dave@lsuc.uucp (David Sherman) (03/22/89)
If you've looked at your 1988 income tax return form, you will
know that things are rather different from the past. Instead
of what used to be personal exemptions and deductions, you now
have a large number of "non-refundable credits", set out in a
rather confusing format. Some of the old deductions still exist,
as well. What's going on?
Well, if you followed Tax Reform at all, you will know that exemptions
were changed to credits to make the system fairer. The concept of
exemptions is a good one: it's that every individual needs a certain
amount of income just to exist, and more if they support dependants.
So the first $N of income isn't taxed, and you pay tax on the excess.
The problem with exemptions comes when you look at it from the other
end. Because of the progressivity of the system, with higher
marginal rates as income goes up, a $5,000 exemption, as a deduction
from income, is worth $2,500 to someone in a 50% bracket but only $1,000
to someone in a 20% bracket. This leads to the complaint that people
with high incomes are getting more of a break from the exemptions.
Whether this is correct is a question of perspective (it depends on
whether you are looking for horizontal equity or vertical equity).
[If you're interested in this policy question, see Sayeed, "Choosing
Between Tax Credits and Exemptions for Dependent Children", 33(5)
Canadian Tax Journal 975-982 (Sept.-Oct. 1985).]
So, the system was changed to use credits. They're called "non-
refundable" credits because if you don't have tax to pay for the
year, they don't trigger a refund. (Don't confuse not having tax
to pay for the year with not having tax to pay in April: if you had
tax withheld by your employer, you can certainly get *that* tax
refunded by the application of the credits!)
Now, the credits were enacted in a most extraordinary way, and
the format was preserved in Revenue Canada's income tax returns.
Let's use just the "basic personal credit" as an example.
The credit, according to all the tax reform documentation, was
to be $1,020. That's a federal credit; all provinces except
Quebec have a provincial tax which is somewhere around 50% of
federal tax, and is calculated on federal tax after the credit
is taken into account. So in Ontario, where the provincial tax
is 51% for 1988, the $1,020 credit is really worth $1,540.20
(ignoring surtaxes).
But the credit wasn't enacted as $1,020! It appears in section
118 of the Income Tax Act as "A x B, where A is the appropriate
percentage for the year, and B is $6,000" (I'm simplifying slightly).
The "appropriate percentage" is defined in s.248(1) to be the marginal
rate which applies to the lowest bracket in s.117(2). Since the
lowest rate for 1988 is 17% (federal tax on the first $27,500),
it's 17% of $6,000, which is $1,020.
This method of enacting the credit is actually quite ingenious
on the part of the Department of Finance from a tax policy point
of view. The credit *really* represents an exemption of $6,000
TAKEN OFF THE BOTTOM INSTEAD OF THE TOP, and it's enacted that way!
If the rates change so the bottom marginal rate is no longer 17%,
nothing needs to change for the credit to continue to represent
an exemption of the individual's first (not last!) $6,000 of income.
(The $6,000 will be adjusted for inflation minus 3% after 1988.
So it's $6,066 for 1989.)
What will now confuse millions of Canadians is that Revenue Canada
chose to mirror this "17% of $6,000" business in the credit
computation which you see on the bottom half of page 2 of your
T1 General return. There are some reasons for doing it this way,
but I think people would have understood it a lot better if they
left the credits as $1,020 etc. rather than forcing you through
the computation. The new credits apply for all the old exemptions,
plus CPP contributions, UIC premiums, medical expenses and tuition.
Charitable donations are done that way too, but after $250 of
donation (for the year) it's credited at 29% instead of 17% --
the TOP marginal rate. That ensures that the credit for high-income
earners who give a lot to charity is exactly equivalent to a deduction,
once they pass the $250.
There are also some refundable credits, most notably the
federal Child Tax Credit and Sales Tax Credit, both aimed
at low-income families. They're "refundable" in the sense
that even people who pay no tax get them "back". If you
have no income, or so little income that you pay no tax, but
you are not being claimed as a dependant by someone else, you
should file a tax return and collect your sales tax credit.
These credits come into the tax calculation at the same level
as instalment payments and source withholdings remitted by
an employer, which is why they will trigger a refund even if
you pay no tax.
Hope this helps clear up some confusion.
David Sherman
Tax Lawyer
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