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How a modest tax change can help low-income families and lower inequality

Wayne Simpson is professor of economics at the University of Manitoba and a research fellow of the School of Public Policy at the University of Calgary; Harvey Stevens is a professional affiliate with the department of economics at the University of Manitoba

There is much discussion about how to address income inequality, including calls to expand income security for low-income Canadians with some form of a guaranteed annual income. But revamping Canada's income security system is not the only way forward nor is it necessarily the most attractive option.

The current tax system contains more than $80-billion of tax credits which are non-refundable, which means that low-income Canadians who do not have sufficient taxes owing cannot benefit from them in the same fashion as higher-income taxpayers. While tax filers will be most familiar with the basic personal amount at the top of Schedule 1 of the federal income tax form, other credits for age, eligible dependents, employment and education are also important.

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Our recent research paper evaluates the effect of converting these non-refundable credits to refundable credits in the fashion of existing credits such as the Goods and Services Tax Credit and the Working Income Tax Credit and the recently replaced National Child Benefit. A refundable credit simply converts any excess between the credit and taxes owing to a refundable benefit, allowing low-income tax filers to realize the benefits of these tax credits that already accrue to higher-income tax filers.

Using the Statistics Canada Social Policy Simulator, we evaluate simple and feasible changes to the current tax system that would make all currently non-refundable tax credits refundable. The effect of these changes is to direct significant benefits to Canada's poorest families at a modest additional cost.

For example, a very simple option that sets the maximum benefit at 15 per cent of the total value of currently non-refundable tax credits for each family and reduces the benefit by $15 for every $100 of taxable income would raise the incomes of Canada's poorest families – those with incomes less than one half the Statistics Canada Low-Income Cut-off – by more than $2,000, or 28 per cent. These benefits would decline for families with higher incomes until they virtually disappear for families with incomes exceeding 150 per cent of the cutoff, as the benefits are targeted to poorer families.

The cost of this adjustment to the current tax credit system would be $6.6-billion, which is in the range of current proposals to deliver benefits to families in the form of income splitting, enhanced child benefits and other niche tax credit initiatives, but with a much larger effect in reducing family and child poverty.

Other simulations show that even greater benefits to poor families can be realized with slightly more complex programs. Introducing an exemption on income – as is the case for some current refundable tax credits – of up to 25 per cent of the Low-Income Cut-off, with a benefit reduction of $20 for every $100 of taxable income thereafter, could improve the incomes of Canada's poorest families by an additional 10 per cent at an additional cost of $600-million.

Allowing the benefit reduction rate to vary by family size, as in the National Child Benefit, could deliver the same benefits to low-income families at lower cost. For example, setting benefit reduction rates that rise from 11 per cent for single individuals to 27 per cent for families with five or more would also raise the incomes of Canada's poorest families by more than $2,000, or about 29 per cent, at a reduced cost of $5.2-billion.

A modest change to the tax system that converts existing non-refundable tax credits to credits that are refundable constitutes an effective step toward improved income security for Canada's poorest families in the fashion of a guaranteed annual income. The new benefits would be almost entirely realized by families below or near Statistics Canada's Low-Income Cut-off and so the poorest families would benefit the most. Tweaking the tax system in this way could potentially improve the fairness of tax filing while addressing Canadian income inequality.

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While the study does not consider provincial and territorial action along the same lines, their participation would provide additional benefits to low-income families of a comparable nature.

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