How The Income Tax Is Hurting Lower and Middle Income People the Most

May 28, 2019

Since April 1, 2019, all people have been talking about is the new federal carbon tax in Canada. Why did the federal government choose April 1st out of all possible days for the federal carbon tax to begin? Perhaps as an April fools joke? Or was it to distract Canadians from their annual obligation to file their income tax returns which were due by April 30th?

We Canadians have been filing income tax returns and paying income tax since 1917.  I have previously written several articles detailing all the outrageous, egregious and preposterous aspects of the Canadian income tax system.  In summary, our current income tax system as it effects individual, families, the self-employed, and small business owners is completely insane, extremely complicated, way too costly to comply with, and seems to be designed to make peoples’ lives absolutely miserable as well as to ensure an ever increasing and growing bloated budget at the Canada Revenue Agency (CRA).

In this article, I would like to discuss a very specific inherently irrational and unfair major aspect of our income tax system which I cannot ever recall having seen discussed in any mainstream news publication or otherwise.  Why do we pay tax on our employment and self-employment income?  If you are an employee and you look at your T4 slip you will see box 22, “income tax deducted”. You can also find these amounts on every pay stub you receive. These are the amounts of federal and provincial income tax deducted from your pay. If you are self-employed, you know that at the end of the year when you file your tax return, you usually have a balance of tax owing which is from the self-employment income you earned during the year. So why do we have such a tax? Is this tax a good tax or a bad tax?

There are different types of taxes that have come into existence thanks to our governments’ insatiable hunger for revenue. One such example is known as “sin taxes”. These are the high taxes that are added to the price of tobacco products, alcohol, gasoline, cannabis products and so forth. In fact, one third of the price of gas at the pump is all sorts of different taxes. Some jurisdictions, such as New York City, Philadelphia and others have proposed or implemented a tax on large soft drinks. The idea behind sin taxes is that the government wants to discourage certain behaviour so it increases the price of said behavior by adding a tax. The hope is that the laws of supply and demand will naturally cause people to consume less of the ‘sin’ products. This is the reason for the carbon tax. The government wants to ensure that as a country, less carbon dioxide is emitted into the atmosphere so they have decided to tax it. The theory behind all sin taxes is that if we tax something, the people will consume less of it.

Now let’s talk about employment and self-employment income tax. If you live in Ontario and earn $60,000 a year in employment income, you will pay income tax of $11,025 or 18.4%. Each additional dollar at that level of income you earn will be taxed at 29.65%. If you earn $100,000 you will pay income tax of $24,213 or 24.2% and each additional will be taxed at 43.41%.  Here is what I fail to understand. The government has implemented a carbon tax and has placed very high taxes on alcohol, tobacco, and gasoline in order to discourage these behaviours. So when it comes to these sin taxes, the government is telling the people, “We don’t want you to consume these products. However, we can’t ban them or prohibit them because we know prohibition doesn’t work, we already learnt that. So we will legalize these products but tax the hell out of them to try and discourage their excess usage. We are clearly admitting that we believe as your all-knowing wonderful benevolent government that the purpose of increasing taxes is to discourage behaviour. We believe in supply and demand and we believe that if we increase the price of a good you will consume less of it. When we tax something, the message we are sending to you is ‘do not use this, do not go near it, this is a bad thing, stay away!”

Now the question is obvious. Why in the world do we tax employment and self-employment income? Does the government want people to avoid working? Does the government want more jobs or fewer jobs? We incessantly hear from the media and the government about how important jobs are, and governments, politicians and political parties are constantly trying to prove how amazing they are at “creating jobs”. So if they are so concerned about creating jobs, why are they taxing the income people earn from their jobs at such high levels? By having our labour through employment and self-employment taxed at such high rates, the government is in fact discouraging people from working.

Additionally, since many government benefits (such as the GST credit, provincial sales tax credits, Canada Child Benefit etc.) are income tested, the incentives are all backwards in our current system. People are incentivized to work less and earn less in order to maximize their Canada Child Benefits and other such benefits. I have seen this in my own accounting practice as clients find every which way possible to show less personal income in order to lower their tax bill and maximize their government tax-free benefits. Trust me; I am not the only accountant experiencing this. Many around the country are doing this. So the government overall is paying out more in GST credits and Canada Child Benefits while it’s collecting less tax revenue as people show less income to maximize their benefits. It’s the exact opposite of what the income tax system should be encouraging and it’s going to further push our government budgets into ever greater deficits and eventually the system will implode on itself. It’s almost as if George Costanza himself was the Minister of Finance and he designed our income tax system while doing the opposite of every one of his instincts. The current Liberal government is bragging about how the Canada Child Benefits have put more money in Canadians’ pockets and reduced child poverty. You know, there is another way to put money in Canadians’ pockets. Stop taking it from them in the first place! Currently a family could be paying tens of thousands of dollars in income tax and receive a few hundred dollars a month in child benefits. Does that make any sense? Just stop collecting the income tax and they won’t need the child benefits!

Now some people are reading this and wondering, “There must be a reason the government taxes employment and self-employment income, surely they are aware of these criticisms.” I believe the reason we still pay tax on our employment and self-employment income is because the government knows that everyone needs to earn an income. There is a tiny percentage of Canadians at the very top of the income scale that are perhaps living off of investment income and do not have to work to earn a living. They of course are taxed on their investment income. But if the government only taxed investment income (such as rental income, dividends, interest, and capital gains), only a miniscule of percentage of Canadians would pay income tax on such income. The majority of lower and middle income Canadians does not earn investment income; they earn employment and self-employment income. So the government must tax the population broadly to maximize revenue. The vast majority of Canadians must work to earn a living and therefore must find a job and earn employment income or start their own small business and earn self-employed income. Therefore the government decides to tax our labour since that will be a very plentiful never ending source of revenue.  Of course, the problem with this is that the tax on employment and self-employment becomes very regressive. A regressive tax means that the taxes affect low and middle income much more harshly than high income people. Even though in Canada, we have a progressive income tax system which ensures that the more money you make, the more tax you pay as a percentage of your income, the income tax still affects lower and middle income a lot more harshly than higher income individuals.

For example, someone making $1,000,000 per year pays $497,482 of income tax (federal + Ontario rates) or 49.7% of income tax. It seems a lot but that individual is still left with $502,518 of after-tax income to support himself and his family. However, someone earning $100,000 per year pays $24,213 or 24.2%. So although it seems fair that the lower income person is only paying 24% as opposed to 49.7%, the problem is that $24,213 out of $100,000 hurts this individual a lot more, especially with the huge increase in the cost of living for most lower and middle income Canadians whether they rent or own their homes in major cities.

It is this aspect of our income tax system that I never hear discussed.  To be fair, the former Conservative government under Stephen Harper introduced the ‘working income tax benefit’ which was a tax credit to offset income tax payable from employment income for those at a lower income and the current Liberal government under Justin Trudeau increased and enhanced this benefit. So that does in fact help working people at the very low end of the income scale but the rates on the middle income brackets, for example those earning between $20,000 and $100,000, are still too high. The amount of actual dollars paid in tax by these people is too high based on their total income and their cost of living. We need to admit as a country that the employment and self-employment income tax is also regressive. Even though, on the surface, it seems like our income tax system is progressive, because the rates go up as the income goes up, we must acknowledge that the lower income and middle income workers are still being taxed at rates that are too high when looking at their total income and total cost of living.

This brings me to my next and final point. Our income tax system works based on reporting our income and then deducting our expenses from said income. Meaning, let’s say I earn $12,000 of rental income from renting out a property.  I must include this $12,000 of income in my tax return. However, I am entitled to deduct expenses from this income to reflect the fact that I didn’t really earn $12,000 because I had to spend money in order to maintain the property to earn this income. So I can deduct the property taxes, insurance, repairs and maintenance, mortgage interest, and any other costs associated with owning the property. So this $12,000 of rental income can easily become $6,000 or $3,000 or even zero of “net income”, which is the actual number used to calculate my taxes payable. This is the same for capital gains. So if I invest in a stock and I paid $1,000 and then I sold the stock for $2,000, my income is not $2,000. It’s $2,000 – $1,000 = $1,000. I am entitled to deduct the cost which allowed me to earn the income. (The capital gain is further reduced in half because of the 50% inclusion rate). But for some strange inexplicable reason, when it comes to employment income, there are few deductions available. For example, if you are self-employed, you are entitled to deduct all expenses incurred in order to earn that self-employment income. Whatever expenses you had to pay for in order to run your business you are able to deduct from your income so your taxes are calculated on the actual amount of money you earned after you’ve paid all your expenses. However, employees (the majority of Canadians) cannot deduct expenses! (There is a mechanism for certain employees to deduct expenses if they have a T2200 form signed by their employer indicating they were required to deduct expenses as a part of their employment. This usually applies to employees who are required to drive to different locations or maintain a home office etc.). However, I am referring to the majority of employees who work in any sort of workplace where they commute to and from one office or the same location each and every day. All of these people pay for commuting costs. Whether they travel by car, bike, or public transportation, there is a cost to this but they are forbidden, in our tax system, of deducting this cost from their employment income to calculate their taxes payable. Why is that? How is an employee supposed to get to work without incurring any expense? Why would this not be a deductible expense? How is this fair? People pay hundreds of dollars a year or even thousands of dollars a year to commute, maintain their cars, and get to work but this expense, literally, directly related to performing their job is not permitted to be deducted!

What about clothing? Do you know any job in the country where an employee can show up completely naked? I know of no such job except for possibly the pornography industry. But in most jobs, we are required to wear clothing. Some jobs require nice fancy business clothing. There is no choice in the matter, we must wear clothes! So why can’t we deduct the cost of clothing as an expense?

What about shelter? Most employees need a place to live. If you start a new job and the HR department asks for your address, which they are required to have on file, and you tell them that you are homeless, do you think they will still hire you? Perhaps, I’m not sure. But most employees must live somewhere and of course the cost of living is not a deduction from our income when calculating our taxes payable. Many employees live in places specifically because they found a job near that location and many jobs are more readily available in locations with much higher costs of living (major cities), yet there is no deduction for cost of living.

What about the cost of education to gain the knowledge required for your job? Well, there are tuition tax credits to offset some taxes payable but that’s not a dollar for dollar deduction. Meaning, every dollar of tuition is worth 15% (federal tax credit amount) so you are not getting a dollar for dollar deduction. Many jobs today require a university degree or college degree, which cost money; yes these costs cannot be fully deducted from employment income.

What about the fact that we are spending approximately 40 hours or week, or more, away from our loved ones doing an activity we may or may not like or enjoy. They say time is money. The opportunity cost of the hours spent at work plus the additional time spent commuting to and from work is not taken into account in our tax system as a cost of our labour.

In my previous articles, I have proposed and urged a massive simplification of our income tax system. I am therefore not proposing that the above mentioned deductions be added to our tax system, as that would be the most ridiculous inefficient costly method of making the tax system fairer for employees. Rather, I would propose that we simply abolish all income tax on employment and self-employment income up to $100,000. Meaning every single Canadian would be able to earn $100,000 from employment and self-employment income tax free. (There would still be CPP and EI contributions).

If that idea is too much too swallow, then at the very least, we should make 50% of one’s employment income tax-free, similar to how capital gains are 50% tax free.  So if you earned $60,000 a year in employment income, $30,000 of that would be tax-free and you would only pay tax on the remaining $30,000, in order to allow for the effective taking into account of the above mentioned costs of employment. Capital gains are only realized by the top 1% of income earners in the country. They are entitled to earn 50% of their capital gains tax-free. (There is a valid reason for this because some capital gains are merely just an increase in price over time as a result of inflation and not an actual realized gain). I propose that employment income also be 50% tax-free.

The income tax on employment and self-employment, at the current rates, for those earning $100,000 or less is very harsh and punishing and is the reason why many Canadians are unable to save for retirement, pay down debt, get ahead, or have enough money to pay an unexpected $400 bill. The government is constantly preaching to Canadians about saving for retirement and trying to create incentives for us to do so, such as the RRSP and TFSA. 90% of RRSP contribution has gone unused and only about two thirds of Canadians have opened a TFSA. The government is the guilty party here, incurring $1 trillion of debt on our behalf (across all provinces and the federal government), taxing us to pay the interest on said debt and then complaining to us that we aren’t saving enough for retirement? Who has any money to put away once it’s all been taxed!?

Our current system of taxing employment and self-employment is regressive, hurts lower and middle income people more than higher income people, discourages people from working more, encourages people to accept more government benefits, and does not accurately take into account the true costs of what workers endure to find and maintain their jobs. With the federal election coming up in the fall, will any political party be brave and propose some major policy changes in this regard? Let’s allow Canadian workers to save more of their money, remove the unfair and high tax burden on them and make our tax system a little more fair for those who need the most help.

Neal Winokur, CPA, CA