Social Policy in Ontario

The real test for the federal Conservatives this coming fall will not be the “voluntary long form census” but a topic far more important to most people: Whether the government can deliver on its promise to restrain taxes. At play are payroll taxes that are slated to rise in the coming years.

With higher unemployment benefits as a result of the Great Recession, EI premiums would normally have been raised to cover program costs. However, as jobs disappeared in the late fall of 2008, killing jobs with higher payroll taxes simply was not in the cards. The government held the line on premiums but, as the economy slowly recovers, payroll taxes will surely rise in the next few years.

On top of this, Jim Flaherty, Minister of Finance, has committed to “modestly” increase payroll taxes on a fully funded basis to provide more retirement support for employees. CPP premiums will especially have to increase for younger workers if they are to have adequate retirement income in the years to come.

For a government that promises not to raise taxes, these looming employee contribution increases will be political dynamite. The 2009 EI rate for employee contributions was set at $1.73 per $100 of eligible earnings and applied also to 2010 (employers pay 140% of the employee contributions). However, the chief actuary has calculated the break-even EI premium for employees to be $2.43 per $100 of earnings in 2010.

How can the Conservatives get out of this box? One approach is simple: Just don’t increase premiums. But then EI will be in permanent deficit and the government will be reneging on its promise to make EI operate more like an insurance program with premiums covering benefits.

Another idea is to cut another tax like the GST as an offset to the payroll tax increase, allowing the government to claim that total taxes are not being raised. With sales tax increases in Quebec and Nova Scotia and sales tax harmonization in Ontario and BC, a GST rate reduction could be politically popular in about three-quarters of the country.

The difficulty with this strategy is both economic and political.

Payroll taxes fall on all workers, while GST reductions benefit both workers and the elderly. Such a revenue-neutral shift from consumption to payroll taxes would raise taxes on workers and lower them on the elderly. With society aging, the last thing Canada needs is another burden on the working population to fund rising health-care and retirement benefits.

Besides, the unemployment rate is still close to 8%. Employers would also have to pay more payroll taxes, making them disinclined to hire more workers unless they could also lower employee compensation to offset these higher taxes. And politically, the public rarely believe shifts in taxes will be revenue-neutral. Ask the hapless Liberals who proposed a green tax shift from income to carbon taxes in the last election. They paid the price at the polls.

A better approach is to consider reforms to the EI program to reduce payroll taxes over time. Two particular ideas could be considered.

The first is to improve the efficiency of the program by reducing incentives for individuals and firms to use the EI system as a subsidy for employee turnover. Even though many recent workers have been badly hit by bad times and have received more support with extended benefits, it is still the case that some workers might claim EI to take short-term holidays, only to be brought back to work later (ask some school boards, for example).

Several commissions over the past 40 years proposed partial experience rating to improve incentives for businesses to keep workers rather than laying them off temporarily. Without experience rating, businesses that lay off workers during the year pay the same premium as those businesses with better records. This contributes to greater unemployment levels, as well as being very unfair to businesses with better employment records.

With experience rating, commonly used in Canadian workers’ compensation and U.S. unemployment insurance programs, employers with better records would pay lower EI premiums. Flaherty could bring in partial experience rating by letting those firms with better employment records have a payroll tax cut. He could also get rid of regional benefits that have distorted labour markets by providing higher benefits in some regions.

Another proposal would strip the EI program of expenditures that have little to do with unemployment. About one-quarter of EI program expenditures provide support for parental leave, compassionate leave, training and certain other programs.

The issue is whether the EI payroll taxes rather than general revenues should be used to pay for costs unrelated to unemployment. EI premiums, even those paid by the employer, fall on the backs of workers. With maximum contribution limits, payroll taxes represent a greater burden on workers with low and modest incomes.

Overall, it would be far better to fund general social benefits with general taxes rather than upping EI payroll taxes. It would not help Mr. Flaherty with his deficit goals to simply shift some EI program costs off the payroll tax system onto the rest of the tax system. He would have to take a stronger stance to cut spending, something that has not been strongly pursued in the past few years.

EI reforms would let the Conservatives avoid payroll tax increases. They have little excuse to let such taxes rise.

Financial Post
Jack M. Mintz is the Palmer Chair in Public Policy, School of Public Policy, University of Calgary.