Can we tax our way to equality?

With the Occupy protesters still camping out on city lawns across Canada, it’s worth investigating whether our tax and transfer system needs a tune-up if we’re going to tackle income inequality.

To be sure, we are a more unequal society than we were thirty years ago, even after one takes into account the redistributive effects of personal income taxes and things like the National Child Benefit and Employment Insurance programs. In 1989, the after-tax income of Canada’s richest 20 per cent was 7.2 times that of the poorest quintile of the population, according to the Conference Board of Canada. In 2009, the richest group made 9.1 times what the lowest income earners did.

Part of the reason is the diminishing role that taxes and transfers have been playing in offsetting income inequality since the mid-1990s. As in many other advanced economies, the gap between rich and poor in Canada started widening in the 1980s, but right at that time the tax system became more progressive, undoing the rise in pre-tax income inequality, says Kevin Milligan, professor of economics at the University of British Columbia. Around the middle of the following decade, however, tax rates across the nation started going the other way. With Canada’s balance sheet back in order, the provincial and the federal governments saw no reason to keep in place the tax hikes they had adopted in the 1980s to replenish the country’s depleted public coffers. “And that’s why by the end of the 1990s we saw a pretty big increase in various measures of inequality,” says Milligan. Eleven years later, things haven’t changed much, and pre-tax income inequality has continued to rise.

Transfers are not what they used to be either. In 1994, for example, a single parent on welfare with one child would receive an average income of nearly $18,200 in 2009 dollars, compared to slightly over $17,000 in 2009, according to the Conference Board.

So what can Canada do, should it want to shrink the distance between the top and the bottom of the income ladder?

“Tax the #@&%ing rich”– as one Occupy Wall Street protester had it–is one possible answer. In particular, we could make the tax system more progressive at the top. After all, the top federal tax rate in Canada kicks in at a mere $128,800, which is much lower than the U.S.’s $377,900 and the U.K.’s $234,000, according to Milligan. But don’t expect the rich to simply write a fatter check to the Canada Revenue Agency, warns Université Laval economist Stephen Gordon. The rich, he says, can elude the taxman more easily than any other group, for example by abandoning provinces with more unfavourable tax regimes, moving to another country, or demanding higher salaries so that their net income won’t suffer as much from the added fiscal pressure–and they can do so, says Gordon, because “today’s highest earners can often credibly say: ‘I’m the best at what I do.’”

And because most of today’s rich get their money from wages like everyone else, rather than family fortunes, raising their taxes would mean diminishing the extent to which Canada rewards education, talent and hard work, says Gordon. Of course, a couple more percentage points worth of taxes on high-income earners isn’t likely to trigger a brain-drain or dampen entrepreneurial effort. But some Canadian economists remain cautious about tax hikes on the wealthy, a policy option they say can have a number of unintended consequences that could harm the economy.

Increasing transfers to low-income groups, on the other hand, seems like a safer bet. That’s because the poor’s reaction to welfare incentives is both better known and easier to predict. Transfers simply work, says Gordon. Take Sweden, he suggests, where inequality in income both before and after taxes is the same as here in Canada, but disposable income is much more equitably distributed. “The big difference,” he maintains, “is the transfers to lower income households.”

Another reason to like transfers is that programs like the Working Income Tax Benefit, which top up someone’s paycheck, play an important role in motivating low-income earners to continue to work or join the workforce, says Milligan. And making refundable tax credits more generous won’t have a large administrative burden, because we already have those systems in place, he adds. Adding some weight on the mice, it seems, is a better bet than putting the fat cats on a diet.

Origin
Source: Maclean's