New personal tax deduction wrongly favours the well-off

I have to admit to thinking that a columnist for the Toronto Star was misinformed when I read that there would be a new personal tax deduction of $400 for employees working from home. As Rosa Saba noted in the Toronto Star:

“Now all employees who worked from home more than half the time over at least four consecutive weeks during 2020 due to the pandemic will be eligible.

As well, the government clarified that eligible employees can claim $2 for each day they worked from home, up to a maximum of $400. Employees claiming expenses this way will not need to track their expenditures, provide receipts, or submit a form signed by their employer.[1]

I thought to myself: that’s funny; most government of Canada tax credits announced over the past many years have either been in the form of non-refundable credits or refundable credits. I haven’t seen a new deduction being offered by government for years if not decades.

Tax deductions, non-refundable credits and refundable credits

We don’t have too many deductions left in our personal tax system. In fact for most people, the two they will be most familiar with are the RRSP deduction and the child care deduction.

Deductions favour the well-off while non-refundable credits (usually) favour all taxpayers equally. Refundable credits tend to favour people with lower incomes.

Canada’s government knows this so it’s a legitimate question to ask why the government chose to favour the better off with this new tax measure. The only reason that I can come up with is that the home office deduction was already a long standing deduction. Perhaps their view was that they were simply streamlining a deduction that was already in place.

But the government has freely replaced other deductions in the past with more equitable non-refundable credits. We only need to look at the non-refundable credit for contributions to registered charities. The government replaced the charitable deduction with a non-refundable credit years ago. So why are we seeing this course reversal now for home offices?

A better question is why aren’t people – especially progressives – up in arms about this change?

The answer to that is that most people glaze over when they start hearing about distinctions between deductions, non-refundable credits and refundable credits.

How do I know this? 

Since 2012, I have conducted over 100 Library seminars on low income retirement. At those sessions, I always ask the crowd if anyone can tell the audience the differences between non-refundable credits, refundable credits and deductions. Hundreds have tried and only twice did the audience hear the correct answer. And in both cases, both correct answers came from published well-established financial advisors.

So we do know with some confidence that general audiences do not have a good grasp of the distinctions between the three most pervasive instruments providing refunds in our personal income tax system. And I did go on-line to look for a good discussion of the distinction and did not find one after an hour of search.

What I did come up with were some incredibly obtuse, complicated but precise explanations of credits and deductions. Most were reasonably correct. Some were flat-out wrong while others assumed that you had a Fifth degree black belt in taxation. Most people don’t.

The difference between a tax deduction and a credit

So let’s simplify things and use an analogy that people do understand and see if I can explain the difference between deductions and credits and show you why you should be up in arms over the creation of a new deduction.

Let’s go to the grocery store.

When you go to the grocery store or to a drug store, you are often equipped with coupons and gift cards in addition to credit/debit cards and cash.

Now here’s the easy part: think of gift cards as refundable tax credits and non-refundable credits as coupons. The analogy works well at the government tax store. A gift card is money paid to you regardless of your tax liability. You can use it for most things. The same is true for government refundable credits.

Non-refundable tax credits work like coupons but only on one item – your tax liability – and they work the same for everyone.

Think about it like this: a working class person has a store coupon for $7.00 off of a product. How much do they get off? $7.00.

Now, in walks a highly paid executive with the same store coupon off of a product. How much does he or she get off? You’re right! $7.00

But if a deduction worked like a non-refundable credit and you handed the clerk the slip of paper showing your deduction, he or she would have to ask you what your tax rate is. Why? Because the value of the deduction depends on your tax rate.

If I have an RRSP deduction for $400 and my tax rate is 50%, I get a $200 refund. If I have an RRSP deduction for $400 and my tax rate is 20%, I get an $80 refund. If I have an RRSP deduction of $400 and my tax rate is 0% because I am low income, I get no refund.

Notice that the nominal value of the deduction is the same in all three cases but its real value depends on your tax rate.

Higher income people have higher tax rates so their deductions result in higher refunds. Non-refundable credits are like coupons and they are worth the same amount to all rich and poor people who owe taxes.

So why is the government supporting a $200 refund to someone in a top tax bracket and nothing at all to someone in a tax bracket where they owe no tax?

In the end, it’s not a great big deal. Perhaps it’s not symbolic and just a bit of administrivia.

But let’s stay vigilant. The people who need tax breaks of any kind are not the well to do. They are the people at the bottom who are struggling.

And those struggling most during the pandemic are low income people and this new deduction is being administered smack dab in the middle.

It is worth watching: a one-off or the beginning of new giveaways to the better off?

Time will tell.