DISPELLING COMMON MYTHS ABOUT INCOME SPLITTING
Analysis by Frank Stokes:
Answers to the objections:
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Objection
Individual-based taxation is one of the key aspects of a fair tax system.
Answer
What makes individual taxation a key aspect of a fair system? It is a feature of the Canadian system, but when applied to taxpayers who have formed an economic union as part of marriage, and wish to make that union complete by pooling their assets and income (which family law assumes), it is inappropriate. Let’s take a logical look at a typical situation: Individuals A,B form a married couple 1, while C,D form married couple 2. A,B each earns $30k. C earns $60k and D earns $0. The individual partners in each married couple share their income. All four individuals are at the same before-tax economic level, but in Canada, individuals C,D both lose much more income as a result of taxation than individuals A,B. Therefore individuals C,D are unfairly treated by the single-income penalty, and this penalty is clearly a contravention of the tax principle of horizontal equity, which states that individuals living at similar economic levels should be taxed equally, and this is a key principle of taxation.
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Answer
That may be so, but why should that be a valid reason for refusal to correct a clear inequity in this case? It is not our job to iron out wrinkles in the tax system caused by this one being straightened out, nor to design a system that will have no wrinkles.
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Objection
Income splitting would lead to a marriage tax.
“Marriage tax” refers to extra tax levied on a couple, compared to the total they paid when they were two singles. It is based on the rationale that it is cheaper for them to live in a single household and so they have more disposable income. Canada currently has no marriage tax.
Answers
1) If the objection is saying that the tax revenue loss resulting from income splitting would have to be recovered by increasing the taxes of all couples including equal-income couples and this would constitute a marriage tax, that might be a detriment in itself, but still fairer than the present clear inequity. If a marriage tax were instituted (as with any revenue-neutral solution to the issue) we would be sharing the cost of wiping out our own unfair penalty. Equal-income couples should not, as a class, blame us if they have to start paying the marriage tax, because it seems we have been subsidizing their freedom from it for decades.
2) Income splitting does not necessarily call for a marriage tax. The revenue loss from elimination of the penalty could be made up by increasing overall taxation, or could be absorbed by the chronic surpluses. If the U.S. can be used as an example – the U.S. has income splitting and no marriage tax.
3) There are now couples in Canada where the partners are both living cheaper by sharing household expenses, than they did as singles and not being made to pay a marriage tax: the equal-income ones. Why should a general marriage tax start now if the tax penalty were eliminated for the others? For the government to say that a marriage tax would then be necessary in order to keep up revenues, is an admission that general application of a marriage tax – a measure that would surely lower their popularity with voters – was avoided at the expense of those paying the tax penalty! The only thing which allows the government to get away with the current tax grab (the single-income penalty) is that it is not well known among the voting public, even though it is a serious inequity. (That could be due to the fact that it started long ago when most couples were single-income and there was not a significant group of dual-income couples to make a comparison with. Even when the jump in the penalty came in 1988, it was just that, not a sudden beginning. Also, since it is an automatic consequence of individual taxation and vertical progressivity, it has always simply been taken for granted). The sudden announcement of the beginning of a marriage tax on the other hand, even though such a tax is not an inequity, would trigger very unfavourable publicity.
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Objection
Why should the government subsidize single-income couples?
Answers
1) That is a distortion of the situation. The government’s ending the single-income penalty would not be a subsidy, because the ending is justly owed to the couples. Rather, it would be the loss by the government of an inequitable tax grab.
2) If there is any subsidising involved, it is presently being done by single-income couples, who are paying more tax than is fair in view of the principle of horizontal equity (that individuals living under similar economic circumstances be taxed similarly – see the objection “Individual-based taxation is one of the key aspects of a fair tax system”
3) Actually, there is justification for subsidizing single-income couples when they are in that situation in order to concentrate on child-rearing, which benefits Canada by alleviating our underpopulation.
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Objection
Income splitting effectively puts the lower income into a higher tax bracket.
Answer
So what? – the higher income goes into a lower bracket with the net result that the couple pays less tax and they are left with more after-tax income to share. There might be a small percentage of couples who don’t share their income, but why should the income tax formula be tailored to them? Besides, we hold that splitting should be optional, and such couples could continue to be taxed as individuals (and pay more taxes as a household) if they want to.
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Objection
Answers
1) Using the tax system as a device to further an agenda of social engineering like this is odious. (Government policy is known to favour employment of women, including married women, but this is not openly and widely declared for all to see, criticize, and take into account in deciding on economic division of labour within a marriage).
2) It assumes that spouses do not pool earnings for at least the major household expenditures like housing and food. Should the tax system be designed to reflect such a bizarre situation when in fact the vast majority of couples largely share income?
3) What about the many situations where one of the partners cannot go into employment? Granted in some cases such as infirmity there are financial compensations made, but do they even approach the magnitude of the tax penalty?
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Objection
Answers
Many comparisons of situations can be made, and judgment of fairness and equity made in each comparison. Why should it be necessary for the situations to be sequential, or involving the same couple, for principles of fairness and equity to be applicable in the comparison? The comparison we make is fair subject matter to be judged under the principle of horizontal equity.
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Objection
Canada’s income tax system is based on the principle of taxation of the individual, so our household-to-household comparison is invalid and there really is no inequity.
Answers
Why should taxation of the individual be considered a principle of taxation (in the sense of a basic principle in the design of a country’s tax system), rather than just a feature? Most other G7 countries have no single-income penalty. Are those tax systems violating a basic principle of taxation?
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Objection
The tax differential between single- and dual-earner couples follows naturally from the combination of individual taxation and vertical progressivity.
Answers
The differential does follow from those two features of Canada’s tax system, but to say it follows “naturally” is misleading because it is a suggestion that the differential is a good thing. It does follow naturally in the sense of a logical consequence, but that does not mean it is fair, or natural in the sense of being good for people, nor in the sense of being absolutely unavoidable.
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Objection
There are ways to avoid the penalty, for example RRSPs
Answers
1) These are not available to, or economically feasible for, all victims of the tax penalty, so the existence of these exclusive ways is in itself an unfairness, which requires general income splitting to correct it.
2) Some require foresight which young people entering careers and marriage, likely do not exercise it they simply trust the tax system to be fair.
3) Because the impact of the single-income penalty is so significant, a more tax savvy younger generation are consulting advisors to arrange household income as well as plan retirement income in a manner that minimizes tax. Many accounting and legal firms specialize in this field and build consultancies around this issue. The very fact that there is a need for people to be so wary in tax planning indicates unfair, illogical and coercive tax laws and systems which simply invite methods of circumvention, legal and otherwise. Most of the western nations have been able to address this by using a tax system that is fair and treats couples in a fair and equitable way. Canada’s approach has been to apply piecemeal fixes when a fundamental change is required.
3) People with Registered Retirement Plans are not permitted to split income, or, when working, designate part of their pension contributions to flow into spousal RRSPs.
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Objection
Answers
1) These are tiny compared with the present massive single-income penalty.
2) Most require conscious knowledge and initiative.
3) They are not universal – there are many circumstances where these breaks don’t apply.
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In some households the income is not fairly shared, which shows the need to tax the marriage partners as individuals.
Answer
1)This does not justify penalizing the great majority of households in which fair sharing does occur.
2) This objection does not prevent the other members of the G7 from having fair tax policies.
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Income splitting won’t ensure that the money is shared equally.
Answer
1)The present system assumes there is no sharing at all, when obviously a vast amount is going on. Will the government only agree to recognize sharing when it is 100% perfect?
2) This objection does not prevent the other members of the G7 from having fair tax policies.
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The annual revenue loss to the government, of income splitting, would be prohibitive.
Answers
1) The figure given by a government official to an advocate for elimination of the single-income penalty during a phone conference in the last few years as the cost of eliminating the penalty for all taxpayers was $3.8B. Perhaps today it is $4B, to use a round figure.
Let’s try to put the cost in perspective against other tax expenditures (the term for foregone tax revenues due to special exemptions, deductions, rate reductions, rebates, credits and deferrals, etc., that reduce the amount of tax that would otherwise be payable), which the government is already making.
a) The cost in perspective against the total cost of all current tax expenditures:
In the Department of Finance document Tax Expenditures and Evaluations – 2004 (available at http://www.fin.gc.ca/taxexp/2004/taxexp04_2e.html), the sum of all projected 2004 federal personal income tax expenditures, not counting transfers to provinces, is close to $90B. If we include the expenditures in the corporate tax system and the GST tax system, the total of expenditures goes to $120B, and that still does not count the many items for which a dollar figure is not available.
Therefore, what we are asking for would cost in the order of 3% of what all current expenditures cost.
b) The cost in perspective against some expenditures of comparable amount (same source as above):
Charitable donations credit $1.6B
Non-taxation of business-paid health and dental benefits $2.2B
Age credit $1.5B
Employee-paid CPP contribution credit $2.5B
Important as the above expenditures are, is the correction of a clear inequity in the tax system, that can cost people thousands of dollars yearly in an unjust tax penalty, so much less important that after decades of protest (back at least to the Carter Commission in 1966).
2) Stopping the single-income penalty should not be considered by the government as incurring a new cost to bear. Since the penalty is unjust, stopping the penalty should be considered as merely giving up an unjust tax grab that has gone on far too long. A tax grab that has been making some taxpayers involuntary extra-contributors to the budget, including all the surpluses years ago! It is even somewhat surprising that advocates have not called for retroactivity.
3) In the end, shouldn’t the test of fairness, equity, and justice be enough? What price justice?
4) Why not start immediately with a small amount of income splitting, and phase it in over a period of several years?
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With a broadening in the definition of marriage to include other sorts of unions, there will be an increase in the number of such unions, with a portion of them single-income. Is the government supposed to extend elimination of the tax penalty to these as well?
Answers
1) It would seem that to be fair, yes. But to suggest that that would make the cost prohibitive would seem to overestimate the number of such new unions.
2) These unions can be expected to less frequently incur the most common reason for a single-income family lifestyle: parenthood.
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A tax system based on the household would be complex and cumbersome.
Answer
This has not been shown, but even if it were so, is it better to leave the system unfair?
Tax returns are not already complex and cumbersome anyway?
Our request for fairness, compared with other taxpayers, is no more complex than current arrangements for CPP and spousal RRSPs
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Advocates for income splitting should be careful in making comparisons to the US on specific items, and leaving out other issues. While the US doesn’t have the “single-income tax penalty”, it does have other items of taxation more severe than in Canada, e.g. significant estate taxes, much higher Social Security contributions, and lacks the principal residence exemption compared to Canada.
Answer
Isn’t that like saying “The US does not treat single-income couples inequitably, but does treat many taxpayers more severely, especially homeowners and heirs”. Does it show that our inequitable treatment is OK? If the US heirs and homeowners complained to the US government, should the US government say “Yes but look how unfairly Canadian single-income couples are treated (in the comparison with Canadian dual-income couples), so don’t complain”, and then should both governments feel justified in doing nothing? More importantly, we have to keep apples and oranges apart. The single-income penalty issue is an equity, thus a justice, issue, while the amount of estate taxes and Social Security contributions is a discretionary matter that depends on political philosophy and judgement. We should not have to put up with an injustice in return for having it easy in arbitrary and discretionary tax categories.
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Income Splitting in Canada 