Tax Free Savings – Who benefits?

My public writing took a bit of a hit in late 2014. Between DEEP, the campaign and a determined push to put together a first draft of my PhD, there weren’t enough work hours left to do much writing. Not much has changed right now but there are a slew of topics that (I think) warrant discussion, in particular changes to Canada’s immigration system, declining oil prices, and what a real middle class economic plan looks like. That said, I’ll start the year with something I’ve been thinking about for about two years now. Tax Free Savings Accounts (TFSAs).

My interest is two-fold. First, assuming part of the TFSA’s purpose is to help increase savings amongst low-income Canadians (traditional non-savers), is the TFSA an effective means of increasing this? And second, dependent somewhat on that outcome, does it actually perpetuate growing inequality given the benefits the TFSA offers to people with wealth over those dependent on income (see Thomas Piketty’s work for example).

In theory TFSA’s are a gift to savers from all income brackets as they allow you to accumulate capital gains tax free. Introduced in 2009 with a contribution ceiling of $5,000 per year, the Conservatives promised in 2011 to double that ceiling to $10,000 per year once the budget was balanced.  I’ve had several people comment to me that they’re looking forward to that move, and from a strictly individual/rational point of view, why wouldn’t they.  They already save, and this will allow them to earn more on their savings. Rational, logical, check.

However from a policy perspective, in particular one that is more concerned about making sure that we let as many people as possible on the economic ladder, I’ve always wondered whether the TFSA actually made sense as an incentive for people who struggle to save in the first place. This is an important question to ask, IMO, as given the impact on tax revenues (eventually upwards of $10 billion if the ceiling is doubled and contributions maxed out according to UBC prof Kevin Milligan), we’re really facing a choice between policy levers (assuming we’re somewhat progressive and want to help those who struggle to save in the first place).

Others have asked the same/similar questions. In a 2012 edition of the Canadian Tax Journal, Maureen Donnelly and Allister Young look at the UK’s Individual Savings Account (ISA), broadly similar to the TFSA, to see what impact it has had for low-income earners.  A decades worth of data from the UK highlights that the ISA has not in fact made a significant impact on the savings behavior of low-income individuals or households. The authors note in fact that “The introduction of ISAs has done little, if anything, to break down the barriers to saving faced by low-income individuals The authors also find that the ISAs, over time, are used increasingly by high-income individuals/families, and are used as a means of transferring income from high-income earning spouses to low-income ones.

At the time of the TFSAs introduction in Canada, analysis by then RBC Chief Economist Paul Ferley and his colleague Derek Holt argued that TSFAs were likely to be used by middle- and upper-income earners, not by lower-income earners. They also noted that it wasn’t certain that we’d actually see increased savings, rather instead we’d see transfers of existing savings into this new tax-free vehicle.

So, have these two scenarios happened? It’s actually quite difficult to tell.

On one hand, participation by those with incomes over $80,000 is approximately double that for those under that threshold. And participation, as expected, decreases significantly as income decreases. And even these levels of participation should come with a rather large asterisk given that about 30% of all TFSA accounts have never received a contribution. It’s a rather safe assumption that a good chunk of those 3.4 million empty accounts are on the low-income side of the ledger.

As for actual contributions, here it’s even harder to see what is happening. In 2013 the Ministry of Finance released some information as part of its annual Tax Expenditures Report as a “Profile of TFSA Account holders”.

The data shows that approximately 50% of total contributions in 2011 were made by those earning less than $50,000. (Note that I’ve eyeballed this as they don’t actually give you the data…..) Based on the participation rates provided, this would work out to an average contribution of approximately $3,000 per account holder. That’s a lot higher than I would have anticipated.  Unfortunately there’s no breakdown of average contributions per income bracket, nor is there any analysis provided as to whether this is new savings or the transfer of existing savings into this new tax-free vehicle.

I find the omission of those two points quite strange. If you were going to defend/advocate for this type of policy, and claim that it helped low-income earners, those are probably the first two data points you’d assume someone would ask for. That they haven’t makes me think they don’t look good.

What we do see in this release is that high-income Canadians use the TFSA aggressively and are far more likely to max it out. They’re rational, logical people so good for them.

But if all of this is premised on wanting to help low-income Canadians save for a rainy day, then, given the data I can find, I’m far from convinced that this is the most effective way to do it. And this shouldn’t surprise anyone. Unless we target the roots of low savings rates, i.e. low incomes and less disposable cash, then we won’t actually make a dent in the percentage of those able to participate in such savings schemes. And if we’re concerned about inequality then this is pretty much the opposite of what we should be doing to address it.

What could we do instead of doubling the TFSA ceiling?

First, cut income taxes for low-income earners/raise the personal credit. This would put more money in the hands/wallets of those who currently need it most. Do it. Do it now. It helps low-income individuals, young adults, single parents, etc etc. Do it.

Second, accompany that cut in income taxes with a matched savings programs for low-income households/individuals. Here’s an example.  As it stands, the Basic Canada Education Savings Grant (RESP) sees parents get upwards of a 20% match from the government for investment in their children’s education. Low-income parents can get an additional 10-20% on the first $500. Why not increase the value of the government match on the RESP for low-income Canadians? And why not offer similar matching schemes for individuals who want to save for further education/reskilling/retraining?  Of if the worry is savings for retirement, why not simply provide a match for low-income savings for specific use post-specific age (…CPP…)?  I’m sure others have better ideas.

Ultimately, the TFSA is great if you have cash to spare. But in a society where far too many have a very different and very real problem involving having too little cash to save, our policy focus should be on helping them. Given the data I have seen, the TFSA doesn’t do an effective job of this given the amount of money spent on the program. There are other, far more effective ways of increasing savings amongst low-income Canadians.