Thursday, April 14, 2011

Tax Freedom Day

Those concerned about our growing tax burden like to draw attention to it by "celebrating" Tax Freedom Day, the day when we've earned enough money to cover all our taxes for the year. However, thinking of taxes as front-loaded like this draws attention away from a different problem with our progressive tax system.

The truth is that the first several thousand dollars of income is barely taxed, or even negatively taxed for those who receive income-tested benefits that exceed the taxes they pay. People with upper middle class income get to keep most of their income for the first half of the year, but the incentive to work drops off in the second half of the year. This is because this later income is taxed more heavily. I'd happily trade one-sixth of my income for two months of additional vacation every year because I'd be giving up less than one-sixth of my take-home pay.

I'm a believer in a progressive tax system, but only up to a point. I fear for our country's future if our most talented people have little reason to work more than half of the year.

10 comments:

  1. Good point. I always employ tax planning regarding RSP withdrawals, capital gains, etc. I often hear people say they refuse overtime because they just end up paying it all in taxes. This is a misperception, but an understandable one when people review taxes deducted from an individual paycheque, not realizing they will get a juicy refund next year.

    ReplyDelete
  2. @Gene: You're right that when you get paid for a large amount of overtime on a pay cheque the taxes deducted will be too high creating a refund at the end of the year. However, the tax rate on the first hour of overtime is very close to the amount of tax that you will pay ultimately. I think people who refuse overtime are often correct to do so. Similarly, it would be right for me (and people in similar circumstances) to refuse work (and forgo the pay) for several months per year if it weren't for the fact that my employer probably wouldn't tolerate it.

    ReplyDelete
  3. While I don't necessarily disagree with a progressive tax system, the biggest problem in my mind is that our tax calculations are far too complicated. People could realistically decide whether or not to accept overtime, or tax six weeks off, if we had only 1 or 2 tax rates after a base deduction. And next to no additional deductions or credits.

    Means-tested benefits are also part of the problem. I agree with providing benefits to those who need them, but currently they create a barrier where someone could earn less after-tax income around the threshhold where they no longer receive benefits.

    ReplyDelete
  4. @Robert: I can deal with multiple tax rates when they are laid out together, but the many different tax rates come from separate federal and provincial systems, various deductions, and income-tested benefits. There is a need for simplification, but politicians would have to sell it to a skeptical public.

    ReplyDelete
  5. Freedom? That is a worship word. Yang worship. You will not speak it.

    -- Cloud C8j

    Tax freedom? Unheard of.

    ReplyDelete
  6. @Big Cajun Man: I may not be a Yang, but I'm definitely not a Com. (For the puzzled, this exchange was geek Star Trek humour.)

    ReplyDelete
  7. I don't see that it's society's role to maximize the amount of time people spend working. "Out most talented people" have better things to do in life than work.

    The idea that your two months would be wasted if not spent working is a symptom of a very common confusion between society and economy. They are not the same thing. I just came back from coaching my son's lacrosse team; would society have been better off if I had spent those two hours at the office? I know the economy would have benefited, but that's a different thing.

    We are more than just our money.

    ReplyDelete
  8. @Patrick: The core of our capitalist system is that people have an incentive to work. This does not mean that we should force them to work. I agree that it isn't society's role to maximize the time people spend working, but there should be an incentive for those who do work. In particular, we all benefit when our most talented people work. This does not mean that a particular talented individual should work if he or she doesn't want to work. Society should make sure that talented people have an incentive to work. As I argued, the incentive to work drops quickly as income rises because each new day worked pays less after tax than the first days of the year. This is a necessary consequence of our progressive tax system, but the degree of progression matters. If tax rates on higher income rise too much we could see higher income earners choosing to take months of unpaid leave every year. This would be detrimental to society as a whole.

    ReplyDelete
  9. @Patrick: A follow-up. It's true that we are more than just our money. But the sum total of our toil is very important. The more people who choose not to work or who choose to work less, the less we have as a society.

    ReplyDelete
  10. @Michael: I'd say the less people work, the less "products of work" we have as a society. It's far too easy to measure the quality of a society in dollars.

    I agree that months of unpaid leave per year would be detrimental to the economy, but it's far from obvious that it would be detrimental to society.

    ReplyDelete