Marginal Effective Tax Rates: Canada in a G-7 Context
The main purpose of taxation is to finance public spending. Tax systems can also be used to achieve a variety of economic, social and environmental objectives. One of the main results in economic theory is that incentives matter in affecting economic performance and taxation has a major impact on incentives by causing a divergence between the market and after tax rates of return: these rates of return include compensation for both labour, in the form of wages, and capital, in the form of interest, dividends and capital gains. On the household side, the incentives, or disincentives, created by the tax system influence the decisions of households to save, supply labour and invest in human capital. On the business side, these incentives, or disincentives, can have a significant impact on the decisions of firms for production, job creation, investment and innovation. This theoretical impact of taxation on economic outcomes is supported by considerable empirical evidence, which shows that tax systems not only affect the levels of income but also their growth rates.
This research on the impact of taxes on economic performance is mostly focused on tax structures. It does not take into account the fact that a wide range of public assistance is made dependent on the recipient’s level of income (or output) and is clawed back using the tax system as income rises. In the context of incentives affecting economic behavior, it is immaterial whether an increase in income at the margin leads to higher income taxes or reductions in public assistance. The key consideration is the proportion of market income a person or a business loses to the state at the margin, through both higher taxes and reduced levels of assistance. This is the concept of the marginal effective tax rate (METR). METRs can be calculated for household income, for the use of labour and for the use of capital. If taxes affect economic performance, then it is more important to look at METRs than just tax rates.
As a first step in that direction, it is instructive to compare Canadian METRs with those of other countries for households earning income. This is possible given the availability of internationally comparable OECD data. We define these METRs for households as the marginal rate of income tax plus employee and employer social security contributions less cash benefits.
METRs can be calculated for many types of workers as tax and assistance rates differ substantially across income levels and household types. The chart below provides representative examples for three groups: a single worker earning average wage; a married couple with two children where one partner earns an average wage and the second one-third of the average wage; and, a married couple with two children where one partner earns an average wage and the second two-thirds of the average wage.
An International (G-7) Comparison of Marginal Effective Tax Rates (2013)
Source: OECD, 2014, Taxing Wages. Table 1.6.Note: S/100 is the METR for a single earner at average wage; M/100/67 is METR for a couple with two children where one earns the average wage and the other 67% of the average wage. M/100/33 is METR for a couple with two children where one earns the average wage and the other 33% of the average wage.
The chart shows quite clearly that, across the three definitions of METRs, Canada has the highest METRs among G-7 countries, and Japan and the UK the lowest. One would expect, if economic theory relating taxation to economic performance were used as a guide, that Canada’s high METRs would negatively affect its economic performance. The OECD data also shows that Canada’s productivity performance is among the lowest in both G-7 and the OECD area as a whole.