A policy that's fair - and it wins votes
Trial balloon or no, there can be little doubt that income splitting -- allowing couples to average their incomes between them for tax purposes, with the higher-earning spouse shifting some of his or her income to the other -- is high on the Tory agenda. It featured prominently at the party’s last convention, it has been a favourite of grassroots Conservatives for years, and has been talked up by more than one cabinet minister. What is more, having granted it to pensioners as part of the income trust package, the Tories can hardly deny it to everyone else. Plus it’s huge, huge politically.
For once, the crass appeal to the base is also the perfect means of broadening the base; the cynical vote-buying thing is also the right thing. A lot of arguments are going to be made about this, so let’s get one point straight off the top. This isn’t about bribing mothers to stay home, nor is it one of those social-engineering Tory tax credits aimed at rewarding one type of behaviour or another. The fundamental case for income-splitting is one of fairness.
Fairness does not just mean sharing the tax burden equitably between rich and poor: what economists call “vertical equity.” There’s another kind of fairness, that also has to be taken into account. If it’s important to treat people in different circumstances differently -- ie the rich pay more tax than the poor -- it’s no less important to treat people in similar circumstances the same: what’s called “horizontal equity.” And, when it comes to couples, the tax law doesn’t.
Compare two couples. In Couple A, both spouses work, each earning $50,000. In Couple B, one spouse earns $100,000, the other stays home. The combined household income for each couple is the same -- $100,000 -- yet Couple B pays thousands of dollars more in tax than Couple A. Why? Because the spouse earning $100,000 pays tax at a higher rate, thanks to the progressive income tax, than either of the spouses earning $50,000. Income-splitting amounts to treating Couple B the same as Couple A. It treats like as like.
So this isn’t part of some secret social conservative plot to keep women barefoot and pregnant. Well, maybe it is, but if so, it’s hard to see how. It’s true that couples with one parent at home would benefit from this change, but only because they are unfairly penalized by the present system. Repairing that unfairness poses no disincentive to women who work: Couple A doesn’t pay any more tax under income-splitting than Couple B. They just don’t pay any less.
And while Couple B’s tax bill does go down, the idea that this would induce a lot of women to quit their jobs is fanciful. Sure, they get to stay home -- but they also have to give up the salary they were earning. Unless the husband suddenly doubles his pay, their living standards undergo a sharp drop, even with the savings in tax. Perhaps the availability of income-splitting as an option would cause some couples to rethink the division of labour between them, over time. But the principal effect of income-splitting isn’t to bring about some fundamental change in people’s choices between work and home. It’s to treat existing choices more fairly.
(Or suppose you view it, not as the correction of an inequity, but as a benefit for mothers who stay home with their kids. Is that so awful? Are you also opposed to maternity leave?)
Is income-splitting unfair to singles? A couple earns $100,000. A single person earns $100,000. Income-splitting would benefit one but not the other. Shouldn’t they pay the same of tax? No, of course not. Horizontal equity requires that we treat like as like. But a single person and a couple aren’t in similar circumstances. The couple has $100,000 to spend between them. The single gets to spend it all on himself. He thus has more discretionary income -- the amount left over after basic living expenses -- out of which to pay his taxes. It’s only fair he pays more.
Income-splitting would mean that some rich taxpayers would pay less in tax. But unless you are pathologically opposed to any reduction in taxes for the rich, even when everyone else gets the same break, it’s hard to see any unfairness in this. The tax rates charged at different levels of income -- the yardstick of vertical equity -- wouldn’t change. But there would be a marked improvement in horizontal equity. It’s not right for the rich to pay less than their fair share. But it’s also not right for some rich to pay less than others equally rich.
Indeed, if there’s a legitimate complaint to be made about income-splitting, it’s that it doesn’t change the taxes paid by the rich. Or rather, it does reduce their taxes -- the amount of tax they pay in total. It just doesn’t change their marginal tax rate: the rate paid on the next dollar of income. Take a taxpayer making $250,000, who now gets to split it with his spouse, $125,000 apiece. Since the top tax rate kicks in at around $100,000, the couple’s overall tax burden goes down: a smaller slice of each spouse’s income will be taxed at the top marginal rate. But as each remains in the top bracket, the marginal rate remains the same.
That’s important, because it’s the marginal rate that matters for decisions to work, save and invest. Income-splitting only cuts marginal rates where it causes a couple’s taxable income to fall into a lower bracket; true for some couples, but not for many others. So for a very large revenue hit -- an estimated $5-billion annually -- there’s a comparatively small payoff in productivity. It comes down to this: which is the more urgent concern to be addressed through tax reform, fairness or efficiency?
Or does it? There is a way to do both. Among the advantages of compressing the present system of escalating marginal rates on higher incomes into a single rate -- the so-called “flat tax,” such as Alberta enjoys -- is that it makes income-splitting unnecessary.
11/22/2006
