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As governments across the country grapple with deficits and growing debt, Canadians should prepare for tax increases in the near future, especially increases that could be introduced without notice but would be costly to pay. Canadians, such as eliminating personal income “indexation”. tax system.

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Indexation is currently applied to the personal income tax system at the federal level and in most provinces. It ensures that the country’s progressive personal income tax system only affects real income gains (rather than inflationary gains) by adjusting the different thresholds applied by higher tax rates depending on the rate. inflation.

A simple hypothetical example helps. Mary is a middle class worker with taxable income of $ 50,000. Suppose Mary pays the lowest federal personal income tax rate of 15% on all of her income, and income over $ 50,000 is subject to the following federal rate of 20.5%.

Mary receives a 5% pay raise, bringing her income to $ 52,500. But inflation was also 5 percent. So in real terms, Mary is no better off because while her income has increased by 5 percent, the cost of goods and services has also increased by 5 percent.

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With indexation, the tax bracket to which the next higher tax rate applies – 20.5% – automatically increases according to the rate of inflation, so Mary continues to pay only the rate d. lowest tax on their income. Now suppose the federal government eliminates indexation. (This is tempting because how many people actually understand how deindexation leads to a tax increase?) Without automatic indexation, part of Marie’s income is now taxed at the highest rate of 20.5%, even if she has not experienced any real increase in her salary. Specifically, Marie will pay about $ 138 more in personal income tax based on inflationary gains because the personal income tax system is not indexed to inflation.

While this increase may seem incidental, imagine this amount spread over millions of taxpayers who start paying higher taxes on inflationary gains rather than actual income gains. And the increase in taxes only keeps growing as inflation continues.

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Governments have gone back and forth with indexation in the past. The Mulroney government partially deindexed the personal income tax system in 1986 to help raise revenues to control the national debt. As a result, many Canadians pay more taxes every year.

Ottawa collected about $ 1.4 billion (adjusted for inflation) more in tax revenue in the first year alone (1986). In the 2000 budget, the Chrétien government reinstated full indexation of the personal income tax system, explaining that it “protects Canadians against automatic tax increases that would have resulted from inflation”.

It is understandable why politicians might favor the elimination of indexation – it generates significant revenue while being a somewhat obscure and difficult to understand tax increase, especially compared to more visible changes such as increases. tax rate.

Faced with large deficits, some provincial governments have already deindexed the personal income tax system. In 2019/20, for example, the Kenney government in Alberta introduced a “temporary” hiatus on indexation.

Federal and provincial finances are in bad shape and governments will likely look for ways to increase their revenues. Canadians should tire of opaque tax changes, including de-indexation, which have big implications for our portfolios.

– Tegan Hill and Jake Fuss are economists at the Fraser Institute