Missing Detail II: Little Boost to Economic Activity Likely from Proposed Tax Changes

From: Alexandre Laurin and Nick Dahir 
To: Campaign promise observers
Date: April 15, 2025
Re: Missing Detail II: Little Boost to Economic Activity Likely from Proposed Tax Changes

Yesterday, we assessed the average tax savings from the Liberal and Conservative campaign promises to reduce taxes. We found that the Liberal proposal – reducing the lowest rate from 15 percent to 14 percent – would cost Ottawa approximately $5.5 billion in 2026, delivering average savings of $180 per filer. In contrast, the Conservative proposal – reducing the lowest rate from 15 percent to 12.75 percent – would cost around $12.5 billion in 2026, resulting in average savings of $405 per filer.

All taxes create some level of economic harm, though some taxes are more harmful than others. Personal income taxes can distort behaviour by affecting decisions about working additional hours, investing in risky ventures, saving, and labour market participation, especially among secondary earners within families.

The magnitude of these disincentives is measured by the marginal effective tax rate (METR) and the participation tax rate (PTR). METRs represent the loss of earnings due to additional taxes and reduced cash benefits for each extra dollar earned, effectively the financial penalty for working additional hours.

PTRs measure the cumulative effect of all taxes, payroll deductions, fiscal contributions, and lost cash benefits relative to total potential earnings. For example, for a stay-at-home parent, the PTR represents the share of total income lost if they choose to enter the workforce.

High METRs and PTRs discourage work effort and should, therefore, be key concerns for policymakers evaluating changes to the tax-transfer system. In Canada, METRs and PTRs exceed 50 percent at certain income levels, meaning some workers lose more than half of any additional earnings through higher taxes and lower benefits. Policymakers should prioritize reducing these disincentives, concentrating on income ranges most affected by high effective rates.

To assess how effectively the proposed tax rate changes address these concerns, we estimated METRs and PTRs for a typical family of four with two children in Quebec and Ontario, using Statistics Canada’s Social Policy Database and Model v. 30.3 (see Table).

Our calculations show that the proposed rate changes have a minimal impact on METRs. We analyzed METRs for three levels of family income $32,000, $72,000 and $200,000. At low-income levels, METRs are modest due to lower benefit clawbacks. At moderate incomes, METRs peak as federal and provincial income-tested benefits such as the Canada Worker’s Benefit and child-related benefits like the Canada Child Benefit are withdrawn, sharply reducing returns to additional earnings. At higher incomes METRs moderate as clawback effects phase out.

Families in the bottom income tax bracket and earning more than the basic allowance would see no METR impact from both proposed reductions. Higher up, METRs for families earning approximately $72,000 would decrease by only 1 percentage point under the 14 percent rate and by just 2 percentage points under the 12.75 percent rate – negligible changes given that these families initially face METRs of 57 percent in Quebec and 48 percent in Ontario. Meanwhile, families with lower or higher incomes would see no change in their METRs at all.

Proposed tax rate changes also minimally affect PTRs. We analyzed two scenarios: One where the employed spouse earns $45,000 and the unemployed spouse considers taking on a job earning $20,000, and another where the employed spouse earns $120,000 and the unemployed spouse considers taking on a job earning $50,000.

In both Quebec and Ontario, and under both scenarios, PTRs decline marginally – by 1 percentage point under the 14-percent rate and 2 percentage points under the 12.75-percent rate – relative to baseline PTRs of 62 percent (Quebec) and 55 percent (Ontario) when the unemployed spouse is considering a job earning $20,000, and 41 percent (Quebec) and 33 percent (Ontario) when they are considering a job earning $50,000.

Clearly, reducing the lowest marginal tax rate does little to meaningfully enhance incentives to earn and work. More targeted tax rate reductions at middle-income levels, where METRs tend to be significantly higher, would offer greater incentives at a comparable cost. For instance, reducing the second-bracket tax rate by 1 percentage point would cost roughly half as much as reducing the lowest bracket rate by the same amount.

Given the high fiscal costs, modest individual savings, and minimal improvements in work incentives, policymakers should not expect these bottom-rate reductions to significantly boost economic activity.

Alexandre Laurin is Vice-President and Director of Research at the C.D. Howe Institute, where Nick Dahir is a Research Officer.

To send a comment or leave feedback, email us at blog@cdhowe.org.

The views expressed here are those of the authors. The C.D. Howe Institute does not take corporate positions on policy matters.

Want more insights like this? Subscribe to our newsletter for the latest research and expert commentary.