Québec has been immersed in the last weeks in much drama following a proposal to further tax the wealthiest. When the brand new Marois government took office (Parti québécois, PQ), it announced it would introduce new tax brackets for the wealthiest. A first bracket would have been added for income falling between $130,000 and $250,000 (taxed at 28%) and another for income above $250,000 (31%). The government also proposed to review capital gain taxation to reduce the current exemption. In the end, the new measures shrunk considerably last week when Minister of Finance Nicolas Marceau reviewed his previous announcement.
The government pulled back because it was under fire from both commentators and businesspeople. From the “progressive” and PQ-leaning newspaper Le Devoir (in a reaction written by Jean-Robert Sansfaçon) to the libertarian Nathalie Elgrably-Lévy of the Institut économique de Montréal (IEDM), in addition to some predictable attacks coming from the Council of Employers and from Alain Dubuc (who writes for the Liberal-leaning newspaper La Presse): all commentators have, in the least, questioned the wisdom of introducing such measures. In this post, we would first like to untangle three common misconceptions concerning Québec’s tax system. We will then take apart one by one a series of three arguments put forth by proponents of the status quo and demonstrate just how far from being based on fact they are.
Misconception no 1: The wealthy already pay 24% of their income in taxes to Québec.
This misconception most probably stems from the fact that —and carries on because— people do not understand the progressive tax system. In reality, a person who earns $100,000 per year cannot pay more than 17% to the Québec government. It’s the difference between what we call the marginal and effective tax rates.
A little reminder on how the system works. At the moment, there are three tax brackets. According to Revenu Québec, the brackets will be divided up as follows for fiscal year 2012:
From $0 to $40,100: 16%
From $40,100 to $80,200: 20%
Over $80,200: 24%
The rate for each bracket is the marginal tax rate. What does that mean? It means that this rate applies only to the income comprised within these cutoff values. Tax brackets are not income categories, they’re ranges of income. It means that the first $40,100 will be taxed at 16%, the next $40,100 at 20% and any income exceeding $80,200 will be taxed at 24%.
A small detail which should not be looked over is the year’s basic exemption set at $10,600, which grants a $2,120 non-refundable tax credit. In short, tax only applies when an individual has earned more than this basic amount.
Now that we’ve covered the theoretical aspects of our progressive tax system, let’s turn to the calculation which led us to state that the maximum tax rate that an individual earning $100,000 can effectively pay is 17% and not 24% as the myth shamelessly argues. Let’s turn to the effective rate reality.
Someone earning 100 grand a year will be taxed 16% for on the first $40,100, i.e pay $6,416 in taxes for the first “slice” of his/her income.
For the next $40,100 (between $40,101 and $80,200), he or she will be taxed at a rate of 20%, thus paying $8,020 in taxes on that second “slice” of income.
It’s only the remaining $19,800 (between $80,200 and $100,000) which will be taxed at 24%, amounting to $4,752 in taxes.
Let’s not forget the non-refundable credit for what is called the individual basic amount we mentioned earlier, so $2,120 must be deducted from the total amount of taxes. Our 100-grand earner will thus pay a total of $17,068 in taxes to the government of Québec, i.e. 17% of his or her income, not 24%.
However, this 17% remains pretty theoretical. In reality, when we take a look at the 2009 tax statistics, taxpayers earning between $100,000 and $150,000 paid on average 14% of their total income in taxes to the provincial government. That’s a far cry from the marginal tax rate of 24% and the effective tax rate we’ve calculated to be at 17%. The difference lies mostly in tax exemptions.
When people say that the wealthy are taxed at 24%, they’re only talking about the marginal tax rate. It’s useful to accountants, but to represent reality, we’re better off speaking of the effective tax rate (the percentage of income which is actually paid once the tax return is filled out). It has the advantage of better translating the fiscal reality of taxpayers.
Misconception no 2: The government wants to raise taxes on the wealthiest taxpayers to 31% of their income.
The Parti québécois’s proposed tax hike would have created two new brackets. The fourth bracket, to be added to those which we’ve just explained, would tax income between $130,000 and $250,000 at a marginal rate of 28% whilst the introduction of a fifth bracket would increase the marginal tax rate to 31% for any income above $250,000.
Some maintain that this increase would come down hard on high-income earners. Those opposing the tax hike speak of a 4 percentage points increase for people earning between $130,000 and $250,000, and a 7 percentage points increase for those earning more than $250,000.
As we’ve seen in relation to the first myth, it’s important to remember that it’s only the earnings which fall within a bracket that are affected. For most taxpayers, including the wealthier, the increase will have little impact on their effective tax rate.
Indeed, someone earning $130,000 will not pay a dime more in taxes, and someone who earns $135,000 will pay, before his or her deductions, $200 more in taxes. When we look in greater detail into the effective tax rates of the varying test cases (without taking into account deductions, but taking into account the repeal of the health tax), we realize that similarly minimal increases apply to the vast majority of taxpayers bringing home such high incomes.
We’ve applied the same calculation to personal incomes of $150,000, $190,000, and $300,000 as when debunking the first myth to see what is the true increase for each of them after these new brackets have been created.
|Annual income||Increase in the effective tax rate|
The table shows that the increase in the effective tax rate is much lower than the myth has it, when it spreads word of tax increases of 4 and 7 percentage points. For the majority of this minority of taxpayers, the tax rate increases between 0.5 and 2.8 percentage points. Only people whose income is higher than $400,000 (a very small fraction of the population) will find that the proposed tax hike will take away more than 5% of their income.
Misconception no 3: The tax rate has already increased in the last years.
The newspaper La Presse published a nice table which, for all its shortcomings, demonstrates that between 2000 and 2010, all taxpayers have seen their taxes decrease, at both the provincial and the federal levels.
To inquire further without getting into too much detail, let’s just take a quick glance at the evolution of the tax system between 2000 and 2009 to have a better idea of how taxation evolved in Québec. This examination compares equivalent incomes, taking into account indexation.
|2000||Effective tax rate||2009||Effective tax rate|
|$0 to $15,000||0.9%||$0 to $20,000||0.6%|
|$15,000 to $40,000||8.5%||$20,000 to $50,000||9.6%|
|$40,000 to $70,000||13.6%||$50,000$ to $100,000||11.2%|
|$70,000 +||16.9%||$100,000 +||14.7%|
Only people now earning between $20,000 to $50,000, often categorized as belonging to the lower middle class, have seen a slight increase in their taxes. Otherwise, taxpayers on the whole have seen their taxes reduced. These tax cuts were especially high for taxpayers now earning more than $50,000. For those earning over $100,000 — the category into which fall those who are targeted by the tax hike — the average tax cut over 10 years has been one of 2.2 percentage points. The proposed tax increase does not even qualify as an adjustment when compared to 2000 tax rates since it affects only part of these high-income earners.
Let’s now turn to the arguments of those opposed to the tax hike and demonstrate why they don’t hold up to closer scrutiny.
Argument no 1: People earning over $130,000 make up 3% of the population and pay 30% of taxes, hence they’re already paying their fair share.
It’s surprising to see many serious commentator using this bizarre comparison (which Michel Kelly-Gagnon put forth — we already commented upon it) between the number of people affected and the share of taxes that they pay. The number of people is not very important for the tax system. What counts is income. If one person owned all wealth, it wouldn’t be unfair for him or her to pay 100% of taxes levied.
Let’s take one example. According to the 2009 tax statistics, the 93,000 individuals earning more than $150,000 annually (unfortunately data for those over $130,000 is not available because of the way in which tax statistics are divided) made up 1.5% of taxpayers. They paid $4.4G in taxes, i.e. 21% of personal taxes levied.
Now let’s take a step further and ask what their earnings represent. These 93,000 individuals were earning a total of $29G, which represents 13% of the earnings of all taxpayers. The taxes they paid to the Québec government represented 15% of their earnings.
The interesting ratios are thus the following: the wealthiest 1.5% of our society earns 13% of the income and pays 21% of taxes, which represents 15% of its income. Can these taxpayers contribute more? Probably, since their available income is still very high, even after taxes. That’s the important question, not their demographic weight. The amount of taxes paid is but the reflection of preexisting inequalities in society.
Argument no 2: If capital gains are taxed any more, it will hurt the middle class.
A capital gain is income generated when selling an asset. For example, selling shares can generate capital gain. It is currently taxed on 50% of its worth. Hence, if you resell a share and earn $100,000 doing so, you will be taxed at your marginal rate (say 24%) on only 50% of this sum. You will thus pay $12,000 in taxes on your 100-grand gain (without taking into account other tax credits). If you had earned the same income in wages, you would have paid, all other things being equal, $24,000 in taxes.
The measure was aimed at lowering this exemption from 50% to 25%. Since selling an asset could potentially mean selling a summer house (selling a primary residence is exempted from the capital gain tax), some worry that this measure would overly hurt the middle class.
What they seem to forget is that, still according to the 2009 tax statistics, of the $685M which this tax deduction represents, $565M (i.e. 82%) are claimed by individuals earning over $100,000 (i.e. 4,1% of taxpayers). The upper middle class (between $50,000 and $100,000, i.e. 18% of taxpayers) use up $88M of this deduction (i.e. less than 13%). Finally, 78% of taxpayers, those earning less than $50,000, share between themselves the remaining 5% of the deduction.
As we can see, the generous tax deduction on capital gains does not benefit ordinary people, so there’s no danger for them if it decreases.
Argument no 3: High-income earners might work less if we tax them too much.
Some bring up the possibility that if we tax high-income earners too much, they won’t want to work as much. The income they would earn from this extra work would be taxed so much that it would seem worthless for them to put in all that extra effort.
Behind this worry seems to lie a bizarre understanding of the professions high-income earners exercise. In their research on the wealthiest 1% of the Canadian population, Forth et al. underscore that more than a third are business managers and that the other popular trades for this segment of the population are health professionals as well as finance and commerce professionals.
With the exception of doctors, who are paid on a fee-for-service basis (but who make up only 11% of the super wealthy), all others are paid either in shares or through an annual salary. The number of hours spent working has no direct impact on their income, which is rather based on the overall performance of their business and negotiated in relation to the international executive pay market which, to say the least, is not on the verge of collapsing.
Simon Tremblay-Pepin and Francis Fortier are researchers with IRIS—a Montreal-based progressive think tank.