Rollback of TFSA contribution limits a good first step

If you had any investments back before the creation of Tax Free Savings Accounts and did your own taxes, chances are that the tax you paid on the modest interest you earned really ruined your day.

If you had any investments back before the creation of Tax Free Savings Accounts and did your own taxes, chances are that the tax you paid on the modest interest you earned really ruined your day.

Unlike employment income – where the taxes are deducted by your employer and paid directly to the taxman – no such withholdings are typically done on investment income. This meant that it was money that you paid out at tax time.

To add insult to injury, that investment income was taxed at your highest marginal rate – or at the rate of your highest tax bracket – so the tax bill could be pretty significant. It kind of made the whole thing seem barely worth it.

Enter Tax Free Savings Accounts – a popular initiative of the Harper government which provided some relief to the unfortunately small number of Canadians who put some of their money away. In a nutshell, TFSAs allow individuals over 18 to put up to a set amount towards into an account each year. The interest earned on that account would be tax free.

Unlike with RRSPs, contributions you make to your TFSA are not tax deductible. That means you can’t reduce your tax bill or increase your refund by making a contribution. If the money you put into a TFSA was earned as employment or business income in the year you contribute it, you still pay the tax that year, not later on when you retire like an RRSP.

But the privilege of not paying any tax on the interest is unique to TFSAs. Even with RRSPs you will pay tax on the interest once you pull it out after your retirement.

The annual limit on TFSA contributions was originally $5,000 but was increased twice by the Conservatives – first to $5,500 per year and in 2015 to $10,000. The limit is cumulative, so if you don’t hit your cap one year it will rollover into the next. If you’ve never put money in a TFSA you currently have $41,000 of contribution room.

One of the first acts of business of the Trudeau-led Liberal government was something it had pledged to do throughout the campaign which was to return the contribution limit to $5,500 for the 2016 taxation year.

The creation of TFSAs to begin with was actually a good idea in theory – one of the better and most popular policies the previous government came up with. Canadians don’t save enough, and a little bit of relief for Joe Taxpayer who puts away some of his money for a rainy day is good policy.

But there is a fine balance that has to be achieved between encouraging ordinary working Canadians of modest means to put away some of their paycheque and creating a new opportunity for the wealthy – many of whom earn a greater percentage of their income from investments – to avoid the tax man.

And some critics of TFSAs as they currently exist don’t think that the Conservatives got the balance quite right.

In the long run TFSAs have the potential to significantly reduce the tax burden of wealthy Canadians. That means fewer government programs, higher deficits or more taxes being by paid those who earn their income through labour. An analysis performed by the non-partisan Parliamentary Budget Office found that TFSA meant $1.3 billion in lost revenues for federal and provincial governments in 2015 – a manageable figure. But this figure is expected to rise as more and more capital is put into TFSAs and the interest is kept away from the government.

By 2020 the PBO estimates that the lost revenue will be $2.8 billion. By 2080 the annual lost revenue will be 10 times greater as a percentage of total government revenues. Now we’re talking about a significant revenue loss.

And who reaps the benefits? According to the PBO, even now 34 per cent of the benefit of TFSA goes to the top 20 per cent of income earners and 62 per cent of the benefit going to the top 40 per cent.

And those calculations were all done under the $5,500 limit, not the $10,000 limit brought in by the Conservatives.

While the research shows that many Canadians across the income spectrum take advantage of TFSAs, a relatively small percentage can afford to contribute the maximum. A study by the Broadbent Institute found that when TFSAs were first created a lot of people of various incomes were reaching their limits as they moved money from other savings into these accounts, but after a few years the number contributing the maximum had dropped substantially. It stands to reason that by increasing the limit to $10,000 even fewer will be contributing the maximum and would skew even more heavily towards the wealthy.

That may be just fine with you if you think that those who risk their money and invest in the economy should enjoy the fruits tax free. But if you accept that government must obtain revenue for its operations somehow and that its options for doing so in a progressive manner are limited, you should have concerns about the long-term implications of TFSAs as presently constituted.

Encouraging investment is all well and good, but encouraging hard work is important too. Shifting the tax burden from capital to labour has significant implications for income inequality.

Returning the limit to $5,500 was a good start. But the long-term repercussions for government revenue and income inequality of allowing so much investment income to be received on a tax-free basis have not been fully addressed by simply reducing the limit and merit further examination.

Kyle Carruthers is a born-and-raised Yukoner who lives and practises law in Whitehorse.

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