Whacking the top one per cent with a tax hike not the bonanza Liberals hype

Posted on in Equality Delivery System

NationalPost.com – News/Canada/Canadian-politics
November 27, 2015.   Andrew Coyne

Whatever other Liberal election promise is or is not included in next week’s throne speech, it’s a fair bet that raising taxes on “the wealthiest one per cent” will feature front and centre. Somewhat less prominence will likely be given to the tax cut for the middle class.

It wasn’t always this way. When the two policies were first announced last spring, it was the middle class tax cut that took first billing. “A Liberal government will give a tax cut to middle-class Canadians,” the party trumpeted, “by asking the wealthiest Canadians to give a little more.”

By the time the campaign rolled around, however, the emphasis had been reversed. In the debates, Justin Trudeau put the tax increase on the rich first, the middle class tax cut second, the better to differentiate his plan from that of the NDP. “I can’t quite understand,” the Liberal leader said in the first debate, “why Mr. Mulcair has ruled out doing what we’re doing, which is asking the wealthiest one per cent in this country to pay more tax, so we can give a big tax break to the middle class.”

By the debate on the economy later in the campaign, the language had gotten harder still. They weren’t just going to “ask” the rich to pay more: they were damn well going to raise their taxes. The Liberal plan to “grow the economy,” he said, “starts with actually raising taxes on the wealthiest one per cent.” Whereas “Mr. Mulcair is not going to raise taxes on the wealthiest Canadians. He’s chosen to not raise taxes on the wealthiest Canadians.” The middle class were still in there somewhere, but as a distinct after-thought.

This was probably not accidental. One suspects the thought of sticking it to the rich tested rather better with the focus groups than a modest increase in their own paycheques. What a shock it will be to most of those voters to find that they are not going to see much of either.

The notion that what fairness demanded most of all was a tax cut for the middle class — as opposed to a tax cut for the lowest class — was always a bit of a stretch. Had the Liberals cut the 15 per cent bottom rate, of course, they could have done both, since the cut would benefit not only those in the bottom bracket but also those above it. But since the point of the exercise was to bribe the middle, they were not about to waste precious dollars on the poor.

But in fact, as others have pointed out, the 1.5 point cut in the 22 per cent “middle” tax bracket — that is, on taxable incomes between $44,700 and $89,400 — leaves out about two-thirds of all tax filers. At the same time, it also benefits those above it, including the top one per cent the Liberals are so anxious to be seen whacking. Indeed, lots of people earning well in excess of the $200,000 threshold at which the new 33 per cent tax rate kicks in will end up paying less tax under the Liberal plan, netting the tax increase against the tax cut.

That doesn’t mean they’re a wash. For the rich, the tax cut applies, in effect, to income they’ve already made. The tax increase, by contrast, applies to income they’re thinking of making: to the next hour worked, the next investment. The first is unlikely to have much impact. The second, because it is imposed “at the margin,” where decisions are made, may well.

This is why the tax increase on the “one per cent” ought to concern the rest of us: not, obviously, because of any hardship the rich are likely to endure, but because of how it might affect their behaviour, namely their incentives to work, save and invest.

Suppose it takes a 10 per cent rate of return, after tax, to persuade someone to make a given investment. At a 50 per cent marginal tax rate (in some provinces, the combined rate is even higher), that implies a pre-tax rate of return of 20 per cent. Cut the top rate to, say, 33 per cent, and the required pre-tax rate of return drops to 15 per cent. So all those projects paying 15 to 20 per cent pre-tax, previously uneconomic, suddenly become economic. And vice versa: raise taxes and you deter investments that might otherwise have been made.

The government plainly can’t collect revenues on income that is never earned. But that is not the only way in which raising taxes at the top may lead to reductions in reported income. As the economists Kevin Milligan and Michael Smart find in a new study published by the Institute for Research on Public Policy, provincial attempts to raise taxes on high-income earners — seven provinces have done so since 2010 — may not yield the revenues projected, given the likely behavioural response on the part of those affected: whether hiring tax lawyers and accountants to shelter income, or simply shuffling income into lower-tax jurisdictions.

The study finds a five percentage point increase in the top rate of tax in each province, rather than yielding the additional $2.9 billion in revenue a straight-line projection might imply, would in fact raise less than half of that amount. Its authors muse that a tax increase at the federal level might not run into the same degree of revenue leakage, since it is harder to shift income between countries than provinces. But another study, this one by the C.D. Howe Institute, finds if anything a rather larger behavioural effect: rather than the $3 billion the Liberals project their tax increase would raise, the Howe study puts the revenue gain closer to $1 billion.

It’s one thing to “ask” the wealthiest one per cent to pay more, or even tell them to pay more. It’s another thing to actually get them to pay more. In which case, who’s going to pay for the Liberals’ middle class tax cut?

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