Alberta should learn from folly of federal tax increase

An old saying explains some folks’ tax philosophy: Don’t tax you, Don’t tax me, Tax that fellow behind the tree.

For our federal government since 2015, “that fellow” has meant anyone with an annual income above $200,000. This means pretty much every obstetrician, anesthetist and dentist has been picked to pay higher income taxes in recent years. And some veterinarians and fieldworkers, whose incomes can reach numbers like those of bankers and lawyers. Remember, the top one per cent of Canadians is still more than 370,000 people.

So, how’s it working out?

Remember that in late 2015, the newly elected federal government announced a new top income tax rate for “top earners,” boosting the federal rate from 29 per cent to 33 per cent.

Because it was preannounced, everyone able rushed to pull income into 2015 by, for example, selling assets to catch a lower capital gains tax rate and pushing expenses and other deductions into 2016. Consequently, federal personal income tax revenue jumped in 2015—and promptly plummeted in 2016. Government revenue has since recovered, but well short of what you would have expected back in early 2015.

Short-term shenanigans aside, what about the longer term when people’s choices include more than shifting income or expense timing but shifting themselves elsewhere or working or investing less than otherwise? People with non-gargantuan incomes can change habits in response to higher tax rates, like by spending more time skiing in Banff or swimming in a Caribbean tax haven.

A recent study by Ergete Ferede of MacEwan University (published by the Fraser Institute) raised this long-term question. Comparing baseline revenue projections to empirical data about how Canadians historically respond to federal tax rate changes, we can make a pretty good estimate. The study’s medium-term estimates show that the federal government does get a little more money, almost in line with its forecasts.

Over time, however, taxpayer responses begin to add up, as taxable income—the federal tax base to which tax rates are applied—grows more slowly than otherwise.

And after about nine years, the study’s numbers show federal personal income tax revenue tracking lower than the baseline. Which means the federal tax rate increase causes the government to get less money than had it done nothing, which of course is pain for no gain.

As you would expect. We are told that if we want less of something, say carbon dioxide emissions, we should tax them more. If we want less smoking, tax it through the roof. And if we want people to earn less income, well, tax it more.

Which takes us to Alberta.

In 2015, the Prentice government opened the gate to tax rate Hades by scrapping Alberta’s hard-won flat-rate personal income tax of 10 per cent. To the surprise of none, after that the province went on to acquire higher tax rates and brackets. And while an oil shock intervened, the province’s personal income tax revenue in 2017 was almost exactly where it was in 2014.

Albertans may be disappointed by the Kenney government’s quietude on personal income tax rates, but they may be surprised to know that taxpayers outside the province are, too. That’s because Alberta’s prior flat-rate heaven was a relative tax haven for Canadians looking for a friendly place to live, work and invest.

Lacking Alberta’s competitive tax rate discipline, other provinces have less incentive to restrain their taxing selves, which is less good for everyone. Perhaps Alberta’s new premier will appreciate the fiscal folly of trying to tax the fellow behind the tree.