By Ben Eisen
and Jason Clemens
The Fraser Institute
In the coming months, finance minister Bill Morneau, the former chair of the C.D. Howe Institute, will be tasked with one of the government’s most important responsibilities: crafting and delivering its first budget. We hope the research and ideas Morneau was exposed to during his time in the think tank world will help shape the government’s policies.
One high profile aspect of the budget will be the Liberals’ election promise to increase the top personal income tax rate. A robust body of research shows that high personal income tax rates are harmful to economic performance. One of those studies, which examined the tax rate increases in Ontario under Premier Kathleen Wynne, was published by the C.D. Howe Institute in 2012. It concluded that tax rate increases in Ontario would “likely create more economic costs than benefits” because of the negative incentives such tax rate increases impose on investors, entrepreneurs, and skilled labour. The study further stated that behavioural responses would likely reduce government revenue in the long term by more than the province would collect.
Although the behavioural response to a federal tax increase would not be as strong as a provincial tax increase (because it is harder to change the country you report income in than the province), the C.D. Howe paper correctly observed that higher-income taxpayers respond to higher taxes by reducing their labour supply. This would be equally true for a federal tax increase, with the consequence of reduced economic growth and weaker-than-expected revenue gains.
Our own work buttresses these conclusions. For example, a recent paper on personal income taxes showed that Canada fared poorly compared to the United States and a number of other industrialized countries in terms of both tax rates and the income levels at which they apply. This suggests that further increases to income tax rates would negatively influence investment, entrepreneurship, and overall economic growth.
Another major initiative for Morneau will be pursuing an agreement to expand the Canada Pension Plan (CPP). A number of studies released over the last 18 months demonstrate that the core assumptions upon which the CPP expansion is based are false or at least misleading.
In June, the C.D. Howe Institute published a study by leading pension expert Malcolm Hamilton evaluating the state of retirement savings. The study demonstrated that hand-wringing over a retirement crisis was based on a misunderstanding of how savings are calculated. Hamilton concluded that Canadians are generally well-prepared for retirement and that for most the greatest financial challenges actually come earlier when people are trying to buy a first home and support young children.
In addition, a recent report quantified the fact that increases in the mandatory CPP will be almost completely offset by reductions in voluntary savings such as RRSPs. In other words, expanding the CPP will not increase overall retirement savings but simply shift it from private, voluntary accounts to the CPP.
Because most Canadians are well-prepared for retirement, our priority should be providing targeted assistance to the small number of people who are actually slipping through the cracks and facing penury in old age. Expanding the CPP will not efficiently help the individuals in greatest need, and takes money out of people’s pockets when they need it most.
On a closely related point to both the proposed tax rate increases and expansion of the CPP, namely an overarching concern with inequality, Morneau would be well-served by considering recent think tank research. For example, a recent paper shows that hyperbolic claims of rapidly growing income inequality are usually based on overly simplistic analyses that fail to take into account existing redistributive tax and transfer policies. When after-tax income is considered, family income inequality has only risen between 6.5 and 12.9 per cent between 1982 and 2010, a much more modest increase than is suggested by more simplistic analyses of pre-tax income. Morneau should consider this evidence and reject populist policy responses to a perceived “inequality crisis” such as higher capital gains taxes, corporate income taxes, and personal income taxes that would harm Canada’s economy.
As the former chair of the C.D. Howe Institute, finance minister Morneau is surely well aware of the important research produced in recent years by his own organization and other think tanks such as ours which provide important insights that can help guide pro-growth economic policy. Hopefully, Morneau will rely heavily on this research as he works to craft the government’s policy agenda.
Ben Eisen and Jason Clemens are economists with the Fraser Institute.