Governments spend a tremendous amount of energy and money on tax policies related to children. To some extent, this attention may reflect a raw political calculation about who is most likely to vote and what kind of election promise will appear most tantalizing to the targeted voters. However, there is also a strong public policy case for child-focused tax measures. In the case of children, the instincts of politics and policy are broadly aligned.
While the policy case for child benefits is strong, our current way of delivering child benefits in Canada is broken and needs to be reset. It has become a tangled mess with too much overlap, obscured work incentives and confusion for everyone involved.
There is a logical foundation for differential treatment of families with children under our tax system. However, trying to make good on this principle of special tax treatment for children has resulted in overwhelming complexity. For example, a family in British Columbia in 2012 had to assess its eligibility for ten separate child-focused tax measures. These benefits cross paths, conflict and confuse. The way forward, I suggest, is to rationalize the cornucopia of credits into one delivery method (I propose a refundable tax credit), to remove overlap by consolidating existing measures into fewer programs, and finally to impose a seriously simplified structure on the whole system.
I limit my focus to straight income transfers delivered through the tax system, leaving aside tax credits for child-related expenditures such as childcare or fitness expenses as well as the expenditure side of the government budget (education, social assistance). I also keep my focus on federal and provincial systems excluding Quebec, since the particularities of the Quebec income tax and transfer system require a separate treatment I cannot accommodate in this article.
Why do we have specialized tax treatment for families with children?
Imagine two families of equal income, each with three members of varying ages. If one of the families had two children and the second had one, why should the family with more children be treated differently by the tax system? What makes a human aged five different from a human aged 25 from the point of view of the government? There are two types of answers to these questions. One is a concern for equity between families with children and those without. The second involves the quality of parental decision-making when investing in children – or “efficiency,” in the cold language of economists. I explore both the equity and efficiency arguments below.
Equity concerns define key objectives of tax policy. Tax systems contain progressive elements that attempt to shift some of the tax burden away from those who are struggling toward those who are doing well. Is there any particular equity reason to favour the five-year-old in a struggling situation over the 25- or 65-year-old in a similar situation? From my point of view, while there may be strong efficiency considerations (discussed below) for age differentiation, for equity all human beings ought to be considered equally. Taking this humans-first point of view helps to clarify and strengthen several arguments about the tax treatment of children.
Some commentators wonder why those who choose to have children should receive special tax benefits compared to those who choose to remain childless. In the words of Rhys Kesselman, the question is whether children are a consumption choice, like buying a “fancy boat,” or something special.1
Ken Boessenkool and Jim Davies argued that parents have a “moral and legal obligation” to care for children, and therefore expenditures on children are not discretionary.2 This obligation argument, however, does nothing to dispense with the original question of why parents who choose to take on such an obligation deserve tax relief compared to similar adults who do not. Moreover, the obligation argument would apply without much stretching of credulity to pets, and as yet there doesn’t appear to be any strong sentiment to extend tax benefits beyond homo sapiens.
The resolution is to view the tax benefits as accruing to the children themselves rather than to their parents. The income tax system accords all tax filers a “Basic Amount” meant to exclude from taxation an amount commensurate with expenditures for the basic necessities of life. As a human being, each child should be able to make a similar claim. Children do not choose to be born, but when they are born they arrive with basic rights and protections. Among these should be the right to enjoy a basic level of consumption free of taxation just as adults do. However, since children do not file taxes, it is convenient to transfer their Basic Amount to their parents, as stewards of the children’s livelihood. This justification for special tax treatment of children as humans avoids questions of what choices a child’s parents have made, and clearly distinguishes children from other entities to which parents may have moral and legal obligations.
Beyond the equity justifications are efficiency arguments for child-centred tax policy. By efficiency here, I mean minimizing misguided decision-making by parents. The misguided decisions of parents could result from incomplete or erroneous information, or from parents’ capacity to interpret available information to make effective choices. These are important problems, but not ones that income tax–based transfers can remedy. What income tax–based transfers can do is provide funds that improve the quality of the environment in which children are raised.
There is strong evidence that ensuring that children receive adequate nutrition and educational stimulation pays high returns. In most families, these requirements are provided adequately by parents. However, some families struggle. There is new evidence on how much this matters. For example, researchers in the United States have examined the long-run impact of providing assistance through Food Stamps by comparing across counties that implemented the program earlier versus later in time.3 They find improved adult health outcomes for those exposed to Food Stamps as children, as well as improved economic outcomes for women.
In some of my own research with Mark Stabile, we find evidence that the expansion of child benefits in Canada has contributed to higher educational and mental health outcomes among lower-income Canadian families.4 Relieving the stress on tight family budgets seems to result in better outcomes for children, at least among the most disadvantaged. As much as lower-income parents might like to make these investments in their children, those in the tightest economic circumstances may lack the ability to finance the investments through borrowing or other means. Providing funds through child transfers ensures that parents have the capability to implement high-return investments in their children.
In addition to investments in children, two other efficiency aspects are important for the design of child benefits. First, there is often a pro-natalist motivation for child benefits. If there are positive benefits that accrue to society as a whole (through, for example, a net lifetime positive fiscal contribution or the continuation of a threatened culture), then an incentive to parents to have children may be justified as a way of alignijng their incentives with those of society. Second, the design of child benefits has proven to be very important for labour market decisions. The Earned Income Tax Credit in the United States and the National Child Benefit in Canada both targeted extra benefits to those who left social assistance to join the work force, and evidence suggests that these incentives have been successful.
A complicated web of programs
The current system of refundable tax credits delivered through the tax system began to take its current form in the early 1990s with introduction of the Canada Child Tax Benefit and the Goods and Services Tax Credit. This new structure for refundable tax credits has two main features. First, while part of the income tax system, these benefits are delivered by monthly or quarterly cheques sent directly to families rather than through refund cheques after tax filing. Second, the size of the benefit is determined by the sum of the incomes of the two parents, with benefits tapered down to zero as income rises above a certain cutoff point.5 This allows a fairly precise targeting of benefits to families according to a measure of family income that is both readily calculated and a fairly good index of need.
Many federal and provincial child benefits are part of this refundable tax credit system. Beyond the refundable tax credits, a number of additional child benefits have appeared in recent years. Below, I provide a brief description of the different elements introduced over the last 20 years. To help the reader keep things straight, I avoid acronyms and leave out the numbers.
The core of the system is the Canada Child Tax Benefit, introduced in 1993. This benefit was a successor to three separate child benefits: the old Family Allowance program, a refundable child tax credit and a nonrefundable child tax credit. The new Canada Child Tax Benefit took the form of a refundable tax credit as part of the income tax system, but was delivered monthly. Because it was phased out all the way to zero as family net income rose, this new benefit removed the universal recognition of children from the tax system, as children with higher-income parents no longer received recognition.
In 1998, the federal government instituted the National Child Benefit, which built on similar programs in British Columbia instituted a few years earlier. This program has a federal and a provincial component. Federally, there is an income transfer aimed at lower-income families with children. Provincial governments were to subtract these federal benefits from social assistance cheques, and the “savings” so generated were to be turned into new program spending by the provinces available to all lower-income families with children (not just those on social assistance) in an attempt to lower the “welfare wall.”
Among these newly created programs were a host of provincial child benefits delivered as part of the refundable tax credit system. As the National Child Benefit program has evolved, several provinces (notably Ontario) have changed from explicitly subtracting the National Child Benefit Supplement from social assistance cheques to a new regime in which the social assistance payment schedules themselves were changed to recognize the existence of the federal benefit. Because the National Child Benefit no longer explicitly reduces social assistance cheques, the calculation of the provincial “savings” is no longer straightforward. This weakens the historical legacy of the benefits-for-new-spending deal made in the 1990s.
In addition to these federal initiatives, several provinces have added refundable tax credits for specific items. For example, British Columbia added the Low Income Climate Action Tax Credit as part of the provincial carbon tax. Several provinces added a Harmonized Sales Tax credit when they merged their sales taxes with the federal Goods and Services Tax. These tax credits, explicitly tied to other tax initiatives, compensate low-income families in whole or in part for the extra taxes they pay elsewhere.
Since the election of the federal Conservatives in 2006, developments have taken place outside the system of refundable tax credits. There are three noteworthy items. First, the Universal Child Care Benefit was introduced in July 2006 as an explicit replacement for the previous government’s childcare policy. This benefit is included as taxable income of the lower-income partner, rather than as a refundable tax credit. Second, a nonrefundable Amount for Children tax credit for each child was added in 2007. Several provinces now also provide a similar credit as part of their own income tax calculations. Finally, the Working Income Tax Benefit was introduced in 2007 to provide further incentives for lower-income Canadians to join the labour market. For some provinces, this federal benefit is implemented with special consideration for the number of children in the family.
Taken together, this 20-year policy development has produced a system with four positive features. First, the nonrefundable child credits and the Universal Child Care Benefit have restored an element of universality to the system. As argued earlier, all children, as human beings, deserve some recognition under the tax system. We don’t take away the Basic Amount from higher-income adults filing income tax returns; neither should we remove all tax recognition of children who happen to have higher-income parents. Second, there is strong redistribution toward those with lower incomes under the current system. Some of my own research has shown that these transfers have been vitally important to boosting the incomes of struggling families over the past two decades.6
Third, the system respects federalism by allowing provinces to implement different policies within a common framework. This flexibility is not some misguided respect for an allegedly outdated constitutional obligation. In this case, federalism provides a tangible benefit by allowing policy to match circumstances that vary across the country. Finally, the system provides stronger labour market incentives for those who are struggling to maintain their attachment to the labour force. In particular, the growth of employment for single mothers over the past 15 years has been remarkable.7
Along with these positive features, however, there is a large and potentially dominant negative feature: the system has become extraordinarily complicated. As one example, a family in British Columbia in 2012 could potentially be eligible for ten separate tax benefits for families with children: six federal and four provincial. Federally, there is the Canada Child Tax Benefit, the National Child Benefit Supplement, the Universal Child Care Benefit, the Working Income Tax Benefit, the nonrefundable Child Amount and the Goods and Services Tax Credit. Provincially in British Columbia there is the B.C. Family Bonus, the B.C. Earned Income Benefit, the B.C. Harmonized Sales Tax Credit and the Low Income Climate Action Tax Credit. Each of these credits on its own has a justification, and many, taken one at a time, are well designed to achieve their intended purpose. However, taken as a whole, it is hard to envision a more complicated web of programs.
This complexity comes at a cost. First, voters do not understand how the system works. In my personal experience talking with voters during the Harmonized Sales Tax referendum in British Columbia in 2011, many voters were unaware they were now receiving the enhanced Harmonized Sales Tax Credit. Given the complexity of the system, they could hardly be blamed.
Second, the complexity obscures the labour market incentives many of these tax credits are designed to create. Evidence suggests a great deal of success for initiatives like the National Child Benefit in improving labour market attachment of lower-income parents. Yet it is hard to believe that a complex, narrowly targeted tax credit like the Working Income Tax Benefit, when added to the stew of other programs, and delivered once a year as a footnote to the tax forms, would readily be incorporated into the decisions of many families. However precisely designed the incentives may be, they are obscured from view.
Finally, there is overlap and waste. As one example, why are there two federal elements designed to improve labour market attachment (National Child Benefit and Working Income Tax Benefit), while the Universal Child Care Benefit does the opposite? As another example, for delivering core benefits to families with children, could not the slew of separate programs just be rolled into the existing refundable Canada Child Tax Benefit? How sure are we that the total net benefits to families across these programs make sense? This complexity is a serious impediment to achieving the goals of the child benefit system.
A vision for structural reform
The first priority for reform of child benefits in Canada must be simplification. I don’t take a stand here about whether the system needs to be more generous to particular parts of the income distribution. Instead, the reforms I advocate are to the structure of the system. Some might prefer that we take as the highest priority increasing the transfers to those in low income; others might argue for further tweaks to the work incentives in the system. To my mind, the effectiveness of reform in either of those directions would be obscured by the complexity of the current system. To make an analogy, before we fine-tune the payload we place within our child benefits vehicle, we need to ensure the vehicle itself is roadworthy.
- A reformed child benefit system needs to be centred on three key features:
- Bring the delivery of benefits together under the refundable tax credit method.
- Consolidate the number of benefits to remove complexity and overlap.
- Deliver the refundable tax credits using a unified, simplified structure.
First, we need to choose one way to deliver child benefits. The system currently uses four different delivery methods: (a) refundable tax credits paid monthly or quarterly (for example, the Canada Child Tax Benefit); (b) refundable tax credits delivered once a year when income taxes are filed (the Working Income Tax Benefit)8; (c) nonrefundable tax credits (like the Amount for Children introduced in 2007); and finally, (d) directly paid benefits counted as income rather than tax credits (Universal Child Care Benefit). I see no advantage to having such an array of delivery methods.
Among these four options, the best way to deliver child benefits is the refundable tax credit, paid frequently. For those on low incomes, paying out benefits once a year when taxes are filed is too infrequent – funds are needed on a more continuous basis throughout the year.9 Refundable credits also allow very precise targeting of benefits using family net income as the indicator of family need. Using refundable tax credits, it is possible to come very close to reproducing the distribution of benefits currently sent through the Universal Child Care Benefit or the nonrefundable Amount for Children. We cannot do the same, however, using direct taxable benefits or nonrefundable tax credits. Their value varies widely depending on other aspects of the family’s tax return. This makes refundable tax credits – timely, flexible and transparent – the best delivery method.
Second, we need to consolidate the number of benefits. We have consolidated and simplified benefit programs before. In 1993, the Canada Child Tax Benefit was formed as a successor to three different child benefits. We need to repeat this exercise. Separate existence of the Universal Child Care Benefit and the nonrefundable Amount for Children is hard to justify. These should be rolled into the Canada Child Tax Benefit. Similarly, separate “branding” for the National Child Benefit could be questioned. It too could be rolled into a consolidated family benefit. Provincially, similar consolidations could occur.
For certain benefits tied to other tax measures (such as the Goods and Services Tax Credit) the importance of continuing the tie to the tax measure might outweigh the gain in simplification, which argues for a continued separate existence. The reward from consolidation is to simplify the alphabet soup that confronts families as they try to understand the benefits they are receiving. It also holds the possibility of improving the targeting of benefits through the removal of overlap.
Finally, we need to force the surviving and consolidated child benefit programs into a simplified and streamlined system. The key focus here is how benefits are clawed back as income rises. The current method of assigning benefits has too many overlapping income phase-out ranges and phase-out rates. I offer one possible suggestion on how to do this below, but the particulars of my suggestion are not as important as the principle – it needs to be much simpler.
One of the reasons for the current complexity is the great flexibility that the provinces and federal government have in designing their benefits. Provinces already give up some flexibility when they have the Canada Revenue Agency deliver their child tax benefits. This flexibility needs to be further constrained to improve the simplicity of the system. All benefits, both federal and provincial, need to adhere to a more rigid, unified structure. To get the provinces to agree to this, the federal government can do as it currently does with the existing agreements to administer taxes and benefits – continue to offer the provinces a very good deal for the Canada Revenue Agency’s handling of the administration of child tax benefits.
What would this unified structure look like? One idea is to have two distinct and clear tiers of benefits. All existing or new benefits, whether federal or provincial, would have to be placed in either the Tier 1 “bin” or the Tier 2 “bin.” Tier 1 benefits would be focused on those in greatest need. Tier 2 benefits would extend, at least in part, to those further up the income scale. As in the current system, the amount of benefits in each bin could vary by number of children, province and other family characteristics. A recipient could still receive a payment slip with the full name of each program to ensure that provincial programs and explicitly tied tax credits continue to receive their proper attention.
To attain the desired targeting, the system would phase out both tiers of benefits with higher family net income, as the current system does. However, the phasing out would happen in a simpler and more unified way. There would be two income cutoff points. No benefits would be reduced until income reaches the first income cutoff point. Tier 1 benefits would be phased out in the range of family income between the first and second cutoff points.10 Tier 2 benefits would be phased out above the second cutoff point at some fixed phase-out rate (perhaps 5 per cent). This is not terribly different from the current structure of the Canada Child Tax Benefit and the National Child Benefit Supplement and accompanying provincial programs, which are phased out over separate ranges. To preserve an element of universality, Tier 2 benefits could be reduced down to a floor of $500 rather than all the way to zero.
The two income cutoff points might be anchored at half the median income and right at the median income. It might be desirable to have the cutoff points vary by province, or across one- and two-parent families. Those under half-median income are considered by standard norms to be low-income families. Tier 1 benefits would especially target these families, then be phased out for those above that low-income line. Similarly, anchoring the cutoff for Tier 2 benefits at median income can be defended by arguing that benefits should be focused most on those up to the middle, as those in the top half have less need for government assistance.
This two-tier structure would require some large changes. As just one example, the 2012 Goods and Services Tax Credit was phased out for incomes above $33,884, which is far below the median family income. If this credit were placed in Tier 2 under the proposed structure, more Canadians would be eligible for the credit as it would only begin to be reduced at a higher income level. That might be desirable, but it would cost the government more.
One barrier standing in the way of such a reform is resistance from those who desire historical continuity with the legacy benefit programs. For example, the National Child Benefit was conceived as a specific trade of federal benefits to replace a portion of provincial social assistance. If the National Child Benefit were to disappear in name, some might be concerned about the survival of the historic legacy of the spending programs tied to the National Child Benefit.. As another example, the federal Conservative government implemented the Universal Child Care Benefit as an explicit counter to the previous government’s national childcare plans. Given the political attention it received and the party’s association with the policy, there would likely be reluctance to see it disappear. Political symbolism is an important motivating force in policy, but it would be unfortunate if it blocked necessary reform.
While I believe the whole system needs reform, there are some incremental changes that may be more attainable in the short run. For example, consolidation of federal benefits does not require provincial agreement, and so could proceed more easily.
A difficult project
I began by making a child-centred case for special treatment of families with children in the income tax system. Children are human beings, and thus deserving of the same form of basic tax relief we offer adult human beings. I then reviewed the current state of Canada’s child benefits delivered through the income tax system, cataloguing the complex array of benefits to which families may be entitled. Finally, I have presented a vision for structural reform with the goal of unifying and simplifying the system.
A reform along the lines of the reset that I suggest would be a very difficult project. I don’t argue otherwise. Some incremental reforms (such as the consolidation of federal benefits) could proceed more quickly, but the ultimate goal of simplification will require provincial participation. The end result would be a system in which Canadians could more clearly identify the benefits they receive and governments could with greater confidence deliver the benefits where they are intended and most needed.
1 Jonathan Rhys Kesselman, “The Child Tax Benefit: Simple, Fair, Responsive?”, Canadian Public Policy, Vol. 19, No. 2 (1993), pp. 109–32.
2 Kenneth J. Boessenkool and James B. Davies, Giving Mom and Dad a Break: Returning Fairness to Families in Canada’s Tax and Transfer System, C.D. Howe Institute Commentary 117, November 1998.
3 Hilary Hoynes, Diane Whitmore Schanzenbach and Douglas Almond, “Childhood Exposure to the Food Stamp Program: Long-run Health and Economic Outcomes,” NBER Working Paper No. 18535, 2012.
4 Kevin Milligan and Mark Stabile, “Do Child Tax Benefits Affect the Wellbeing of Children?: Evidence from Canadian Child Benefit Expansions,” American Economic Journal – Economic Policy, Vol. 3, No. 3 (August 2011), pp. 175–205.
5 In practice, this “net family income” measure is formed by adding the “net income” from line 236 of the income tax form for both adults living as married or common-law spouses in the household. There are different cutoff points for different benefits.
6 I find that the evolution of refundable tax credits has knocked about three points off the percentage of Canadian families on low incomes. See “Income Inequality and Income Taxation in Canada: Trends in the Census 1980–2005,” School of Public Policy Research Paper Volume 6, Issue 24. August 2013.
7 Among single mothers with children aged 0 to 17 in 1995, 52 per cent were employed. In 2011, this proportion had risen to 70 per cent. Mark Stabile and I tie these trends directly to the structure of the National Child Benefit. See “The Integration of Child Tax Credits and Welfare: Evidence from the Canadian National Child Benefit Program,” Journal of Public Economics, Vol. 91, No. 1–2 (February 2007), pp. 305–26. Of course, other factors also contributed to this increase in work, such as changes to social assistance through this time period. See John Richards, Reducing Lone-Parent Poverty: A Canadian Success Story, C.D. Howe Institute Commentary 305, June 2010.
8 There is an option for prepayment of the Working Income Tax Benefit, but I have learned in discussions with federal officials that this option is not well used.
9 It should be noted that the “fiscal year” for refundable tax credits runs from July 1 to June 30, with benefits based on the previous year’s income tax filing. So while frequent payments avoid lumpy one-time payments when taxes are filed, they are somewhat deficient in timeliness. A different model is found in the Saskatchewan Employment Supplement, which uses monthly earnings to determine eligibility and payments in a much more timely fashion.
10 With fixed cutoff points, the actual phase-out rate would be defined differently according to circumstance. For example, if there were $2,500 of benefits to be phased out over a range of $25,000, then the necessary phase-out rate would be 10 per cent. On the other hand, another family might have only $250 to be phased out over that range and so would face a phase-out rate of only 1 per cent. This kind of phase-out is currently seen in the National Child Benefit Supplement and related provincial programs.