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).