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Archived - Tax Expenditures and Evaluations - 2004 : 4

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Part 2 - Tax Evaluations and Research Reports

The Disability Tax Credit:
Evaluation Report

1. Introduction and Summary

The Government of Canada is committed to supporting full participation for persons with disabilities in Canadian society. As part of this commitment, the Government provides substantial direct assistance to persons with disabilities. Examples of this assistance include the Child Disability Benefit (a supplement to the Canada Child Tax Benefit), Canada Study Grants for students with disabilities to help with the costs of post-secondary education, funding for the Labour Market Agreements for Persons with Disabilities with the provinces and territories, Canada Pension Plan disability benefits, and disability pensions for veterans.

Another important aspect of the Government of Canada's commitment to persons with disabilities is ensuring that Canadians with disabilities are treated fairly by the tax system. Persons with disabilities and their supporting families may incur extra non-discretionary expenses related to their condition that reduce their ability to pay tax. Without recognition of these additional expenses, they would face the same tax bill as persons with identical income who do not have these costs. Tax fairness is therefore improved when the extra costs of disability are recognized in the tax system. Currently these expenses are recognized by three types of tax measures.

  • Tax credits for specific expenses related to disability: the medical expense tax credit and the recently proposed disability supports deduction.
  • The disability tax credit (DTC), which provides relief for extra everyday expenses incurred by persons with disabilities.
  • Tax credits providing relief for individuals caring for family members with disabilities: the caregiver credit, the infirm dependant credit and the eligible dependant credit.

In the Government's response to the Seventh Report of the Standing Committee on Human Resources Development and the Status of Persons with Disabilities, it was agreed that an evaluation of the DTC would be conducted by the Department of Finance. This evaluation assesses whether the DTC is achieving its policy intent of contributing to tax fairness for persons with disabilities.

The evaluation shows that:

  • The DTC improves tax fairness for over 400,000 Canadians with severe and prolonged disabilities, as well as their supporting families. While there are other tax measures that help persons with disabilities, only the DTC recognizes the extra spending on everyday items that reduce the ability to pay tax.
  • An aggregate comparison suggests that the DTC is reaching its target population-Canadians with severe and prolonged disabilities. Estimates of the DTC recipient population based on Statistics Canada survey data are in the same range as the actual number of DTC recipients. It is not possible with available data, however, to determine whether a given individual reporting a severe and prolonged disability receives the DTC.
  • Better information will be required to assess whether the DTC dollar amount is set at the right level. Steps are being taken to try to develop better data on the extra spending on everyday items incurred by persons with disabilities.

The evaluation is organized as follows:

  • Section 2 provides background information on the DTC and key disability-related tax measures.
  • Section 3 discusses the importance of tax fairness for persons with disabilities and considers the DTC's policy role in this context.
  • Section 4 uses survey data on activity limitations to assess whether the DTC is reaching its intended recipients.
  • Section 5 discusses the issues associated with determining if the DTC amount is set at the right level.
  • Section 6 presents the conclusions of the evaluation.
  • An annex provides further detail on tax measures that benefit persons with disabilities.

2. Description of the DTC and Other Tax Measures That Benefit Persons With Disabilities

This section describes the main federal tax measures that promote tax fairness for persons with disabilities and their supporting families (i.e. measures that recognize that individuals with disabilities and their families incur extra costs that reduce their ability to pay tax). It first provides background information on the DTC, and then describes other tax measures recognizing disability-related expenses and tax credits for individuals caring for family members with disabilities.[1]

The Disability Tax Credit

The DTC is a non-refundable credit implemented to recognize that individuals with severe and prolonged impairments incur additional expenses related to their disability that reduce their ability to pay income tax.

Origins

. The Canadian tax system has a long history of recognizing the additional expenses of disability. In 1944 a deduction was introduced for blind persons in recognition of their additional expenses. A few years later this deduction was extended to individuals confined to a bed or who use a wheelchair. In the mid-1980s the definition of eligibility for the disability deduction was extended to include individuals with a severe and prolonged mental or physical disability that markedly restricts a basic activity of daily living. The deduction was converted into a credit in 1988.

Eligibility

. The DTC provides tax relief to individuals who, due to the effects of a severe and prolonged mental or physical impairment, are markedly restricted in their ability to perform a basic activity of daily living as certified by a qualified medical practitioner, or would be markedly restricted were it not for extensive therapy to sustain a vital function. Individuals are markedly restricted if, even with therapy or the use of appropriate devices and medication, they are blind or unable to perform a basic activity of daily living, or if they require an inordinate amount of time to perform the activity, all or substantially all of the time. The basic activities of daily living are: walking; feeding or dressing oneself; perceiving, thinking and remembering; speaking; hearing; and eliminating bodily waste.

In addition, since the 2000 tax year, an individual who receives therapy essential to sustain a vital function (e.g. dialysis treatment) may be eligible to claim the DTC.[2]

Eligibility is determined by an assessment conducted by a medical professional. While medical doctors can certify all types of impairments, other professionals are limited to certifying impairments in their respective fields, as summarized in the following table.

Table 1
Professional Certification of DTC Eligibility


Medical professional Type of impairment

Medical doctors All impairments
Optometrists Vision
Audiologists Hearing
Occupational therapists Walking, feeding, dressing
Psychologists Perceiving, thinking and remembering
Speech-language pathologists Speaking

Parameters. In 2004 the DTC dollar amount is $6,486. This represents a benchmark amount of extra everyday costs incurred by DTC-eligible individuals. No receipts are required to claim the credit-that is, all eligible persons may claim the full amount. The credit amount is multiplied by the lowest marginal tax rate (currently 16 per cent), and the person's federal tax liability is reduced by this amount (currently $1,038). The credit amount is fully indexed to inflation.

Families with children under 18 who are eligible for the DTC are also eligible for a supplement in the amount of $3,784 which, at a credit rate of 16 per cent, translates into an additional reduction in federal taxes of up to $605. The supplement is reduced if child care deductions for this child exceed $2,216 in 2004.

Since the DTC is non-refundable-it can be used to reduce taxes to zero, but it does not trigger a payment from the Government when the amount of the credit exceeds tax otherwise payable-it may be the case that an individual with a severe and prolonged disability does not have enough taxable income to make use of any or all of the DTC. In other words, their federal tax liability may be less than $1,038 in 2004, even before the DTC is applied. If someone cannot use all of the DTC himself or herself, the unused portion can be claimed by a family member-either a spouse or another supporting relative. The list of family members eligible to receive a transfer of the DTC has been expanded in recent years, most recently in 2000.[3]

Number of DTC Claims

. Most DTC-eligible individuals, even if they do not have enough taxable income to make any use of the credit, can be identified in tax data because they still claim the credit on their own tax return. Some, however, transfer the credit to a supporting relative but do not file their own tax return, and this requires some adjustment to the tax data.

In 2001, the most recent year for which tax return data are available, approximately 344,000 individuals claimed the DTC for themselves. It is possible to use data on the DTC supplement for children to determine that claims were made for 37,000 children with severe and prolonged disabilities. In addition, it is estimated that 20,000 DTC transfers were claimed on behalf of eligible adults who did not file their own tax return.[4] In total, DTC claims were made by, or on behalf of, approximately 400,000 individuals with severe and prolonged impairments in 2001.

Age

. It is widely known that disability rates increase with age. The 2001 Participation and Activity Limitation Survey indicated that seniors have the highest rate of disability in Canada (41 per cent).[5] It is not surprising, then, that most DTC-eligible individuals are senior citizens. As Table 2 shows, of those DTC-eligible adults who claimed the DTC on their own tax return in 2001, 60 per cent were 65 or older and 40 per cent were 75 or older. By way of comparison, less than 20 per cent of all tax filers in 2001 were 65 or older.

Table 2
DTC Self Claims by Age, 2001


Age of tax filer Number
of DTC
self claims
% of DTC
self claims
% of all
tax filers

< 25 4,900 1.5 13.6
25-34 12,800 3.7 16.8
35-44 24,500 7.1 21.5
45-54 39,200 11.4 18.6
55-64 54,900 16.0 12.4
65-74 70,400 20.5 9.3
75-84 86,500 25.2 5.8
85 + 50,600 14.7 2.0
Total 343,800 100.0 100.0

Note: Numbers rounded to nearest hundred. Percentages may not add to 100% due to rounding.

Income

. Individuals who claimed the DTC for themselves in 2001 had below average incomes (Table 3).[6] There is, however, a substantial difference by age: while the average income of younger self claimants was well below the income of other persons under 65, the incomes of older self claimants in 2001 were not substantially different than the incomes of other seniors. The data suggest that most seniors with a disability developed it relatively late in life. Consequently, they would have approximately the same work history and income as the total population over 65. In contrast, DTC-eligible individuals under 65 have a lower rate of labour force participation and hence lower incomes, on average, relative to other individuals in the same age group.

Table 3
Average Total Income by DTC Status and Age, 2001


Age Average total income
for DTC self claimants
Average total income
for others

All ages $24,612 $31,862
Under 65 $20,881 $32,719
65 and older $27,062 $27,517

Table 3 also shows that DTC self claimants 65 and older have substantially higher incomes than younger persons with disabilities. The biggest difference by age occurs for individuals with less than $10,000 in income: almost one-third of individuals under 65 making a DTC self claim were in this income category, compared to less than 10 per cent for individuals 65 and over (Table 4). This difference at low income levels likely reflects the availability of Guaranteed Income Supplement payments to persons 65 and over.

The lower share of seniors having incomes less than $10,000 translates as well into a higher share at all income levels above $10,000, with particularly large differences for incomes up to $30,000.

Table 4
DTC Self Claims by Age and Income, 2001


Under 65 65 and older Overall
Total income Number % of
<65
Number % of
5+
Number % of
overall

< $10,000 43,800 32.2 15,500 7.4 59,300 17.3
$10,000 - $20,000 44,600 32.7 91,400 44.0 135,900 39.5
$20,000 - $30,000 20,000 14.7 48,900 23.5 68,900 20.0
$30,000 - $40,000 11,100 8.1 23,200 11.2 34,300 10.0
$40,000 - $80,000 14,600 10.7 23,300 11.2 38,000 11.0
$80,000 + 2,100 1.5 5,200 2.5 7,300 2.1
Total 136,300 100.0 207,500 100.0 343,800 100.0

Note: Numbers rounded to nearest hundred. Percentages may not add to 100% due to rounding.

Tax Relief

. In 2001 the DTC provided a reduction in federal taxes of $330 million to Canadians with severe disabilities and their families, up substantially from $275 million in tax relief in 2000. The significant enrichment of the credit amount, from $4,293 in 2000 to $6,000 in 2001, was primarily responsible for this increase. This estimate of tax relief does not include the additional tax relief provided through provincial disability tax credits, which is typically half of the federal amount.

Other Tax Measures That Benefit Persons With Disabilities

Medical Expense Tax Credit

The medical expense tax credit (METC) is a non-refundable credit that recognizes the effect of above-average medical expenses on an individual's ability to pay income tax. The list of eligible METC expenses is quite broad and is regularly reviewed and expanded in light of new technologies and developments. The METC provides a substantial and rapidly growing amount of tax relief to Canadians. In 2001 the total reduction in federal taxes provided by the METC was $570 million.

Although the METC is a measure of general application for all taxpayers, it plays an important role in recognizing out-of-pocket disability expenses. In 2001 the average METC claim for a family making a DTC claim was $1,123, almost five times higher than the average METC claim of $248 for families with no DTC claim (Table 5). Further, families with a DTC claim were more than twice as likely to make an METC claim than families with no DTC claim.

Table 5
METC Claims by DTC Status and Age, 2001


Overall < 65 65+
DTC No DTC DTC No DTC DTC No DTC

Average METC claim $1,123 $248 $682 $146 $1,568 $768
% with METC claim 33.0% 13.7% 28.0% 11.1% 38.1% 27.3%

The high average METC claim for families with a DTC claim reflects, in large measure, the inclusion of disability-related items in the list of expenses eligible for the METC.[7] Examples of such items include attendant care,[8] fees paid to a group home, tutoring and talking textbooks, communications devices and services, renovations to make a home more accessible, expenses paid to move to a more accessible home, vehicle modifications and guide dogs. More details on the METC and how it has been expanded in recent years to include more items purchased by persons with disabilities are provided in the Annex.

Disability Supports Deduction

The 2004 budget proposed the introduction of a deduction for disability supports for employment and education. The effect of this deduction will be to ensure that no income tax will be payable on income (including government assistance) used to pay for these expenses. Eligible expenses for this new deduction will include, for example, note-taking and tutoring services, sign language interpretation fees, and attendant care purchased for purposes of employment or education. While expenses eligible for the disability supports deductions are generally also eligible for the METC, the expenses can only be claimed under one of the two measures.

Tax Credits for Caregivers

Individuals caring for an adult family member with a disability, other than their spouse, may be able to claim a non-refundable tax credit in recognition of the additional expenses they incur.[9] There are three tax credits associated with caregiving: the caregiver credit, the infirm dependant credit and the eligible dependant credit. Generally, to be able to claim one of these three credits, the adult family member for whom someone is caring has to be "infirm" (except in the case of the caregiver credit, where a dependent parent or grandparent age 65 or more does not have to be infirm). In addition, the dependant's income must not exceed certain levels. While there is no specific definition of infirmity in tax legislation, a broader definition is implied than the severe and prolonged impairments that serve as the basis of DTC eligibility.[10]

The three credits operate side-by-side as follows:

  • If the infirm dependant does not live in the caregiver's home, the infirm dependant credit is the only credit available.
  • If the infirm dependant lives in the caregiver's home and the caregiver has a spouse or common-law partner that they live with or support, the only option is the caregiver credit.
  • If the caregiver and infirm dependant live in the same home and the caregiver does not have a spouse or common-law partner that they live with or support, the caregiver may be able to claim the eligible dependant credit instead of the caregiver credit. While the eligible dependant credit potentially offers a higher amount of tax relief than the caregiver credit, it cannot be claimed for as many types of relatives. Further, the eligible dependant credit is subject to phase-out provisions that make it no more generous than the caregiver credit beyond a certain income range.

In addition, a DTC-eligible dependant may choose to transfer any unused portion of their DTC to the caregiver. Finally, as proposed in the 2004 budget, a taxpayer can claim medical expenses paid on behalf of a dependent relative that are in excess of the relative's net income threshold, subject to a maximum claim of $5,000.

3. The DTC's Policy Role

An important part of this evaluation is assessing how the DTC contributes to tax fairness by recognizing the impact of additional disability-related costs on the ability to pay tax.

There are two notions of equity that are important in the tax system: vertical equity and horizontal equity. Vertical equity means that individuals who are better off should pay more in taxes. Horizontal equity means that two individuals in similar circumstances should pay similar amounts of tax. The concept of horizontal equity provides the rationale for the DTC. Because of their condition, persons with disabilities incur additional expenses that do not contribute to consumption enjoyment and that effectively reduce their disposable income. Without special recognition, however, their tax bill would be the same as a person with identical income who did not face these additional costs. By allowing an income tax credit for additional expenses that do not contribute to consumption enjoyment, the DTC establishes greater horizontal equity between people with and without disabilities.

Disability gives rise to different types of additional expenses. Some of the extra costs of disability are for items, such as wheelchairs and full-time attendant care, that are only needed by persons with disabilities. All of the money spent on these items can be considered extra costs of disability. These expenses are relatively easy to document and are generally recognized by the tax system, notably under the METC.

Other aspects of the extra costs of disability, however, are of a different nature. Individuals with disabilities also spend higher than average amounts on everyday goods and services, such as utilities, housing, clothing, household goods and transportation. For example, someone with a disability may spend more on utilities because they have medical devices that require electricity, or because reduced mobility makes them more sensitive to temperature and leads to higher heating bills.

These additional costs generally represent out-of-pocket expenses for persons with disabilities but are not recognized by the METC. This is because, in general, there is no way for someone with a disability to quantify all of these incremental costs and include the total on their METC claim. To improve fairness, therefore, the tax system needs a measure that provides general recognition for the extra expenses of everyday living incurred by Canadians with severe and prolonged disabilities. This is the DTC's policy role.

Canada is not alone in trying to ensure that the tax system treats persons with disabilities fairly. Some countries, including the United States, Australia and France, also offer tax measures that recognize the negative impact of additional disability expenses on the ability to pay tax. Other countries, such as the United Kingdom, offer no general tax measure for persons with disabilities. In the United Kingdom, however, persons with disabilities may receive some help with their extra costs through a direct non-taxable benefit, so there is less of a need for a tax credit that serves this purpose.

4. Is the DTC Reaching Its Target Population?

Assessing whether the DTC is reaching its target population is an important part of an evaluation of its effectiveness. It is possible to generate estimates of the DTC-eligible population using Statistics Canada surveys that ask Canadians about their activity limitations. These surveys include data on income, which can be used to determine how many of these eligible individuals, together with their supporting families, can make use of the credit. These estimates of the potential DTC recipient population can then be compared with the number of DTC recipients indicated by tax return data. It is not possible, however, to determine on an individual level whether a given person with a DTC-eligible activity limitation also reports receiving the DTC, and vice versa. The best that can be done is to compare survey estimates of the DTC-eligible population with the actual number of DTC claims at an aggregate level.

Estimating the DTC-Eligible Population

The first step is to produce an independent estimate of how many Canadians, regardless of their income, have severe and prolonged activity limitations that make them eligible for the DTC.[11] Statistics Canada has a number of surveys that ask individuals about different types of activity limitations. The first survey used in this analysis, the 2001 Participation and Activity Limitation Survey (PALS), is a survey of Canadians with disabilities.

All of the DTC-eligible population cannot, however, be captured using only PALS since that survey interviews only Canadians with disabilities living in private households. Some individuals with severe and prolonged disabilities live in nursing homes, group homes for persons with disabilities and other types of health institutions. If these individuals are excluded from the estimates, the size of the DTC-eligible population will be underestimated, and probably by a significant amount. As it turns out, Statistics Canada has another survey, the 1996-1997 National Population Health Survey (NPHS), which asks individuals living in health institutions about different types of activity limitations.[12] Since these two surveys cover mutually exclusive subpopulations and they both ask questions about activity limitations, they can be combined to produce an overall estimate for the DTC-eligible population.[13]

The match between the survey questions and the DTC eligibility criteria is imperfect. For a given activity limitation, the choice is often between one set of survey responses that may fail to capture everyone eligible for the DTC and another set of responses that may include some individuals who should not be considered eligible. To take account of this uncertainty, two estimates, one low and one high, are generated for each activity limitation, and by extension for the overall count. The underlying DTC-eligible population should be interpreted as lying somewhere between these low and high estimates.

Table 6
Estimates of the DTC-Eligible Population, 2001


Low High

DTC-eligible population in households (PALS) 353,000 559,000
DTC-eligible population in health institutions (NPHS) 133,000 166,000
Adjustment for missing activity limitations 12,000 20,000
Total 498,000 745,000

Note: Numbers rounded to nearest thousand.

Table 6 presents the estimates of the DTC-eligible population. For individuals living in private households, the low estimate of the DTC-eligible population is 353,000, and the high estimate is 559,000. The NPHS indicates that there are many DTC-eligible individuals living in health institutions. For this group, the low estimate is 133,000 and the high estimate is 166,000.[14]

Both the PALS and NPHS surveys have questions on most, but not all, of the activity limitations covered by the DTC. Neither survey has direct questions on eliminating bodily waste or life-sustaining therapy. The estimates therefore do not include individuals who would qualify for the DTC solely under one of these criteria (although those who also experience one of the activity limitations captured by the survey would already be in the count). Consequently, it is necessary to adjust the estimates of the DTC-eligible population for these missing activity limitations.

To adjust the estimates of the DTC-eligible population, it is possible to use tax return data, which provides some information on the types of activity limitations experienced by individuals claiming the DTC. In 2001 between 2.3 and 2.7 per cent of individuals who claimed the DTC listed eliminating bodily waste and life-sustaining therapy as their only activity limitations. Assuming that the same ratios apply to the survey estimates, it follows that the estimates of the DTC-eligible population should be adjusted by 12,000 to 20,000.

Combining the two sets of estimates and adding an adjustment factor to account for missing activity limitations yields overall estimates of the DTC-eligible population that range between 498,000 and 745,000. The actual number of DTC-eligible individuals is likely somewhere between these two numbers.

Estimating the Potential DTC Recipient Population

Since the DTC is an ability to pay tax measure, an estimate of the size of the DTC recipient population needs to take account of who can make use of the credit. More specifically, for an individual with a severe and prolonged disability to be a DTC recipient, they need to be in a position where they would be paying tax or have a family member in a position to benefit from a transfer of the credit.

The first step in estimating the DTC recipient population is to determine how many DTC-eligible individuals have enough income to make use of the credit directly. Both PALS and the NPHS include information on the individual's total income. Ideally, however, there would be data available on the individual's taxable income, since some forms of income, such as social assistance and the Guaranteed Income Supplement, are not taxable. By making adjustments for non-taxable components of income and taking account of basic personal credits that can be claimed, it is possible to use these data sets to estimate the number of taxable DTC-eligible individuals.[15] As Table 7 shows, the low estimate of the number of taxable DTC-eligible individuals is 214,000 and the high estimate is 331,000.

Table 7
Estimates of the Potential DTC Recipient Population, 2001


  Low High

DTC-eligible population (from Table 6) 498,000 745,000
DTC-eligible individuals who are taxable 214,000 331,000
Transfers (assuming 0.43 ratio of
transfers to taxable individuals)
92,000 142,000
Total DTC recipient population 306,000 473,000

Note: Numbers rounded to nearest thousand.

The second step in this estimation process is to determine how many DTC-eligible individuals who cannot use the DTC themselves can transfer the credit to a family member who is taxable. Neither data set, however, includes enough information to permit a precise estimate for the number of transfers. On the one hand, PALS includes a variable on household income, but no information on family members living outside the household. On the other hand, the NPHS provides no information on the income of other family members.

Since these surveys do not include any direct information on transfers, the next best option is to study tax return data to learn about the ratio of transfers to taxable DTC recipients. In 2001, out of the claims made by or for 400,000 DTC-eligible individuals, 280,000 were claims directly made by taxable individuals (or taxable parents), and 120,000 were for transfers from non-taxable adults with disabilities. This translates into a ratio of 0.43 transfers for each taxable individual. It seems reasonable to assume that the same ratio of transfers to taxable individuals holds for the survey data as well. This assumption would yield estimates of the number of DTC transfers that range between 92,000 (low) and 142,000 (high).

Combining the estimates of the number of taxable DTC-eligible individuals and the number of transfers produces measures of the potential DTC recipient population. As Table 7 indicates, the estimates of the DTC recipient population range between 306,000 and 473,000.

Comparison With the Number of DTC Recipients

The next step in this analysis is to turn to tax return data to determine the number of DTC recipients. In Section 2, it was estimated that in 2001, DTC claims were made by or on behalf of 400,000 individuals with severe and prolonged impairments. This estimate leaves out some potential DTC recipients who are better off forgoing the DTC and including all of their attendant care or nursing home expenses in their METC claim. Since these individuals are being counted in the analysis of survey data on activity limitations, they should be included in this comparison. While there is no direct information on how many potential DTC recipients choose this option, tax return data on METC claims suggest that the total number in this category is approximately 22,000.[16] The resulting estimate of the total number of DTC recipients, both actual and potential, in the 2001 tax year is therefore 422,000.

The number of DTC recipients falls well within the range of estimates of the DTC recipient population based on survey data. Sensitivity analysis indicates that even when reasonable alternative assumptions are chosen for the number of transfers, the independent estimates of the recipient population are consistent with the actual number of DTC claims. This comparison indicates that, on the whole, Canadians with severe and prolonged activity limitations are making use of the DTC. This does not rule out the possibility that some potential recipients are not receiving the credit, or that some recipients are not in fact eligible. The analysis, however, suggests that there is no overall problem with take-up of this measure.

5. The Challenge of Measuring the Extra Costs of Disability

To determine whether the DTC is achieving its stated policy purpose, it is necessary to assess whether the dollar amount of the credit ($6,486 in 2004) is appropriate. That is, on average, do DTC recipients incur approximately this amount in extra out-of-pocket costs for everyday items?

Estimating the additional everyday expenses of disability is extremely challenging. It is not simply a question of asking individuals with severe disabilities what they spend on, for example, wheelchairs or full-time attendants, and defining all of the money spent on these items as extra costs. Rather, it requires understanding the difference between what individuals with severe disabilities currently spend on everyday items, such as housing, and transportation, and what they would have spent on these items if they did not have a disability. For persons with disabilities to provide direct measures of these incremental costs, they would have to know the difference between what they currently spend on different items and what they would have spent in the absence of their condition.

The other alternative is to try to come up with indirect measures of the extra everyday costs of disability. To do this would require a data set with information on spending patterns for persons both with and without disabilities. This would make it possible to analyze whether persons with disabilities as a group spend more than those without disabilities, all else equal, in different categories. For example, such an analysis could examine whether individuals with disabilities spend more on household goods than others, taking account of other differences between the two groups. If they spend more on average on household goods, the difference in spending levels would be defined as an extra cost of disability. This approach would produce an estimate of the average level of the additional expenses of disability in a given category, and these extra costs could then be aggregated across different categories.

Even with such a data set, there would be challenges associated with measuring the extra expenses of disability. One unavoidable issue will be the heterogeneity of the population with a disability. Different types of disability often cause some individuals to spend more than average and others to spend less than average in a given category. For example, while some individuals with disabilities may spend more on transportation, others may be unable to leave their home and may therefore spend less on transportation. Persons who spend less than average in a given category because of their disability should not be counted, but there is no way to remove them from the calculation. As a result, persons with disabilities spending less than average would drag down the average for those with disabilities as a whole. As a result, indirect estimates of the extra expenses of disability would likely be understated to some extent, and it is impossible to say by how much.

The Limitations of Current Data Sources

At the present time, there is no existing Canadian data set that allows the estimation of the extra everyday costs of disability. One natural starting point is Statistics Canada's Survey of Household Spending, Canada's principal source of information on what families spend on different items. However, the Survey of Household Spending does not currently ask any questions that indicate who has a disability.

Another potential resource for examining disability expenses is Statistics Canada's 2001 Participation and Activity Limitation Survey (PALS), Canada's main source of information on disability. PALS asks individuals with disabilities about their out-of-pocket spending in six different categories:

  • Prescription and non-prescription drugs
  • Aids and specialized equipment
  • Health care and social services
  • Help received
  • Transportation
  • Home modifications

Most of the expenditure categories in PALS refer to expenses that can be claimed under the METC, whereas this evaluation requires an analysis of the extra everyday expenses of disability for which receipts cannot be supplied. The only categories that relate to the DTC are non-prescription drugs, occasional help (i.e. housekeeping) and transportation. There are no questions in PALS about additional expenses for regular housing payments, utilities, clothing or household products. Consequently, using PALS in its current form would yield an underestimate of the extra everyday costs of disability.

Steps Being Taken to Develop Better Data

Since there is no appropriate data set, it is not currently possible to begin to develop a good estimate for how much DTC recipients incur in extra everyday costs. Given the importance of understanding the extra costs of disability, discussions are underway with Statistics Canada to develop better data.

One option being considered is adding questions on disability to the Survey of Household Spending. It may also be possible to modify the next version of PALS, currently scheduled for 2006, to try to measure the extra everyday costs associated with disability.

The discussion above suggests that no data set, even with modifications, will provide a complete measure of the extra everyday costs of disability.

6. Conclusion

The DTC is one of many measures that contribute to tax fairness for persons with disabilities. These measures provide tax relief for specific disability-related expenses (e.g. the METC) and for individuals caring for family members with disabilities. The unique role of the DTC is to provide tax relief for the additional everyday expenses incurred by individuals with severe and prolonged impairments and their supporting families. These expenses cannot be documented for tax purposes, so there is a need for a measure that provides general recognition of the negative impact of these extra everyday costs on the ability to pay tax.

This report shows that, based on existing eligibility criteria, the DTC seems to be reaching its target population. Independent estimates of the DTC recipient population, based on Statistics Canada survey data on activity limitations, are consistent with tax return data on the number of DTC recipients.

Finally, given the difficulty of quantifying the extra everyday costs of disability with current data, it is not possible to determine whether the DTC dollar amount is set at the right level. Steps are being taken to try to develop better data on the extra everyday costs of disability.

Annex
Government of Canada Tax Measures That Benefit Persons With Disabilities

Summary of Measures

Personal Income Tax

Tax relief for persons with disabilities and those who care for them

  • Disability tax credit
  • Disability supports deduction (proposed in the 2004 budget)
  • Caregiver credit
  • Infirm dependant credit

Benefits delivered through the tax system

  • Refundable medical expense supplement
  • Child Disability Benefit

Measures with special benefits for persons with disabilities

  • Medical expense tax credit
  • Eligible dependant credit
  • Child care expense deduction
  • Education credit
  • Lifelong Learning Plan
  • RRSP/RRIF rollover
  • Registered education savings plans
  • Home Buyers' Plan

Corporate Income Tax

  • Expensing of capital expenses incurred to adapt buildings

Customs Tariff

  • Duty-free entry of disability-related goods

Goods and Services Tax

  • Special treatment of goods and services used by persons
    with disabilities

Excise Tax on Gasoline

  • Refund for persons with a mobility impairment

Personal Income Tax

Tax Relief for Persons With Disabilities and Those Who Care for Them

Disability Supports Deduction

Proposed in the 2004 budget, this measure replaces the attendant care deduction. Under the attendant care deduction, taxpayers eligible for the DTC who required attendant care in order to earn business or employment income or, after 2000, to attend a designated educational institution or a secondary school were able to deduct the cost of that care. The proposed disability supports deduction will recognize attendant care as well as other disability supports expenses incurred for education or employment purposes, unless they have been reimbursed by a non-taxable payment (e.g. from an insurance company). Individuals will not have to be eligible for the DTC in order to claim the deduction.

For those earning employment or business income, the disability supports deduction will be limited to the lesser of:

  • the amounts paid for eligible expenses; and
  • the taxpayer's earned income.

For those attending school, the deduction will be limited to the lesser of:

  • the amounts paid for eligible expenses; and
  • the taxpayer's earned income plus the least of:
    • the taxpayer's non-employment income net of other deductions (i.e. the difference between the taxpayer's net income without taking the proposed disability supports deduction into account and the taxpayer's earned income);
    • $375 times the number of weeks in school; and
    • $15,000.

In other words, the deduction will generally be limited to the lesser of the amounts paid for eligible expenses and the taxpayer's earned income, which includes wages, self-employment income, and scholarships.

For students, the deduction will be limited to the lesser of the amounts paid for eligible expenses and the student's earned income plus an additional amount equal to the lesser of $375 times the number of weeks in school (up to a maximum of 40 weeks) and the student's other income net of other deductions.

The limit for students allows those who pay for disability supports in order to attend school with income other than earnings or scholarships to benefit from the deduction.

The effect of the new deduction will be that no income tax will be payable on income (including government assistance) used to pay for these expenses, and that this income will not be used in determining the value of income-tested benefits.

Caregiver Credit

The caregiver credit, introduced in 1998, recognizes that people who support certain adult relatives in their own home often incur expenses that reduce their ability to pay income tax. Eligible relatives include infirm dependent relatives who are 18 or older, and any parent or grandparent 65 years of age or over (regardless of infirmity).[17] For 2004 the maximum credit is $605 (16 per cent of $3,784). The credit is reduced when the dependant's net income exceeds $12,921 and is fully phased out when the dependant's net income reaches $16,705.[18]

Infirm Dependant Credit

The infirm dependant credit recognizes that individuals providing support to an infirm adult relative who lives in a separate residence may incur expenses that reduce their ability to pay income tax. This non-refundable measure applies to the same infirm adult relatives as the caregiver credit and generally provides the same amount of tax relief (up to $605, or 16 per cent of $3,784). The infirm dependant credit, however, is phased out at lower income levels; it is reduced when the dependant's net income exceeds $5,386, and is fully phased out when this net income reaches $9,152.

Benefits Delivered Through the Tax System

Refundable Medical Expense Supplement

Introduced in 1997, the refundable medical expense supplement recognizes that the loss of subsidies for disability-related supports under provincial social assistance for working adults with low incomes and above-average medical expenses can act as a barrier to participation in the labour force. This refundable tax credit supplements relief provided through the medical expense tax credit. Consequently, persons who claim the medical expense tax credit may also be able to claim this supplement, and any disability-related expenses claimed as medical expenses also qualify for the supplement.

To be eligible for the supplement, the person's net income from employment[19] must exceed $2,809. For 2004 the maximum supplement is 25 per cent of the allowable portion of expenses that can be claimed under the medical expense tax credit and 25 per cent of the amount claimed under the disability supports deduction announced in the March 2004 budget, up to a limit of $562. To target relief to working adults with low incomes, the supplement is reduced by 5 per cent of net family income in excess of $21,301. The supplement is refundable to the extent that the taxpayer's total income tax payable is less than the amount of the supplement. The supplement is fully indexed to inflation.

Child Disability Benefit

Introduced in 2003, the Child Disability Benefit (CDB), a supplement to the federal Canada Child Tax Benefit, assists low- and modest-income families with the extra expenses associated with the care of children who are eligible for the DTC.

The maximum benefit for July 2004 to June 2005 is $1,653 per child with a disability under 18 years of age. The full CDB is provided for each eligible child to families having a net income below the amount at which the National Child Benefit supplement is fully phased out. For a family with one child with a disability, the maximum benefit is provided to families with net incomes of less than $35,000. These thresholds are higher for families with more DTC-eligible children. The CDB is reduced as net family income exceeds the family's threshold. The CDB amount and income thresholds at which benefits begin to be reduced are indexed to inflation.

Measures With Special Benefits for Persons With Disabilities

Medical Expense Tax Credit

The medical expense tax credit (METC) is a non-refundable credit that recognizes the effect of above-average medical expenses on an individual's ability to pay income tax. For 2004 the credit equals 16 per cent of qualifying medical expenses in excess of a net income threshold, which is the lesser of $1,813 or 3 per cent of net income (the $1,813 threshold is fully indexed to inflation). A person may claim medical expenses incurred by themselves, their spouse or their minor children. Taxpayers are also able to claim qualifying medical expenses paid on behalf of other dependent relatives that are in excess of the relative's net income threshold, subject to a maximum claim of $5,000.[20]

The list of eligible METC expenses is quite broad and is regularly reviewed and expanded in light of new technologies and developments. In particular, there have been a substantial number of disability-related expenses added to the list of eligible METC expenses in recent years.

Recent Additions of Disability-Related Expenses
to List of Eligible METC Expenses

1997

  • 50 per cent of cost, up to $1,000, of air conditioner necessary to help individual cope with severe chronic ailment, disease or disorder
  • 20 per cent of cost, up to $5,000, of van adapted for transportation of individual in wheelchair
  • Sign language interpreter fees
  • Expenses incurred during move to accessible housing
  • Altering driveway to facilitate access to bus (for individuals with severe and prolonged mobility impairment)
  • An increase in the part-time attendant care limit from $5,000 to $10,000.

1998

  • Training expenses for caregivers

1999

  • Care and supervision of persons with severe and prolonged impairments living in group home
  • Therapy for persons with severe and prolonged impairments
  • Tutoring for persons with learning disabilities (or other mental impairments)

2000

  • Reasonable expenses of adapting a new home (i.e. during construction of the home) to the needs of a person with a disability

2003

  • Real-time captioning services for persons with a hearing or speaking impairment
  • Note-taking services for persons with a mental or physical impairment
  • Voice-recognition software for individuals with a physical impairment

Eligible Dependant Credit

If someone who does not have a spouse is caring for an infirm adult relative in their own home, they may be able to claim the eligible dependant credit. It is not possible to claim the full amount of both this credit and the caregiver credit. The eligible dependant credit has a maximum value of $1,088 (16 per cent of $6,803), which is higher than the caregiver credit. However, it is phased out at lower income levels; the phase-out starts at $681 and ends at $7,484. In addition, the eligible dependant credit can only be claimed for infirm dependent children, grandchildren, brothers and sisters, as well as any child under 18 or any parent or grandparent.

Child Care Expense Deduction

Introduced in 1972, the child care expense deduction recognizes that taxpayers, their spouses or common-law partners often incur significant costs for child care to enable them to work or attend school. Child care expenses can act as a barrier to participation in the labour force, with their deductibility reducing this barrier. Furthermore, children with a disability or infirm children often require specialized care.

A supporting person may deduct the lesser of the expense limit, two-thirds of earned income,[21] or the actual amount of child care expenses incurred. If the child is eligible for the DTC, then the expense limit is $10,000 regardless of the child's age. For a child over 16 years of age who has a disability or is infirm, but does not qualify for the DTC, the expense limit is $4,000. Otherwise, the expense limits are $7,000 for a child less than 7 years of age and $4,000 for a child between 7 and 16 years of age.

Generally, only the supporting person with the lower net income can make a claim and this supporting person must also live with the child. In addition, if the child for whom the expenses are being claimed is dependent on either supporting person, but is not the child of either individual, then the child's net income must be less than the basic personal amount.

Since it reduces taxable income, the deduction may increase the disability amount that can be transferred to a spouse or to a relative who provides dependant care. However, it also reduces the amount of the disability supplement for a child with a disability less than 17 years of age.

Education Credit

Students can claim the education credit for each month of study at post-secondary institutions or in occupational training institutions that have been certified by the Minister of Human Resources and Skills Development. The credit is 16 per cent of $400 per month of full-time study, or $120 per month of part-time study. The credit is provided in recognition of non-tuition costs of post-secondary education, such as the costs of textbooks. Persons with disabilities, however, are often unable to attend a post-secondary institution on a full-time basis because of their disability.

Consequently, to improve their education opportunities, the full-time education credit is available to individuals who attend a qualifying post-secondary institution on a part-time basis and who are either eligible for the DTC or certified as being mentally or physically impaired for purposes of this credit.

Unused education amounts may be either carried forward for use by the student in a subsequent taxation year or, together with the tuition amount, transferred, to a maximum of $5,000, to the student's spouse, or to a parent or grandparent. However, amounts carried forward cannot be transferred at a later date.

Moreover, if even a portion of the education amount can be used by a student, then that portion must be used before any excess amount can be carried forward or transferred, and before the non-refundable medical expense tax credit can be used.

Lifelong Learning Plan

Introduced in 1999, the Lifelong Learning Plan allows any individual to make a tax-free withdrawal of up to $20,000 over four years from their registered retirement savings plan (RRSP) to help finance their education or training, or that of their spouse. Funds withdrawn for this purpose must be returned to the RRSP in equal annual instalments over no more than 10 years.

In general, this provision applies only to full-time students. However, people with disabilities are often unable to attend a post-secondary institution on a full-time basis because of their disability. Consequently, the Lifelong Learning Plan extends eligibility to part-time students who are either eligible for the DTC or certified as being mentally or physically impaired for purposes of the education credit.

RRSP/RRIF Rollover

When the annuitant under an RRSP or registered retirement income fund (RRIF) dies, the value of the RRSP or RRIF is generally included in computing the deceased's income for the year of death. However, preferential tax treatment on RRSP or RRIF distributions made after death is provided in certain cases, including where the proceeds are distributed to a child or grandchild who was financially dependent on the deceased annuitant by reason of physical or mental infirmity. In this case, the RRSP or RRIF proceeds may be transferred without tax to the RRSP of the child or may be used to purchase an immediate life annuity. For 2004 a child or grandchild is considered to be financially dependent if the child's income for the year preceding the year of death was below $14,035. This threshold is indexed to inflation.

Registered Education Savings Plans

Generally, a student has to be registered full-time at a qualifying post-secondary institution in order to receive a payment out of a registered education savings plan to further his/her post-secondary education. The full-time requirement is waived for students who qualify for the DTC and those who cannot reasonably be expected to be enrolled as a full-time student because of a certified mental or physical impairment.

Home Buyers' Plan

The Home Buyers' Plan allows individuals to make a tax-free withdrawal of up to $20,000 from their RRSP to purchase a home. Funds withdrawn for this purpose must be returned to the RRSP in equal annual instalments over no more than 15 years.

In general, the plan is targeted to first-time home buyers. However, since 1998, persons eligible for the DTC need not be first-time home buyers to benefit from the plan. In particular, these persons, their spouses and their relatives may draw funds from their RRSPs to help finance the purchase of a house that is better suited to the needs of the person with a disability. Furthermore, either the person with the disability, his/her spouse or relative of the person with the disability may own the house.

Corporate Income Tax

Expensing of Capital Expenses Incurred to Adapt Buildings

Certain capital expenses incurred to adapt a building to enable individuals who have a mobility impairment to gain access to the building or to be mobile within it can be deducted fully in the year the expense is incurred instead of being depreciated over time through the capital cost allowance system. Eligible capital expenditures include ramps, door openers and modifications to bathrooms, elevators and doorways. The same corporate tax treatment applies to expenses for certain disability-related devices or equipment (e.g., visual fire alarm indicators and listening devices for group meetings).

Customs Tariff

Duty-Free Entry of Disability-Related Goods

The Customs Tariff provides for duty-free entry of goods that are specifically designed to assist persons with disabilities in alleviating the effects of those disabilities, and articles and materials for use in such goods.

Goods and Services Tax

Special Treatment of Goods and Services Used by Persons With Disabilities

Many goods and services used by people with disabilities or infirmities are exempt from, or are zero-rated for purposes of, the goods and services tax/harmonized sales tax (GST/HST). Rebates of GST/HST are also available in certain cases.

  • Exempt goods for which the GST/HST does not apply include most health care services, personal care and supervision programs provided in a business establishment, programs to provide prepared meals in the homes of people with disabilities, and recreational programs offered by public sector bodies.
  • Zero-rated goods include prescription drugs as well as many medical devices and supplies and guide dogs.
  • A rebate applies to modifications made to vehicles for persons with disabilities.

Excise Tax on Gasoline

Refund for Persons With a Mobility Impairment

A partial refund of 1.5¢ per litre is available for gasoline for the personal use by a person with a permanent mobility impairment who cannot safely use public transportation.


Taxation and Economic Efficiency:
Results From a General Equilibrium Model

1. Introduction and Summary

The fundamental role of the tax system is to raise the revenue necessary to finance the programs and services provided by the government on behalf of citizens. While the provision of public services has clear benefits, taxes impose unavoidable costs on the economy through their effects on incentives to work, save and invest, and on a nation's ability to attract and retain skilled workers, entrepreneurs and investment capital. These impacts on economic efficiency vary by type of tax so governments can, in principle, adjust the mix of taxes to minimize the cost of financing a given level of government services.

Efficiency, of course, is not the only criteria according to which a tax system should be assessed. How the tax system affects the distribution of income in the economy is also an important consideration. In addition, the administrative burden imposed on government and the compliance costs imposed on taxpayers need to be taken into consideration.

This paper addresses the efficiency of the tax system and its various components. It provides estimates of the comparative long-run economic costs imposed by the principal taxes in Canada, as revealed by simulations with a model of the Canadian economy developed at the Department of Finance Canada. The estimates of the economic costs are a reflection of the effects that taxation has on behaviour. For example, labour taxation causes people to work less than they would in the absence of such taxation. Similarly, taxing investment causes people to invest less than they would otherwise.

The key finding of the analysis is that, in the current Canadian setting, taxes on saving and investment impose higher economic costs than taxes on wages and consumer spending. This is attributable to the impact on productivity and wages of capital accumulation effects that occur in response to changes in taxes on saving and investment. Taxes on wages and consumption also affect economic performance, but the effects are smaller because of the relatively low sensitivity of labour supply to changes in wages. While the estimates of the costs for specific taxes are sensitive to the assumptions made in constructing the model and to the channels of influence captured in it, the ranking of taxes by economic cost is robust and indeed consistent with other studies in the Canadian and international economic literature.

2. Principal Taxes in Canada

Canadian governments (federal, provincial, territorial and local) raised about $360 billion through taxation in the 2003-04 fiscal year, which is equivalent to about 30 per cent of Canada's gross domestic product or GDP (Table 1). This amount was split roughly equally between the federal government on the one hand and provincial/territorial/local governments on the other.

Table 1
The Tax Mix in Canada (Fiscal Year Ending March 31, 2004)


% of tax revenues
Federal Provincial/
territorial/
local
Total % of
GDP2

Personal income taxes1 26.4 14.4 40.9 12.1
On wage income 25.3 13.8 39.1 11.6
On investment income 1.2 0.6 1.8 0.5
Payroll taxes 6.1 5.7 11.7 3.5
General payroll taxes 0.0 2.4 2.4 0.7
Contributions to social
security plans3
6.1 2.4 8.5 2.5
Health and drug insurance premiums 0.0 0.8 0.8 0.2
Property taxes1 0.0 11.2 11.2 3.3
Residential 0.0 6.5 6.5 1.9
Business 0.0 4.7 4.7 1.4
Corporate income taxes 7.5 3.2 10.7 3.2
Corporate capital taxes 0.4 0.9 1.4 0.4
Sales taxes1 8.6 8.5 17.0 5.1
Value-added taxes4 8.6 2.8 11.4 3.4
Retail sales taxes 0.0 5.6 5.6 1.7
   On consumer spending 0.0 2.9 2.9 0.8
   On business inputs 0.0 2.8 2.8 0.8
Excise taxes and customs duties 3.4 3.6 7.1 2.1
Total tax revenues (%) 52.4 47.6 100.0 29.7
Total tax revenues ($ billions) 189.6 171.9 361.5
Total government revenues5
($ billions, %)
203.5 254.8 458.3 37.6

1

Breakdown based on calculations by the Department of Finance.
2 Based on 2003 GDP estimate in current dollars.
3 Does not include Canada Pension Plan and Quebec Pension Plan.
4 Consists of the goods and services tax/harmonized sales tax and the Québec sales tax.
5 Non-tax revenues include user fees, net revenue from gaming activities, liquor profits and investment income. Excludes intergovernmental transfers.
Note: Numbers may not add due to rounding.
Source: Statistics Canada, tables 385-0001 and 380-0001.

Roughly 75 per cent of government tax revenue is raised through direct taxes on persons and corporations. Taxes on wage and salary income are the largest component, followed by payroll and property taxes. Corporate income taxes are next, accounting for just over 10 per cent of government tax revenues in Canada. Taxes on personal saving, or on investment income such as interest, dividends and capital gains, as well as corporate capital taxes, represent a small share of tax revenues.

Sales and other indirect taxes account for nearly 25 per cent of government tax revenues. In contrast to value-added taxes such as the goods and services tax/harmonized sales tax and the Québec sales tax, provincial retail sales taxes are imposed not only on consumer spending but also on certain intermediate materials and capital goods used by businesses.

3. General Equilibrium Models and Policy Analysis

Economic models provide a simplified representation of the market for a specific good or service, an industrial sector or the entire economy. They are used to evaluate the impact of changes in the economic environment, including government policies, on the market or economy being studied. Models that examine how long-run, or equilibrium, relationships are affected by changes in the economic environment are described as "general equilibrium" models.

General equilibrium models assume that capital and labour are fully employed at all times; the focus is therefore on how efficiently resources are being allocated in the economy rather than on how intensively they are being used. General equilibrium models use standard microeconomic theory to specify how the principal actors in the economy (i.e. consumers, firms and governments) respond to changes in relative prices and how their decisions interact. For example:

  • The decision made by consumers about how much to save depends on the level of interest rates, which is in turn influenced by the investment decisions of firms. Ultimately, the interest rate adjusts to ensure that the total supply of savings equals the total demand for investment.
  • Hiring decisions made by firms are influenced by the market wage rate, which in turn affects the number of people seeking work. In this case, the market wage adjusts to ensure that the demand for labour equals its supply.

General equilibrium models provide a unified and consistent framework within which several policy options can be evaluated and compared. The model results are dependent on estimates of the sensitivity of economic decisions to changes in relative prices. While these are empirically based, analysts may use different values of parameters to arrive at different quantitative results. Hence, general equilibrium models are more useful for the qualitative insights they provide and for ranking different policy choices than for the specific numerical results obtained.

The general equilibrium model used in this paper features a representative consumer and four representative corporations operating in four industries. The foreign sector consists of a single representative "agent" who owns a substantial portion of the domestic capital stock and who trades goods, services and financial capital with Canada. In the model, the consumer makes decisions about work, leisure, consumption and savings in a manner that maximizes his or her economic well-being, which is defined as a function of consumption and leisure time available. Economic well-being can therefore be thought of as the level of satisfaction over time associated with the amount of goods and services being consumed and the amount of leisure time available. Production decisions are made by profit-maximizing firms operating in a competitive environment using one type of capital,[22] homogeneous labour and intermediate materials produced in Canada and abroad. Relative prices are the key determinant of the flow of goods and services between Canada and the rest of the world while the relative rates of return on investment determine the net flow of financial capital across borders.

The model examines the effects of altering the tax mix on four key decisions: the decision to consume or invest; the decision to invest at home or abroad (by both Canadians and foreigners); the labour-leisure decision; and the composition of consumption and investment in terms of domestically produced and imported commodities. While the demand and supply of labour and the economy's output are assumed to be always in balance, the stock of business capital and the stock of the consumer's financial assets take time to reach a new equilibrium value. As a result, the benefits of tax reductions that affect desired asset stocks take longer to be realized than tax reductions that affect consumption and labour supply decisions.

A thorough description of the structure of the model, data sources and calibration procedure is available in a background paper.[23]

4. Impacts of Taxation on Economic Efficiency

The estimates of the impact of various tax reductions on economic well-being are summarized in the chart below.[24] The simulations incorporate stylized tax measures that offset the revenue loss from the tax cut without creating any economic distortions. More specifically, the lost tax revenue is assumed to be recovered through "lump-sum" or head taxes, which have no effect on the incentives to work, save or invest. This assumption is used as a simplifying device, providing a neutral benchmark against which all policy options can be compared.

The full impacts of tax reductions take time to be realized and, as noted above, the time profile varies by type of tax. These differences can affect the estimated well-being gains from tax reductions. If two initiatives have the same long-run impact, the gain will be larger for the initiative that provides benefits earlier. In order to take these differences in the transition path into account, the change in economic well-being is measured on a discounted present-value basis. The figures in the chart are scaled to represent the economic well-being gain in dollars for a $1 reduction in tax revenue. For example, reducing personal capital income taxes by one dollar, and financing the revenue loss by a one-dollar lump-sum tax, would raise well-being measured on a discounted present-value basis by $1.30. This is the economic benefit to taxpayers and society of reducing the economic distortions that would otherwise result from this dollar of taxation.

Long-Run Economic Well-Being Gain From Revenue-Neutral Tax Reductions

The estimates in the chart can be used to assess the efficiency effect of replacing the lost revenue with another tax. To continue with the previous example, if the lost tax revenue were replaced by a tax on consumer spending, there would still be a large net well-being gain since the economic benefit from reduced taxation of investment income is substantially higher than the economic cost associated with the taxation of consumer spending.

Before analyzing the results, it is worth explaining the two bars to the right of the dashed line in the chart. The first bar represents the weighted average gain in well-being for all taxes analyzed.[25] This calculation shows that a small, equal reduction in all taxes would raise well-being by 30 cents per dollar of revenue forgone. The second bar is the result for a simulated increase in capital cost allowance (CCA) on new capital only. Since the depreciation of capital is a cost borne by firms in the production process, the tax system allows the deduction of depreciation costs according to legislated CCA rates. This simulation is reported separately because increasing CCA is not a tax reduction per se but rather an increase in a deduction applicable against the corporate income tax.

As can be seen from the chart, the model suggests that reducing taxes on saving and investment produces larger gains than reducing taxes on wages or consumption. In particular, increasing CCA on new capital, cutting sales taxes on capital goods and cutting personal capital income taxes appear particularly potent.

Taxes on Saving and Investment Versus Labour and Consumption Taxes

The larger effect of taxes on saving and investment is attributable to capital accumulation effects. For example, reducing the tax on investment income raises the net-of-tax rate of return, which increases saving leading to a lower cost of capital to firms and higher investment. In turn, the higher capital stock boosts economic well-being by increasing productivity and, hence, wages.

In contrast, while reducing taxes on wages and consumption raises the real wage and improves economic performance by increasing hours worked, the benefits are small relative to tax cuts that affect saving and investment. This difference is largely determined by the relative size of two key model parameters: the sensitivity of labour supply to the wage rate and the sensitivity of investment to changes in the cost of capital. Estimates in the economic literature indicate that labour supply is less sensitive to changes in wages than investment is to the cost of capital.

The dynamics of the two types of tax cuts are also quite different. Reducing taxes on saving and investment initially leads to a fall in consumer spending as consumers find it beneficial, in light of the higher rate of return, to postpone consumption and to save. Eventually, of course, higher saving leads to a higher sustainable rate of consumption. In contrast, cutting wage and consumption taxes raises consumer spending immediately.

Reducing Taxes on New Investment

The model results suggest that reducing the sales tax on capital goods is a particularly effective way of promoting capital accumulation and hence well-being. The high cost-effectiveness reflects the fact that the tax cut is channelled entirely to new investment so there is no windfall gain to existing capital. Some of the tax cut will, however, accrue to foreigners, who undertake a substantial proportion of new investment in Canada.

Increasing CCA on new capital is a policy option whose mechanics are similar to those of reducing sales taxes on capital goods: only new capital is affected but there are also benefits to foreign investors. The results confirm the potential benefits of aligning CCA rates with economic lives where depreciation costs are not adequately covered. Such a policy change would reduce not only inter-temporal distortions but also inter-sectoral and inter-asset distortions.[26]

Reducing Personal Capital Income Taxes

The model indicates that cutting personal capital income taxes (that is, taxes on interest, dividends and capital gains) provides benefits about as large as reducing the sales tax on capital goods or aligning CCA rates with economic lives. The key avenue of effect here is that the tax reduction increases the pool of Canadian savings, which reduces the cost of capital for Canadian firms. This result depends importantly on the assumption that most induced savings will be invested in Canada. Canadians invest about 80 per cent of their wealth in Canada, and it is assumed that this average "home bias" applies to the additional savings induced by the tax cut.[27]

Reducing Corporate Income Taxes

Reducing the statutory rate of corporate income tax promotes capital accumulation by increasing the after-tax return to capital. This option is, within the confines of the model, a less cost-effective way to improve well-being than reducing sales taxes on capital goods and personal taxes on capital income. The gap with sales taxes on capital goods largely reflects the fact that the statutory rate reduction applies to both old and new capital. There are two key factors that explain the gap with personal capital income tax reductions. First, some of the corporate income tax cut will accrue to foreigners, who own a substantial portion of the Canadian capital stock, while the personal capital income tax cut applies to Canadian residents only.

Second, the corporate income tax rate reductions interact with CCA and adjustment costs. When CCA exceeds economic depreciation, as it does on average in Canada, firms receive a tax benefit on new investment from CCA that is valued at the corporate tax rate. Reducing corporate taxes therefore lowers the value of the CCA tax benefit.[28] Since there is no interaction between CCA and personal capital income taxes, reducing them has a larger impact on the effective tax rate on new investment than a revenue-equivalent reduction in the corporate income tax rate.

This effect is reinforced when the adjustment costs that firms must go through when they make new investments are taken into consideration. Adjustment costs, modelled in the form of temporarily lower production as firms invest, reduce taxable income since they are, in effect, immediately expensed. A corporate tax rate reduction increases the after-tax cost of this "expense." This also lowers the benefit of the corporate income tax rate cut for new investment. There is no parallel effect with personal capital income taxes.

The model result does not take into consideration any tax-planning effects. In 2000 Canada's combined federal/provincial statutory rate was the second highest in the Group of Seven (G-7), giving multinational enterprises (MNEs) operating in Canada an incentive to shift taxable income to other jurisdictions. As a result of the rate reductions in the Five-Year Tax Reduction Plan announced in Budget 2000 and rate reductions by some provincial governments, Canada's statutory tax rate is now below the average U.S. (federal-state) rate and in the middle of rates in the G-7 countries. The tax cuts implemented since 2000 would be expected to deliver two benefits: additional investment in Canada and additional revenue since MNEs now have less of an incentive to shift taxable income out of Canada. The model results may therefore understate the impact on economic well-being for Canada of corporate tax reductions.

Capital Tax Reduction

Capital and corporate income tax reductions have different impacts on economic efficiency despite the fact that, in the absence of risk, they are equivalent ways of taxing income from capital. The difference arises because of the interaction between corporate income taxes and CCA and adjustment costs discussed above. Since there are no parallel effects with capital taxes, this interaction causes the corporate rate reduction to give less of the benefits to new capital than a revenue equivalent capital tax reduction.

Note, however, that the model does not capture the risk-shifting aspect of the capital tax. Unlike corporate income taxes, capital taxes must be paid even if the investment is not profitable, which makes them more distortionary. For example, capital taxes add to the losses incurred by businesses during economic downturns and reduce the cash flow of start-ups and expanding firms. In other words, because they are profit insensitive, capital taxes increase the risk of investing to business more than corporate income taxes, which share the risks between the firm and the government. In fact, profit insensitivity is the principal argument in favour of reducing capital taxes. Since this feature is not captured in the model, the results clearly understate the gains from capital tax reduction.

5. Sensitivity Analysis and Comparison
With Other Studies

Sensitivity tests are implemented by performing the tax reduction simulations described in the section "Impacts of Taxation on Economic Efficiency" using alternative, yet equally plausible, values for important model parameters. This exercise reveals that the ranking of policy options is more or less unaffected, but that the point estimates do change substantially. This finding is consistent with results from other reviews of general equilibrium models.[29]

Another issue that can affect results is model design. The choice of the theoretical framework that underpins the functioning of a model is of great importance since different frameworks can affect the results. In addition, because modellers tend to refine some areas and simplify others, different results can be obtained even within the confines of a given theoretical framework. A recent survey of the general equilibrium tax literature conducted at the Department of Finance explores the issue of result consistency across general equilibrium tax models.[30] The study reviews results from seven general equilibrium models (including the one used in this paper) and finds that they paint a fairly consistent picture. All but one of the seven studies reviewed find that taxes on capital are the most distortionary, followed by taxes on wages and then taxes on consumption. Furthermore, although only three studies examine the issue, measures targeted towards reducing taxes on new investment only are found to be highly effective. The magnitudes of the numerical results do, however, vary considerably by model and country.

6. Conclusion

This paper uses a general equilibrium model to simulate the impact of tax reductions. The simulations suggest that taxes on saving and investment impose the highest economic costs, followed by wage and then consumption taxes. Measures targeting new investment and personal capital income tax are found to be especially potent. The model results suggest that changes in the structure of taxation could improve economic performance.

It is important to remember a number of caveats in interpreting the results. Some of the channels through which tax policy affects the economy are not modelled. For example, tax-planning effects, which can have significant impacts in some circumstances, are not captured in the model: in this case, the results may underestimate the impact of corporate income tax reductions. Further, the model does not provide information about the effects that altering the tax mix might have on capital and labour quality. Finally, the estimates could be affected if the model were enriched by including more types of capital, more than one consumer and a more detailed modelling of the rest of the world.

Lastly, this paper focuses entirely on efficiency, which is but one of the criteria according to which any tax system should be assessed. Since the other criteria are also important to judgement on tax policy, the analysis provided herein offers only part of a larger picture.


[1] In addition, some tax measures include special provisions for persons with disabilities. These measures are described in the Annex. [Return]

[2] The life-sustaining therapy must be administered at least three times each week for a total duration averaging not less than 14 hours a week, and it cannot reasonably be expected to be of significant benefit to persons who are not so impaired. [Return]

[3] A DTC transfer can be claimed on behalf of someone's (or their spouse's or common-law partner's) parent, grandparent, child, grandchild, brother, sister, aunt, uncle, niece or nephew. Brothers, sisters, aunts, uncles, nieces and nephews were added to this list by the 2000 changes. [Return]

[4] Since tax return data include detailed information on spouses, it can be shown that in the case of 16 per cent of DTC spousal transfers, or approximately 11,800 claims, the DTC-eligible spouse did not claim the credit himself or herself. If this same 16 per cent ratio were applied to DTC transfers from other adult relatives, there would have been an additional 8,400 transfers with no corresponding self claims, for a total of 20,200. [Return]

[5] Human Resources Development Canada, Disability in Canada: A 2001 Profile, p. 8. [Return]

[6] The measure of income used in this analysis is personal income, and does not take account of the financial support that DTC-eligible individuals may receive from family members. In addition, this measure excludes various forms of non-taxable income that are not reported on income tax returns, such as disability insurance benefits. [Return]

[7] These expenses can only be claimed if someone is eligible for the DTC. [Return]

[8] An individual with a severe and prolonged disability who claims the DTC can claim up to $10,000 in nursing home or attendant care expenses (up to $20,000 in the year of death). If this person's expenses for attendant care are higher than $10,000, he or she also has the option to include all of these expenses in the METC claim, but then the DTC cannot be claimed. [Return]

[9] The additional expenses associated with caring for a child under 18 with a disability are essentially recognized by the DTC supplement for children. There are also special child care deduction provisions for children with disabilities; these provisions are described in the Annex. [Return]

[10] Income tax interpretation bulletin IT-513R, published by the Canada Revenue Agency, notes that there is no specific definition for the term "mental or physical infirmity," and therefore the term "takes its ordinary meaning." This interpretation bulletin also notes that a temporary illness is not classified as an infirmity. [Return]

[11] Since these survey estimates will be compared with 2001 tax return data, the DTC eligibility criteria in effect in 2001 are used as the basis for comparison. [Return]

[12] The 1996-1997 NPHS Health Institutions Survey is the most recent survey of this population that provides a representative cross-section. [Return]

[13] The DTC certification form considers an activity limitation to be prolonged if it lasts for at least one year. PALS, however, asks individuals about activity limitations that have lasted, or that are expected to last, six months or more. The NPHS does not specify an amount of time when asking about activity limitations, but rather refers to "a person's usual abilities." It is possible, then, that the estimates of the DTC-eligible population derived from the survey data are too high, since the surveys consider a somewhat shorter timeframe than is used to determine DTC eligibility. [Return]

[14] Since the NPHS Health Institutions Survey was conducted in 1996-1997, the estimates are adjusted for population growth between this period and 2001. Since the large majority of individuals in health institutions are senior citizens, the adjustment factor used is based on growth in the 65+ population. [Return]

[15] For individuals under 65, $10,000 of total income is used as the threshold below which individuals are non-taxable and above which individuals are taxable. For individuals 65 or older who are eligible for the age credit, $15,000 of total income is used as the threshold for taxable status. An analysis of tax return data, which also includes information on taxable income, indicates that these thresholds work well. For children, data on parents' income are used. Technically speaking, virtually all DTC-eligible children transfer the credit to their parents or another family member, but these claims do not count as transfers in this discussion. The discussion of transfers that follows therefore pertains to DTC-eligible adults who can transfer the credit to a family member. [Return]

[16] With detailed data from previous years on the composition of METC claims, it is possible to show how many individuals with net METC claims above $16,000 made these claims for attendant care or nursing home expenses (individuals with attendant care expenses below this amount would be better off claiming $10,000 of expenses under the METC and the DTC). Taking individuals who did not claim the DTC, it can be shown that 83 per cent of seniors with high METC claims and 20 per cent of those under 65 with high METC claims had attendant care or nursing home expenses. These percentages can be applied to the 2001 data on METC claims. [Return]

[17] For the purposes of the caregiver credit, an infirm dependant relative could be someone's (or their spouse or common-law partner's) parent, grandparent, brother, sister, aunt, uncle, niece or nephew. [Return]

[18] The credit amounts and income thresholds for these three credits are fully indexed to inflation. [Return]

[19] The sum of employment income, net of deductions for registered pension plans, union dues and other employment expenses, plus net self-employment income. [Return]

[20] These particular arrangements for claiming the METC on behalf of dependants were proposed in the 2004 budget. [Return]

[21] Earned income includes employment and self-employment income, scholarships, bursaries, fellowships, research grants, amounts received under a federal program to encourage employment and disability benefits under the Canada or Quebec Pension Plan. [Return]

[22] The useful life and the rate of capital consumption allowance of the single capital good do, however, vary by industry. [Return]

[23] Maximilian Baylor and Louis Beauséjour, "Taxation and Economic Efficiency: Results from a Canadian CGE Model," Department of Finance Canada working paper (forthcoming), www.fin.gc.ca/access/ecfisce.html. [Return]

[24] The simulated tax reductions represent small changes, not a fundamental restructuring of the tax system. [Return]

[25] A reduction in property taxes is not included in this calculation. [Return]

[26] These impacts are not captured in the model since, as indicated earlier, it contains only four industries and one representative capital good. See John Whalley, "Efficiency Considerations in Business Tax Reform," Working Paper 97-8, Technical Committee on Business Taxation, Ottawa for a discussion of the estimates of the efficiency gains from a more neutral corporate income tax system. Note that setting CCA rates in excess of economic lives would have negative effects because the tax system would distort the true economic cost of using a capital asset. In addition, "accelerated" CCA can encourage economically costly tax-planning activities. [Return]

[27] Theoretical arguments can be developed to support or refute this assumption, and empirical work does not provide firm guidance on the issue. The results are also affected by the assumption that the marginal source of investment funds for Canadian corporations is a taxable domestic resident. If the marginal source were a foreigner or a domestic tax-exempt resident, the cost-effectiveness of reductions in personal capital income taxes would be smaller. In this case, the existing empirical evidence points to the marginal supplier being a taxable resident. [Return]

[28] If CCA were on average less than economic depreciation, firms would be paying a tax penalty on new investment. In this case, a reduction in the statutory rate would result in a smaller penalty, which would favour investment in new capital and raise the cost-effectiveness of the corporate tax cut. [Return]

[29] See Kenneth Judd, "The Welfare Cost of Factor Taxation in a Perfect-Foresight Model," Journal of Political Economy, 1987, Vol. 95, No. 4 for a particularly convincing exposition. [Return]

[30] Maximilian Baylor, "Ranking Tax Distortions in Dynamic General Equilibrium Models," Department of Finance Canada working paper (forthcoming), www.fin.gc.ca/access/ecfisce.html. [Return]

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