Tax Season·Analysis

Critics question Tax Freedom Day concept

The concept of calculating a Tax Freedom Day may not be the best way to inform Canadians about the amount of taxes they have to pay each year.
The Fraser Institute figures that the average family made $93,831 in income and paid a total of $39,960 in taxes (42.6 per cent) in 2011. (Istock)

As the April 30 Canada Revenue Agency filing deadline nears, the issue of taxes - and more specifically, how much we pay in taxes - is top of mind for many Canadians. Tax Freedom Day, calculated and trotted out annually by the Fraser Institute to great media fanfare, is supposed to be the day in the year when the "average Canadian family" has earned enough money to have paid off all their combined federal and provincial taxes for that year.

The concept has been around for a long time, but critics say it's a flawed way of gauging the tax burden of Canadians.

Last year, the institute figured that the average family made $93,831 in income and paid a total of $39,960 in taxes (42.6 per cent).

Using these figures, the institute then calculated that Tax Freedom Day fell on June 6, 2011.

"The way to think about it is, if you had to pay your taxes up front before you could spend money on anything else, every single dollar you earned from January 1 to June 6, 2011, would have gone to pay for taxes," the Fraser Institute's Niels Veldhuis told in an interview.

The institute says that while Canadians likely know what they shell out in income taxes, employment insurance (EI) and Canada Pension Plan (CPP) premiums, it's the other taxes, like total sales tax paid over the year, import duties, and excise and gas taxes that are not so easy to figure out. Those less-visible taxes are what's behind the Tax Freedom Day calculation.

"It's a graphic way of showing people how much tax they actually pay," Veldhuis says.

Flawed methodology

But not everyone is sold on the concept and some experts feel there are problems with the methodology.

In 2005, Osgoode Hall law professor Neil Brooks, who teaches tax law, published a report for the left-leaning Canadian Centre for Policy Alternatives that slammed the whole idea of Tax Freedom Day.

Calling it a flawed, incoherent and pernicious concept, Brooks accused the Fraser Institute of using calculations that were "preposterously exaggerated" by understating the income of Canadians and overstating the amount of taxes they pay.

Among his criticisms, Brooks said that the Fraser Institute calculates the tax rate based only on "cash income" – which includes wages and salaries, interest, dividends and pension payments.

The more accurate calculation, he argued, would be "total income before taxes," which also includes employment benefits, retained earnings and investment income from pension plans and insurance companies.

By using the figures it does, the institute "dramatically understates the income of taxpayers, and therefore significantly overstates their effective tax rates," Brooks said.

Who are you calling average?

Brooks also objected to the use of an "average" family's income instead of "median" family income – the latter being those families at the midpoint in the income scale where 50 per cent are richer and 50 per cent poorer.

Median income better represents a typical Canadian family, Brooks argued, and using that figure would provide a much lower family income figure as well as overall tax burden, compared to the numbers the Fraser Institute employs.

University of British Columbia professor David Duff, who teaches tax policy and is co-director of the National Centre for Business Law, said the Fraser Institute is just trying to make the ideological point that the government takes too much of our money.

"I think it's a deliberately slanted way to inform Canadians about the taxes they pay, because its abstracted from the benefits one gets from government and from the reasons we pay taxes, and it looks at taxes as though it's just money you take and throw into the sea. It gets people to focus only on that side of it."

Veldhuis rejects that criticism, though, saying there's no denying that governments provide benefits.

"The question is, are we getting our money's worth? If Canadians don't have a good idea of how much it's costing, which they don't unless they look at Tax Freedom Day, then there's no way to do that calculation."

The finer points

Veldhuis also took aim at some of Brooks's criticisms, saying the Institute uses the term average because most Canadians understand that term.

He also said that when it does it calculations, the Fraser Institute takes an average around the average – meaning it knocks off the extremely high-end and low-end income earners.

"If we did a true average, Tax Freedom Day would be later," Veldhuis said, adding that the institute relies on Statistics Canada data based on a representative sample from 88,000 Canadian families.

As for cash income versus total income before taxes, Veldhuis said cash income is a legitimate figure since it's the "income people pay their taxes out of every year. It's the same income that Statistics Canada uses for compiling family incomes."

He said the sums that are included in the "total income before taxes" encompass deferred income, such as investment income on pensions plans, interest on insurance plans and corporate retained earnings that are not paid out.

Economist Mike Moffatt, who lectures at the Richard Ivey Business School at the University of Western Ontario, said the cash income debate is "an arguable point" and that there's no clear definition of what should be used in these kinds of comparisons.

"The Fraser institute has chosen the definition that makes it look like we're paying the most taxes. It is not that they're using a faulty definition, it's just that they've chosen the definition that makes their argument look better."

Moffat said the year-to-year changes – whether Tax Freedom Day comes earlier or later in a given year – is a worthy measure, but that he believes the institute does overstate the taxes the average Canadian pays.