August 9, 2023 – Inflation and taxation are a painful mix. Money losing its purchasing power hurts on its own, but tax provisions that ignore inflation can multiply the pain for earners, savers, and recipients of benefits, says a new C.D. Howe Institute report.
In “Double the Pain: How Inflation Increases Tax Burdens,” the C.D. Howe Institute’s William B.P. Robson and Alex Laurin identify problematic interactions between inflation and taxes and highlight some fixes, notably indexing various thresholds and amounts to the consumer price index (CPI).
While many personal income tax thresholds rise with the CPI, many do not, and many other amounts related to business taxes and the GST do not change. As a result, taxes bite harder over time, and more transactions become taxable, raising administrative and compliance costs.
“To help ease this pain, automatic increases in line with consumer prices are better than ad hoc changes, which governments often present as tax relief, even if they leave taxpayers no better off,” says Robson.
Thresholds that have not changed for years or decades need an update, argue the authors. “While nothing guarantees that nominal values set years ago were ‘right’ at the time, or that nominal values updated for subsequent inflation would be ‘right’ today, thresholds that no longer function as intended, such as the $450,000 GST/HST new housing rebate, should rise,” says Laurin.
The list of thresholds and amounts that are not automatically indexed to inflation is long. Nova Scotia and Prince Edward Island index none of their thresholds. Ontario does not index its top two income thresholds of $150,000 and $220,000. Since they were established in 2014, inflation has eroded their value by 20 percent.
The maximum amount for the federal Child Care Expense Deduction does not rise regularly with inflation. Twenty-five years ago, the maximum amount per child under 7 years old was $7,000. Today it is $8,000, rather than the $12,000 it would be if it had risen with the CPI. The maximum residency claim for the Northern Residents Deduction does not rise regularly with inflation. Indexation to the CPI since 1991 would have made it 30 percent higher today.
On the business side, the income threshold for the federal small business income deduction has not changed since 2009. The GST/HST small supplier threshold has not changed since 1991. On the investment side, the $1,000 exemption on capital gains on personal-use property has not changed since 1972; indexation to the CPI would have made it more than $7,000 today. Robson and Laurin document dozens of such examples.
Although annual CPI increases have fallen from their high of 8.1 percent last summer, the Bank of Canada’s own projections indicate that they will not return to the Bank’s 2 percent target until summer 2025. By then, the purchasing power of a dollar will be 15 percent less than it was before inflation rose above the Bank’s target in March 2021. Robson and Laurin argue that automatic indexation of all thresholds should become the norm. They also highlight the need to avoid tax changes that would compound the damage, such as increasing the inclusion rate of capital gains taxes.
“Inflation hurts, and taxes should not make it worse,” they conclude. “Now would be the best time for some changes to lessen the pain Canadians feel.”
For more information contact: William B.P. Robson, CEO, C.D. Howe Institute; Alexandre Laurin, Director of Research, C.D. Howe Institute; Lauren Malyk, Communications Officer, C.D. Howe Institute, 416-865-1904 Ext. 0247, lmalyk@cdhowe.org
The C.D. Howe Institute is an independent not-for-profit research institute whose mission is to raise living standards by fostering economically sound public policies. Widely considered to be Canada's most influential think tank, the Institute is a trusted source of essential policy intelligence, distinguished by research that is nonpartisan, evidence-based and subject to definitive expert review.