Or at least, it is for some ranges of income. Don't believe me that marginal tax rates are regressive? Follow me:
For this analysis, I will need to do the following:
- Ignore provincial income taxes since the tax system differs from province to province.
- Assume that the person does not live in Québec (for reasons we will discuss later).
- Ignore industry specific insurance premiums on income, such as WSIB premiums since these vary from industry to industry (and, as it turns out, do not change our story in any fundamental way.
Federal Income Taxes
If we include the Federal Basic Personal Amount as a separate tax bracket (it's the amount of money a person needs to earn before they start paying federal income taxes), Canada has five marginal income tax brackets which are as follows:
- 0%: $0 - $10,382
- 15%: $10,383 - $40,970
- 22%: $40,971 - $81,941
- 26%: $81,942 - $127,021
- 29%: $127,022 - inf
(all tax rate data from Taxtips.ca) So far this looks pretty progressive, with low-income earners paying no income tax. Interestingly, the first tax bracket starts up well before Statistics Canada's Low-Income Cut-Off (LICO) which is a widely used (but far from universally accepted) definition of poverty. In 2004 the LICO for a single person was between $14,000 and $20,337, depending on where the person lived (source: CCSD).
Payroll Taxes on Employees
There are two payroll taxes paid by the majority of working Canadians: Canada Pension Plan (CPP) contributions and Employment Insurance (EI) premiums, both of which are proportional to labour income. There are some exceptions:
- People can be exempt from either CPP or EI, for a variety of reasons. For instance, individuals who own 40% or more of the companies they work for are exempt from EI premiums.
- Québec has their own version of CPP (QPP). Currently the marginal tax rates are identical, but the plan is administered by the province rather than the federal government.
CPP Employee Contribution Rates
- 0%: $0 - $3500
- 4.95%: $3501 - $47,200
EI Employee Premium Rates
- 1.73%: $0 - $43,200
Note, there is no basic exemption level for EI and both EI and CPP payments kick in well before LICO.
Adding it Together
For a person who is eligible to pay both EI and CPP along with income taxes, there are now eight effective tax brackets on labor income:
- 1.73%: $0 - $3,500
- 6.68%: $3,501 - $10,382
- 21.68%: $10,383 - $40,970
- 28.68%: $40,970-$43,200
- 26.95%: $43,201-$47,200
- 22%: $47,201-$81,941
- 26%: $81,942-$127,021
- 29%: $127,022-inf
Note that marginal tax rates are declining from $40,970 to $127,021, and a person earning $41,000 a year faces almost the same marginal tax rate as someone making $410,000. And it gets worse from here.
Payroll Taxes on Employers
Employers are required to pay EI premiums and CPP contributions for their employees as well. Canadian law requires employers to match CPP contributions dollar-for-dollar, and EI contributions 1.4-to-1 (that is, for every dollar employees pay, employers pay $1.40). Thus the tax rates for employers are as follows:
CPP Employer Contribution Rates
- 0%: $0 - $3,500
- 4.95%: $3,501 - $47,200
EI Employer Premium Rates
- 2.422%: $0 - $43,200
As such, 50% of the legal incidence of CPP Contributions falls on employees along with 41% of the legal incidence for EI premiums.
But Who Really Pays Payroll Taxes
Stephen Gordon examined this question a few weeks ago in The economics of tax incidence: paying the tax is not the same as bearing the burden:
Payroll taxes. These include employer contributions to EI and C/QPP as well as Worker's Compensation premiums. But as a HRCD survey notes, long-run labour demand is more elastic than labour supply, so the ultimate effect of payroll taxes is to reduce wages: "labour's share of the payroll tax burden in the long run is in the range of 87 to 100 percent."
Additional evidence to this point - The Incidence of Payroll Taxation: Evidence for Chile (Jonathan Gruber, Journal of Labor Economics, July 1997) has a useful literature survey which includes the following:
More recent work in the United States has examined the effects of changes in the costs of government mandated employer benefits within different states over time, controlling for correlated time-series and fixed location effects. These studies have found that the incidence of mandated employer benefits is fully on wages, with little to no disemployment effect.
Meaning that the incidence falls on employees. Gruber's study of Chile came to the conclusion, but this is not a universal finding in the literature. Holmlund's 1983 study of Sweden found that only half of the employer's share was paid by employees in reduced wages.
Given all of this evidence, it is difficult to imagine that less than 75% of payroll taxes are ultimately paid by employees. We will use this figure as a lower bound, though HRDC's figure of 87-100 percent is likely more accurate.
If employees are paying 75% of payroll taxes, then their tax rates on EI and CPP are roughly 3% and 7.5% respectively. Using these figures along with income tax rates leads to the following marginal tax rate schedule:
- 3%: $0 - $3,500
- 10.5%: $3,501 - $10,382
- 25.5%: $10,383 - $40,970
- 32.5%: $40,970-$43,200
- 29.5%: $43,201-$47,200
- 22%: $47,201-$81,941
- 26%: $81,942-$127,021
- 29%: $127,022-inf
Now the highest marginal tax rates are on people making around $41,000 a year. Marginal tax rates are regressive from income levels of $40,970 to $81,941, and people under the LICO 'poverty level' making $11,000 face roughly the same marginal tax rate as those earning $110,000 a year.
Complications and Considerations
There are at least three additional factors we may want to consider:
1. Are Payroll Taxes Equivalent to Income Taxes
They potentially could differ in one significant aspect. If a person pays additional income taxes, they do not receive any additional services from the government. However, if a worker pays higher EI or CPP contributions, they may receive additional benefits. From Gruber:
However,Summers (1989) noted that this analysis missed an important of feature of payroll taxation: tax revenues are often used to finance programs which benefit workers only, such as retirement benefits under Social Security or compensation for workplace injuries.This restriction of benefits to workers creates an important tax/benefit linkage...
If workers believe that EI and CPP payments benefit them directly, while income taxes do not, the behavioural response to changes in each will be different. Specifically, we would expect that higher income taxes would lead to sharper reductions in labour supplied than higher payroll taxes.
The question then is, "Do workers perceive payroll taxes as being fundamentally different than income taxes?" I am not aware of much research in this area. It would be very difficult to argue that for EI, there is a close relationship between tax and benefit. Premiums are not based on expected benefits, as the rates for people with almost no chance of finding themselves unemployed are the same as for higher risk persons. Secondly, since EI premium revenues were incorporated into general government revenues in the 1990s, there is not necessarily a close link between overall EI revenue received and EI payments made. This distinction is discussed in great length in Economics versus Politics in Canadian Payroll Tax Policies (Jonathan R. Kesselman, Canadian Public Policy, September 1998). The link between a person's taxes paid and expected benefit is quite weak in the case of EI.
The case for CPP is much less clear, as there is a closer (but far from one-to-one) link between taxes paid. Younger workers also have an additional concern - will the system still be in place when they retire? There is not much data for Canada, but there is a significant body of evidence that suggests that young Americans believe Social Security is important, though they will not be able to collect it. From the New York Times:
Yet here’s the odd part: only a third of the younger respondents, and only a third of all respondents, expressed confidence in the program’s future. How do you square these opinions that Social Security is crucial, that you want it to be available decades hence, with the belief that it probably won’t be?
Think tanks and life insurance companies are recommending to young workers not to count on a young social security system - to the point which the Social Security Administration felt the need to respond. Whether or not the claims of the demise of Social Security are valid or overblown is somewhat irrelevant - if young workers believe they will receive no personal benefits from their contributions, then the behavioural response is the same as an income tax.
In the previous analysis, I have treated CPP contributions as a straight tax. That may be excessive, though I am not convinced. However, it may make more sense to treat it as 75% tax and 25% forced saving, or 50% tax and 50% forced saving. The latter would drop the CPP tax burden by workers down from 7.5% to around 4% - which does not look too much different than the marginal tax rate figures that did not take into account employer contributions, which were still regressive. The tax/benefit linkage may reduce the regressivity of labour income taxes, but it does not eliminate it.
2. Provincial Income Taxes
We have only considered federal income taxes. Perhaps once we take into account provincial income taxes, the labour income tax system ceases to be regressive.
The difficulty: Provincial income tax systems are not progressive enough to swing the pendulum back to an overall progressive tax system. Alberta has a flat tax on income, so it does not make the overall situation more progressive. Ontario, on the other hand, has a progressive income tax regime which is as follows:
- 0%: $0-$8,943
- 5.05%: $8,944-$37,106
- 9.15%: $37,107-$74,214
- 11.16%: $74,215-inf
If we add this to the marginal tax rate schedule that includes both employer and employee contributions, we get a rather lengthy marginal tax rate schedule that looks as follows:
- 3%: $0 - $3,500
- 10.5%: $3,501 - $8,943
- 15.55%: $8,948-$10,382
- 30.55%: $10,383 - $37,106
- 34.15%: $37,107-$40,970
- 41.65%: $40,971-$43,200
- 38.65%: $43,201-$47,200
- 31.15%: $47,201-$74,214
- 33.16%: $74,215-$81,941
- 37.16%: $81,942-$127,021
- 40.16%: $127,022-inf
Once again, we see the highest marginal labour tax rates paid by individuals earning roughly $41,000 a year, with the system being highly regressive between the income range of $41,000 and $74,000.
3. Tax Incidence of Income Taxes
One assumption we have made through this entire discussion is that the incidence of labour income tax rates fall wholly on those earning the income. What if, instead, some of the incidence falls on firms or customers?
Remember, though, that the income tax portion is the progressive part of the whole labour income tax system. The higher the level we assume is paid for by non-workers, the more regressive the system actually is. The only way this consideration would make the system more progressive is to assume that the tax incidence faced by workers is greater than 100%. That is theoretically possible, but in reality unlikely.
Labour Income Tax System - Conclusion
When payroll taxes and tax incidence is taken into consideration, the Canadian labour income tax system is highly regressive in the income range of $40,000-$70,000. Taking into consideration the benefit/tax linkages of payroll taxes mitigates this, but only partly. Given that both EI premiums and CPP contribution rates are both likely to rise in the near future, expect an even more regressive Canadian tax system soon.