Montreal – Raising provincial tax rates on Canada’s wealthiest 1 percent leads taxpayers to change their behaviour in ways that mitigate the impact of tax increases, according to a new study by the Institute for Research on Public Policy.

Kevin Milligan and Michael Smart use a simulation model to evaluate the effectiveness of such policies as a response to rising inequality. They find that higher provincial tax rates reduce reported income as top earners step up their use of tax shelters and shift their income to other jurisdictions.

“While further taxing top earners might seem like an easy way to bring in more revenue, provinces will receive much less than expected if they fail to recognize how tax hikes alter behaviour,” they say. Moreover, the revenue to be gained would vary substantially across provinces: poorer provinces, which tend to have lower average income among top earners and higher prevailing tax rates, would stand to gain the least.

According to the authors, such policies would reverse only a small fraction of the income concentration at the top seen over the last 30 years. The impact on average tax rates would be small, because the higher rate would apply only to the portion of income that exceeds the threshold for the top-1-percent tax bracket.

The authors point out that there would also be consequences for the federal tax base, which might shrink as a result of provincial tax rate increases on high incomes.

“If the federal government were to increase its tax rates on high incomes — or if the provinces coordinated their own actions — there might be less scope for this behavioural response,” they say. While seven provinces have already introduced new tax brackets for high earners since 2010, some (such as New Brunswick) may reconsider this policy in light of the new Liberal government’s proposal for its own tax rate increase on top earners.

The study, “Provincial Taxation of High Incomes: The Effects on Progressivity and Tax Revenue,” is a chapter from Income Inequality: The Canadian Story, which can be downloaded from the Institute’s website (irpp.org).

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Media Contact: Shirley Cardenas tel. 514-594-6877 scardenas@nullirpp.org