The curious case of income splitting

It is well known that the Harper Conservative government has pledged to allow income splitting for families with children under the age of 18 once the Budget is balanced. We will find out more about how far away the government is from the goal on February 11 when the federal budget comes down, but suffice to say this proposal will likely become a reality within the next year regardless of the evidence against the policy.

This issue of income splitting in the Canadian tax system is not remotely a new idea. It was floated back in the 1960s by the Carter Commission and several times since then. The Conservative Party first signaled their interest in income splitting for single income families with children in 1999. The idea was investigated by the Standing Committee on Finance which rejected the proposal for a variety of reasons including costs and the failure of the proposal in valuing home production. This post by Frances Woolley over on Worthwhile Canadian Initiative nicely summarizes the history of the proposal as well as some excellent research in the area.

While not much has been said about what the objectives of Harper’s policy are, which focuses on families as opposed to all households,  I imagine that it has something to do with trying to address child poverty, particularly in those households where one spouse elects to stay home with the kids. As readers may recall, in 1989 the House of Commons resolved to eliminate child poverty by 2000 and this commitment is what launched our current system of child benefits in Canada. Despite this commitment, however, child poverty rates are pretty much at the same level as they were in 1989, hovering around 15%.

This raises the question of whether this income splitting proposal will have any legs in helping reduce child poverty or benefiting lower to middle income households in anyway. It would seem that the answer is a resounding, no. Last week the left-leaning (slanted?) Canadian Centre for Policy Alternatives dropped a report on Income Splitting in Canada. The report comes out against income splitting noting that it disproportionately benefits wealthy households, a sentiment that I tend to agree with.

An area not discussed so far is how this proposal can benefit those with personal corporations. Take the case where one spouse is an employee earning $130,000, more than enough money to pay their bills and then some, and the other spouse is a business owner who pays themselves a small salary out of the business.

They recently had a child. Once the income splitting policy comes into effect, they change their approach to their business income. The business owner elects to no longer pay themselves a salary. Instead of paying themselves a salary, the business owner  keeps their earnings in their corporation where it is subject to corporate tax but at a far lower rate than had they paid themselves a salary and paid personal income taxes. They can now split the employee’s salary, thereby reducing their tax bill. But here is the kicker. The income accruing in the corporation will remain in the corporation until such time as the owner disposes of their shares. This triggers a capital gain but because the shares are in a Canadian-controlled private corporation (CCPC), up to $750,000 of the capital gain on the disposition of the shares is completely tax free. They now get to benefit from the tax savings from income splitting but also from the CCPC capital gain exemption. The family wins but the taxpayer loses. After all, this is a family who might like the taxpayer funded help but honestly does not need the help. I know this because this is my family.

There are much better ways at getting more money into the hands of low and middle income earners other than income splitting. This includes enriching the child deduction, personal exemption, child tax benefits and the national child benefit, HST credit, child care tax deduction (a topic of my next post where our business owner makes a reappearance), WITB, and the like. The CCPA argues that instead we should provide universal child care, which I find curious as that too disproportionately benefits the wealthy. In addition, universal child care is of no benefit to those families where a spouse elects to stay home with the kids, which are the families mostly targeted by the income splitting proposal.

What I do know, though, is that we will see income splitting because it very much benefits Harper’s core voting base. This is disappointing because we are once again throwing money at something that is not a substantial problem (the problem of a $130,000 earner paying more in tax than two $65,000 earners).

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5 thoughts on “The curious case of income splitting

  1. Christoph Luelfesmann

    It is true that the proposed income tax splitting benefits single earner families (or more generally, those in which spousal incomes are very asymmetric) the most. What the article ignores is that many of those families currently have a substantial tax disadvantage relative to symmetric double income families because they cannot claim child care expenses (those have to be claimed by the lower income spouse in Canada). To illustrate this, consider two middle class families with 3 kids (under the age of 6) who both have a total annual income of 150,000, and possibly annual child care costs of 21,000 (or higher). A one-earner family of this type is not entitled to any credit for child care expenses. Instead, assume now that each of the spouses has an annual income of 75,000. In BC, this would translate into an annual federal plus provincial tax credit of about 9,000 dollars — which is away more than the highest possible benefit from the proposed income tax splitting. Now rethink. What the income tax splitting proposal mostly does is to give some tax benefit to families in which one spouse decides to be there for her own children instead of working (full time) — in a situation where families who decide otherwise receive a substantial benefit, plus the benefits of lower income taxes for the same total income. I don’t think this is unfair. However, the example also shows that it might be a good idea tie the splitting benefit to the number of children in the family (an easy way of doing this would be by making the maximum splitting amount dependent on the number of children).

    • Thanks for the comment. I actually have a post coming up on the child care expense deduction. Should be up somewhere after a few post about taxation and Olympic medals. I talk about this from the perspective of both parents working but one earning no income.

  2. Anthony van Berkel

    Regarding your paragraph “They recently had a child. Once the income splitting policy comes into effect, they change their approach to their business income. The business owner elects to no longer pay themselves a salary. Instead of paying themselves a salary, the business owner keeps their earnings in their corporation where it is subject to corporate tax but at a far lower rate than had they paid themselves a salary and paid personal income taxes. They can now split the employee’s salary, thereby reducing their tax bill. But here is the kicker. The income accruing in the corporation will remain in the corporation until such time as the owner disposes of their shares. This triggers a capital gain but because the shares are in a Canadian-controlled private corporation (CCPC), up to $750,000 of the capital gain on the disposition of the shares is completely tax free. They now get to benefit from the tax savings from income splitting but also from the CCPC capital gain exemption. The family wins but the taxpayer loses. After all, this is a family who might like the taxpayer funded help but honestly does not need the help. I know this because this is my family.”
    How can this be an argument against income splitting, it is an example of having a good accountant and the rules need to be tightened up.

    Now back to my question that I am hoping someone can answer: Couple A: asymmetric income $120K/$20K, couple B: symmetric income $75K/$75K. Both have 2 kids and work very hard and even with income splitting both partners in A would have to keep working. What is the argument that A and B should not have same combined net income? I agree neither couple is in dire straits but that is not an argument for unequal treatment. I am a member of the family unit A, it is not that I am greedy or do not care about people who need help, my only question is why the difference between Couple A and B is ok. I know there are a variety of situations that income splitting would affect and in some situations there could be arguments against income splitting, I am asking specifically about my situation which I think is quite common

    • I can’t quite keep up with all the comments. This is a blog, not instant messaging.

      You seem to want to know if you will benefit from income splitting. Yes, you will. That though is a very different aspect from sitting back and analyzing the policy from a tax framework perspective. What is in it for me is NOT how we decide tax policy. We decide tax policy using a framework and considering the system as a whole. That system, is based on the notion of progressive income taxation, among others. I have a post on my blog about a framework for tax analysis.

      I might direct you to the research regarding income splitting. A very negative unintended consequence is the labour supply effects. For a summary, see: http://worthwhile.typepad.com/worthwhile_canadian_initi/2013/06/family-feuds-canadas-interminable-tax-unit-debate-.html.

      You also have to appreciate the affects of income splitting for ALL families. As a high income earner, you will benefit a great deal. Whereas a low or middle income earner will derive no to few benefits, yet they are in the same position as you. Income splitting is regressive. As I and others have written, there are much better ways of addressing the perceived inequities of statutory tax rate bias without engendering regressivity.

      If you want to read a report that is pro-income splitting to understand the conditions under which is needs to be presented, read the Krzepkowski-Mintz proposal, a link to which is on the page I link to above.

      • Anthony van Berkel

        If this inequity between Family A and B was corrected in a tax neutral way I would be happy. A pay less tax and B pay more tax, so that the 2 families at the $140 level have the same net income. No regressivity there and use the surplus on the needier families, no problem for me there. I think family B would raise a stink because right now they got it pretty good compared to me, not that either of us in dire straits

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