STFC Committee Meeting

SUB-COMMITTEE ON TAX EQUITY FOR CANADIAN FAMILIES WITH DEPENDENT CHILDREN OF THE STANDING COMMITTEE ON FINANCE

SOUS-COMITÉ SUR L'ÉQUITÉ FISCALE POUR LES FAMILLES CANADIENNES AVEC DES ENFANTS À CHARGE DU COMITÉ PERMANENT DES FINANCES

EVIDENCE

[Recorded by Electronic Apparatus]

Wednesday, April 21, 1999

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[English]

The Chairman (Mr. Nick Discepola (Vaudreuil—Soulanges, Lib.)): Pursuant to a motion adopted by the Standing Committee on Finance, and dated March 17, 1999, the subcommittee resumes its study on tax fairness for Canadian families.

This afternoon we are pleased to have with us, from the Department of Finance, Mr. Munir Sheikh, who is the assistant deputy minister, tax policy branch.

To the gentleman accompanying him, I don't know your name. Are you one of the technical advisers? Could you introduce yourself?

Mr. Louis Lévesque (General Director, Tax Policy Branch, Department of Finance): My name is Louis Lévesque. I am the director general in the tax policy branch.

[Translation]

The Chairman: Welcome.

I believe you have a 10- or 15-minute presentation. Unfortunately, the slides are in English only because we are having technical problems, but you have documents in French. With your permission, we will go on. Serge, I greatly appreciate your understanding.

[English]

Go ahead, please. Welcome, make your presentation, and hopefully leave enough room for questions. Technically we have until about 5.30; there might be a vote, but I don't anticipate one.

Again, with respect to this very important issue, I'd like to welcome you on behalf of the committee members

Mr. Munir Sheikh (Assistant Deputy Minister, Tax Policy Branch, Department of Finance): Thank you, Mr. Chairman.

First of all, let me apologize for the fact that for technical reasons we could not put up the French version of my presentation, but as you have said, Mr. Chairman, a French copy of my remarks is available. I apologize again.

My feeling is that my presentation is going to take longer than 10 to 15 minutes. We will have, hopefully, a lot of discussion of the issues that will arise. The simple reason that it takes a long time is that we have an income tax system that is more than 2,000 pages long, so to cover it comprehensively would require more time.

First of all, let me say that I really want to thank you for inviting me to speak to you here today on the issue of the tax treatment of families. One thing I want to say upfront—and I want to be quite open about it—is that I am here as a bureaucrat. I work as a public servant in the Department of Finance and I am here only to provide factual information on the tax system in the area of the taxation of families.

There are obviously policy and individual judgments that are quite important in forming views on this very important issue. I, however, would not want to comment on policy issues or offer value judgments. These two things appropriately belong to you, the members of Parliament, and to the government, so I will restrict my remarks to providing factual information on how the tax system works.

Mr. Chairman, in our monitoring of the debate on the taxation of families, we have come to a view that there are really three very different issues that are being discussed, and I think that for the sake of clarity it is important to clearly distinguish among those three views. These three issues, in my view, are the following.

One is the tax difference between one-earner couples and two-earner couples without children. As you know, more than 50% of couples in Canada do not have children, so that issue alone is quite important. The second issue that we deal with is the tax treatment of parents who stay home to provide child care. Finally, there is the issue of the level of tax support for children in general. This presentation, Mr. Chairman, provides background information on each of these three issues in turn.

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Let's start with the first issue. Are there tax differences between one-earner and two-earner couples and, if there are, what are the reasons for that? I have given you a table that shows the typical tax burden, the tax burden that is the combined federal-provincial tax for one-earner and two-earner couples, and, as I said, without children, at various income levels. This is in a mature federal system, which would start operating in the year 2000. As you know, the 1999 budget introduced tax changes that begin in July 1999, so that is the reason we have picked 2000 as the full tax year for which we provide information.

As an example, there is $3,848 more tax for a one-earner couple at a $60,000 income. In determining this gap, we obviously needed to know what the split of income was in the two-earner families. The split that we have assumed is based on the typical split in the Canadian economy, which is 60% of the income in the hands of one earner and 40% in the hands of the other earner. If the split is different, the tax gap would also be different. As an example, the tax gap would be the largest at a 50:50 split in income.

Let me first of all give you the conclusion of what I'm going to be saying in the next few minutes. The conclusion is that the difference you see here results from a combination of two principles that are fundamental to the current Canadian tax system: a progressive tax rate structure and individual-based taxation. Those are the two things that produce this. Let me explain how that gap results from these two factors.

Let me first explain what progressive income taxation is and what it does. The term “progressive” is a technical term that is widely used in describing the tax system. Simply stated, a tax system is progressive if higher income earners pay a larger proportion of their income in tax than lower income earners do. This is achieved by subjecting additional dollars of income to increasing or, in other words, “progressive” tax rates. Canada's personal income tax system is progressive. As you can see, the tax system has three tax brackets beyond a basic exempt amount up to $7,000. Combining federal and provincial taxes, the tax rate goes up from zero to 25%, then to 39%, and then to the top tax rate of 50%.

I should also mention that progressive income taxation is a social policy choice. It is a statement of principle.

Individual-based income taxation is economically neutral. Let me explain. In this system, the individual, not the family, is the basic unit of Canada's personal income tax system. This means that each spouse in a couple faces a tax rate based on his or her income, not on the couple's combined income. The individual-based tax system is neutral with respect to choice between paid work and working at home.

Simple family-based taxation, on the other hand, is non-neutral. Let me explain again. If the tax system were family-based, a second-earner spouse entering the labour market would face a tax rate that is higher than his or her own individual tax rate. With that explanation of the two factors, let me show you some examples on how the difference arises.

Consider John and Karen, a couple without children, where John, a single earner, earns $60,000, and Karen does not work outside the home. Our table shows how the income for the couple is taxed—again, total tax, federal and provincial—under the progressive tax rate structure and individual-based taxation.

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For this couple, John and Karen, approximately $15,500 of the couple's income is not taxed. That is because of the basic exemption, the spousal exemption, and the fact that CPP and EI are not taxed up to a certain level. The next $14,100 of income up to about $30,000 is in the 17% federal tax bracket and faces a combined federal-provincial tax rate of 25%. Income between $30,000 and $60,000 in the 26% federal bracket faces a combined federal-provincial rate of 39%.

So what I'm saying is that for John, the single earner, with the three brackets I've shown you applying to the income thresholds I've shown you, the result is that John and Karen are going to pay a combined income tax, in this one-earner family, of $15,382.

Now we'll compare the one-earner and two-earner couples. The second example is that of Mike and Jane—again, a couple who doesn't have children. Mike earns $36,000 and Jane earns $24,000. As I said, here I'm using a standard or typical income split of 60% for one earner and 40% for the other. For Mike and Jane, $17,900 of the income is not taxed, largely because they get the basic personal exemption. In this case the 0% tax bracket applies at a somewhat higher level because the basic exemption is somewhat higher than the spousal exemption and there is also a difference between CPP and EI premiums. This couple has a larger portion of their income—$35,700—subject to the 25%, compared to $14,100 in the case of John and Karen.

With individual-based taxation, Jane's income does not face Mike's tax rate of 39%, which would apply to any of Mike's additional income. This really is an important point, because that explains in a fundamental way the difference in the tax treatment of the two families. In this example, Jane faces her own tax rate of 25% on her income rather than the 39% rate that Mike faces. In this example, Mike has a small amount of income—$6,400—in the 26% federal tax bracket, facing a combined provincial-provincial tax rate of 39%.

So you can see that in the 39% bracket a one-earner family has an income of $30,400 on which the tax has to be paid, compared to only $6,400 for a two-earner family. As a result, if you multiply these tax rates with the values on which that tax is applied, it turns out that Mike and Jane have a lower tax burden than the one-earner couple, John and Karen.

So far we have looked only at the tax situation, and we have seen that in terms of tax alone the two-earner couple is indeed better off. But let's also look at the disposable income of the two couples. In trying to achieve the results that we need on disposable income, we should take into account the CPP, QPP and EI premiums and any other work-related expenses. Only John, in this example, pays CPP, QPP and EI premiums, while in the second example, both Mike and Jane pay those premiums. With these adjustments, Mike and Jane still have a disposable income that is approximately $1,000 higher than that of the one-earner couple, John and Karen.

There may be a variety of other factors affecting the financial situations of these two families that are not captured in the table. There are a lot of other things that could be having an influence on the disposable incomes of the two families. These differences make their financial situations even less comparable.

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In our current example, the tax difference is $3,848 between one-earner and two-earner couples at $60,000 in family income. I think it's interesting to figure out how this tax difference changes if a number of the approaches that have been suggested were to be put in practice.

Some have suggested that the spousal credit should be equal to the basic credit. If that were the case, the tax difference in this example would be lower by about $180 at $3,670, but there would be a revenue cost of $430 million to do that.

Others have suggested that the middle tax rate should be lower. If that were done, the result would be that for every percentage point of lower middle tax rate, the gap would fall to $3,500 or $348, at a revenue cost of $1.1 billion.

These things that I have just mentioned reduce the amount of the gap. With a flat tax rate of 22% instead of our progressive structure with the three layers that I've shown you—and at 22% the Government of Canada would not lose any revenues—the gap between the two types of families would disappear completely, assuming, again, that the spousal and basic credits are also equalized. However, at a 22% rate, where the government doesn't lose any revenues, there would many losers. Actually, 80% of tax filers would find that their taxes have gone up and 18% would find that their taxes have gone down. With the 22% flat rate, you can totally eliminate this gap, with the result that a lot of filers would find their taxes going up. There would be only a few winners in the economy.

If, on the other hand, one were to run an experiment asking what the tax rate would have to be so that there would be no losers in a flat tax system, the rate that would have to come into play would be 17%, which is our lowest rate in the three rate brackets, but the cost of such an option would be $17.8 billion.

Another option that has been suggested, along the lines of what the Americans do, is to allow income splitting. In this scenario, the incomes of the two spouses are combined and each spouse then declares half of that income for tax purposes. If income splitting were to be pursued, again, the tax difference between one-earner and two-earner families would disappear, but the cost of that would be $4 billion. Also, keep in perspective the fact that if we do income splitting, we're only dealing with one-earner and two-earner families with children. Singles would not see any reductions in their taxes. In fact, they may see an increase in their taxes.

Finally, the difference would again be zero with a family-based tax system, and here I'm merely talking about a simple family-based tax system, whereby the second spouse entering the labour market would find the tax rate of the first spouse also applying to his or her income. With the current tax structure, there would be revenue gain of $8.5 billion and many losers—84% of all tax filers. However, it would be quite possible to design a revenue-neutral tax structure that would eliminate this gap. But even in that structure there would be winners and losers.

So the message here is that there are certain things you can do within the existing tax structure that would reduce the gap but would never eliminate it. Or one could move on to a totally different tax structure, to either the flat rate or family-based taxation, which would totally eliminate the difference between one-earner and two-earner families.

What are the main conclusions that we draw from this analysis of the first issue? We have seen, one, that there is a tax difference at average income levels for families without children, two, that this results from progressivity and individual-based taxation, and three, that the size of the difference indeed depends on tax brackets and tax rates, and if you play around with those rates and brackets, they would have an effect on the size of the tax gap.

That's the first issue that I wanted to touch upon: the difference in the taxation of one-earner and two-earner families. As we can see, there are differences in the tax treatment of those two, and that result occurs without there being any children in the equation.

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Now let's go on to the situation where we have parents who stay at home to provide child care. How does the tax system treat those situations?

The main question that we have heard in this area is, how does the tax system affect parents' choices to seek paid employment? Let me again provide you with tax facts that would help answer this question.

In answering this question, there are actually two approaches that one can pursue. We'll pursue both of those approaches. First, we can look at the income situation of our one-earner family compared to our two-earner family, in this case, with children, exactly repeating the experiment that we did in the first section. A second approach would be to look at how much income the second earner finally keeps when he or she is employed outside the home.

Before looking at the situation for couples with children, let us look at two important tax measures that are related to children. The first is the Canada child tax benefit. The Canada child tax benefit recognizes the cost of raising children. It is provided to all families that meet the income criteria, and income testing is undertaken to target benefits. The cost of the program is close to $7 billion annually—that is the cost that will exist in the year 2000—including recent initiatives of $2 billion, which includes what was done in the 1998/1999 budget. In the 1998 budget, the child tax benefit was increased by $1.7 billion, and there was a further increase of $300 million in the 1999 budget. Without income testing, the cost of the program would be over $10 billion annually.

The Canada child tax benefit provides benefits to over three million families out of a total of four million families with children. The Canada child tax benefit provides benefits to about 80% of families with children, and about one and a half million families among these received the full base benefit of $1,020. I'd like to mention something really important about the Canada child tax benefit, and that is, for those who do not claim the child care expense deduction—and these are normally families where a spouse is not working outside the home—the Canada child tax benefit provides a $213 supplement for each child under the age of 7.

Our chart shows you how much Canada child tax benefit is provided based on what the level of income is in a family. It is clear from the table that the child tax benefit falls quite rapidly as income goes up. At an income level of $80,000, the child tax benefit is totally gone. As I said earlier, the targeting is done to reduce the cost of the program. Without the targeting, the cost of the program would be over $10 billion.

The second instrument to provide assistance to children is the child care expense deduction. The child care expense deduction is based on the rationale that child care expenses to earn income should not attract tax in the hands of persons incurring such expenses. The purpose of the child care expense deduction is to recognize expenses beyond common expenses incurred by all families. Common expenses are taken care of by the Canada child tax benefit to some extent, and the child care expense deduction is provided only to those families that can produce actual receipts for those expenses.

A simple mechanism in the system limits the amount of deduction to ensure that it only goes to incremental expenses. The average child care expense deduction claim per family, among those families who actually claim it, is $2,600, and the average tax saving per family is $700.

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Having seen what policies there are to support children, let's now look at the example to compare one-earner and two-earner families again. Let's first look at how the tax system recognizes the costs of raising children for our families.

We'll start with the example where Dennis earns $60,000 in income, while Julie is a stay-at-home mother. The couple has two children aged 4 and 8. This couple pays the same income taxes as John and Karen, a couple with one income and no children, who we have already seen in the first section of this presentation. Julie, however, will receive $520 a year in monthly payments under the Canada child tax benefit, the first of the two policy instruments we saw that have beneficial impact for children. As I mentioned earlier, Julie also receives $213 as a supplement for the child under 7 years of age, for a total Canada child tax benefit of $733.

So when I take into account both the tax and the benefit, the tax being exactly the same as the tax for the childless couple, we find that the combined tax and benefit of this family is $14,649, which is different from the one-earner family without children by exactly the amount of the child tax benefit.

Now let's consider the situation of the two-earner couple with children. The table shows that comparison. Again, using the 60:40 income split for the two-earner couple, Louis earns $36,000 in income, and Sandra, in this example, earns $24,000. Again, the couple has two children aged 4 and 8.

As explained earlier, income taxes tend to be lower for two-earner couples because of progressivity and individual-based taxation. Louis and Sandra have annual expenses of $8,000 for child care outside the home, which are eligible for the child care expense deduction. These expenses are necessary for Sandra to earn income outside the home. Because of the child care expense deduction, the income tax difference is $5,874, considerably higher than the $3,848 difference for similar couples with no children. The couple is also eligible for a somewhat higher Canada child tax benefit of $920, although the two-earner couple is not eligible for the $213 supplement because of the $8,000 in child care costs.

When I put the whole thing together, I find that while our one-earner family paid a tax benefit of $14,649, the two-earner family, with children of the same ages, paid a tax of $8,588. So there's a substantial difference in the tax and benefit situation of the two, to the tune of about $6,000.

As I did last time, let's now again look at the complete income picture of these two couples, not just their tax benefit picture. When I do take a look at the complete income pictures of these two couples, I would factor in not just income taxes and the child tax benefit, but also the Canada and Quebec pension plans, the EI premiums, the expenses for child care outside the home, and any other work-related expenses.

While Louis and Sandra obtain about $2,000 in tax savings from the child care expense deduction, this offsets only a portion of the $8,000 in expenses for child care outside the home. Louis and Sandra pay more in CPP, QPP and EI premiums and also in work-related expenses. As a result, Louis and Sandra have $4,704 less in take-home pay despite their lower tax burden, mainly as a result of the $8,000 in expenses for child care outside the home.

Let's now look at the effect on the take-home pay differences of a number of policy changes that many have proposed publicly.

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Abolishing the child care expense deduction: this would increase the shortfall for a two-earner family by $1,839, and that is composed of two factors, a tax increase of $2,026 and a child tax benefit increase of $187. So the gap for the two-earner families would rise from $4,704 to $6,543.

Increasing the $213 supplement in the child tax benefit to $500, as some have proposed, at a cost of $600 million, would increase the shortfall of the two-earner family by $287, so the gap would rise from $4,704 to $4,991.

Providing a refundable credit of $1,000 for every child would not affect the shortfall of $4,704, but would cost over $7 billion. The reason it doesn't have an effect on the shortfall is that under this proposal everybody would get that increased credit.

Extending the full CCTB base benefit of $1,020 to all families would cost $2.8 billion and would actually increase the shortfall, by $400, to $5,104.

All of the proposals I have mentioned either do not affect the gap in income of the two families or increase the difference in the gap, where the two-earner family has a lower take-home income to start with.

As I said in the beginning, in dealing with this issue there are two approaches one can take to answering the question that was posed: how does the tax system affect parents' choices to seek paid employment? The second approach to the question of whether the tax system encourages parents to seek paid employment is to take a look at the net return from employment outside the home for Sandra, the lower earner spouse in the two-earner couple. How much of the increased income from working outside the home would Sandra be able to keep?

Sandra and Louis, in our example, earn a combined income of $60,000. Their take-home pay is $36,815. If Sandra were not employed outside the home, their take-home pay would be $28,162 from Louis' gross income of $36,000. So the family would drop an income of $24,000 because Sandra is not working outside the home any more, but the family's disposable income or take-home pay would fall by only $8,653. So in deciding not to work, to stay home.... Or in other words, if Sandra decides to go to work and earn $24,000, two-thirds of the income she earns disappears. The question is, where will that income go?

Let's find out what happens to that income. Sandra decides to work. She gets $24,000, which is 100% of the income. On that $24,000, she has to pay income tax. Before the child care expense deduction, the income tax is $5,449. Factoring in the reduction in taxes of $2,026 because of the child care expense deduction, the net tax is $3,423. An amount equal to $1,411 goes to pay the CPP and EI premiums, there's the child care expense deduction of $8,000, there are work-related expenses of $1,500 for Sandra, and, given the increase in income, the child tax benefit falls by $1,013. As a result of all of these, of the $24,000 in earnings, $15,347 goes to get that extra income, which means that 64% of her income goes to earn that income of $24,000, with the result that the net increase in take-home pay is $8,653, which is 36% of the $24,000 she earned.

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However, a somewhat different perspective can be taken by taking into account the benefits that Sandra may get from paying CPP, QPP, and EI premiums. If it is assumed that her benefits are dollar-for-dollar for her contributions, in our table we should not be showing the CPP and EI premiums of $1,411, which means that her take-home pay is going to be 42% of the income that she earns, not 36%.

Let's look at our chart again with respect to our experiment to see what the results would be of the different proposals that we have heard.

One proposal is to introduce a new credit or deduction for all children. I gave you the example of a $1,000 credit earlier. This would not affect the cost of Sandra's paid work since, again, as I said earlier, it would go equally to all parents.

Another proposal is to eliminate the child care expense deduction. Without this deduction, the cost would increase to $17,373—or 72% of earnings instead of 64%.

Family-based taxation, which would force Sandra to pay a higher tax rate than otherwise, would increase the cost of paid employment from 64% to 68%.

Increasing the child tax benefit supplement of $213 to $500 would increase the cost of Sandra's employment from 64% to 65%, a modest increase.

That completes my remarks on the second of three questions that I pose. The third question is related to the general level of support that we provide for children.

As we see, the Canada child tax benefit provides benefits to about 80% of families with children—or to three million out of four million children. The child tax benefit provides significant benefits for families with incomes of less than $30,000, and that is about 36% of families. For incomes of less than $30,000, the benefit is $1,000 or more. You see, as the income level goes up, the benefit goes down, to $10 a year at an income of $70,000, and it totally disappears at incomes of slightly over $70,000. Twenty per cent of families with children do not receive any child tax benefit. As I said earlier, the rationale for that is to target the benefits at different income levels in order to be able to contain its cost.

With our next table, I'll do exactly what I've done before in my previous two sections. I'll talk about the consequences of various proposals that we have heard in dealing with issues.

In the area of support for children, some proposals have also been put forward. There are two proposals to enrich the child tax benefit, and there are some other new tax options. I'll deal with all of them one by one.

On the child tax benefit, there is a proposal to reduce the phase-out rate—what some people would call the clawback rate or the tax-back rate—from the current 2.5% to 1.25%, which is half the existing rate. That would significantly increase benefits at middle income levels. At an income level of $80,000, where the current benefit is zero, the clawback rate reduction would provide a benefit of $390 and, at an income level of $70,000, almost a $500 increase.

Completely removing the phase-out rate—the second proposal—would extend the base benefit of $1,020 to all families with children. This proposal would have a revenue cost of $2.8 billion, compared to the previous proposal of a clawback, the cost there being $1.2 billion.

Those were the proposals on the child tax benefit front. There is a third proposal, which came from the C.D. Howe Institute, and that is, to provide additional benefits of a $2,000 deduction for each child. This proposal would have a revenue cost of $3 billion.

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Another proposal is a new $1,000 credit for every child in addition to the child tax benefit. This proposal, given that there are 7.4 million children, would have a revenue cost of $7.4 billion.

That, Mr. Chairman, completes my presentation. I'll be glad to answer any questions that you may have.

The Chairman: Thank you very much. We welcome the detailed presentation. We're accustomed to getting very high-tech presentations from finance over the past few years. This is certainly up to the measurement.

Mr. Forseth has foregone his first spot at questioning. We'll start with Monsieur Cardin.

[Translation]

Serge, you have 10 minutes.

Mr. Serge Cardin (Sherbrooke, BQ): There are indeed a lot of figures.

Obviously, there are several options and several recommendations. As we can see, there is a cost estimate for every recommendation. It is also evident that in some situations, there were loosers. Given the desire of the government to have a balanced approach, the Departement of Revenue could attain the objectives that the government established with the aim of reducing the gap between the tax burden of two-earner couples and that of couples where only one of the parents works.

In the case of families with children, there could be other available provisions that are completely out of the equation. One must distinguish between support to families, support to children and the tax system for working parents. It would be possible for the Department to ensure equity in terms of revenue for a couple, whether there is one income earner or two, even though there would be a cost involved. There are ways that would enable us to establish a more equitable situation. We know that a couple where both partners are at work incurs incremental expenditures and you have showed that, but we still have to define the objective that we are seeking in terms of equity. Are we thinking merely about the net income, the take home pay of families, or are there other considerations? It may be that couples where both partners are working and do not have any children are in a different social situation. We must define what we are aiming for. Given the tools that the Department has, you can fine-tune the means according to the desired goals.

[English]

Mr. Munir Sheikh: As I said right at the beginning, it is not my place to set the objective for the Government of Canada. The government does that.

I can answer part of your question by emphasizing that once the government decides what it wants to do—you're absolutely correct—there are a variety of instruments one can use to achieve those objectives. As I mentioned, if the progressivity of the tax system changes, that would have an effect on the tax difference between one-earner and two-earner families. If one decides to use a flat tax structure or considers moving to family taxation, that would also have an effect. It's the same thing for the support for children. Indeed, there are instruments available that would have an effect on these differences. What the objectives should be belongs to somebody else; it's not my place to make a comment on it.

[Translation]

Mr. Serge Cardin: Well, all I can do at this point is thank the officials from the Department of Finance. It's quite clear. I already knew how the process worked and it is quite clear. All those who want to be heard and to intervene in the process are given information so that they fully understand the way the system works.

I believe it is up to the Committee to establish the goals it wants to reach and to define the equity it has in view. I am fully convinced that the Minister of Finance will then be able to suggest to us some models that would be relatively easy to implement in order to reach those goals. But we must first define the goals that we want to reach.

Thank you.

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The Chairman: Thank you, Mr. Cardin.

[English]

Ms. Dockrill.

Ms. Michelle Dockrill (Bras d'Or—Cape Breton, NDP): I have to agree. When I listened to this presentation...now I know why I never fill out my own income tax.

Some hon. members: Oh, oh!

The Chairman: Paul's happy because he's an accountant by trade.

Ms. Michelle Dockrill: I know, and if we all knew it as well you do, Paul....

One of the interesting things in yesterday's presentation by the officials with Status of Women was something that was on the first page, that is, that dependent care is the key issue, and how do families meet income and care needs? Part of our objective, I think, is to support families in exactly that. Also, the second remark is that the answers may not all be in the tax system. I'm just wondering if you would like to comment on that. Do you believe that the answers are in the tax system or are there other issues that have to be taken into account in dealing with the objective?

Mr. Munir Sheikh: I'm not sure how well I can answer the question. My knowledge of issues beyond tax is quite limited and I certainly do not want to venture into that area. In the area of tax, the tax system can, does, and, I guess, will continue to provide support for child care.

As I mentioned, there are two instruments that already provide child care to some extent. The child tax benefit does that for general expenses, keeping in mind that it provides support only to a certain income level—it doesn't provide it to everybody—and that the support falls quite rapidly after a certain income level is obtained. We also have the child care expense deduction. There are obviously many other ways of providing support for child care. Tax is not the only one, but I really cannot comment on what other appropriate ways there could be, because I just don't know.

Ms. Michelle Dockrill: I guess my question was, do you believe that the objective of this committee can be addressed in the tax system?

Mr. Munir Sheikh: My understanding of the objectives of the committee is that they are in the three areas which I've mentioned. One is in the area of whether or not the tax difference between one-earner and two-earner families is appropriate. As I've said, if you decide that it is not appropriate, the tax system does provide instruments to change it. In the area of, again, the difference in the tax treatment of one-earner versus two-earner families and the presence of children, if the objective is that the difference for some reason is not appropriate, the tax system does provide instruments to change that as well.

The tax system also provides a lot of support for children. Indeed, the tax system was the key instrument for increasing the level of that support in the last two budgets. In the last two budgets, the Minister of Finance put out an extra $2 billion for children, which I think was a very substantial increase in the level of the support.

Given those three objectives, I would say that the tax system does have the instruments to deal with them.

Ms. Michelle Dockrill: I have just one more question. I think it was Paul yesterday who brought up the issue of the underground economy. Certainly from my perspective, women in Canada have been told that a national child care program is just too costly for the government. As a result, I believe, a lot of Canadians have gone to caregivers within the underground economy. I'm wondering about what we're losing in terms of taxes from that underground economy as opposed to the cost of a national child care program. Does your department have any sense of what we're losing?

Mr. Munir Sheikh: The department does not have any numbers on how much we lose as a result of the underground economy.

I'm sure you've seen the report of the Auditor General.

Ms. Michelle Dockrill: Yes.

Mr. Munir Sheikh: He has come up with some numbers on the size of the underground economy. They are in the same range as estimates that were put out by by Statistics Canada some years ago.

• 1625

To get to an estimate of how much taxes are being lost as a result of the size of the underground economy is a very complicated task. From the information that I've seen from private sources over the last many years, the range is really very wide. One possibility is to pick up a number on the size of the underground economy and apply to it the average tax that everybody pays in the above-ground economy, which would produce the kind of estimates that the Auditor General has come up with.

Others have pursued different approaches. Some have said that the effective tax rate at that income level, which is underground, could be quite a bit less than the average tax rate for the economy, in which case you'd get somewhat smaller numbers.

It is very hard to really come to grips with the actual tax laws. By definition, these people are underground; we don't have precise information on them. I think it's fair to say that there is some tax loss associated with the underground economy.

Ms. Michelle Dockrill: But would you not have access to the number of Canadian families...?

Paul, yesterday you threw out the figure of 700 and—

Mr. Paul Szabo (Mississauga South, Lib.): Seven hundred and fifty-nine thousand.

Ms. Michelle Dockrill: Seven hundred and fifty-nine thousand that are claiming child care expenses.... Could you in that way get some sense of what's being lost?

Mr. Munir Sheikh: Just looking at the number of people who claim child care expenses, those are the people who have receipts and those are the people who have declared their expenses, so those are people who are above-ground. If you look at the aggregate numbers, only about 15% of families with children claim child care expenses. There's a huge difference between those who claim child care expenses and those who do not. It's not obvious to me right now how to determine how I can get a sense from those numbers as to what the size of the underground economy is. I'll have to think more about it.

Ms. Michelle Dockrill: I just want to be sure that I heard you. Did you say that 15% of Canadian families claim?

Mr. Munir Sheikh: That's right.

Ms. Michelle Dockrill: Okay. Thank you.

Mr. Munir Sheikh: My colleague would like to provide further information on it.

Mr. Louis Lévesque: In terms of the revenue loss specifically in the area of child care, as long as the policy would remain that these are considered expenses to earn income and so are deductible, in the end, by the person that pays those expenses, and taxable, in the end, in regard to those people who receive them...as long as this policy principle is maintained, the revenue loss associated with the underground economy of “informal care arrangements” must be pretty small, because there's both a benefit side and an inclusion side.

The people who go for informal care arrangements are foregoing a deduction of the cost, and the person who's providing the services, you assume, to some extent, is not declaring the income. There's a kind of offset there. This is different from the construction industry, for example, where the revenue costs are higher because these are personal expenses that we do not otherwise recognize. When somebody undertakes work and does not declare that kind of income, the person on the other end would not get the deduction. The revenue costs are much smaller in the area of child care as opposed to other areas in the underground economy because of the underlying policy, that is, if you have those costs, we'll allow you a deduction against taxable income. We're just shifting the taxation of the income to the person that is receiving the money because of performing the services.

Ms. Michelle Dockrill: The reason I ask is that, as you all know, I am a new mom of a seven-month-old, and one of the most difficult tasks I've had over the course of the last seven months has been to access child care for which the caregiver was willing to claim the cost.

Mr. Louis Lévesque: I could give you an example. In many circumstances—I too have young children—for example, your neighbour may be a stay-at-home mom and her husband may be claiming the spousal credit. If she were to give you a receipt, there would be a loss of a spousal credit.

• 1630

But in terms of the actual tax revenue loss or the change to the government, whether or not there's a receipt, let's say, of $3,000 for child care, the impact on the revenues is fairly small, because if you don't have a receipt, that person's husband is still claiming the spousal credit, and you're not claiming your deduction. If you get a deduction, that person will have to include this as income. So on the net basis in terms of revenue for government, it is not likely to be that big.

Ms. Michelle Dockrill: My point was just the accessibility to child care.

The Chairman: Any more questions, Ms. Dockrill?

Ms. Michelle Dockrill: No.

The Chairman: Ms. Redman, please.

Ms. Karen Redman (Kitchener Centre, Lib.): Thank you, Mr. Chairperson.

I have a couple of questions. I really appreciate the fact that you're here, and I'm assuming that your department will continue to be a resource to us as we deliberate.

On page 11, you talk about the flat tax. I go back to Ms. Dockrill's earlier comment about not filling out her own income taxes. There's something appealing, at first glance, in a flat tax, because it seems simple, and if it's simple, it must be fair. But I look at the statement that 80% of tax filers would be losers, and I'm wondering if you could break that down even further. If the current tax system demands that some taxpayers at the higher income brackets pay 50% of their earnings in taxes, it strikes me that it's probably the middle income earners who get hit the hardest. I'm just wondering if you could flesh out those comments a little more for us.

Mr. Munir Sheikh: Before I answer your question on page 11, let me take you to page 8 as an example. Page 8 is an example of a progressive tax system. If that progressive tax system were all there was, you can see that you could fill out your tax return in half a box. There are a lot of other things beyond progressivity that make sure this is not our tax return; the tax return goes beyond that. This is not the only area of complexity in the tax system.

As for your question on the flat tax, a flat tax, by definition, is the average tax that raises the same amount of revenues that you're raising at this time. What that would mean, then, is—

The Chairman: Could you repeat that?

Mr. Munir Sheikh: A flat tax? If you have three brackets and three tax rates, and if you're trying to raise the same amount of money as before—

The Chairman: So your definition of flat tax, if I understand it, is that it's a tax that generates the same amount of revenue.

Mr. Munir Sheikh: No. I said that if you generate the same amount of revenue—

Mr. Paul Szabo: Assuming—

The Chairman: Oh.

Mr. Munir Sheikh: If you don't generate the same amount of revenue, you can have any tax rate you want and there'll be a huge deficit cost. But if you want to raise the same amount of revenue and you want to go from a progressive tax to a flat tax.... Maybe I can draw a line for you. The tax system right now has rates that go up like this: the higher your income, the higher your tax. Instead of that progressivity, you'd have a straight line. That's your tax rate, one tax rate, right? So instead of 17%, 26%, and 29%—

The Chairman: But it's not like that.

Mr. Munir Sheikh: It's not like that.

The Chairman: It's like this, correct?

Mr. Munir Sheikh: To keep things simple, if you look at the federal tax structure, we have 17%, 26% and 29%.

The Chairman: Right.

Mr. Munir Sheikh: Instead of that, you have a flat tax, which is 22%. That means that anybody who is now paying 17% would pay more. People who pay 17% are at the lower end.

The Chairman: But your definition on page 5 was:

a tax system is progressive if higher income earners pay a larger portion of their income in tax than lower income earners.

Mr. Munir Sheikh: That's right.

The Chairman: So why is it that a flat tax rate would not be progressive?

Mr. Munir Sheikh: A flat tax rate is—

The Chairman: If I'm paying 22%, and I'm a high income earner, do I not retain your definition? Do I not pay more income tax?

Mr. Munir Sheikh: No. It doesn't matter what your income is, you pay 22%. That's what a flat tax is.

Ms. Karen Redman: So the gross amount is high. What you actually pay is higher, but the rate....

Mr. Munir Sheikh: So instead of somebody paying 17%, they would pay 22%. Instead of someone paying 26%, they will pay 22%. Instead of somebody paying 29%, they'll pay 22%. It's only one rate of 22%. A flat tax means that anybody who is now paying under 22% will pay more taxes. Anybody who is paying over 22% will pay less taxes. We all know that people at the lower end pay lower taxes; people at the higher end pay higher taxes.

• 1635

What a flat tax does, then, is to raise taxes for lower income groups and to lower taxes for middle income, upper income and high income groups. It takes income away from the lower income levels and gives to people at the higher income level. That is the outcome.

One can offset the effect of the higher tax at the lower end by raising the basic exemption, something that Alberta has done. You can do something to offset the effect at the lower end by raising the basic exemption, but the flat tax has to provide larger tax cuts at the high income end at the expense of the middle incomes. That is what the flat tax is all about.

Ms. Karen Redman: Thank you.

In a presentation we heard yesterday from Status of Women officials, they made a couple of suggestions. You've already covered some of them in your presentation. One that I've heard people talk about is removing the waiting period for maternity and parental benefits. Is that the kind of scenario that you would have the statistics on or is that something we would go to HRD to get statistics on?

Mr. Munir Sheikh: That is an HRD issue. I don't have any information on that.

Ms. Karen Redman: As well, if we want to look at EI and those kinds of benefits, is that something HRD would have statistics on, rather than you?

Mr. Munir Sheikh: That's right.

Ms. Karen Redman: Thank you.

The Chairman: Thank you, Ms. Redman.

Mr. Szabo.

Mr. Paul Szabo: Thank you.

Thank you for your presentation, gentlemen.

It's extremely important that you've come here and presented this information, because it starts to put some of the issues in context. I think Status of Women officials made an excellent presentation yesterday, outlining the fact that with respect to the configurations of families, the choices etc., there's a broad range. It's going to be very difficult to find a simple solution to a complex challenge. I think you've brought the same message: there are some dynamics here that you have to look at.

I thought that the most important thing you brought to us was the fact that we have principles within our tax system—the progressivity and the individual as the unit of taxation—that create disparities between the tax burdens of families depending on one income or on two incomes and the distribution of income between the two—and that has nothing to do with children. It has nothing to do with child care choices, etc. It has to do with the social policy basis of our income tax system.

You can give us your advice. If we were going to analyse the impact of caregiving benefits or something to do with tax or something outside the tax-back benefits, I wonder if you would agree, then, that we should exclude the impact of progressivity and the individual taxation unit from the comparison numbers.

Mr. Munir Sheikh: I think you probably would have to expand on what you said in order for me to fully understand what you are saying.

Mr. Paul Szabo: Okay. Let's do that. I think this is really important, Mr. Chairman, because it will help us to really narrow the ballpark that we're dealing with. On page 4...I'm going to explain it to you in English as best I can.

I hope, Serge, that you're going to follow.

The Chairman: Are you going to read the French text?

[Translation]

Mr. Paul Szabo: Do I speak French?

[English]

On page 4, we have the example of a $60,000 family income basis. There is almost a $4,000 differential between a one-earner couple and a two-earner couple. It says that a two-earner couple actually gets...the difference is $3,848. That is the difference in the taxes, so in fact a two-earner couple is better off. Two people working are better off by about $4,000, and that has to do with progressivity and individual assumption for our unit of taxation.

Mr. Munir Sheikh: Can I just make one small comment?

Mr. Paul Szabo: Sure.

Mr. Munir Sheikh: I chose my words very carefully. They pay less tax. Whether or not they are better off clearly depends on—-

Mr. Paul Szabo: No, but there is.... It has nothing to do with children. It has nothing to do with child care.

Mr. Munir Sheikh: That's right.

• 1640

Mr. Paul Szabo: There is a difference between these two because of our conventions of income taxation. So if there is this discrimination—if some would use that word—this discrimination is attributable to the income tax system that is applicable to all Canadians. It has nothing to do with child care choices or whether you have children or not.

Mr. Munir Sheikh: Absolutely.

Mr. Paul Szabo: It has to do with the fact that it's our taxation.

Mr. Munir Sheikh: Yes.

Mr. Paul Szabo: So if this $4,000 discrepancy or a discrepancy of any comparison has nothing to do with children, shouldn't we eliminate from our analysis all of the impacts of progressivity and individual taxation so that we could look at the marginal or incremental impact of child care choices and the value of benefits?

Mr. Munir Sheikh: You're absolutely correct. Indeed, that is what I tried to do. Of the gap that you have—-

Mr. Paul Szabo: Exactly, and you did, because you shifted from comparing one family to another family to in fact analysing a single family and two choices for that family.

Mr. Munir Sheikh: That's right.

Mr. Paul Szabo: Mr. Chairman, I believe that this is a very important point. Unfortunately, the C.D. Howe Institute did the same thing. They raised this issue about there being a differential between a one-earner family and a two-earner family and put it in the context of child care choices, when, in fact, finance officials have now confirmed to us that about $4,000, which is what the C.D. Howe Institute was in fact talking about, is entirely due to matters unrelated to children. We have to learn that, and I think we will hear that from other people.

I thank you for that, Munir, because it's going to help us to understand the differential between a one-earner family and a two-earner family and whether they decide to have both in the workforce or not. The impact on their pocket is going to be due in part to our tax system, in part to their choices of caregiving, and in part to other discretionary things like RRSPs and all that other stuff. Thank you for that. That's very important.

I noted in here that you've included in the comparatives that CPP and EI are expenses out of the pocket of an income earner, but you've attributed no benefit to having an opportunity to contribute to CPP and in fact earn a CPP—that's if you assume they collect the benefits. Should we not, if we are going to do a proper analysis, acknowledge that if somebody has the opportunity to contribute to CPP there is a future value, a future benefit that should be acknowledged?

The Chairman: They did that on page 22, did they not?

Mr. Paul Szabo: No. It's different. It basically says that if I assume my annual benefits earned, like I went on EI, for the same value of the premiums I paid, this would be a wash. I'm talking about how if I'm working and paying CPP premiums, when I retire I have years of benefits accruing to me. There's actually a value that's going to come, regardless of what other claims I may have made under EI or CPP. I'm earning a pension.

Mr. Paul Forseth (New Westminster—Coquitlam—Burnaby, Ref.): That's a big maybe.

Mr. Paul Szabo: But you would acknowledge, I think, that having a pension, which is a pension until death with survivor benefits, in fact has to have some value. Otherwise, we would be saying to Canadians that the moneys that you're putting in there you're not going to get anything for.

The Chairman: While you're answering that question would you also lump in maybe the benefits of RRSPs and why you didn't include those? They're similar. If I contribute to QPP or CPP I'm going to get a future benefit. If I do the same thing with RRSPs, there's a benefit—and you're also getting the deduction. Maybe you can combine both answers.

Mr. Munir Sheikh: Okay. Let me comment on all three things. The first point you made was about there being a $4,000 difference even without children. That is an important point. In fact, if you look at page 18, I think that provides a good summary of the point you're trying to make.

• 1645

On page 18, we say there's a $4,000 gap to start with, of which a $2,000 gap or difference is offset in our example by the child care expense deduction. There is a third element, which is the Canada child tax benefit. If you take a look at those three elements, that gives you the complete picture: $2,026 because of the child care expense deduction and $187 because of the child tax benefit. Those really are three elements of the whole equation.

Regarding your point about the benefits of EI and CPP, my comment on page 22 was not supposed to leave the impression, which unfortunately I think I have left, that those benefits may not be collected. What I was trying to say was that there's no direct one-to-one link between what you pay and what you get, because I don't know what you can get. Somebody may pay $600 in EI premiums and end up getting a benefit that is many times more.

For the purpose of the table, I did not know what numbers to put in, so I assumed a one-to-one link. It could be one-to-four or whatever. You're absolutely right when you say that one should factor into the example the benefits of CPP and EI. Those benefits would of course differ among different individuals, depending on how much they get out of it.

Regarding the chairman's question about RRSPs, the difference between what we have shown here and RRSPs is simply that there are certain things that we are supposed to do by law, and there are others that are discretionary. When you calculate disposable income using the definition that Statistics Canada uses, they take out the contributions you make for CPP and EI because you have to make those contributions. There's no choice. When StatsCan provides the definition of disposable income, they do not take the RRSPs out, again, for the simple reason that you have a choice as to whether or not you want to put income in.

If you were to take out the RRSP contributions, that could create a problem in comparing families. Somebody says that they're going to put money into an RRSP, that it's their money and they'll take it out later, and another person says that they're not going to put money into RRSPs. If you were to take the RRSPs out of disposable income, then you would be showing that the person who does not put money into an RRSP is better off, that he has more disposable income. I understand that the person would have less discretionary income, but it can give a misleading impression, so just for the sake of following convention, we did not do that.

The Chairman: Mr. Szabo.

Mr. Paul Szabo: Okay. So I take it that when we do our analyses we should assume that there are values for CPP and EI contributions that realistically would be earned back in some sort of benefits—or at least in the value of insurance. CPP offers disability coverage and EI provides maternity benefits as well as parental leave, etc., which aren't factored into any of this stuff. So maybe we shouldn't take the costs off as if there were no benefits associated. That's probably a reasonable assumption.

Let's move on to another point here. With regard to the spousal non-refundable tax credit that someone would claim if one spouse was in the home caring for preschool kids, the amount of the spousal credit is not reduced dollar-for-dollar for income until you pass a certain amount.

Mr. Munir Sheikh: It's $500.

Mr. Paul Szabo: So you can't just say that the spousal amount is not as big as the basic personal amount, because you can earn up to $500 before you lose any of that. For every Canadian family in that situation, any spouse can earn, for instance, $500 of investment income, interest income on bank accounts or whatever, and not pay any taxes and not reduce or not change the tax burden that otherwise would.... So there is that $500 cushion, which wasn't built in here. Again, in the scheme of things, $500...I have a feeling that taken with the CPP and the EI stuff it's going to change the numbers a little bit here.

With respect to the child tax benefit, actually in the calculation it's not just reduced by a clawback of income. There is also another adjustment to it. Is it with regard to a percentage of the child care expense deduction claimed?

• 1650

Mr. Louis Lévesque: I can answer that. This applies only to the supplement for younger children. There's a base benefit of $1,020, and that's reduced on the basis of family income in excess—as of July 2000—of basically $30,000. On top of that, there's a supplement for younger children.

Mr. Paul Szabo: If you do not claim—

Mr. Louis Lévesque: That supplement is added to the $1,020, but you're right when you say it is linked to your child care expenses. But it's only the child care—

Mr. Paul Szabo: I was of the understanding that in the formula for the calculation the basic child tax benefit is also reduced by a percentage of the child care expense deduction claimed.

Mr. Louis Lévesque: No.

Mr. Paul Szabo: Can you provide the committee with the calculation?

Mr. Louis Lévesque: Absolutely.

Mr. Paul Szabo: The actual formula?

Mr. Louis Lévesque: We can do examples that would show it. It's only—

Mr. Paul Szabo: Yes, but I'd like to see the formula, because I—

Mr. Louis Lévesque: —the $213, the supplement for younger children.

Mr. Paul Szabo: I have a feeling that it would be helpful for the committee. You've done this in layman's language, which is very good, because it helps people to follow better, but if we have to get into some of the detail it might be useful to have the specifics with regard to the mechanics of the child care expense deduction, the various non-refundable tax credits, the child tax benefit, the national child benefit, and the actual rates of the tax calculation.

On page 18, you assume that this typical couple incurred child care expenses of $8,000, obviously a lot of money. I'm curious as to why you picked that number when in fact, as you pointed out in your presentation, the average claim per taxpayer is only $2,600.

Mr. Munir Sheikh: There's a simple answer for that. I have children who I can get child care for. I don't, because for every dollar that I spend, my wife will get a 40¢ reduction in her taxes. Since we don't really need child care, I think it's a losing proposition for us to spend that money. But there would be another family that would make full use of the child care expense deduction, so if you were to add families, their average would be substantially lower than the limit we allow.

For the sake of comparison, we needed to pick up a family that was making use of the child care expense deduction and we needed to take out families that were not making use of the deduction at all, which would lower the average numbers. I think the point is driven home by the fact that the criticism of the child care expense deduction that is made is that it provides a tax reduction to some and not to others.

The point we're making is this. Let's assume that you are spending on child care and let's then see what happens if the deduction gives you a tax break. If, on the other hand, there was no deduction being taken in the first place, there is no issue to start with. One has to start with bigger numbers to drive home the point that even there a big number does not really confer a benefit. Smaller numbers, or to go to the limit, a number of zero, would basically take the issue away totally.

Mr. Paul Szabo: But on page 19, Munir, when you give the so-called complete income picture, you show that the differential between this one-earner family and two-earner family is $4,700. That's in take-home pay. That's in your pocket.

Mr. Munir Sheikh: You're right.

Mr. Paul Szabo: If your assumption on the child care expenses is not $8,000, but only $4,000, your analysis basically would show that they effectively make the same take-home pay.

Mr. Munir Sheikh: In fact, I can go one step further and take the example where there is no child care expense.

Mr. Paul Szabo: Sure.

Mr. Munir Sheikh: In that case—

Mr. Paul Szabo: It would be $4,000 higher.

Mr. Munir Sheikh: Yes, $4,000 higher, but—

Mr. Paul Szabo: I'm glad you said that, because it cautions us with respect to the fact that you can play with numbers and get a totally different answer by your assumptions.

Mr. Munir Sheikh: But the point I want to make is that if you remove the child care expense deduction as I did in my example.... Let's suppose it's zero. Then you're $4,000 better off. But what is that $4,000? It takes you back to my first example of no children in the system.

Mr. Paul Szabo: Sure.

Mr. Munir Sheikh: All this child care expense deduction is doing.... If you have no children in the system or if somebody is not making use of the child care expense deduction, the two-earner family is better off by $4,000 on the tax form.

Mr. Paul Szabo: Yes.

• 1655

Mr. Munir Sheikh: Now if you do have child care expenses, then let's see what happens—and that's what happens. But the simple point I want to make is that if there is no child care expense deduction there is no tax break.

Mr. Paul Szabo: There's no...?

Mr. Munir Sheikh: Tax reduction.

Mr. Paul Szabo: Okay.

As long as we're on page 19, there you have this analysis that shows take-home pay and shows that the differential is $4,700. But that differential of $4,700 in your pocket is now due to two things: one is progressivity and the other is the child care expense deduction.

Mr. Munir Sheikh: Actually, the math works very simply. With regard to the tax that is $4,000 lower for the take-home for the two-earner family, from our first example, and the $8,000 of child care, the difference is the negative, the approximately $4,000 that you see here.

Mr. Louis Lévesque: It's really $4,000 on the basic tax, $6,000 net, of child care expense, because you get $8,000 of expense minus the $2,000 of the child care expense deduction, and then you get the work-related expense and the EI and the CPP that come into play—

Mr. Paul Szabo: But on page 19, this includes the impact of progressivity.

Mr. Munir Sheikh: That's right.

Mr. Paul Szabo: How much would progressivity change these numbers if we were to eliminate the discrimination between one- and two-earner families that has nothing to do with children?

Mr. Munir Sheikh: It's $3,848, the very first number you see on the page. You see that $3,848 is exactly the same number.

Mr. Paul Szabo: Yes. I understand that, but you have CPP and EI and other work-related expenses, etc., in here, and it's a plus number. It goes the other way.

All right. We're going to work it out. The point that he's made, Mr. Chairman, I believe, is that you have to be careful with these numbers. I think that's one of the reasons why, as we saw during the debate, the C.D. Howe Institute could argue that if you simply look at the Income Tax Act, the situation with a stay-at-home parent is discriminated against or is adversely affected, whereas the Status of Women would represent, when you put all of these other things in, that it was actually the other side. People are wondering, and they're saying, well, jeez, somebody must be giving us incorrect information. In fact, they were giving correct information, but they were dealing with two different scenarios, one with other than income tax impacts.

Mr. Chairman, it just serves to caution us that when we start dealing with these numbers we have to make sure we understand our assumptions and work through it on a marginal basis; each step has a cost or a benefit that we have to be aware of.

The Chairman: Could we jump to another discussion point, then? Would it be the wish of the committee that we ask the finance officials to maybe prepare a spreadsheet showing one-income and two-income families? It could show one-income with one child and with two, and two-income with one child and two, and it could give us the whole tax scenario as well as all the related expenses and the disposable net income, all on one spreadsheet. Do you want that analysis?

Mr. Paul Szabo: Mr. Chair, there are so many different scenarios, and I'm sure that we could get all that stuff, but I don't want to make work at this point. I think the committee needs to continue to educate itself. We'll maybe collectively be in a better position to requisition analyses or examples—on costing as well—when we think we have this ballpark narrowed down to something a little more focused.

The Chairman: Because there's also the GST tax credit, for example, that's not included here.

Mr. Paul Szabo: Absolutely.

The Chairman: Do you have very many more questions?

Mr. Paul Szabo: No. I have three more questions.

The Chairman: Do you want to go now, Paul, or do you want to come back to them?

Mr. Paul Forseth: He's on a roll now.

The Chairman: Go ahead, Paul.

Mr. Paul Szabo: Let me go right to my last question. I asked the Status of Women officials the same question yesterday.

I understand that you're not in a position to have a government position for us about what we should do about this, but it seems to me, in layman's terms, that what we really should be looking at is not family A compared to family B. What we should be looking at is “a family”.

• 1700

The family started off with two people. Let's assume they were both working, making an income, and then had a child. Now we have to help them understand the economics of whether they should both continue working and pay a third party for care or make some arrangement that may or may not include some cash outflow. Or what happens if one of them withdraws from the paid workforce, stays at home, and provides direct care for a certain period? They may have EI parental benefits. That comes into it as well. What are the economics for them for the first year, for the second year, or maybe for the longer term if they're going to have a family of two or three, etc.?

They want to look at the mechanics of what it mean to them as a family. They know they have a child care expense deduction that, for a preschool child, could be $7,000. So if they pay $7,000, they'd get that deduction, and if they're at the low rate, it's 25¢ on the dollar, so it's basically a 25% subsidy on their daycare.

No matter how you cut it, in the example you have of Sandra here, if it's a $24,000-a-year job and there is $8,000 of child care expenses, that means that the amount she's going to be taxed on is $16,000, less her personal exemptions, which are $10,000. That puts it at about $2,500 of tax on $24,000 of income. It's about a 10% tax rate. So if I'm paying $2,500 of tax plus $8,000 of child care expense deduction, I have a very significant increase in my take-home pay. You're looking at somewhere around $10,000 of new cash in the pocket because I chose to work.

It's the issue of economic gain, of the opportunity to earn economic gain, and it's my view that those who withdraw from the paid labour force to provide direct parental care do in fact forego the opportunity to earn economic gain so that they can provide direct parental care. There is a real economic loss, a real cash loss. On a $24,000-a-year job with an $8,000 child care expense deduction, we're probably talking of giving up in the range of $10,000 cash in my pocket to make that choice.

There are people who have said to members of Parliament that if they're prepared to forego $10,000 cash in their family's pocket, not take up a child care space, free up a job, and basically provide the best possible care that any parent who loves that child could ever want for a child, shouldn't they be able to have some sort of a tax benefit that would put them on a level playing field with the 25% subsidy that they would get if they were in the paid labour force?

The discrepancy there, the differential or the discrimination, has to do with the 25% subsidy on child care, and it's my view that child care expenses exist for all parents, regardless of their choices. Some of them happen to be paid to third parties for providing human care, but other costs exist, and what we provide for a child care expense deduction comes nowhere near the real cost of raising a child.

In fact, what we're really saying is that in the tax act the child care expense deduction is simply a modest contribution to raising children, given and paid for by all taxpayers, who in fact subsidize all tax expenditures.

So the issue, I think, is the following. Should we be looking at one family and analysing its choices, whether we have both working or have one who has withdrawn from the paid workforce? If there is a discrepancy between the two scenarios that is due primarily to, say, the child care expense deduction, offset by maybe an adjustment in the child tax benefit, then maybe we should address that discrepancy, so that no matter what choice I make, the amount of benefit that is going to be subsidized by all taxpayers is going to be level or equal or equitable for all families, regardless of the choice they make, regardless of the configuration.

That's how I understand the problem. I guess my question to you is, do you believe we should simply be concentrating on one family and looking at what happens to its tax burden and its take-home pay when they do this or when they do that?

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Mr. Munir Sheikh: Different people have looked at the issue differently and find different approaches useful, but the approach that you have suggested, which is what we have also tried to cover here, is an extremely useful one.

If you also look at page 22, which is a continuation of the same example, that table says that if you were to put out all these hours of work outside the home and if for all these hours of work you get only 36% of the income that you've earned, which comes to, out of an income of $24,000, $8,600, at a tax rate of 64%, I guess you have to ask the question whether that take-home pay in relation to gross income would encourage a lot of people to seek work outside the home and whether or not that money in the pocket is worth the effort that is being put out to earn that income.

Mr. Paul Szabo: I thought that was my last question, but your statement right now about whether it would encourage people to seek work in the paid labour force raises the issue about whether or not our Income Tax Act should be involved in social engineering and whether it should penalize or compel people to do anything.

Mr. Munir Sheikh: No. The point I'm making is that we have a tax system, and the tax system has results, which are shown on page 22. The results are that if you earn $24,000 of income you would keep one-third of it. That is the reality—and it does have an effect.

The Chairman: That's not the reality, because you have the $8,000 figure right in there, and if the average is only $2,600, it's a totally different scenario.

Mr. Paul Szabo: That's right.

Mr. Munir Sheikh: No. I thought you started with the example that this person has the flexibility to use the child care expense deduction. We can work it both ways, whatever way you want. Either that person uses it or doesn't use it. If she uses it, this is the outcome. If she doesn't use the child care expense—

The Chairman: You said that the average child care expense is $2,600.

Mr. Munir Sheikh: Right. But—

The Chairman: So why would that person use an $8,000 figure in deciding whether it's beneficial for them to go to work or not? Why wouldn't they use $2,600, the average figure?

Mr. Munir Sheikh: Because the average is a number based on the total population, which says that some of them are going to use it and others will just not use it.

The Chairman: No, that's not true. If 759,000 taxpayers claim the child care expense deduction, the total deduction is just a little over $2 billion, which, divided by 759,000, is about $2,600. For those who claimed it, the average claim was about $2,600.

Mr. Munir Sheikh: But of that average some are claiming a very small amount, while others are claiming $8,000.

The Chairman: Yes, that's right.

Mr. Munir Sheikh: The point I want to make is this. It really is an important point, and I haven't been able to make it, I guess. If the argument is made that there are some who are benefiting from the child care expense deduction, one has to start with an assumption that somebody is using the child care expense deduction and, then, that there is a tax benefit to go with it.

As I said earlier, if the child care expense deduction is not being used or is being used in a limited sense, there is not much of a tax benefit to go with that limited use of the child care expense deduction. We cannot use a small number on the child care expense deduction and continue to claim at the same time that there's a significant tax benefit to go with it. It's one of the two. Either it's not being used, in which case it's not a tax issue, or it is being used in a substantive way, in which case it is a tax issue.

The Chairman: Thank you, Paul.

Mr. Forseth.

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Mr. Louis Lévesque: May I just clarify one factual point? In the lead-in to your question, you were saying that in this example the kind of increase and the economic cost of foregoing the the income of work outside the home may be $10,000 or something like that. I just want to confirm something. If you assume that this person has to expend $8,000, the $8,653 we have here is exactly that.

From a psychological perspective, it's a very different decision to say that you have a one-earner couple and the second earner goes out to earn $24,000 or you have a $60,000 income two-earner couple and the spouse stays at home to take care of the young children. It's a different decision, but in terms of the mathematics of the tax system it is the same decision, and that's what's in the paper here. You can look at it both ways; it doesn't make a difference at the end of the day. It's really what the incremental disposable income is that is associated with the work of a spouse earning $24,000. You go one way or the other; in the end, it doesn't make a difference.

Mr. Paul Szabo: It depends on your assumptions, because if there were only one child—

Mr. Louis Lévesque: Correct.

Mr. Paul Szabo: —it would change this pretty significantly as well.

Paul has a couple of question.

Mr. Paul Forseth: On the first page you say that you're here as a “bureaucrat only to provide factual information on how the tax system works in the area of taxation of families”. You say that “obviously policy and individual value judgments can have a profound impact in forming views on many of these issues” and that it's not really your place to comment on “policy and value judgments”.

However, using your words, we do have a tax system, and there certainly is a lot of confusion and controversy out there about there being inequities and various hurdles and thresholds. So we have a lot of differences; that's the existence of it. It must be built on an existing set of principles.

Here's what I want to hear from you. We have a tax system: what are the existing principles that give us that present tax system? What are they? If we can look at that, we might be able to start getting to a new world. We first have to understand this and you have to enunciate it. You don't want to talk about proposed policy directions or recommendations, but the system we have now must rest on some principles, and certainly you can say what they are. Then we can go from there.

Mr. Munir Sheikh: Let me see. In the area that we're discussing, let me very quickly try to gather these principles together, based on the presentation.

There are four principles. The first principle is that the tax system is progressive. The second principle is that the tax system is based on individual income, not on family income. The third principle is that the state recognizes the cost of raising children, but has limited the delivery of this benefit to individuals up to a certain income level; the benefit is a function of the income level and declines after a certain threshold. The fourth principle is that the basis for taxation would be income that excludes the expenses incurred for child care. I don't know if I have explained it properly: the basis for income tax is the income excluding the expenses incurred for child care.

So those, which I can quickly think of, are the four principles, and those four principles are the basis for all of the results that you see here. The first two principles give you the tax difference between one-earner and two-earner families without any children. The child care expense deduction gives you the key difference between the tax treatment of children in regard to one-earner and two-earner families. The child tax benefit, to the extent that it is related to the level of income, can also produce some differences. Those are the four principles. If the outcomes are not acceptable, then, I think, one has to try to make adjustments to those basic principles on which the tax system is based.

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The Chairman: Mr. Forseth.

Mr. Paul Forseth: Is it somewhat correct to say that taxes are based on individual income, yet, when we get into the business of children, the return of benefits is based on a family? That's where we get into some trouble.

Mr. Munir Sheikh: That is right. While it may seem inconsistent that you base your taxes on individual income and your benefits on family income, I don't think, since we're talking about benefits and tax, that there is any inconsistency in this. One may, as a matter of value judgment or policy view, say that they should probably be based on both. That view can be taken, but technically or analytically, I would say, one can have a system in which taxes are based on individual income and benefits are based on family income.

The rationale for that, which lies behind what we have—and I'm not here to justify or agree with the rationale, I'm just providing information as to why we have this—is that an individual-based tax system implies that when a spouse goes to work, he or she would face their own tax rate, that their tax rate would not be dependent on what the partner is doing, so that in a sense there is some independence in making economic and social decisions. That is the rationale for an individual-based tax system.

Why do we then have a family-based benefit system? The family-based benefit system starts from the rationale that if the government is to provide benefits and if it is to finance that benefit by raising taxes, then the cost of that benefit can be contained and the benefit targeted to the most needy if it is based on family income rather than on individual income. So to maximize the “benefit” of the benefits being provided at the least cost, you would pursue, as the current tax system does, a family-based benefit system. The two approaches are quite consistent, because the objective is to contain cost and provide the most benefits for those who need them.

The Chairman: But in your presentation you labelled the child tax benefit as a tax cut. You shouldn't label it that way if it's based on family income. The child tax benefit...and the taxation system, as you said, is based on individual income. So if it's a tax cut, it should go back to the individual taxpayers...not based on family income, then.

Mr. Munir Sheikh: It is called a tax benefit. In our report, it's actually called a tax expenditure. The reason that it is neither a tax nor a benefit but a tax expenditure is simply that it is an expenditure program that is delivered through the tax system; that's what the definition of tax expenditure is.

But even beyond names—as to whether it's a tax or a benefit or spending or what—I think the real issue is, what is the best way of providing that? The rationale in the current tax system for any such thing, where the state provides something to somebody, even when you're not paying a tax—the child tax benefit goes to people who don't even have to pay a tax, so it's a negative tax in that sense, which is a benefit—is that this is the most efficient way to provide government support: to base it on family income.

The Chairman: To add to the confusion....

Mr. Forseth, do you have more questions?

Mr. Paul Forseth: Is it not inconsistent to provide horizontal equity with respect to a dependent spouse but not provide horizontal equity with respect to dependent children?

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Mr. Munir Sheikh: Let me say that there is a cost to raising children, just like there's a cost that is accommodated through the spousal credit, and that cost is taken care of in the tax system. But given the fiscal situation and the need to contain that cost, that benefit is being targeted.

That does create the kind of issue that you have raised about horizontal equity, but I think the trade-off there is that to provide horizontal equity you need to have more money, and the kind of money that you're talking about here.... I mentioned a cost estimate in my presentation. If you were to make the child tax benefit available to everybody, just like the spousal credit, the cost of doing so would be close to $3 billion. So it really becomes a question of priorities and policy, which, as I've said, is not something I can really comment upon.

[Translation]

The Chairman: Mr. Cardin, please.

Mr. Serge Cardin: I would like to approach the problem from a different angle.

We hear that it is unacceptable that a one-earner family pays more income tax then a two-earner family. Anybody who does fiscal planning would tell someone who wants to save as much income tax as possible: “Try to split your income; you will then have more fiscal benefits and you will pay less income tax”. Here the problem is approached in this way.

The basic assumption is a couple with a single $60,000 income and another couple with two incomes totalling $60,000. Obviously, you create a splitting situation. It is as if the individual with a $60,000 income could split that income and give part of it to his spouse for a total family income of $60,000 which at the bottom line gives him increased benefits. You pay less tax when you split the income. However, the basic assumption is somewhat faulty.

Let's do a quick calculation for a one-earner couple. In this scenario, without children, we end up with an income of $40,786. Only one person works. Let's suppose that that person works 37.5 hours per week; we then have an average net hourly wage of $20.91. In a two-earner couple, the average is $10.74.

I would like to share with the Committee a thought that occurred to me. It sometimes happens that the problem we are grappling with involves more than the figures or the income tax paid by a one-earner or a two-earner couple. In fact, both couples are in quite different social and economic situations.

Let's take the case of a person earning $60,000 per year whose spouse does not work. If that spouse decides some day to find a job, there probably won't be any income splitting. It won't be $60,000 anymore, but rather $60,000 plus the salary of the spouse.

It is simply to give food for tough that I approach the problem in this way. In a family with children, if you compute the hourly rate, the person earns $21.29 an hour. If there are two incomes and two children, the persons are working at a rate of $9.44 an hour.

I have some concerns when I hear that dual income families are benefiting as compared with one-earner families. If you extrapolate and assess the impact, the amount of work that must be accomplished by a two-income family, you see that the fiscal benefit is not enormous. Perhaps the problem was stated in a biaised way to start with. It is not the other way around.

People who have an income of $60,000 pay their income tax. In two-income families, there is twice as much work being done. It's almost normal that they would have an incremental take-home pay. I merely wanted to show you that the problem can be viewed differently.

The Chairman: Are there any comments?

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[English]

Do you have any comments on that?

Mr. Munir Sheikh: No. I could say that it is indeed another way of looking at it. If somebody did that at that level of income—$60,000—and the spouse goes to work, my feeling is that the quality or the results would be similar to what I presented here, but one could probably take a look at that.

The Chairman: Thank you.

Maybe we should be looking at it like Mr. Szabo and our presenters yesterday said: at different stages in a family's life. At this stage, it could be Mike and Jane earning $36,000 and $24,000, and John just earning $60,000, but at an earlier stage you would have had the choice, where he was earning $40,000 and had to make the decision for his wife—or his whatever, his spouse—to go out and earn the extra $20,000. The analysis, I think, would end up being the same. We could debate the philosophy.

Ms. Redman, please.

Ms. Karen Redman: Thank you, Mr. Chairperson.

My question is probably on similar lines. I'm just looking at the scenario on page 21—Sandra and Louis. What would happen if the wage earner that stayed home was the higher income earner? How would that change this scenario?

Mr. Munir Sheikh: Of course the person who is staying home doesn't have any income, but if that person went out to work and ended up earning an income higher than that of the person who is already in the workforce, then the person who is already in the workforce would be the one who would have to report the child care expense deduction, because the child care expense deduction is only available to the lower income spouse. So although the second earner ends up getting more income, the deduction would go to the person who was already in the workforce.

If you look at the total family perspective, it would not be different from this situation with Sandra and Louis. What this is really showing is that if the person entering the labour market gets $24,000, the family keeps $8,653. If I were to work with an example that would say Sandra goes to work and makes $40,000 instead of $24,000, which is more than what Louis is getting—$40,000 compared to $36,000—I would go through the same calculation. There will be a taxpayer and there will be a child care expense deduction, which actually is not going to be any different from what I reported here, and all the other expenses would accordingly move up. I think the end result would be somewhat different from $64,000, but not much.

Ms. Karen Redman: Unless it's onerous, I would be interested in seeing that, just to compare the two.

Mr. Munir Sheikh: We can do that calculation.

Mr. Paul Forseth: You mentioned that the child care expense is only available to the lower income earner, by policy. Why is that?

Mr. Munir Sheikh: Again, it's a question of making sure that the cost is contained. The person who goes to work has to report child care expenses, and the assumption is that if there is a choice in the family as to who should go to work, to contain costs one would assign the child care expense deduction to the lower income spouse.

Mr. Paul Szabo: Actually, if you allowed it to be claimed by either spouse, then, even if you had a stay-at-home spouse making zero, you could.... Actually, a stay-at-home scenario would be able to claim the child care expense deduction, and that's exactly what we're talking about.

Mr. Chairman, that's my question. I think this child care expense deduction issue is going to have to be fleshed out substantially by us. I don't know whether the finance officials have access to a more detailed breakdown as to the claimants, the age groups, the distribution between preschool and school-aged children—because there's a different level—and any other information that we can get on the idea of the distribution.

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I am extremely concerned. It appears that there is a very small number of Canadians who should be and are eligible for the child care expense deduction but are not claiming it. It does affect the amount of child tax benefit, because it's based on that income. It does affect somebody else's income and whether or not...it's the underground economy thing, etc. I think this child care expense deduction is really fraught with a lot of difficulties and I think it's going to open up a little bit of a Pandora's box.

I did have one question to you about the child care expense deduction, which I also asked the Status of Women group about yesterday. It had to do with the fact that a deduction is worth more to a higher income earner than it is to a low income earner. If there are two families who each send their one child to the same child care place and, say, put out $5,000 for the year for child care expenses, if the lower income earning spouse in house A is making...at the highest marginal rate, they would get a refund cheque of $2,500 on the $5,000 in expenses, whereas with the next-door neighbour, if the lower income earner spouse is making only $28,000 a year, the refund cheque would only be $1,250, roughly one half.

In other words, the value of the deduction is worth twice as much to the higher income family than it is to the lower income family, which seems to be totally contrary both to the principles of taxation that we use and to the distribution of benefits, to basing it on family income and directing that to low and middle income Canadians. In fact, it is totally the reverse with the child care expense deduction. That, to me, would legitimately constitute a claim of discrimination on the basis of “I have a lower income”. The government's subsidy of child care expenses is better for high income earners. I don't believe it has anything to do with progressivity, because our progressive income tax system was put in before the child care expense deduction was created. It's not part of the progressivity equation.

So I ask you the question: does our child care expense deduction in fact discriminate against families who have lower incomes?

Mr. Munir Sheikh: It is a question of what you call income. To work with a totally hypothetical example to try to drive home the point, suppose someone goes to work and earns a $10,000 income. Suppose in this hypothetical and totally absurd example that they also pay $10,000 for child care expenses. I would argue that this person's net income from this work is zero and that this person should not be charged any tax.

If, however, we were to calculate the tax and the deduction based on different tax rates, I can think of a situation where a person was facing a tax rate of, let's say, 20% on the income, and a credit rate of 10% on the child care expenses. I would come up with a situation, then, where this person would have to pay tax because that person went to work, although the net income for that person is zero in that example. You take the income of $10,000 and multiply it by a 20% tax rate and that's her tax. You give her a deduction based on the current rate of 10% and her credit is $500. So although she doesn't make any income from this, she has to end up paying tax.

It's actually the way you look at income. What is that person's income? In the tax system, that income is defined as the income you earn minus the expenses you incur. You then take that income and put a tax on it.

Mr. Paul Szabo: I understand what you're saying. Could we look at it so that everybody in this room will understand? If the taxpayers of Canada are providing a subsidy to families with children by way of a child care expense deduction and if a family spends $5,000 on child care expenses, would it not be fair and equitable to give, in the pocket, the same net benefit to all families who pay $5,000 for child care expenses, as opposed to a different amount varying with income? More succinctly, shouldn't this deduction in fact be a credit so that the value of the tax expenditure is fair, equitable, and equal for all taxpayers?

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Mr. Munir Sheikh: I think I'm going to argue that it really is a question of how you define somebody's income. Here's the way the tax system defines income. It says, take your income, subtract the cost of earning that income—that is not your income—and tax it in the hands of the person who is actually getting that income.

Mr. Paul Szabo: But I'm going to argue, Munir, that child care expenses are not an employment expense. The child care expense deduction is in there as a benefit for families with children. We do not allow employees to deduct the cost of transportation to and from work, but it's a legitimate cost associated with their employment.

The Chairman: Like mechanics with tools.

Mr. Paul Szabo: Yes, like mechanics with tools. We have all kinds of examples. You can't have two standards. In fact, in regard to the child care expense deduction, if you want to argue that this is an employment expense, there should be no limit on it. If I hire a full-time nanny to live in because my child has psychological problems and needs 24-hour attention, that should be totally deducted from income if I choose to go into the labour force. If we're going to have this arbitrary thing about how some things are going to be employment expenses—directly or indirectly or deemed to be—we should have it for all things, but we don't.

I don't believe that the child care expense deduction is an employment expense. It happens to be a benefit that we extend to families because they have children. The proof of it is that the child care expense deduction and the child tax benefit replaced the family allowance, which was universal, and also replaced a universal deduction or exemption for families with children. It was just simply a social benefit.

The child care expense deduction is a social benefit and it's unequal between two families simply because of the amount of income that the family has. That's the discrimination. I believe that's why there has been so much use of the word, “discrimination”, in regard to this question, because the discrimination exists within the deduction itself. As well, I believe—and most people around this table probably also believe—that there is an inequity between those who qualify for it and those who don't because they've made a caregiving choice.

Mr. Munir Sheikh: What I was trying to do was to explain what the rationale in the Income Tax Act is for putting it as a deduction. It's quite obvious that you disagree with that rationale—

Some hon. members: Oh, oh!

Mr. Munir Sheikh: —so I'm going to leave it at that.

Mr. Louis Lévesque: On a factual basis, as far as I know, there are no historical links between the decisions on the child tax benefit and on the child care expense deduction. A series of decisions was made by the federal government over the years, from 1978, if I recall correctly, to 1993, which basically changed the structure of the child benefit system in the sense of the child benefit being defined broadly as things available for all families with children. From a regime where you have universal family allowances, you add a tax exemption in the tax system, way back, and this was changed over the years to a system—

Mr. Paul Szabo: I claimed it for my kids, so it's not too far back.

Mr. Louis Lévesque: But that then evolved into a refundable income-tested credit, which was introduced in 1978. There were changes to the rules of indexation, a change from an exemption to a credit in 1988, and a clawback of family allowances, which was introduced in 1989. These three measures—the non-refundable tax credit for children, family allowances, and the refundable child tax credit—were moulded into one thing called the child tax benefit. But on an historical basis, I'm aware of no link to the child care expense deduction.

Then you go back to the basic disagreement. In the tax law as it stands, it's more a recognition of expenses to earn income.

[Translation]

The Chairman: Mr. Lévesque, on behalf of my colleagues, I want to thank you.

[English]

Thank you very much, Mr. Sheikh. I think it was a very detailed presentation. It was very complex, as you can guess from the questions of the members. Nonetheless, we want to thank you, and we reserve the right to ask you to do some analyses in the future, as you volunteered to do.

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Members, we meet tomorrow morning at 9, in full committee, I believe. Thank you very much. Have a good evening, all.