxing investment income. But they don’t want to come out and say ‘We’re not going to tax capital gains.’ This is a stealthy way to do that,” Young said.
Under the program, Canadians over 18 years old can deposit up to $5,000 a year into a tax-free savings account. The Conservatives pledge to double this annual contribution limit to $10,000 once the federal budget is balanced, which they project for 2014. The amount deposited is not tax deductible, but all future earnings from it escape taxation, even when withdrawn from the account.
Almost any type of investment – including stocks – can be held in a TFSA. All dividends and capital gains received from these stocks escape tax.
While the annual contribution limits make the program appear modest, the sheltered amounts can grow very large over time.
So, by the age of 40, an investor could have $220,000 in the account. But that’s only the beginning. Had the money had been well invested, that $220,000 could have grown to $500,000.
If the $500,000 were then invested in speculative securities that, say, quadrupled in value, the entire gain of $1.5 million would be tax-free, adding greatly to the ever-accumulating tax-free treasure chest.
For investors who get lucky in the stock market, the tax savings are unlimited.
“These accounts could shelter millions and millions worth of capital gains,” says Young.
This explains why the investment community has been so enthusiastic. Finn Poschmann, vice-president of the C.D. Howe Institute and one of the early promoters of the scheme, has called the TFSA program a “tax policy gem.”
But Brooks notes that, by shielding capital gains from taxation, the program will exacerbate Canada’s already high level of inequality.
Taxing capital gains is the closest Canada comes to taxing wealth. Unlike other developed nations, Canada lacks an inheritance tax to tax large fortunes passing to the next generation.
The revenue losses from the TFSA program also threaten to be huge, although not immediately visible.
Already, almost $20 billion has been socked away in some 4.8 million TFSA accounts.
Kevin Milligan, an economics professor at the University of British Columbia, estimates that seven years from now – or sooner with the higher contribution limits – the annual revenue loss will be in the range of $6.6 billion.
And the revenue loss will grow over time, limiting the ability of future governments to pay for public programs.
Brooks believes this is “part of the Conservatives’ long-term plan to defund the welfare state.”
None of this is evident however in government promos about the program, which stress that “Canadians at all income levels and all walks of life can benefit.”
True, but the benefits at the lower end are tiny, notes Young.
He and tax colleague Maureen Donnelly studied a 10-year-old British program similar to Canada’s TFSA program. They concluded that the British program, which also claimed to help low income people, has done almost nothing for them, and has mostly benefited rich, older men.
Young and Donnelly found that only 5 percent of Britain’s low income earners started saving due to the program. But even this may be an exaggeration, since many of the “low income earners” appear to be stay-at-home spouses of wealthy earners. (The British program, like the Canadian one, allows an earner to contribute to a spouse’s tax-free account.)
Young says most low income people simply don’t have extra cash to put towards savings – that’s why 29 percent of Canadians have no retirement savings at all.
Even Jon Kesselman, a public finance professor at Simon Fraser University who co-wrote an influential C.D. Howe paper promoting tax-free accounts, opposes the Conservative plan to increase contribution limits to $10,000, noting that the increase will mostly help those earning above $125,000 a year.
Government and financial commentators stress that TFSAs are better for low income seniors than Registered Retirement Savings Plans (RRSP). They point out that withdrawals from RRSPs are counted as income, and therefore can prevent seniors from receiving full benefits under income-tested government pension programs.
But Brooks says that if Ottawa wanted to correct this problem, it could have simply legislated that RRSP withdrawals also wouldn’t count as income for income-tested programs.
If Ottawa really wanted to improve financial security for seniors, it would strengthen public pensions, Brooks notes.
Young agrees, adding that: “The TFSA is nothing more than another weapon in the current Canadian government’s ideological attack on the foundations of our tax system.”
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