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Doubling contribution limit to Tax-Free Savings Accounts exposes true intent of a bad policy

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Photo courtesy of Terrance Lam

Last week, federal finance minister Joe Oliver re-affirmed that his government seeks to double the annual limit to Tax-Free Savings Accounts (TFSAs), from $5,500 to $11,000.

This is a terrible idea.

When the TFSA was first introduced, the claim at the time was that the policy was intended to support modest-income people wanting to save for retirement, but for whom the RRSP may not make good economic sense. There was some merit to this argument, although boosting the CPP and Old Age Security (OAS) would have been a far preferable solution.

It's true that RRSPs don't make sense for many modest-income people. That's because if a lower-income senior hopes to claim the full OAS and Guaranteed Income Supplement, if they have accumulated RRSPs, then having to claim this RRSP income in retirement may simply lead to an equivalent clawback of their OAS/GIS entitlements, leaving them no better off.

However, the proposed doubling of the annual TFSA contribution allowance throws such pretenses out the window, and instead lays bare the government's true intent, which is two-fold.

First, it makes clear that this is not a policy aimed at encouraging savings by modest-income people. Rather, it is for richer people, pure and simple. It was always a bit of a stretch to think that modest-income people would have $5,500 in available cash to tuck into a TFSA. But $11,000?! That's about half the annual income of a minimum-wage worker.

Second, the policy is about starving future governments of tax revenues. That's because the TFSA policy becomes increasingly expensive over time, as more and more wealth is accumulated tax-free. Indeed, the TFSA program represents one piece of a larger problem -- as troubling as rising income inequality is in our society, wealth inequality is much, much worse. Yet more and more wealth in our society is accumulating to fewer people without ever being subject to tax -- we only tax 50 per cent of capital gains; we exempt capital gains on principal residences from taxes entirely; we are one of three industrialized countries without an inheritance tax; the RRSP system subsidizes wealthier people saving for retirement (who then pay a lower tax rate when RRSPs are drawn down); and that only scratches the surface with respect to the myriad ways in which the tax code allows wealth accumulation to escape taxation.

The TFSA is the latest installment in this trend. Already over $130 billion has been tucked away into TFSAs, a huge sum that will earn interest tax-free into the future. And that amount was already scheduled to balloon, without a doubling of the annual contribution limit. With it, a vast amount will accrue mainly to the wealthy tax free, foreclosing on many policy options that would be a far better use of these forgone revenues.

This problem has been well documents in reports by SFU economist Rhys Kesselman, and by the Parliamentary Budget Officer (PBO).

As the Vancouver Sun's Don Cayo summarizes:

TFSA contributions aren't tax deductible, but earnings on the money invested are tax exempt. So even without doubling the contribution limit, forgone tax revenue, which was just $69 million for Ottawa in 2009, had already soared to $410 million by 2013, the last year for which figures are available. This hit is projected to rise to $15.6 billion a year, plus $9 billion for the provinces, over time as top savers' TFSAs grow from a few tens of thousands of dollars today to hundreds of thousands or even millions.

According to the PBO:

In 2015, PBO projects the fiscal impact of the TFSA to be $1.3 billion… Two-thirds of this cost is borne by the federal government, $860 million, while the remaining third ($430 million) affects provinces.

But by 2020, the cost grows to $2.8 billion. Longer term, by 2080, the TFSA fiscal costs increase ten-fold.

We will see if the government formalizes this ill-advised policy in next week's federal budget. Hopefully, in the interests of addressing inequality and fiscal prudence, a rethink will prevail.

Photo courtesy of Terrance Lam.

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