Federal Government’s “Eat the Rich” Plan Backfires

Commentary, Matthew Lau, Taxation

A few years ago, the federal Liberals told Canadians that they would help the middle class by raising taxes on the rich. According to the early evidence, the plan has flopped. This was entirely predictable. Indeed, in 2015, the C.D. Howe Institute (formerly chaired by the current federal finance minister) called the policy a “losing proposition.” However, the government forged ahead with the tax hike anyway.

The data so far suggests that this soak-the-rich fiscal strategy was so economically damaging that it actually reduced federal tax revenues. The Globe and Mail recently reported that the “Liberal government’s tax on Canada’s top 1 per cent failed to produce the promised billions in new revenue in its first year, as high-income earners actually paid $4.6-billion less in federal taxes.”

Currently, the top personal income tax rate is higher than 50 percent in seven Canadian provinces. That means top earners in seven provinces pay more than half of their next dollar of income to the government in income taxes. Then they pay yet more tax when they use their after-tax income to buy retail goods (sales tax), or to own property (property tax), or to fill up their car (gas taxes).

With such a high marginal tax rate, high-income workers have a strong incentive to reduce taxable income, such as by shifting it to other jurisdictions or simply by reducing income by decreasing work effort. The incentive to work harder and earn more money is greatly reduced when the government taxes away more than half of it.

Some proponents of the tax hike on top earners suggest that the $4.6 billion revenue loss might be due to factors other than the high tax rate encouraging top earners to reduce taxable income – for example, the revenue loss might have more to do with Alberta’s struggling energy sector. Indeed, the vast majority of the lost federal revenues was attributable to Alberta.

However, the drop in taxable incomes among Alberta’s top earners likely also has to do with Alberta’s own recent tax hike on top earners. A few years ago, Alberta’s top earners paid a marginal income tax rate of 39 percent, but the provincial and federal tax hikes boosted this to 48 percent. It is easy to see how this massive tax hike would have discouraged high-income Albertans from working harder and earning more.

Moreover, even if the federal government’s tax hike increased rather than decreased federal revenues, it could still have reduced total government revenues by reducing provincial government revenues. Indeed, the C.D. Howe Institute study in 2015 estimated that the federal tax hike would reduce total government revenues because it would erode the provincial income tax base.

In addition to likely reducing government revenues by damaging the economy, such high taxes on top earners reveal politicians’ dangerous worldviews. By imposing such heavy marginal taxes (in most provinces, of over 50 percent), politicians are treating successful Canadians as natural resources to be annually harvested and squeezed to raise as much money for the government as possible. That is unfair and wrong.

Importantly, Canadian consumers – even those not directly subject to these confiscatory tax rates – are also harmed by high taxes on top earners. High marginal tax rates make it harder for businesses to attract the best and brightest workers. These high taxes means businesses are forced to offer higher pre-tax salaries to attract top talent. This additional cost of business means consumers face higher prices.

As it turns out, punitive taxes on the most economically productive workers in society benefits nobody. Indeed, according to the research and early evidence, by reducing tax revenues, the Liberal plan to eat the rich doesn’t even help fill the government coffers.