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The economics and politics of income-splitting

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Photo: BC Gov Photos/flickr

You could hear the sound of jaws dropping across the nation last week when Finance Minister Jim Flaherty, in response to a question from a journalist, cast doubt on the idea of income-splitting for young families, something his party has been promising since March 28, 2011.

The idea -- which would allow the higher-earning spouse to transfer income to their lower-earning spouse in order to reduce their total tax hit -- provoked controversy right from the start. But it became an increasingly hard sell as economists and think tanks from across the political spectrum lined up in agreement: Income-splitting costs too much for something that is worse than doing nothing.

The day after last week's federal budget, Mr. Flaherty seemed to agree, saying, "I'm not sure that over all it benefits our society." He vowed to further study the idea.

What changed his mind?

Without question, there would be clear winners from income-splitting.

It would benefit two-parent families who already have one person staying at home; once commonplace, but today a choice that is most available to families with one high-income earner. They would see a windfall.

But it's also attractive to young families with two working parents who would love to spend more time at home raising their kids, and could make ends meet if one parent worked less.

(Relying on one job is a risky proposition for many households. Young workers are more likely to have "precarious" jobs than boomer-generation workers. That's one reason why dual-earner households are the norm among young families: They are their own social safety net.)

Finally, the Conservatives may feel it would appeal to newcomers to Canada with more traditional preferences for keeping one parent at home.

Families in Canada's biggest urban centres would benefit most from income-splitting. That's where you find the biggest concentrations of high-income and newcomer families -- and the lowest percentage of votes cast for federal Conservatives. So, in addition to satisfying the social conservatives in the party, income-splitting could be a vote-grabber in some areas, possibly winning elusive downtown ridings for the Conservatives.

But the proposal is certainly not a winner from an economic point of view.

It's a lot of money -- about $3-billion from federal coffers, another $1.9-billion from provinces. But most families raising kids won't see a red cent from it.

The Canadian Centre for Policy Alternatives estimates that 86 per cent of families get nothing out of this plan; and high-income families get the biggest share of this big bag of money, by a long shot.

The C.D. Howe Institute, crunching the numbers in 2011, said 85 per cent of families get nothing, and pointed out it would reduce labour force participation rates. This would be happening just as retirements start accelerating due to the country's aging demographics -- a time when we'll need all hands on deck.

Though income-splitting is not specifically targeted at keeping more women at home, most women still earn less than men. If maximizing household incomes is the goal, the cold, hard math would suggest it would make more sense for the female spouse to step back. It's too easy to characterize this proposal as retro pining for the 1950s-style nuclear family.

Then there's the macroeconomic impact: If more people opt out of paid jobs, there will be less disposable income per family to spend. Canada's tepid economic recovery has been fuelled primarily by consumers. Policies that undercut purchasing power undercut the pace of growth.

The Conservatives are now signalling that they may be considering a change of course.

But while some MPs have echoed the Finance Minister's concerns, others have re-pledged their unconditional allegiance to the idea.

Mr. Flaherty said income-splitting needs another "long, hard analytic look" -- even though the Conservatives have been studying this proposal since 2007. That's because it has become a political hot potato.

This is a government prone to digging in, not reversing, when its logic is challenged. It's difficult to think of anything that approaches this scale of flip-flop, if that is what is about to happen, from a political or cost point of view. (The Conservatives' U-turn on income trusts in 2006 involved less than $1-billion, and didn't kick in for four years.)

So it was of interest that, in a scrum after caucus last week, Conservative MP James Rajotte floated a way to fix the proposal: an income test for income-splitting.

The Conservatives are twitching in public at the condemnation that this campaign promise has rightfully triggered: Criticism for costing taxpayers billions to further enrich the already rich, and do nothing for our poorest families (single parents, who have no incomes to split).

The government didn't announce income-splitting in this budget. It could have. We won't be certain how they'll blow billions on widely expected tax cuts until they publicly commit to something, perhaps in next fall's fiscal update, perhaps earlier. (You can enter a contest on how you would spend the money here.)

But don't be too quick to rule out some form of income-splitting for young families. Like the GST cut, this government may take another step that makes no economic sense, but makes for ruthlessly brilliant politics.

Armine Yalnizyan is Senior Economist at the Canadian Centre for Policy Alternatives. You can follow her on Twitter @ArmineYalnizyan. This piece was first published in the Globe and Mail's Economy Lab.

Photo: BC Gov Photos/flickr

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