Split income, not hairs
Families with the same income should be taxed the same. So why do critics try to write off income splitting?
Peter Shawn Taylor, Financial Post Published: Thursday, April 03, 2008
British jurist Lord Bowen once said defining equity reminded him of “a blind man in a dark room looking for a black hat which isn’t there.” Why so difficult? Because people keep messing with what equity means. Just consider the current debate on income splitting in Canada.
This week economist Jonathan Kesselman weighed in on the topic for The Globe and Mail, recapping a paper he wrote in February for the Institute for Research on Public Policy. Kesselman’s answer to whether it’s fair to allow spouses to split labour income for tax purposes is a firm no. But to get to there, he must define equity in a way that most people should find surprising. And his preference for contradictory conclusions opens up the tax system to even greater chaos. All this to argue against what even he admits is a wildly popular idea for reducing taxes on Canadian families.
Income splitting allows a couple to pool their earnings for tax purposes. While the tax system uses family income as the basis for awarding numerous social benefits — and while it seems obvious that households are the basic decision-making unit in an economy –married Canadians have always filed taxes as individuals. This quirk creates issues of equity.
The archetypal income-splitting example involves two families with identical incomes. Family A has one earner making $80,000 a year. Family B has two earners making $40,000 each. Both households have the same income, but Family A will pay thousands more in tax, thanks to Canada’s progressive tax structure. Supporters of income splitting argue this is unfair since it violates the principle of horizontal equity. Two families with identical incomes should face identical levels of tax. Seems simple. Not for Kesselman.
Our scholar argues these two families are vastly unequal. The family with two earners is much poorer than the one with a stay-at-home spouse, he claims. That second job entails more spending on transportation, clothing, dry-cleaning and take-out food. If children are involved, the two-earner family must shell out for child care, while the other family gets it free. All this adds up to substantial savings for the one-earner family. Says Kesselman: “If horizontal equity is to be judged by real living standards, one cannot compare two-earner couples and one-earner couples with the same money income.”
Kesselman ignores the many ways in which the tax system already recognizes the extra costs of the two-income family. The $7,000 child care expenses deduction, for instance, only compensates families for child care costs when both parents work and is mentioned nowhere in his report. At-home parents face real costs as well, including forgone earnings. But his broader point is far more interesting: Kesselman argues that since one-income families have a more pleasant lifestyle
than two-income families, they deserve to pay more taxes. He’s probably right with the first half of this assumption. The attraction of a less-stressed life is undoubtedly the reason why income splitting is so popular. Polls typically show support in the 75% range, a phenomenal level for an allegedly controversial notion.
But claiming that two families with the same income should not be equal in the eyes of the tax system creates some worrying implications. The Canada Revenue Agency uses income as its basis for applying taxes because it’s a dispassionate standard that everyone can agree on. If we abandon this and instead apply taxes on “real living standards,” how will anyone ever see eye to eye on equity? And why just focus on who’s getting home-baked cookies and free daycare? Dropping income as the basis for taxation opens up a host of new and exciting opportunities for the Canada Revenue Agency. Life in balmy Victoria easily rates higher on a lifestyle scale than snowy Sudbury, Ont. So tax that West Coast slacker more!
In fact, Kesselman has in mind a far broader tax revolution than most people could possibly imagine. He would prefer to tax everyone’s potential income as a way of bypassing actual income and getting directly at their lifestyle choices. Those lucky stay-at-home parents would thus have to cough up for the work they aren’t doing because they’re home looking after the kids. Allowing governments to get their share of income you don’t earn is his “economic ideal.”
Further confusing his outlook, Kesselman supports splitting pension income and investment income, which benefit the elderly and the wealthy, but not labour income, which has the biggest appeal for middle-class working Canadians. He obsesses over picayune issue of gender equity, ignoring the fact that the most vocal supporters of income splitting tend to be women. And he curiously accepts the notion of income splitting in cases where one spouse drops out of the workforce to assist the career of the other. The political wife is thus deserving of a tax break, the at-home mom is not.
To be fair, Kesselman provides a handy summary of the current debate, as well as a nice historical summary of the tax treatment of families in Canada and other countries. And his point that income splitting could lead to a reduction in the female labour supply is both correct and important. If we are going to have a discussion on the merits of income splitting, this should be the contentious issue: Does society have a stake in keeping women in the workforce or should we allow families to make their own decisions on labour supply without bias from the tax system? But twisting the definition of equal and plotting ways to tax lifestyles rather than earnings are of little use to Canadian public policy and will no nothing to staunch the popularity of income splitting.
-Peter Shawn Taylor is editor-at-large, Maclean’s magazine.
