Trudeau takes from the rich, gives to the median

Posted on May 5, 2015 in Governance Debates – Full Comment
May 4, 2015.   Stephen Gordon

Economists have a question they like to ask when evaluating a policy proposal: what is the problem that this measure is supposed to solve? The Liberals have spent many months preparing the ground for policies aimed at supporting the “middle class” and Monday’s announcement is the first roll-out of specific measures: of higher taxes at the top, lower taxes at the middle and a Child Tax Benefit targeted at the bottom.

Justin Trudeau unveils his plan: Tax hikes on the rich to boost child-care benefits

But does the middle class need more support than other segments of the population? A proper definition of what it means to be “middle class” involves committing sociology, so instead I’m going to use the economist’s definition of someone whose income puts them at or near the middle — that is, the median — of the income distribution.

A 2014 story in the New York Times based on Luxembourg Income Study data suggested that median after-tax incomes in Canada have overtaken those in the U.S. To be sure, all cross-country comparisons have to be taken with a grain of salt, and the recent depreciation of the Canadian dollar has almost certainly changed things since then. Although the comparison with the U.S. attracted much of the attention in Canada, the real story in the U.S. has been the recent decline in median incomes. Moreover, there’s evidence that the U.S. income distribution is “hollowing out” — the share of people whose incomes put them close to the median is getting smaller, leading to an income distribution that is increasingly polarized. A narrative in which there was once a time when incomes were rising steadily, only to now find ourselves getting steadily worse off, makes sense in the U.S.

Such nostalgia is misplaced in Canada: median incomes fell dramatically between 1976 (when Statistics Canada’s data start) and 1997. For reasons that I still don’t fully understand, 1997 marked a significant turning point, and incomes have grown steadily since them. Moreover, as the University of Toronto’s Mark Stabile has found, there doesn’t seem to be much evidence that the Canadian income distribution has been hollowed out: the Canadian middle class has been holding up pretty well over the past 20 years. A narrative based on how things were full of promise in the good old days and how our dreams have since turned sour simply doesn’t fit the Canadian data.

[Chart] The State of the Middle Class; < >

Nor does it make much sense to claim that the middle class has been ignored over the years. Governments of all stripes — both federal and provincial — have been reshaping policy in its favour. In 1976, governments redistributed income away from the middle class: median after-tax incomes were more than 6 per cent lower than median market incomes. Since then, the tax and transfer system has been revised to produce the opposite outcome: median incomes after taxes and transfers in 2011 were more than 6 per cent higher than median market incomes.

This swing was not entirely — or even primarily — engineered by Stephen Harper’s Conservatives, but his government’s actions were generally consistent with this trend. Indeed, the recent expansion of the limits on Tax-Free Saving Accounts and the introduction of income-splitting are something of a departure. As the Parliamentary Budget Office noted in a report in March of last year, “(c)umulative tax changes since 2005 have been progressive overall and most greatly impact low-middle income earners (households earning between $12,200 and $23,300), effectively resulting in a 4.0 per cent increase in after-tax income.”

So to sum up: median market incomes have been rising, and — thanks to policy changes over the years by governments of all stripes and all levels — median after-tax incomes have been rising even faster to reach an all-time high. But it’s far too early to declare victory on this front: much of the damage of the 1976-1997 lost generation’ has yet to be repaired.

Broad-based income inequality worsened over 1976-1997, and notwithstanding governments’ efforts to reinforce the middle class, the tax and transfer system has become less effective at reducing inequality, partly because governments have been so focused on the median. In 1976, the bottom income quintile received 27 per cent of all government transfers; this share had fallen to 19 per cent in 2011. In contrast, share of transfers going to the middle income quintile increased from 17 per cent in 1976 to 23 per cent in 2011. (The share going to the second-lowest quintile remained roughly constant.)

So what about those whose incomes are too small to be considered part of the middle class? To be sure, low-income families with children will receive the largest payments under the Child Tax Benefit. But these households won’t benefit from the reduced income tax rate in the middle, and childless low-income households won’t benefit from either measure.

While there are important changes on the administrative side — most notably replacing a Universal Child Care benefit with a targeted program — the Liberal policy proposals fall squarely in the traditions of the Conservative government and those that preceded it. It’s an updated version of Robin Hood’s motto: “Take from the rich, give to the median.”

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