Implementing Local Income Taxes in Toronto: The Devil is in the Details

As you may be reading, The City of Toronto is mulling over imposing a municipal income tax for the city in an effort to plug its never ending budget deficit. There are a few things to know about this.

Municipal governments may only raise revenue through any means authorized by the province. Here is the City of Toronto Act, and income taxes are a tool that have not yet been devolved. In fact, income taxes are expressly forbidden under section 267(2)1. In order to obtain that power, the City must seek the authority from the province and the City of Toronto Act would have to be modified accordingly. Expanding municipal tax authorities in this way would set a potentially undesirable precedent (not only in the granting provinces, but others as well) and likely to get lukewarm reception since provincial governments have traditionally been unenthusiastic about granting additional authorities to municipalities. Perhaps then it is time to have a broader discussion about devolving this revenue tool.

While municipal income taxes are unheard of today, they were an important source of municipal revenue before WWII. Municipal income taxes were abandoned in 1941 when the provinces signed onto the wartime tax rental agreement.Despite no longer being popular in Canada, municipal income taxes are used in some areas in the U.S (as well as in many European countries). To my knowledge, about 5,000 jurisdictions in 17 U.S. states levy a local income tax. Local income tax rates in the U.S. are typically low but broad based (an economists tax dream).

Local income taxes are more popular in the U.S. for two reasons. First, their origin is the Great Depression and were turned to when property tax revenues dried up. Second, many U.S. states have a long history with property tax revolts, making property taxes unpopular and have placed strong restrictions on rates and rate increases. In fact, many ballot initiatives for local income taxes occurred around the same time as a rejection of property tax increases. So in the U.S., the issue became would you rather a property tax or a local income tax and residents choose the latter.

Another benefit in the U.S. is that local income taxes are deductible for income (state and federal) tax purposes (though so are property taxes). At one point Obama considered eliminating the deduction, but I believe that did not go forward. In Canada, local income taxes (and property taxes) are not deductible and I doubt the federal government has any plans to go down that road.

In the case of Toronto, I expect that the choice is really would you like an income tax or a larger property tax (or possibly both?). Which is possibly too bad, because median house price to medium income ratio is quite high in Toronto a local income tax would probably be more progressive than property taxes and better linked to income rather than an imputed measure of wealth so dissociated with income in such a market. And it would mean less reliance on provincial property assessments, which is a whole other kettle of disgruntled fish. Local income tax is also better suited than a property to pay for regional-wide needs, such as poverty, social services, crime, and transportation, all substantial issues in the City of Toronto.

Now there is no talk yet about how a local income tax in Toronto would be implemented, which leaves lots of questions about the feasibility and burden of this tax. I have not seen any talk about who the tax would be levied on. People, unlike property, are mobile, very mobile. What would be the implication for mobility of a local income tax? How you implement it and the rate matters to understanding this.

And would you impose it on residents in the City of Toronto or employees in the City of Toronto? The City of Toronto has many people that work in its region that do not live in the region. Workers still consume services provided by the City. In fact, many local income taxes in the U.S. are imposed on workers. That said, you have residents that consume services but do not work in the City boundaries. These issues lead many U.S. municipalities to impose one rate for residents and one rate for non-residents. But you need a way to define who is who.

I also see no talk about the burden a local income tax would place on businesses. How would a local income tax rate work for businesses and business owners? Would they be expected to collect and remit the tax? If the tax base is not workers, how would they sort out who to withhold and who not to withhold? And to whom do they remit the tax to? In the U.S., there are models where the local income tax is embedded into the income tax system, but in the U.S., you file state taxes. In Canada, through the tax collection agreements, CRA collects on behalf of all provinces (except Quebec which has the opposite model).

So a City of Toronto local income tax may require a lot of work with CRA to determine eligibility, how the tax form would be modified, how the funds would be returned, and who would pay for these administrative costs. In addition, going this route means that the City of Toronto would have to accept the federal government’s definition of taxable income. More commonly though, U.S. local income taxes are collected by local tax authorities which imposes a huge burden on both the tax filer and the local authority. That is not a tax structure though that I would have a lot of faith in.

We should not necessarily be opposed to local income taxes, in fact, they have a lot of benefits over a property tax, but we need to understand the details before knowing how this would all play out. I’d like to see the City of Toronto (and even more broadly the provinces) envision such implementation issues before going too far down the road of seeking authorities for such a tax.

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4 thoughts on “Implementing Local Income Taxes in Toronto: The Devil is in the Details

  1. Hi Lindsay–do most US municipalities that levy income taxes just ‘piggy-back’ off the state tax administration / tax base definition? In Canada, short of setting up a seemingly-difficult City of Toronto Income Tax Administration, it strikes me the easiest way would be to piggy-back off the CRA administration/auditing/tax base.

    • From what I read, ‘most’ (though I don’t know how this is defined) seem to collect locally, which I agree is not the way to go. The easiest way would, in my mind and as you note, be to piggy-back off CRA. I assume this could be done by IDing postal codes. But that is easy if done on a residency basis. If there would also be a non-resident tax, it does get a bit more challenging.

      • Yes, non-residential tax would seem to present challenges. I guess you withhold at source and then reconcile in some way.

        I get headaches thinking about it, but I find Canadians tend to over-react to municipal sales or income taxes (OMG!) without adequate consideration of the fact that it is very common in the US.

        I see a lot of downsides–not just on administration and implementation but on pure tax policy principles–but we shouldn’t dismiss these ideas as prima facie impossible.

      • Absolutely agree on all fronts! We need to get back to a world where ‘tax’ is not a dirty word and we can think and talk about the ‘best’ way to raise revenue for needed expenditures.

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