Canada’s high income taxes are hurting the country’s international competitiveness and contributing to reduced economic growth, says a report released by the Fraser Institute in October. High personal taxes also are depressing saving rates, investment, business formation and job creation, says the report from the institute, a Vancouver-based conservative think-tank.

The report – entitled The Economic Costs of Increased Marginal Tax Rates in Canada – is based on an extensive review of theoretical and empirical research on the importance of taxes to the economy’s health. The research compared Canada with the G7 countries and Australia (referred to as the “peer group”) and focused heavily on comparisons with the U.S.

“There is general consensus among people from all walks of life, including politicians,” says Sean Speer, associate director, fiscal studies, with the Fraser Institute, “that taxes influence our personal decisions.”

The report states that federal tax reforms in the 1990s and early 2000s have made Canada’s business and investment taxes competitive. But the study also found that Canada trails its peer group when it comes to the level of personal income taxes.

Deceptive

Canada’s top federal personal income tax rate of 29% appears to be the lightest tax burden among the G7 countries and Australia, the report says. However, this is “deceptive,” it says, because Canada places relatively greater emphasis on provincial taxation than does the peer group.

“This contrasts with the U.S.,” says Speer, “where the federal rate is the primary rate, with low or virtually no taxes at the state level.”

Indeed, when Canada’s provincial taxes are added to federal taxes, the marginal tax rate on personal income is much higher. For example, Quebec and Ontario have top marginal rates of 24% and 18.97%, respectively.

Making adjustments for differences in marginal tax rates and the income thresholds to which they apply across the peer group, the report places Canada in the middle of the peer group in terms of the level of personal taxation.

In an example cited in the report, Canadian individuals earning 167% of the average wage have a combined federal and provincial marginal personal income tax rate that is 3.7% higher than for peers in the U.S., 5.3% higher than for peers in France and 10% higher than for peers in Japan.

The research also found that if an individual was earning an income that would just place him or her in the top federal tax bracket in Canada in 2012, that individual would face a higher total income tax rate in every single province than in any of the U.S. states.

The report cautions that lower U.S. taxes can have “serious consequences for the Canadian economy,” given the relative ease with which highly skilled workers move between Canada and the U.S.

The report stresses the importance of the marginal tax rate, which determines the amount of taxes an individual will pay on each additional dollar earned above a certain threshold. The report suggests that the amount of taxes that individuals pay influences several of their decisions: how much time they devote to work; whether they find a new job or incur the risk of entrepreneurship; how much they save or spend on education; and whether they look for legal or illegal ways to reduce their taxes.

Regarding work effort, the report cites research showing that individual decisions about whether or not to work are affected by taxes. Consequently, if marginal tax rates are high, individuals may choose to work less.

Savings rates

The report also notes that marginal tax rates influence the amounts that individuals contribute to tax-deferred savings vehicles. In research that supports higher marginal tax rates, albeit from the perspective of lessening the tax burden, one study found that an increase of 10 percentage points in the marginal tax rate increased the probability of participation in RRSPs by 8%.

Taxes also influence the decision to be self-employed. Using U.S. data, another study used in the Fraser Institute’s research found that individuals may choose not to become entrepreneurs under a progressive tax structure that would lead to more taxes on profits earned but reduced tax savings on losses incurred.

At a more macro level, the Fraser Institute report reviewed research on the impact of high marginal tax rates on economic growth, business activity and investment. Using data for 23 member countries in the Organization for Economic Co-operation and Development between 1951 and 1990, one study found that an increase in 10 percentage points in marginal tax rates decreased the annual rate of economic growth by 0.23 percentage points.

Another study, which examined 20 other studies on tax rates and economic growth in the U.S. and abroad, concluded that reducing all marginal tax rates by five percentage points and reducing average tax rates by 2.5 percentage points probably would increase long-term economic growth by 0.2 to 0.3 percentage points.

The Fraser Institute report also cites studies that looked at the impact of progressive tax rates on economic growth. In one such study using U.S. data, it was found that a tax system with a rising marginal tax rate reduced growth by 0.13 to 0.53 percentage points.

The Fraser Institute report suggests federal and provincial governments pursue tax reform, with the aim of lowering marginal tax rates and increasing the income thresholds to which they apply.

The report also recommends flattening income tax rates and broadening the tax base, without insisting on the need to be revenue-neutral.

Speer says another report, with specific recommendations based on the research used in the October report, is expected to be published next year.

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