When analyzing tax policy, economists consider a number of aspects, including equity issues and efficiency. My Economy Lab colleagues Armine Yalnizyan and Frances Woolley examined the equity issues around the Conservative income splitting proposal, while Stephen Gordon has examined the efficiency loss from raising the corporate income tax rate. Following Stephen's lead, we can ask the same question of income splitting.
The proposed Conservative tax splitting measure will reduce federal government revenues by roughly $2.5-billion. The true cost to governments is higher than that, since the definition of taxable income used by provinces is the same as the one used by the federal government, a point made by my Economy Lab colleague Kevin Milligan on Twitter. Milligan estimates that the measure will cost the provinces roughly an additional $1-billion in tax revenue. Milligan wonders if anyone has asked the provincial premiers how they feel about losing a billion dollars in tax revenue a year.
How much added efficiency are we buying for our $3.5-billion? Likely not very much.
By transferring income, for tax purposes, from the higher earning spouse (known as the primary earner) to the spouse with the lower income (secondary earner), this lowers the effective marginal tax rate on the primary earner, but raises it on the secondary earner. Higher marginal tax rates are a deterrent to earning taxable income, so we should expect to see primary earners spend more time in the labour force, and secondary earners less.
But how big is this response likely to be for each group? A report by Simon Fraser University economist Jonathan Kesselman cites studies that find the labour force participation rate of married women is significantly more sensitive to changes in marginal tax rates than that of married men. Since secondary earners are still predominantly women, we should expect to see secondary earners decrease their paid hours worked at a greater rate than primary earners increase theirs. Having secondary earners reduce their hours worked or drop out of the labour force entirely does not bode well for economic growth.
But we have to consider the fact that those secondary earners that drop out of the labour force are not going to do nothing – rather they are going to spend more time engaged in home production such as cooking, cleaning and home repair. Although home production does not show up in our GDP statistics, which are based on market transactions, this home production has a great deal of value.
All tax systems by their very nature are biased towards home production. If I pay someone to paint my house, between us there are a number of taxes we must pay to the government, most notably sales taxes and income taxes. If I paint my house myself, there are no taxes on my labour since there was no monetary transaction. Because of this, the tax system is necessarily biased in favour of home production and we have more hours spent in home production than is economically efficient. Introducing income splitting on labour income just adds to this inefficiency.
It is difficult to defend income splitting on economic efficiency grounds. Other tax cuts, such as a cut to general income taxes, would provide far more added economic growth per dollar spent.
Mike Moffatt is a chemical industry consultant and a Lecturer in the Business, Economics and Public Policy (BEPP) group at the Richard Ivey School of Business
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