Study: Market Behaviour Versus Tax Planning Responses to Changes in Marginal Income Tax Rates Among Older Couples
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The aging workforce and retirement of the baby-boom generation pose challenges for economic growth, national saving and the operation of pension systems. As such, the extent to which the employment decisions of older workers are affected by tax and transfer systems is increasingly important for public policy.
Many previous studies assess how individuals' pension receipt and retirement decisions are affected by specific features of Canada's retirement income system, such as the 65-year-old eligibility threshold for Old Age Security benefits. In contrast, little is known about how personal income taxation affects the employment decisions of older workers. A better understanding of this issue may inform the optimal designs of income tax and retirement income systems.
This study looks for the first time at the extent to which the total taxable incomes of older Canadian tax filers, aged 60 to 69, respond to predictable changes in their marginal tax rates created by the federal and provincial/territorial tax and transfer systems. Total taxable income refers to total income from all sources minus deductions reported on the tax return.
Economic theory suggests that individuals' taxable incomes will decrease when their marginal tax rates increase. This can happen if, for example, individuals decide to work less when the marginal tax rate on employment income increases.
The study shows that individuals' taxable incomes significantly decline following an increase in their marginal tax rates, consistent with the prediction from economic theory. However, only those who are married or in common-law relationships are found to exhibit large responses to changes in their marginal tax rates. This happens because, as members of couples, they use the pension income splitting provision of the tax code to reduce their combined tax burdens.
This finding suggests that older individuals do not reduce their work hours but, rather, adjust their total taxable incomes through channels other than the labour market.
Overall, the results of this study indicate that older workers do not significantly adjust their labour supply in response to predictable changes in their marginal tax rates, but are sensitive to changes in tax liabilities through their use of available tax-planning strategies. This offers credible new evidence of intra-household tax planning behaviour that depends on the availability of deductions.
The research paper "Market Behaviour Versus Tax Planning Responses to Changes in Marginal Income Tax Rates Among Older Couples," part of the Analytical Studies Branch Research Paper Series (11F0019M), is now available.
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