How high tax rates hurt the economy

The government has couched this latest tax hike as part of its commitment to tax fairness for Canadians. But just how exactly is this fair?

What is tax fairness?

For me, the concept of fairness is about levelling the playing field for all to give everyone the best chance to do well. When it comes to tax fairness, at least to my way of thinking, this would mean lowering tax for everyone.

But that’s not what the federal government has done. Instead of focusing on better managing its spending—which I believe is the real issue—the Prime Minister and Finance Minister increased tax on the people already paying much more than their fair share of tax, while furthering the misconception that this same group is not paying enough.

Research from the Fraser Institute shows that the top 20% of income-earning families pay nearly two-thirds (62.7%) of Canada’s personal income taxes and more than half (54.2%) of total taxes. Dig deeper into more data, and you will see that Statistics Canada reveals the top 1% of Canadians at the highest marginal tax rate pay about 22% of all personal income taxes, but they only earn 10% of all income.

The message is clear: In Canada, if you do all the right things—pay for a good education, work hard, succeed in your career, and build wealth—you are rewarded with some of the highest tax rates in North America. For example, as a result of both federal and provincial tax hikes, Ontario now has the third highest top combined federal/provincial-state personal income tax rate in Canada and the United States.

Progressive tax rates are based on the logic that as your income rises, so, too, should the amount of tax you pay. But how much? And at what cost to the country?

How high tax rates hurt the economy

The Bank of Canada is concerned—as am I—with our lagging productivity, pointing out that Canada has seen the largest decline in productivity relative to the United States of any of our G7 peers, except for Italy.

There’s a clear connection between productivity and taxes. Too-high tax rates are a disincentive and deterrent to growth. Why work hard and put in overtime when more than 50% of what you earn could end up going to the Canada Revenue Agency?

At a time when Canada, just like every other country, is looking for highly skilled workers, our tax rates make it more difficult for them to choose to work here. This is equally true for Canadian citizens and potential new immigrants. Anecdotally, I’m hearing more and more from clients and people in my network that their children who have chosen to study abroad aren’t coming back home because they can earn and keep more of their income elsewhere. I’m not surprised.

Our high tax rates also make it hard to attract investment into our country and for existing businesses to expand. That is essential to improve productivity, innovate, create jobs and compete against peers in lower-tax jurisdictions.

_{The Allan Small Financial Show, featuring three tax experts—Fred O’Riordan of Ernst & Young, Jake Fuss of The Fraser Institute and Tim Cestnick, a Globe and Mail tax columnist and CEO of Our Family Office—originally aired on September 18, 2024.}

Let’s explore a flat tax

We need a better, more thoughtful tax strategy as a country—one that is fair for everyone. Canada has not taken a hard, comprehensive look at our tax system since 1962, when Prime Minister John Diefenbaker appointed the Royal Commission on Taxation.

At the very least, it would be an opportunity to streamline what is a very complicated system, as I see it. At best, it may point to a better way forward. One potential way to streamline our tax system, and make it more efficient and fair, is to implement a flat tax rate across the board. This is not a new concept for taxation.

For the past decade, Estonia has reaped the rewards of having the most competitive, simple and transparent tax system in the OECD. Its personal and corporate tax rates are 20%. It’s set to increase to 22% in 2025 to match its consumption tax, which increased from 20% to 22% in 2024. In the case of individuals, the tax rate does not apply to dividend income; and businesses only pay tax on distributed profits.

The result: the country has been very successful attracting startups and investment.

And we don’t have to leave Canada for an example of a flat tax. From 2001 to 2014, Alberta had a single 10% personal and business income tax rate, dubbed the Alberta Tax Advantage. The Fraser Institute is now calling for Alberta to implement an even lower flat tax of 8% on personal and business income to attract people, businesses and investment in the province and to encourage spending. When Canadians pay less tax, they have more to spend and put back into the Canadian economy.

Another potential way to ensure tax fairness and generate revenue to meet government responsibilities is to foster more opportunities for the public, business and government to collaborate. For example, why not give individuals and businesses the ability to invest in infrastructure projects, such as new roads and highways, and get a rate of return over time.

There are ways to level the playing field for everyone while generating the revenue governments need—and incentivize people to work hard and be successful. I don’t know what the answer is, but I think we as a country need to do the research, explore our options and see what’s possible.

What are your thoughts on tax fairness?

Read more on taxes in Canada:

• Capital gains tax in Canada, explained
• How much is capital gains tax in Canada?
• Canada’s income tax brackets, plus the maximum tax you’ll pay based on income
• Update on bare trust tax filing rules

About Allan Small, FMA, FCSI

Allan Small is the Senior Investment Advisor at the Allan Small Financial Group with iA Private Wealth and host of The Allan Small Financial Show. He is also the author of How To Profit When Investors Are Scared. He can be reached at [email protected].

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