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Ontario moves ahead in tax rate race — pushes Quebec into third place

06/29/2012 by John Clinkard

Effective July 1, the estimated 25,000 Ontarians earning $500,000 or more and who already account for 20% of the province’s total income tax revenues, will see their marginal tax rate increase from 46.4% to 49.5%.

As a result of this tax hike, Ontario shoulders aside Quebec and achieves the rather dubious distinction of having the second highest marginal personal income tax rate in Canada.

According to a recent C.D. Howe Institute E-brief authored by Alexandre Laurin, the government seems to have based its tax rate hike decision in part on the “Occupy” movement which holds that the top 1% of income earners are not paying their fair share of taxes.

However, as Laurin points out, while the top one per cent of taxpayers in Ontario earn approximately 12% of all the income from taxable sources in the province, they already (before the tax hike) account for about 27% of all income tax paid in the province. Furthermore, the top 10 per cent of earners in the province account for almost two thirds of all income tax revenues.

To put these percentages in context, even before the higher tax rate is implemented, based on the Reynolds-Smolensky (R-S) Progressivity Index that indicates the extent to which the tax system reduces income inequality, the tax system in Ontario is more redistributive, i.e. “fairer,” than in any other province.

Laurin also points out that, in addition to “fairness,” taxes also have a significant impact on individual behaviour. Individuals respond in various ways to higher taxes.

First, some do nothing. However, others cause “tax leakage” by substituting leisure for work.

Given the fact that many high income earners have marketable skills that are very portable, some move to jurisdictions with lower tax rates.

For example, by moving from Ontario to Alberta, an individual with after tax earnings of $500,000 would realize a personal income tax saving of over $37,000 in addition to paying no provincial sales tax. Higher tax rates also increase the returns to more sophisticated tax planning strategies such as shifting income from a high tax province to one with lower tax rates.

Based on a Department of Finance study titled “ The Response of Individuals to Changes in Marginal Income Tax Rates” for high income earners, a 1% increase in their marginal “net-of-tax” rate is estimated to lead to a 4% decline in high earners’ taxable incomes in the short term, thereby cutting the government’s projected tax receipts in half.

Over the near term, research indicates that this hike in tax rates will probably boost tax revenues. However, over the longer term, as taxpayers adjust to the higher rates, revenue growth will slow and by 2027 it is estimated that total revenues will have shrunk by an estimated $200 million.

This research supports the results of countless studies which have found that higher tax rates ultimately discourage private enterprise and hurt job creation and it also is consistent with Winston Churchill’s oft-quoted statement “that for a nation to try and tax itself into prosperity is like a man standing in a bucket and trying to lift himself by the handle.”

Marginal tax rate on taxable income of $500,000+

Marginal tax rate on taxable income of $500,000+
Data Source: Ernst & Young/Chart: Reed Construction Data, CanaData.

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