Which tax, what middle class? Debunking the income splitting debate.

When MPs head back to the Hill next week, we can expect an already heated debate about tax fairness to go up a few more degrees. At the heart of the matter is a decade-old tax loophole accessible to very few people and with very few spinoff benefits to the economy as a whole. But the debate also raises important questions about who we consider members of the middle class, and how serious we are about addressing income inequality in this country.

Who are the income splitters?
For most of September, political parties, business associations, farmers, doctors, and the tech sector have been arguing over the federal government’s plan to remove a tax exemption designed to allow small businesses to assign the income of one earner to other members of their family. The exemption is being used by high-earning professionals, who make more than $90,000 a year. Currently, these high-earners can incorporate as a small business by setting up a Canadian-controlled private corporation (CCPC). This allows those professionals to assign a share of their income to family members, which frequently pushes them into a lower tax bracket. The federal government is proposing to close this loophole and stop allowing this kind of income splitting (or “sprinkling”).

breakdown of who benefits from small business income splitting

Professional associations, including the Canadian Medical Association, have raised multiple objections to this proposal. They argue that income splitting predominantly benefits middle class families and leaves more capital available to finance new business ventures. These groups also claim that since family members are implicated in the financial risk taken on by the incorporating individual, it is only right they should receive income from that corporation. Let’s examine these claims.

Risk and reward
Starting a business can indeed be risky and government supports for small businesses make sense. However, there is nothing inherently risky about incorporating as a CCPC. Too many high-income earners are doing it to lower their tax burden, not to create new enterprises.

For those who do start small businesses, from which they and the economy will hopefully benefit, is income splitting really the best way to help mitigate risk? Income splitting provides the greatest reward (tax break) to the enterprise with the greatest profits, and the least benefit to small businesses who are working hard to break into new markets and break even.

This is an upside-down approach to risk mitigation with little spinoff benefit to the economy. It would be better to build on government financing programs for small- and medium-sized enterprises by targeting support where private equity is lacking.

Not a tool for gender equality
Opponents of the proposed changes have attempted to portray income splitting as a tool for gender equality. This argument suggests that female professionals who incorporate can then split their income by assigning a portion of that income to their (presumed to be) male spouse. The male spouse, in turn, takes on a fuller share of unpaid child care work, freeing up the female professional to work irregular and long hours.  

While an interesting example of inverted gender roles, in reality only 7% of families are made up of a sole female earner and one spouse who stays home (i.e., 93% of the time a sole male earner or both spouses have paid employment). In fact, every high-income country that has ever implemented a form of income splitting has seen the same result: lower female labour force participation.

Income splitting provides an incentive to keep the lower-income earner in low income, or no income. Because women (even female physicians) earn less than their male peers on average, perform more unpaid child care work than do men, and the cost of paid child care is so high, all of the incentives in income splitting point toward keeping women out of the labour market.

Solutions for everyone
Policies like providing universal and accessible child care—which has a demonstrable impact on women’s rates of employment, promotion and pay—would have a far greater capacity to support professional women. Paternity leave, along the model offered by the Quebec Parental Insurance Program, has also been shown to shift the burden of unpaid child care work—with three out of four new fathers in Quebec now taking over a month of leave after the birth of their first child. These are reforms that would really work for working women.

Tax reform is complicated. This is one small piece. But a more progressive (reformed) set of tax policies could deliver the revenue needed to improve health care, support the unemployed, provide childcare and even pay for new programs like pharmacare. It could do it in ways that cost less and benefit everyone, not just the top 10%.  


David Macdonald is a senior economist and Kate McInturff is a senior researcher with the Canadian Centre for Policy Alternatives.

6 comments

  1. I agree that there are many solutions that would be for everyone and need to be addressed asap. I agree that workers who make less than $90,000 need to have a tax that is more fair. I also think that when we are looking at tax reform we must look at those individuals and corporations with way higher income. There is so many loop holes that often they pay a less tax rate than the rest of us, and, often get government subsidies. Lets start at the top. Inundertand thwre there is a new report out that says the top 10% have more wealth than the rest of us – the lower 90%. I am sure that they pay a way lower rate of taxes than we do.

  2. Wow you miss the whole point that families with same household income should pay the same amount of tax and that is no longer happening with the removal of income splitting.

    Today a family earning 80k split between two spouses earning 60/20k pay more tax than the family also earning 80k but split 40/40k. Neither are wealthy but income splitting provides fairness and equity so both families pay the same.

    We claw back benefits based on household income and have no problem with treating oth families the same that way but are unable to do so when it comes to paying taxes.

    I plead with you to address this issue!

    1. Income splitting is a different beast that income sprinkling. Income sprinkling is not available to salaried incomes and thus is not equitable.

  3. There are more female scores than male doctors . Check your facts! That’s why doctors have this . Doctors were encouraged by the Government to do this. Now they suddenly take it away. How is that fair.

  4. I am a small business owner and I feel that the conversation around these tax changes has only heightened the belief that all business owners, regardless size are somehow taking advantage of the tax system. One piece of information that is missing is exactly how many individuals/corporations are set up to simply avoid paying taxes? There is a big difference between an entity that incorporates for legal/liability reasons and those that incorporate as a tax shelter. Every year, as an incorporated business I submit my financial yearend information that I have prepared through an accounting firm to Revenue Canada where they determine whether I have remitted sufficient taxes. Each month I remit my source deduction paperwork and payment which indicates how many staff I employ and the payroll deductions. I see no reason why Revenue Canada is unable to discern between corporate entities that are using the tax system to lower personal taxes and corporations/businesses that are employing individuals and contributing to the economy. It would seem it is not the tax system that needs to be changed but rather the gatekeepers who approve who can incorporate.
    And just as an aside, trying to remain viable as a small business in Canada (one that employs people that actually work in the business) is extremely difficult when financial services, and government support are focused on large corporations. Chartered banks view small businesses as too risky and generally require the business owners to offer up any and all personal assets before they will even offer a credit card with a $7000 limit, never mind, lines of credit or favourable rates.

    1. This is a great comment. There has to be a proper analysis of who’s-doing-what before any generalizations/deductions can be made.

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