A look at income splitting and its alternatives

Finance Minister Jim Flaherty's seemingly off-the-cuff remark on Wednesday that he is not entirely convinced income-splitting for families with children would overall benefit Canadian society, signalling a possible policy backtrack, caused quite a bit of brouhaha.

Unsurprisingly. After all, it was a major campaign promise in the run up to the 2011 federal election — which vaulted the then minority Conservative government into majority status — with the roll-out contingent on a balanced budget. 

With this year's pretty-much-balanced federal budget, which shows a $2.9-billion deficit — within the $3-billion cushion set aside for potential blows to Canada's economy — and next year's guaranteed surplus, many wondered about that long-promised election goodie.

Of course, well before Flaherty made his comments, the prospect of this kind of income splitting received major criticism from think-tanks across the ideological spectrum, with the resounding common argument that, mildly put, there are much better ways to provide tax relief for families. 

What is income splitting?

The "Family Tax Cut" would allow couples with children under 18 to split up to $50,000 of their incomes each year for tax purposes. A spouse in a higher tax bracket would be able to transfer his or her taxable income to the spouse in the lower tax bracket, thereby reducing overall taxes the family has to pay. 

An argument in favour of income splitting is that it's unfair for couples who earn similar total earnings to pay different tax amounts when it comes to how their incomes are divided. Couples where one spouse earns significantly more than the other spouse typically pay higher taxes than couples whose respective incomes are fairly equal.

"The tax system does not recognize the fact that many, even most families, pool their income to pay their household bills. Nor does it recognize that families share together the special expenses of raising their children and planning for the future," Prime Minister Stephen Harper said in 2011.

"Instead it treats families the same as roommates living under the same roof with no financial attachment. That is not realistic. That is not fair."

The 2011 Conservative platform also noted the family tax cut will provide "significant tax relief for approximately 1.8 million Canadian families — each of them saving, on average, $1,300 per year." 

But according to a report by the left-leaning Canadian Centre for Policy Alternatives, the richest five per cent of families stand to benefit more than the bottom 60 per cent combined. 

The C.D. Howe Institute, an economic think-tank, concluded 40 per cent of total benefits would go to high-income, one-earner families making more than $125,000 a year. Of all households, 85 per cent would receive nothing, it noted. 

For a policy that stands to not benefit the majority of households, it's quite costly. 

According to the more conservative-minded C.D. Howe Institute, if implemented, it would cost the federal government $2.7 billion in annual revenue and $1.7 billion more for provincial governments if they went along with similar income splitting efforts. The CCPA pegs forgone revenues at $3 billion federally and $1.9 billion provincially. 

If the government chooses to extend the splitting proposal to all couples, regardless of children, the C.D. Howe report said the revenue cost would double to $5.6 billion federally and $3.5 billion for all provincial governments ($2.1 billion for Ontario alone). The total annual cost would be more than $9 billion.

And so experts say the approximately $3-billion income splitting proposal would be better spent on something else. Below are a few suggestions.

Increase the Canada child tax benefit

Both the Broadbent Institute and the CCPA endorse upping the amount the federal government currently sends each month to low- and moderate-income families with children under age 18. Included in the CCTB is the national child benefit supplement (NCBS), which is a monthly benefit targeted towards low-income families with children. 

The CCPA's David Macdonald suggests doubling the NCBS, which he says "is a very simple measure." All it is changing the value of the money being sent out, he says.

“You get a better bang for your buck with the NCBS in terms of reducing child poverty,” he said.

Other tax/transfer benefits aimed at children

"If a major objective of income splitting is to permit parents to spend more time child rearing," notes the C.D. Howe Institute, "then it is a poor choice of policy instrument." Its report said "splitting would provide no fiscal support for single parents — those in greatest need of such help — and little or none for lower-earning couples with children."

As well as the Canada Child Tax Benefit, C.D. Howe suggests looking at existing policies, such as the $100-a-month universal child care benefit given to parents of children under age six and the EI provision for parental leave. 

"Indeed, the $2.7 billion federal revenue cost of income splitting would go a long way if the money were spent instead on helping families with very young children."

Emulate the Quebec child care model

Speaking of young children, the CCPA report notes, "If Canadian governments are concerned about supporting families with children, a far more equitable way of doing so would be to provide a universal child care program similar to the Quebec model, reducing child care costs from their current $40 to $50 a day to the $7-a-day range."

Macdonald also advocates this plan for its incentives for women.

"By dramatically reducing those costs, you’ll increase the number of women in the workforce."

In contrast, the C.D. Howe report says the family tax cut income splitting proposal would significantly raise marginal tax rates for most lower-earning spouses, and therefore create barriers for working or returning to work. It would "make married women more vulnerable by reducing their work experience."

Eliminate middle tax brackets

The right-of-centre Fraser Institute proposes cutting out the 22 per cent and 26 per cent marginal tax rates to leave only one tax rate for the majority of Canadians and another for upper-income citizens. Going a step further, it suggests implementing a 15 per cent flat tax, which "would negate the need for income splitting." 

Across-the-board personal income tax cuts

In its October 2011 report, the C.D. Howe Institute wrote, "If the intention of the income-splitting proposal is to provide tax relief with a tilt favouring higher earners, this could be achieved more effectively by just cutting tax rates in the relevant brackets."

The report says it wouldn't target assistance at families with children, but it would "address equity concerns about the exclusion of single parents and childless couples and singles."