Two reports came out this week sounding the alarm on the growing costs of Tax Free Savings Accounts, now in their seventh year, and criticizing the Harper government's long-standing promise to double the TFSA contribution limit. The reports, from the Parliamentary Budget Officer and Simon Fraser University economist Rhys Kesselman, largely agree that the relatively new and still tiny TFSA program is growing like compound interest. Both say it won't be long before it is taking a huge bite out of federal and provincial government revenues.
Question: Is that necessarily a problem? Is a tax break that encourages Canadians to save more for retirement, thereby costing government some hoped-for revenue, even a lot of revenue, necessarily a bad idea? Answer: No.
But is the TFSA, including a doubling of contribution limits, the best way for Ottawa to go about boosting retirement savings? No.
TFSAs allow Canadian adults to contribute up to $5,500 a year to a tax-free account. Unlike Registered Retirement Savings Plans (RRSPs) or pension plans, you don't get a tax deduction when you put money in. But once inside a TFSA, investments compound tax-free, and can be withdrawn tax-free. TFSA withdrawals also don't count against geared-to-income government benefits.
The Parliamentary Budget Office says the fiscal impact of the TFSA program – that means the cost to government – will be about $1.3-billion this year, split roughly two-thirds to the federal government and one-third to the provinces. By 2020, the cost will have more than doubled, to $2.9-billion per year. The PBO says those costs will keep on growing for decades, and at a rate much faster than inflation or the economy.
The TFSA's cost to both levels of government is today worth just 0.06 per cent of GDP. But by 2080, the PBO says that will grow tenfold, to nearly 0.6 per cent of GDP.
Canada's economy is currently worth $2-trillion, so think of that future impact of 0.6 per cent of GDP as the equivalent of a $12-billion hole. The PBO says roughly one-third of the cost will be provincial; the other two-thirds – about $8-billion – will be federal. Mr. Kesselman's study expects an even bigger impact.
Eight billion dollars a year is nothing to sneeze at. But let's put things in perspective. The last federal budget had revenue of nearly $280-billion.
What's more, the TFSA's eventual impact on government revenues will still be much smaller than the current cost of tax-sheltering in RRSPs and employer pension plans. And nobody's talking about scaling those back in order to give government more revenue.
So what's wrong with the TFSA as it is? And what about the Conservative promise to double the $5,500 annual contribution limit?
The trouble is that the benefits of the TFSA are going overwhelmingly to higher-income Canadians. The Parliamentary Budget Officer's research on this is incontrovertible.
In a sense, this isn't surprising. We have a progressive income-tax system, so upper-income Canadians face the highest taxes. They also have more money to save – and fewer opportunities for tax-sheltered retirement savings than their Americans peers, because of relatively low contribution ceilings for RRSPs and pension plans. It can be argued that TFSA expansion, even if it primarily benefits wealthier Canadians, is entirely justified.
It's an argument that can be made – but it's not an easy argument to win. Context matters, and Ottawa is already implementing several other measures primarily benefiting the upper reaches of the tax code.
For example, pension splitting for seniors, which arrived in 2007, is a relatively new tax break that is of greatest use to higher-income families. The greatest benefits go to retired couples where one spouse is high-income, and the other is low- or no-income.
Income splitting for two-parent families, as originally promised by the Conservatives on the campaign trail in 2011, is similar. The late Jim Flaherty's final major act as finance minister was to criticize it because of its tilt to the top end of the income scale. (In response, the Harper government watered down the promise before it became law.)
Then there's Old Age Security. Beginning in 2023, the age for collecting the pension will gradually rise from 65 to 67. The Harper government sold this as a plan to prevent long-term OAS costs from skyrocketing – and the government was right about the dangers. OAS is a universal program, providing payments of $563.74 a month to seniors, with additional benefits to low-income seniors. Unlike the Canada Pension Plan, which is partly a savings plan, today's OAS payments are paid entirely by today's taxpayers.
With the retired population booming and the percentage of Canadians in the work force falling, OAS had the potential to eventually crush the federal budget. The long-term danger was real. But the chosen fix, raising the eligibility age, will disproportionately hit low- and middle-income Canadians.
But wait, there's more, TFSA rules mean that a growing number of upper-middle-class Canadians will be able to avoid the OAS clawback, which in 2014 kicked in at income above $71,592. Remember, income from a TFSA isn't taxable, and doesn't count against benefits such as OAS.
All of which yields unexpected results. Starting in less than a decade, the average lower- and middle-income Canadian will, over the course of their retirement, collect less OAS – but a good number of upper-income Canadians, thanks to their TFSA, may get more from OAS, even as they pay less tax on their other income.
Given all of this, what is to be done? Should the Harper government stick to its promise to double TFSA contribution limits? And if more TFSA isn't the solution, what is? How can Canada build a better retirement system? For answers, meet us back here on Tuesday.