Are tax-free savings schemes missing their intended mark?

One of the first to propose the TFSA is not certain if tax-free savings plans have had the ideal effect

Are tax-free savings schemes missing their intended mark?
When Rhys Kesselman and a colleague first floated the idea of a tax prepaid savings account in 2001, they meant to create a savings scheme that suited low-income savers better than RRSPs. The late Conservative finance minister Jim Flaherty ran with the idea in 2009, introducing Canadians to the tax-free savings account. However, research shows that neither TFSAs nor RRSPs have done what economists had hoped.

Kesselman, who currently holds the Canada Research Chair in Public Finance at Simon Fraser University, said studies investigating the schemes’ effect on saving – whether it’s a lift or a drag – have yielded “pretty mixed” results, according to CBC News.

“A lot of it is simply diversion of savings from taxable forms by upper-middle and high-income individuals to less-tax forms,” said Kesselman. To him and other economists, tax breaks on savings were supposed to be an incentive to counteract any strong urge to spend money in the present.

However, the current tax breaks are helping wealthier people save more, while not motivating lower-income people enough to save. “A lot of middle-earners do, but the second car, the speed boat or the additional vacation seems more pressing,” he said.

2013 data from Statistics Canada showed more people contributing to tax-free accounts – but also more withdrawals. Surveys conducted by Canada’s big banks in 2016 and 2017 have shown that Canadians still aren’t saving, and the few savers aren’t setting enough aside. Scotiabank estimates that nearly half of eligible Canadians don’t have a tax-free account, and nearly 40% are not doing any saving for their retirement years.

Given the seeming ineffectiveness of tax breaks as incentives to save, Kesselman has reluctantly turned in favor of a compulsory savings plan, under which savers have to contribute to a pension big enough to support themselves through retirement.

He also noted the need to change a provision that allows people to amass huge tax-free savings accounts and remain eligible for benefits intended for lower-income seniors. Some relatively well-off people can have their assets and income protected in a tax-free account, but can still get Old Age Security benefits and the guaranteed income supplement meant for low-income seniors – which they did not pay tax on.

“That, of course, is stupid, silly, [and] short-sighted,” Kesselman said. “I'm sure the day of reckoning will come when governments do start to somehow factor it in, when more people have TFSAs in the hundreds of thousands and the millions.”

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