Will the 'tax the rich' plan scare them away?

In a climate where taxing the rich seems to be all the rage, the Ontario Liberal government is unlikely to suffer much political fallout with its plan to create a new tax bracket for the wealthy.

But will the extra two per cent tax imposed on those making over $500,000 prompt high income earners to slack off or leave the province, dealing a severe blow to the local economy?

Unlikely. 

But so too is the policy unlikely to have a huge impact on curbing the $15.3-billion deficit, one of the stated goals of the new tax, according to the premier.

"We're still going to raise revenue from this new tax. But it just might not be as much as the Liberals or NDP hope," said Kevin Milligan, a University of British Columbia economics professor. 

Taxing the world's rich

A number of politicians have recently been championing the cause of taxing the rich. U.S. President Barack Obama has been campaigning for a so-called Buffett Rule that would slap a 30 per cent tax on Americans earning more than $1 million . (The proposal failed to pass the Senate).

In France, Socialist candidate François Hollande has called for a 75 per cent tax on millionaires.

Ontario Premier Dalton McGuinty announced the new tax on Monday after reaching a deal with the NDP to support his budget and avoid an election. McGuinty said all revenues from that new tax would be devoted to "accelerating our plan to eliminate the deficit."

According to finance officials, about 23,000 people — or 0.2 per cent of tax filers — would pay an average of about $19,000 more in income tax. The Liberals and NDP have estimated the new tax will generate somewhere between $440 million and $570 million.

But Milligan said those numbers are "ambitious."

Send in the accountants

"There’s very strong evidence there as well that, especially for the highest earners who have access to really good tax advice, when tax rates go up, they find legal ways to readjust their affairs so they lower their tax bill."

The British government,  for example, is lowering its top tax rate from 50 per cent to 45 per cent because the projected revenues didn't materialize after raising the rates. Chancellor of the Exchequer George Osborne, Britain's finance minister, said that the higher tax rate had raised "next to nothing" because people had found ways to avoid paying the tax.

Milligan said for the Ontario government to raise the projected revenues, "you have to assume that people who have access to all this great tax advice don't use it. And that seems to me like a bit of a strong assumption."

Brian Quinlan, a Toronto-based accountant, explained ways of minimizing your tax burden, including income splitting with a spouse or children or putting the money in a holding company.

People can also reduce their net income through investing their money in tax shelters like flow-through shares. These shares are issued by mining, oil and gas, and renewable energy and energy conservation sectors to help finance their exploration and project development activities, according to the Canada Revenue Agency website.

"Let's say you have a $600,000 salary and you buy $200,000 of these flow-throughs. All of a sudden your net income is $400,000," Quinlan said.

As well, those who are just slightly over the $500,000 can put money in an RRSP and avoid the tax.

Asked about how that might affect overall revenues, Marion Nade, a spokeswoman for NDP Leader Andrea Horwath, said via email  that "all governments are concerned with tax avoidance. We support any means of addressing those loopholes."

"The estimates of how much money this tax will generate vary and ultimately we won't know how much revenue will be raised until the year has passed," said said.

Milligan also said he doubted the tax would scare off the very wealthy.

Moving income somewhere else

"We know quite a bit about the impact of this kind of tax," said Milligan. "You hear some people say it will deter business investment , this will deter entrepreneurship. And the evidence on that is pretty strong that that’s not the case."

Milligan said that's because at the very, very high end of income distribution, most of the income is earned income.

"These aren’t entrepreneurs and investors. These are people who are working for a living. They are very well-compensated people working for a living, but it just makes it a very different set of people than if these were all investors with a big pot of money wondering where they will invest it."

But Milligan said he doesn’t believe top executives won't work as hard or leave the province because they’re earning a couple percentage points less.

"I'm not so worried about people physically moving somewhere else. What I'm worried about is they are moving their income somewhere else," he said.

A tipping point for taxes

Milligan estimates that the marginal rate for someone earning over $500,000 would now climb to 49.5 per cent from 46.4 per cent. (When factoring in the provincial surtax, the overall tax hike will actually be 3.12 per cent.)

But he also noted that tax rates approaching 50 per cent are common in other very high income OECD countries.

He said there is a "tipping point" where pushing the tax rates higher could yield no more revenue, or, in fact, drop the revenue.

"I don't think evidence suggests that we’re hitting that point yet. My own best estimate is you have to get rates into the 60s before you stop raising new revenue."