Could tax policy be used to solve job shortages?

Research examines impact of federal income-splitting policy on older workers' retirement decisions

Could tax policy be used to solve job shortages?

Is tax policy in Canada having an impact on people’s retirement decisions … and if so, can it help address worker shortages for businesses?

That’s the question posed by researchers at the Retirement and Savings Institute with HEC Montreal.

“Worker shortages pose significant challenges for labour markets in Canada. For example, more than one-third of businesses report that recruiting skilled workers is an obstacle. These shortages are partly driven by retirements of baby boomers, particularly since the COVID-19 pandemic,” wrote Derek Messacar of the Retirement and Savings Institute. “To counteract these challenges, governments have grappled with ways to keep older workers in the workforce longer.”

In a paper titled “Labor Supply Responses to Income Taxation among Older Couples: Evidence from a Canadian Reform,” which is set to be published in the American Economic Journal: Economic Policy, researchers examined administrative data from a sample of Canadian tax filers and their spouses.

Read more: The income-splitting benefits that couples should remember

The retrospective analysis was performed with a specific objective: to see the effects of pension income splitting for couples, which was enabled by a 2007 federal reform explicitly designed to target the income tax bills of older workers.

“Analyzing this reform is ideal since the eligibility rules include an age component, hence it is a reform that could potentially have a large effect on retirement,” he said.

Not too surprisingly, the research revealed a high degree of sensitivity among older couples with respect to their tax bills, which prompts them to strategize around reducing total liabilities and take advantage of income splitting for tax planning.

“Changes in total after-tax income brought on by the tax reform directly affect retirement decisions,” Mesacar wrote. “For example, a tax cut that increases after-tax income by 10% leads to a 4% greater likelihood of retiring, on average.”

The analysis also found that changes in total after-tax income of spouses have an impact on people’s retirement decisions.

But researchers determined that the cross-spouse effect is smaller – a tax cut that increases spouse’s after-tax income by 10% leads to almost a 1% greater likelihood of retiring, on average – suggesting one’s own tax bills as the primary motivation behind their decision to leave the workforce.

Those tax filers who don’t retire right away, the researchers found, could also respond to the tax reform by adjusting the amount of work they do. A tax cut that increases after-tax income by 10%, they found, results in a 2.2% decline in labour earnings on average.

Read more: Majority of baby boomers would prefer semi-retirement

“There is a trade-off between offering programs that ease tax burdens of seniors and incentivizing older workers to remain employed,” Messacar said. “Tax allowances, credits and deductions that are not tied to labour force participation may induce retirements.

“To the extent that the tax and transfer system affects labour supply decisions of older workers differently than younger and middle-aged workers as this study suggests, there may be a role for greater use of age-dependent taxation [in influencing work and retirement decisions to tackle labour shortages,” he said.