The Costs and Benefits of the Income Split

Cayla Baarda

After months of debate both in and outside of Parliament, the federal government recently announced plans to lower the tax burden for Canadian families. A core component of these plans is an income splitting policy designed to allow couples with children under the age of 18 to split their incomes between the higher and lower earners. Couples will be able to split up to $50,000 by transferring that money to their spouse, effectively lowering taxes paid, with a maximum tax benefit of $2,000.

The government’s stated rationale behind income splitting is to promote fairness among Canadian families, as the current tax system enables dual-earner families to pay less in income tax than families with a sole, higher earner (even if total net income is the same). For example, a household with one parent making $70,000 a year will forfeit more in income tax than a household with two parents making $35,000 each.

Prime Minister Stephen Harper first made reference to income splitting during the 2011 federal election campaign, where he promised family tax cuts through the model. At the time, Harper argued that the current tax system was unfair because it treated families “as roommates living under the same roof with no financial attachment.”

The initial proposal failed to say whether or not there would be a maximum tax benefit, and faced intense criticism. Some of the most noteworthy criticism included a study released by the C.D. Howe Institute detailing how income splitting would create ‘more harm than good’, and concluding that gains from the policy would be concentrated among high-income and one-earner couples. The study noted that it would have no impact on the majority of families, and that single parents in particular would receive little to no benefit.

The recent version of the income splitting policy featured some modifications to the original proposal, including a maximum tax benefit. The projected cost has been lowered to 2 billion a year (in foregone tax revenue), down from the minimum 2.7 billion as outlined in the 2011 C.D. Howe study. A maximum benefit limit has also been imposed to address concerns that higher income families could take advantage of the policy to get tax breaks that they do not really need.

Earlier this year, Canadians were polled on their opinion of income splitting. A modest 57 per cent supported the idea, with 20 per cent on the fence — and the extent to which the average Canadian understands this policy proposal is questionable. As debates continue both in Parliament and in the media, Canadians have two good reasons to pay attention: the government’s income splitting policy is regressive, and it adversely impacts women.

Although the federal government has altered its income splitting policy to appease some of its more major critics, this policy continues to encourages a ‘one-earner’ family model. Households that will benefit the most are still those in which only one individual is employed, allowing that individual to pass off a significant proportion of their income to a stay-at-home partner. Single parent and sole-earner families, many of whom make less than $50,000, will comparatively see little benefit.

To add to that, income splitting benefits only a small minority of dual earner families, as it only impacts couples whose incomes fall into very different tax brackets – and so, for example, if both parents are low-income earners, such as policy would not help them at all. The Canadian Centre for Policy Alternatives (CCPA) found that the bottom 60 per cent of Canadian families (those making $56,000 or less) would likely receive only $50 under this scheme, while the richest 5 per cent of families (those making over $147,000) would see benefits of $1,100 on average.

Harper’s income splitting policy also bears implications for women in the labour force. A recent study released in the Harvard Business Review suggests that men continue to see themselves in the breadwinner role, while women continue to be seen as the caregivers. Given that the lower earner in a household is typically the woman, income splitting provides incentives for women to continue to work fewer hours or at a lower rate than their male counterparts (in order for their spouse to transfer any “excess” income and save on income tax). Indeed, C.D. Howe’s original study found the policy to be gender biased, imposing barriers for working women and for women returning to work.

If the federal government is indeed concerned with supporting families with children, continued investment in universal child care could provide much greater equity to families in achieving this goal than an income splitting policy. This would particularly benefit low-income families, as both parents would be more likely to work and contribute earnings. Here, the government could look to Quebec as a model, where a universal program has reduced childcare costs to a mere $7 per day.

An objective of greater equity is difficult to justify given that income splitting is estimated to have no benefit for 85 per cent of Canadian households. A policy aimed at assisting families through tax breaks that has no effect — or potentially even a negative effect — on already vulnerable populations, such as low-income families, single parents and working mothers, must be reconsidered. Even former Conservative Finance Minister Jim Flaherty showed skepticism about income splitting in 2013. Going forward, the federal government must carefully consider the implications and risks of such a policy.

Cayla Baarda is a 2016 Master of Public Policy candidate at the School of Public Policy and Governance, University of Toronto. She holds a Bachelors degree in International Development from Guelph University with a specialization in Political Economy and Administrative Change. Cayla recently worked as a researcher with a social start-up in Copenhagen, Denmark. Her main areas of policy interest include education policy and foreign policy.

[IMAGE SOURCE]: Ken Teegardin

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