November 30, 2022 – Canada’s tax system has a punitive impact on lower income families with children hoping to earn more money, according to a new report from the C.D. Howe Institute. In “Softening the Bite: The Impact of Benefit Clawbacks on Low-Income Families and How to Reduce It,” authors Alex Laurin and Nicholas Dahir reveal how benefit reductions serve as hidden tax rates and reduce the effective gain from working to generate additional income.
The report presents illustrative estimates for both the “marginal” effective tax rate (METR) and the “participation” tax rate (PTR), which bite into any additional income discouraging work for lower-income families with children. The METR conveys the loss, through additional taxes and diminished benefits, associated with an extra dollar of earnings. For a working parent, it represents the financial penalty paid for working extra hours. The PTR is the cumulative effect of all taxes and loss of fiscal benefits on the entire prospective earnings from work. For a stay-at-home parent, it represents the financial penalty paid out of the total income derived from getting a job.
There are five main factors that determine how much a family would lose through additional taxes and benefit clawbacks after taking on more paid work: the province of residence, the initial level of family income, the number of children, the number of earners in a family and how earnings are split among earners. Authors Laurin and Dahir show that working low-income families’ METRs are generally high compared to those of higher-income earners. This is mainly influenced by benefit programs that pile up at the lower end of the income scale.
“In Ontario, the family METR on extra earned income peaks at 79 percent for two-children two-parent families and at 96 percent for single-parent families. In Quebec, it peaks at 88 and 71 percent, respectively,” says Laurin and Dahir. “In other provinces, it tends to peak at around 60 to 70 percent. METRs reach their peak at relatively low levels of family income for two-parent families and at around average income levels for single-parent families.”
The paper recommends the federal government:
- Implement “benefit shields,” similar to that introduced by Quebec in 2016, that would focus on the Child Tax Benefit and the Canada Workers Benefit. Under the shield approach, a sudden jump in employment earnings would be excluded for the purpose of calculating income-tested benefit reductions in the first year of recipients’ higher income earning capacity, such that family benefits for the CCB and the CWB would remain the same for that year. The shields would likely stimulate parents to take on more paid work. The immediate cost of such benefit shields would likely be small in comparison to the long-term repeated annual government revenue yield of higher family earnings.
- Allow income averaging to lessen the impact of fluctuating incomes on tax liability. Workers could average their income over many years, so that any single large earning year would not lead to a disproportionate loss of fiscal benefits and higher tax payments
Replace the federal childcare expense tax deduction with a refundable credit with very generous rates for lower-earning families – designed along the lines of the Quebec and Ontario childcare expenses credits – diminishing up the income scale to higher-earning families, who would still reap some benefit.
For more information contact: Alex Laurin, Director of Research, C.D. Howe Institute; Nicholas Dahir, Research Assistant, C.D. Howe Institute; and Tafadzwa Ndlovu, Communications Officer, C.D. Howe Institute, 416-479-9520 Ext. 9520, tndlovu@cdhowe.org
The C.D. Howe Institute is an independent not-for-profit research institute whose mission is to raise living standards by fostering economically sound public policies. Widely considered to be Canada's most influential think tank, the Institute is a trusted source of essential policy intelligence, distinguished by research that is nonpartisan, evidence-based and subject to definitive expert review.