A ‘Boost’ Up the Income Ladder: The Role of Income-Based Tax Credits

September 19, 2018
Kristine St-Laurent

The Income Ladder

Addressing income inequality is an important challenge for policymakers and communities. Establishing a consumption floor below which no person falls is a policy goal in many jurisdictions.

Of course, even poor Canadians would be considered well-off compared to people in the developing world. But relative poverty is still present in Canada. In responding to this issue, there is a growing debate around the tools to improve well-being for individuals in the lower segments of the income distribution.

Basic Annual Incomes and Income-based Tax Credits: How to Incentivize Work?

Talk of basic annual income (BAI) programs has become common, and the previous Ontario government even launched a now-disbanded BAI pilot program. Essentially, a BAI aims to provide a set payment to eligible families or individuals to ensure a minimum income level, with no strings attached. Payments are guaranteed, regardless of whether recipients are working or not.

However, as some academics point out, a guaranteed income does not necessarily foster or maintain labour force attachment. In other words, give people free money and there is evidence to suggest that some will choose to work less. In a 2013 University of Toronto study, researchers simulated the labour supply response of a hypothetical income top-up program to estimate the magnitude of the potential effect on employment. They found that, under this particular BAI system, the number of single working-age men and women not participating in the labour market rose as much as 22% and 19.4%, respectively.

There is also the question of costs. Depending on the design and level of a BAI, the additional cost to governments in Canada could reach many tens of billions of dollars annually, even if one assumes that other income support programs (e.g., social assistance, Employment Insurance, the Guaranteed Income Supplement for seniors, etc.) would be eliminated once a fulsome BAI was in place.

There is another way to incent work and raise incomes for the working poor. In Canada, the federal government has the Working Income Tax Benefit (WITB), an earnings supplement for lower-wage workers. It is a refundable tax credit intended to assist eligible low-income individuals and families. But it is a modest program: it pays no benefits until someone earns more than $3,000 a year via work. The tax credit operates on a sliding scale: as income goes up, it pays out more -- up to a maximum, after which the payment declines. In 2016, the WITB provided approximately $1.1 billion in benefits to over 1.4 million Canadians. Unlike a guaranteed basic income, the advantage of an income-based tax credit targeted at workers is that it creates an incentive for labour force attachment among individuals with relatively low employment incomes. Also unlike a BAI, it doesn’t reward non-work.

Getting More from the WITB

The WITB has the potential to play a part in boosting incomes for lower-paid workers. However, the current program is very limited in scope. For 2017, the national[1] WITB provided a maximum of $1,043 a year for someone earning between $7,171 and $11,838, then less for each dollar earned above $11,838, before dropping to zero for those with employment incomes above $18,792. The rates for families were slightly higher. The maximum WITB for 2017 was $1,894 for a family with income between $10,576 and $16,348, gradually reduced once net income reached $16,348, with no benefits paid once family income exceeded $28,975.

In 2019, the maximum benefits will go up to $1,192 for individuals and $2,165 for families (see Figure 1). The WITB could be further enhanced to give individuals and families a greater incentive to work and to increase the support provided to lower-income workers and their families.

Figure 1: New WITB Rates for 2019, Canada

Source: Department of Finance, Canada, 2017.

The American Model of Income-based Tax Credits

The U.S. has a similar but considerably more expansive program with its Earned Income Tax Credit (EITC). It may provide a basis for widening the similar program in Canada. In 2017, the EITC refunded up to $6,431 to working Americans, depending on their income, marital status and number of dependents (Figure 2).

Figure 2: U.S. Earned Income Tax Credit Returns, 2018

Source: Center on Budget and Policy Priorities.

The EITC is also phased out at a higher net income than Canada’s WITB (Tables 1 and 2), which points to the logic of expanding the program here.

Source: 26. U.S. Code 32-Earned Income.

Income-based Tax Credit Advantages

Due to its structure, the WITB (like the American EITC) provides income support for working individuals and their families at the bottom rungs of the income ladder. Unlike other social assistance programs, a more generous Canadian WITB could help to reduce inequality by helping to lift the after-tax earnings of lower-income workers, while maintaining an overall incentive to participate in the labour market. In addition, by encouraging lower-paid individuals to stay engaged in work, an expanded WITB could create a better environment for upskilling and increased market wages (since employees’ earnings often rise with years of work experience). In short, expanding the WITB could provide a welcome “boost” to many Canadians and help government improve on an existing program.

[1] These rates are for those provinces that rely on the national program. These amounts differ for residents of Alberta, Quebec. Nunavut and B.C., which have signed agreements to align WITB with their own programs.

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