January 16, 2008
Why Tax Exemptions Trump Minimum Wage Hikes
Raising minimum wages and increasing government subsidies are two approaches often suggested to help the working poor. But there is a far simpler way to put more money into their pockets: stop forcing the lowest income workers to pay income tax.
Hikes in minimum wages are lauded by some anti-poverty campaigners and trade unionists as small victories against low wages and poverty. But the unintended consequences of such well-meaning initiatives do more harm than good.
When minimum wages are forced up, the number of jobs or extra hours of work available for the least skilled and educated workers actually decrease because they have effectively been rendered uneconomic. In particular, opportunities for newcomers to the labour force, many of whom are single and living at home, and who just want to find a way to enter the workplace, are diminished. Businesses that would like to hire more workers cannot afford the higher rates.
The federal government recently implemented a better approach – a tax benefit for qualified low income workers. The Working Income Tax Benefit provides for an income top-up of $500 to $1000 per year.
But this program, too, has serious limitations. Not every needy worker can access the benefit. For example, an individual working full time, or a family with one-and-a-half full time workers, at the minimum wage earns too much to receive it. More troubling, someone working full time at the minimum wage pays more tax than they get back from the working income tax benefit.
There is a far simpler and more effective approach than either of these two initiatives. The simplest and most elegant way for earners on low incomes to take home more pay is to pay less tax. The effect is the same as receiving government benefits but is accomplished much more efficiently and at less cost. It is also in line with the principles of a welfare state, whereby those with the most help out those with the least.
A recent study for the Frontier Centre for Public Policy, Which Best Helps the Poor: Minimum Wages, Tax Credits or Tax Exemptions? by Winnipeg social activist David Pankratz, looked at the powerful impact of reducing taxes on the poor. Looking at Manitoba, it found that simply raising the provincial and federal tax free threshold by $6,000 (which matches the threshold at which Alberta starts taxing at the bottom) effectively increases the take-home pay of a minimum wage earner by the equivalent of a minimum-wage increase of between $8 to $9.18 per hour.
Raising the tax-free threshold targets those most in need, that is, people working long hours on low wages. It does not help teenagers working a few hours a week, because their income is already below the current annual tax exemption threshold. But by leaving minimum rates at current levels, it encourages job creation. And, unlike the federal tax subsidy program, it doesn’t require more paperwork to allocate benefits. It is simple to implement, and that is key.
Of course, governments would collect less in income tax if they raised tax exemption levels. But this approach is less expensive for taxpayers than collecting taxes from low income workers, simply to hand them back in a subsidy. To make up for the lower tax collection, more competition could be injected into government service delivery models, and healthcare, municipal and welfare systems could be brought up to international performance standards.
The government could also reduce the impact on tax revenues by progressively reducing the exemption threshold for higher income earners. For example, an earner receiving $20,000 would be eligible for the maximum exemption increase; an earner receiving $50,000 might be eligible for a partial exemption increase, while an earner receiving $100,000 would face the standard exemption level. Doing so would concentrate the program even more on low income earners and reduce the impact on government revenues. A phased out income tax exemption would have the same annual impact on income as the Working Income Tax Benefit, but it would be simpler to administer.
Like all wars, the war on poverty requires a simple, effective and aggressive strategy. Raising tax exemption thresholds will take us a lot further towards victory.
is the founding President of the Frontier Centre for Public Policy, an award-winning western Canadian based public policy think tank. Since its founding in 1997, Frontier has brought a distinctive and influential Prairie voice to regional and national debates over public policy in areas such as core public sector reform, housing, poverty, aboriginals, consumer-focused health care performance, equalization, rural policy and much more. Of the nearly 100 recognized think tanks in Canada, Frontier is one of only 5 to make the 2008 global "Go-To Think Tanks" list published by the Think Tanks and Civil Societies Program of the Foreign Policy Research Institute in Philadelphia. Mr. Holle has worked extensively with public sector reform and has provided advisory services to various governments across Canada and the United States. His publications have appeared in various newspapers and journals including dozens of newspapers, the National Post and the Wall Street Journal. He has a Masters of Business Administration from the University of Wisconsin at Madison. He is a member of various organizations including the Mont Pelerin Society, an international organization of classical liberals.