The Economic Costs of Increased Marginal Tax Rates in Canada

Economists often focus on marginal tax rates (the extra tax an individual (or firm) will owe to the government for engaging in a little more of the taxed activity) as particularly important for altering economic behaviour. The marginal tax rate is significant because it indicates the amount of tax a person will pay for an additional dollar earned. An extensive literature documents that taxes?particularly progressive income and capital taxes?reduce economic growth, saving and investment, business formation, and job creation.

Superficially, with a top federal personal income tax rate of 29 percent, Canada appears to enjoy the lightest tax burden among the G7 countries and Australia. However, this appearance is deceptive. Canada places a relatively greater emphasis on provincial taxation than do other countries in its peer group. For example, both Quebec and Ontario have steeply progressive income tax codes, with top rates of 24 and 18.97 percent, respectively.

Also, the top marginal rate kicks in at different thresholds around the world: in Canada, personal income tax thresholds are typically lower than in the other reference countries. In fact, both the federal top rate and the threshold at which that top rate kicks in are low compared to other countries. Taken together, these two adjustments put Canada?s tax rates somewhere in the middle of those in the peer countries, underscoring the need for federal and provincial tax relief and reform if Canada wishes to build on past improvements and its current success.

The most obvious solution to the relatively high total burden is income tax reform, particularly at the provincial level. The principles for income tax reform are straightforward: flatten rates and broaden the tax base (by reducing or eliminating tax credits, deductions, etc.).