Beware unintended consequences of fiddling with OAS clawback
It’s difficult to pass a week without seeing another attack on the Old Age Security pension in the media. Attention is often drawn to the fact that taxpayers with incomes over $150,000 still receive at least a partial amount.
The culprit most often identified is the so-called clawback, an income tax provision that taxes Old Age Security (OAS) at a 15 per cent rate, starting at a taxable income above $90,000 in 2026. The usual remedy is lowering the clawback’s starting income well below the current threshold.
Ostensibly, the goal is to take OAS away from rich seniors who really don’t need this income. But another framing of this argument is that tax rates on better-off seniors should increase because they don’t need all their income.
The implicit goal of increasing the progressivity of Canada’s tax and transfer system is laudable; the problem is the specific remedy. To claim the fault lies entirely with the clawback is myopic and piecemeal.
To start, a recent report of Canada’s Auditor General noted the government doesn’t even have clear objectives for the OAS. Historically, the OAS has served both as an anti-poverty measure, in combination with the Guaranteed Income Supplement, and to maintain continuity of income after retirement from working, in combination with the Canadian and Quebec Pension Plan.
Regardless, the progressivity of the tax and transfer system, including specifically for the 65-plus population, can be increased in many ways.
The most obvious is to increase income tax rates at higher incomes. Others could involve cutting the age deduction, or tightening the limits for Tax Free Savings Accounts.
But as soon as we start thinking about such alternatives, we enter the thicket of complexity. Canada’s tax and transfer system is encrusted with decades of piecemeal policy initiatives. Cavalierly touching just one part risks serious unintended consequences.
So it is with the OAS clawback.
The 15 per cent clawback starts at just above $90,000, but is stacked on top of federal and provincial income tax rates. The result: an individual in Ontario with $100,000 income faces a higher tax rate than anyone with income over $260,000 (54 per cent compared to 48 per cent).
The simplistic suggestion of lowering the starting clawback income would make this worse: middle- and upper-middle income individuals would start facing unusually high tax rates.
Even if you do not know your tax bracket, you probably understand that your RRSP savings, drawn down through a Registered Retirement Income Fund, will face a stiff rate of tax. So, too, would any income earned by working after age 65, an increasing trend. Investment income would also face these higher tax rates.
Canada’s tax system has been paying out money for almost half a century. Cash transfers, paid out through programs like OAS, can be seen as negative taxes; alternatively, refundable income tax credits can be seen as spending programs.
Indeed, Canada’s Tax Expenditure Account, published by the Department of Finance, shows the budgetary costs of dozens of tax provisions as if they were actual spending programs.
Focusing on OAS, and more narrowly on the clawback, is a failure to understand the full nature of Canada’s tax and transfer system. What really matters is their net effects on individuals’ disposable incomes—the impacts of all cash transfers and taxes together, given an individual’s earnings and investment incomes.
The joint impacts of cash transfers and income taxes on an extra dollar of income—individuals’ marginal tax rates—also matters. These rates can have major effects on incentives, whether to work after the usual retirement age, and how best to save for retirement.
The simplistic remedy of reducing the starting income of the OAS clawback could have the unintended consequence of seriously and adversely affecting these incentives at middle-class incomes.
Beyond this, however, lies the thicket of tax and transfer complexity—not an area one enters lightly. To increase the progressivity of the tax and transfer system for older Canadians, as pushed naively by recent attacks on OAS, requires a much smarter approach, with expertise, data, and simulation models.
The federal government must take a holistic approach to significant tax changes that involve Canada’s seniors—unfortunately a rarity in Canadian public policy.
Governments so far have not shown themselves up to this task.
Some sort of ongoing Observatory, possibly building on the recently created non-partisan Canadian Tax Observatory, is a promising path forward for Canada.
Michael Wolfson’s career included policy analysis in tax policy, finance, and as the former assistant chief statistician at Statistics Canada. He is a current member of the University of Ottawa’s Centre for Health Law, Policy and Ethics.
The Hill Times