By Justin Hatherly
AIMS on Campus Fellow
The Maritime provinces have tried a diverse range of economic development strategies, largely proven to be costly failures. After decades of regional development spending, equalization and enhanced unemployment benefits, Nova Scotia, New Brunswick and P.E.I. still have per capita incomes substantially below the average for the nation. The only thing that these provinces have yet to seriously try is market reforms that have a proven record of working in other jurisdictions.
If Nova Scotia were serious about improving its economic performance, a good place to start would be reducing the high marginal tax rates the province levies on personal income. At present, income taxes in Nova Scotia range from 8.79 percent to 21 percent. When combined with the highest federal bracket of 33 percent, this means that the combined top tax rate in Nova Scotia reaches a punitive 54 percent.
Economic theory and empirical evidence suggests that high tax rates on personal income have an adverse effect on long-run economic growth. For example, according to the OECD, lower marginal tax rates contribute to both faster economic growth and an increased labour supply.
High income tax rates reduce economic growth through two main channels. Firstly, higher tax rates increase the attractiveness of leisure relative to work. For instance, at a 50 percent marginal tax rate, an individual would only be only able to keep 50 cents of any additional dollar that he or she earns. By contrast, at a 20 percent marginal tax rate, a person could keep 80 cents of each additional dollar. Thus, the higher that marginal income tax rates go, the more expensive work becomes (as one keeps less of one’s income) and the cheaper leisure becomes (as one would be giving up less income than one would in a lower tax environment). As such, high tax rates, by distorting relative prices and tradeoffs between work and leisure can reduce incentives to work and reduce economic growth.
Secondly, high personal income tax rates also reduce economic growth by discouraging improvements in human capital (i.e. the skills and knowledge of the workforce). For instance, a medical student who would probably take on large amounts of debt to finance his or her education might be discouraged from doing so by high tax rates. This is because the after-tax return on doing so would have declined. Though a doctor is likely to be a high-income earner, high tax rates reduce the rewards and increase the opportunity cost of entering such professions. As such, at the margin high taxes reduce the accumulation of human capital in an economy.
Given the uncertain fiscal situation faced by the Maritimes, it is unlikely that the provinces can undertake immediate, unfinanced reductions in tax rates. However, to boost long-term economic growth, it is essential that, as soon as the budgetary situation is resolved, the provinces commit to lowering their high-income tax rates.