Business·Analysis

Tax-free savings accounts rob tax revenue from the future: Don Pittis

A flood of money into tax-free savings accounts will leave holes in future public finances that will need to be plugged by other means, writes Don Pittis.

Contributing to a TFSA is no-brainer for private savers, but public benefit not so clear

For governments seeking a balanced budget today, tax-free savings accounts are a way of borrowing from the future, writes Don Pittis. (CBC)

From the viewpoint of your private financial welfare, saving for the future with a Tax Free Savings Account is almost always a good idea. In fact, the more you invest in a TFSA, the better.

But as personal tax advisors discuss the advantages of a proposed Conservative Party plan to increase or even double the amount Canadians are allowed to set aside, there's another consideration that has hardly been mentioned.

And that is, the impact of tax-free saving on future government finances.

Of course, TFSAs have their critics. But they come mostly from the social democratic viewpoint, like that of the Broadbent Institute, that TFSAs only benefit the rich.

That is not strictly true, as there are folks with incomes below the national average who manage to save part of their earnings. And as Wealthy Barber author David Chilton has suggested, there are many people who seem rich but are in fact not saving enough, especially compared to groups like teachers, who are forced to contribute to a life-long pension plan.

TFSAs are almost always good for savers. And as Chilton and even the Dickens character Wilkins Micawber have pointed out, good savers tend to end up rich.

Taxes now or taxes later

While TFSA contributors pay taxes on the money prior to putting it into an account, they never have to pay tax on the income earned. Never ever. No matter how much they earn. Even when they take the money out to spend it. 

This is unlike pensions and RRSPs, which cut your tax bill in the year you contribute. Income earned inside the plan is also tax-free. But you pay income tax on every penny you withdraw. Unlike TFSA savers, people with a combination of big pensions and big RRSP savings will contribute a significant stream of tax revenue to governments.

After the tax benefits are taken into account, TFSAs almost always provide a better net return, especially for those whose tax rates are currently low.

Governments, which must consider public finances, face other considerations.

For governments seeking a balanced budget today, TFSAs are a way of borrowing from the future. In the past, savers would have been grateful for the tax break an RRSP provided in the current year. Now, they gladly pay current taxes for the future benefits of a TFSA. So the government collects more revenue now and less in the future.

Boomer contributions

Late finance minister Jim Flaherty introduced TFSAs in 2008. (Nathan Denette/Canadian Press)

It used to be that the retired well-off – boomers who bought houses when they were cheap and were better able to save – contributed a certain share of their accumulated good fortune as they paid tax on their retirement income. But as more and more savers use TFSAs instead – possibly with higher contribution limits – government won't have that money to spend down the road.

In the last few decades, the notion of private welfare has prevailed in North America – that is, the low-tax, small-government ideal where each person looks after him- or herself and public spending is seen as a waste

But in previous periods, such as after the Great Depression and the decades following the Second World War, there was a much stronger belief in the value of public welfare economics. That's the idea that some of the good things in life can never be paid for privately.

The classic example is street lighting, which the rich cannot afford to buy for themselves, is not easily captured with private tolls and that shirkers can enjoy without paying. That class of what we might call natural public welfare goods can only be paid for by public taxation. Those needs won't go away when income shrinks.

Shirkers don't pay

TFSAs, introduced by late finance minister Jim Flaherty in 2008, are still a relatively new experiment in Canada. The longer the program exists and the higher the contribution limits, the more private savings will be locked behind a tax-free wall. And the more future governments will have to look elsewhere for their revenue, including to strapped millennials trapped under 10-ton mortgages.

Future governments may discover that TFSAs are too generous and just don't work, as Jim Flaherty did himself with income trusts in 2006.

But even without a change in government rules, money tucked safely into TFSAs is not beyond reach. 

If you believe that economics has a way of balancing things out and righting inequalities, then there is another way that the invisible hand can reach right through that tax-free wall: Inflation.

We have just passed through a period of record low inflation. Historically, such periods are followed by higher inflation. 

Inflation, which critics sometimes call "a tax on savings," makes the money you have set aside worth less, while increasing the relative value of earned income as prices and wages rise.

Even if those shrinking savings aren't taxable, the growing wages will be. And in this scenario, maybe private and public welfare will return to balance.

ABOUT THE AUTHOR

Don Pittis

Business columnist

Don Pittis was a forest firefighter, and a ranger in Canada's High Arctic islands. After moving into journalism, he was principal business reporter for Radio Television Hong Kong before the handover to China. He has produced and reported for the CBC in Saskatchewan and Toronto and the BBC in London. He is currently senior producer at CBC's business unit.

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