The costs of moving up Canada’s income ladder can end up too steep for those at the bottom rungs
Moving up in life takes sacrifice — and for those at the very bottom, it can be too much.
In a new paper titled The Paycheck Blues: Why Extra Work is often Not Worth the Effort for Lower-income Families, C.D. Howe Director of Research Alexandre Laurin examined the costs that low-income Canadian families with children stand to face if they choose to enter the workforce or do more work.
“As families earn more taxable income, benefit entitlements are reduced (or ‘clawed back’) at various phaseout rates,” Laurin said. While such measures are necessary to control the impact on the public purse, he argued that they also lead to higher effective tax rates that reduce the overall gain one experiences from working to earn additional income.
The costs were determined based on computations of marginal effective tax rates (METR), which measures the impact of taxes and benefit reductions from earning an additional dollar in income, and the participation tax rate (PTR), which measures the impact of taxes and benefit reductions on the entire prospective annual income from taking on a new job.
“Because benefit programs pile up at the lower end of the income scale, low-income families’ METRs and PTRs generally have been higher than those of higher-income families,” Laurin said.
He found that in some dual-income families with three children, the lower-earning parent might lose more than 70 cents in additional taxes and clawed-back benefits from an extra dollar of earnings. Similarly, an unemployed parent that takes on a new job may lose more than 65% of their prospective salary to higher taxes and reduced benefits.
More broadly, he found that among lone parents with a job or the lower-earning parents in dual-income families, 16% face an METR of more than 50%. As for stay-at-home parents, he determined that the PTR can soar above 50% in 12% of cases. Looking back at the numbers from the mid-1980s to early 1990s shows a substantial rise in the proportions of families facing such high METRs and PTRs.
“Because taxes and benefit programs can interact to create extraordinarily high effective tax rates, governments need to be mindful not to discourage work, especially among mothers and secondary earners in a family,” Laurin said. Many studies, he added, have established a negative effect on work incentives for mothers, as shown by statistical correlations between family work decisions and high METRs and PTRs.
He also noted how work decisions can be affected by non-fiscal family costs, particularly those relating to paid childcare. “Adding median paid childcare expenses yields participation tax rates generally ranging from 50 percent to more than 80 percent nationally,” he said.
To curtail such negative consequences, the paper encouraged federal and provincial policy makers to:
- Better integrate new federal and provincial benefit programs;
- Monitor the effectiveness of Quebec’s tax shield, which partly compensates workers for the loss of work premium and tax credit for childcare expenses in the first year after they take on more work; and
- Subsidize childcare costs through a federal refundable credit with generous rates offered to lower-earning families.