Comparing the Benefits under the Canadian and U.S. Programs
Let’s consider two hypothetical taxpayers in 2020. Andrea is a 30-year old single mother of a 5-year old daughter living in Forks, Washington, a state with no state income tax. Across the border in Bamfield, British Columbia lives Carolyn, another 30-year-old single mother of a 5-year-old daughter. Neither Andrea or Carolyn receive any child support and both have sole custody of their daughters. Both Andrea and Carolyn are employed full time and earn 30,000 USD. Andrea files as Head of Household in the United States and receives the EITC for her household. Carolyn, like all Canadians, files her taxes independently. She does not have any deductions outside of her deduction for her dependent. Carolyn receives the CCB. For the purposes of calculation, assume that both Carolyn and Andrea also fulfill any non-income requirements for their respective programs.
Andrea will qualify as a head of household for a standard deduction of $18,650. She will receive a $2,000 refundable child tax credit that eliminates the rest of her federal income tax liability and provides an $865 refund. Washington has no state income tax. In addition, Andrea will receive an EITC of $1,879. While Andrea will owe no income tax over the course of the year, she will still have FICA contributions withheld (Social Security 6.2% and Medicare1.45%) of 7.65%, or $2,295 ($191.25 per month). After taxes, FICA contributions and EITC credits, Andrea would have an after-tax income of $30,449. Any refund Andrea receives for withheld taxes, her refundable child credit and her EITC credit will come to her in one fat check early in the following year.
In contrast, Carolyn will owe income taxes every month to both the federal and provincial governments, which will be deducted at source. TurboTax calculations show that she will owe 1819.58 CAD ($1364.69) to the federal government and 897.67 CAD ($673.25) to the provincial government. Carolyn will also have to contribute 5.1% of earned income to the Canada Pension Plan (1861.50 CAD or $1396.13) and 1.62% to Employment Insurance (648 CAD or $486). In total, Carolyn will pay CAD 5226.75 ($3920.06) over the course of the year in taxes and contributions. Carolyn would receive 515.39 CAD monthly in Canada Child Benefit payments. In addition, Carolyn will receive 133.33 CAD monthly in B.C. Early Childhood Tax Benefit payments. Carolyn will also receive 168.08 CAD quarterly in GST/HST credits, and 87 CAD quarterly in BC climate action tax credits. This totals 8,804.96 CAD per year ($6603.72). Taking into account taxes, CPP and EI contributions, and credits, Carolyn will have an after-tax income of 41,376.97 CAD ($31,032.73).
Carolyn will be in a net better position than Andrea, but the difference is not huge –$583.73 or a little less than 2% of their respective gross incomes. Carolyn will have significantly more transactions with the government. This may make the various programs less administrable and may also present logistical difficulties and check cashing fees for the underbanked and transaction fees for the overbanked. In general, Andrea will receive more tax relief and a much smaller EITC payment. Carolyn, in contrast, will pay provincial and federal taxes over the course of the year but receive more benefits over the course of the year. Since money is fungible, it probably matters very little to a low-income taxpayer whether or not they receive assistance in the form of government benefits or tax relief.
Timing of Payments
Although the magnitude of payments and taxes are almost a wash between Carolyn and Andrea, the timing of the payments is not. In the United States, an EITC tax refund provides a significant annual lumpsum to low-income families. Carolyn will likely receive a tax refund for overcontributions spread across the year. These refunds can have a wide array of impacts. For some who owe balances to the IRS, the entire tax refund, including EITC payments, will be applied to their tax debts. In these cases, the advantage of a lumpsum refund is lost. In the absence of tax debts, taxpayers may use their refunds for one-off expenses, including paying court fees to file for bankruptcy or paying back non-tax debts accrued over the course of the year. Paradoxically for a program intended to encourage paid work, some Americans may use their EITC refund to extend a period of unemployment falling around the time of their tax refund.
Canada smooths payments across the year, which may allow for more predictable budgeting and less reliance on high-interest credit. Nevertheless, for certain groups of people, receiving money even as infrequently as once a month can present risks. Paramedics in Vancouver, Canada report seeing an increase in drug overdoses on the day of the month when social assistance checks are deposited. In the United States, mortality increases in the first week of the month (closer to when Social Security checks are issued) than in the last week of the month. While issuing monthly benefit checks may solve some of the financial problems that low-income households have, it is not particularly popular. In the past, American taxpayers have had the option of receiving a portion of their estimated EITC along with their paycheck over the course of the year. Even though this would give EITC recipients money sooner, very few (~2%) choose this option.
Some behavioral economists consider the lumpsum nature of EITC payments a positive since taxpayers see tax refunds (and EITC payments) as a different type of income and are more likely to use them to pay for large purchases. In effect, the single payment acts as a savings plan over the course of the year, forcing self-control and allowing taxpayers to make significant financial moves that they could not have done otherwise. Whether or not a single lumpsum for family benefits is a positive thing probably depends mostly on what it replaces. If the lumpsum replaces a savings account, enforcing financial discipline on recipients, then an annual payment is preferable. If the lumpsum is used to pay off payday loans that would not have been taken had the benefit been paid monthly, then more frequent payments are preferable.
Marginal Tax Rates
What if Carolyn and Andrea were offered promotions? They would need to evaluate if it would be worthwhile to take the promotion based on their particular circumstances. The drawbacks of the promotion—additional time at work, additional stress, etc.—must be weighed against the additional income. These decisions are inherently personal, with multiple factors. A rational taxpayer would, however, consider any additional tax they would pay to determine the net income they would receive. Carolyn and Andrea would consider not only the additional taxes due but also any benefits foregone because of the additional income. They are both in the “phase-out” of benefits, so any additional money will be subject to clawbacks.
Since Andrea’s child tax credit is refundable, she will not have additional income tax liability but will lose her refundable benefit dollar-for-dollar, effectively making the income subject to her marginal tax rate of 10%. Andrea will also owe the 7.65% FICA tax on any additional earned income. Since Andrea is in the EITC phase-out portion, her EITC will be clawed back at 15.98%. Andrea’s effective tax rate on the raise is thus 33.63%, a rate that ordinarily applies to those with more than $200,000 of ordinary income.
Carolyn’s wide array of benefits are subject to different clawbacks. She will pay additional income taxes (and EI/CPP contributions, since she is not yet at the maximums for those benefits) on any additional income. Her marginal federal and provincial tax rates are 15%, and 5.06%, respectively. Her CPP and EI rates total 6.72%. Her CCB will be phased out at 7%. Her GST/HST tax credit will be clawed back at 5%. She has not yet reached the maximum on her B.C. Early Childhood Tax Benefit (CAD 100,000), but her Climate Action Tax credit will clawback at 2% when she reaches the maximum (CAD 41,706). Carolyn will thus face a marginal tax rate on the raise of 38.78%, a rate ordinarily applicable to Canadian incomes of considerably more than CAD 100,000.
Carolyn thus faces a higher effective marginal tax rate than Andrea. Both are faced with far higher rates on the additional income than they might expect from their ordinary tax rates. Interestingly, this means that they both fall into a category that Senator Long wanted to avoid—one in which the economic calculation falls on the side of retaining current benefits rather than accepting additional paid employment.
Proposals for Different Family Benefits in Both Countries
In the United States, the Center for Budget and Policy Priorities has proposed a system to replace the child tax credit that is more like the CCB. In exchange for his support for the 2017 tax legislation, Marco Rubio proposed a significantly enhanced child tax benefit that would be refundable from the first dollar. The $1.9 trillion COVID-19 relief bill before Congress (the House may vote on passage of the American Rescue Plan Act, as amended by the Senate, as early as the week of March 8) expands the U.S. child tax credit to $3000 per child and $3600 for children under six years old and makes the credit fully refundable for 2021. It also instructs the IRS to establish a program to provide advances on the credit through monthly installments. Similarly, during the 2019 Canadian general election, party platforms reflected a relatively narrow set of changes to the CCB, possibly indicating political consensus about changes. The governing center-left Liberal Party created the current CCB version. Ironically, it offered the most substantive proposal to increase the benefit by $1000 for children under the age of 1. The right-leaning Conservative Party did not propose CCB changes but did call for a refundable tax credit for children to take arts classes or sports. Since this would be creditable at 15% long after the expenses were incurred, there would likely be little uptake from low-income households. The left-leaning New Democratic Party platform included mention of a universal income pilot that would potentially replace the CCB.
Conclusion
Canada and the United States both use the tax code to promote work among poor families and lift children out of poverty. Whether or not the U.S. EITC or the Canadian CCB is the better program is a value judgement. Should the primary goal of low-income family tax credits be encouraging work or should it be providing financial relief to the most destitute? Decades ago, Canadian Prime Minister William Lyon Mackenzie King and Louisiana Senator Russell Long answered this question differently. Their two countries still do.