As a result First World War funding demands, the federal government brought in personal income and corporate income taxes in 1917. A federal sales tax followed in 1921.
Personal income tax marked a shift in federal tax philosophy. In the first 50 years after Confederation 150 years ago, the ethos was that taxing incomes weakened Canada’s competitive position. That changed in 1917.
Federal personal income tax arrived on Sept. 20, 1917. A four per cent tax was imposed on all income of single people (unmarried persons, widows or widowers without dependent children) over $1,500. For everyone else, the personal exemption was $3,000. In today’s dollars, the exemptions were worth approximately $24,500 and $50,000 respectively.
For married Canadians with dependents and an annual income greater than $6,000 (approximately $99,500 in today’s dollars), the tax rate ranged from two to 22 per cent.
However, because of the relatively high exemptions, only two to eight per cent of individuals filed returns during the initial years of the federal personal income tax. Indeed, personal income taxation remained a relatively modest source of federal government revenue until the Second World War.
The Second World War dramatically expanded the federal personal income tax, with the most notable change being the introduction of high marginal tax rates. For example, the pre-Second World War marginal rate on taxable income between $1,000 and $2,000 was four per cent. By 1942, it had increased to 44 per cent. For taxable income between $10,000 and $15,000, it was 13.7 per cent before the war but 69 per cent by 1942.
While marginal tax rates came down after the war, they remained substantially higher than they had been before the war. And the proportion of the population having to file income taxes rose over time. While only 2.3 per cent of the population filed personal income taxes in 1938, by 1975 that number had grown to 52 per cent. Now, approximately 75 per cent of Canadians file income taxes.
Changes continued to occur in tax rates and brackets over time. By 2015 there were four brackets with rates of 15, 22, 26 and 29 per cent. A fifth bracket was added in 2016, with rates ranging from 15 per cent to 33 per cent. And further changes may be on the way given the ramping up of federal government spending.
The one constant in all of this change is growing government revenue from the personal income tax. The burden of federal income taxes has increased from roughly $14 per person in 1918 (in 2016 dollars) to about $4,120 in 2017, an almost 300-fold increase. As a share of gross domestic product, it has grown from 0.2 per cent and is expected to be 7.2 per cent in 2017. As a share of total federal revenue, the tax has grown from 2.6 per cent in 1918 and is expected to reach 51 per cent in 2017.
A tax that was anathema to federal politicians in the first 50 years after Confederation and that many believe was introduced as a temporary wartime measure has come to be the dominant source of federal government revenue. Its creation and most dramatic expansion occurred during periods of war.
While the late 20th century saw a series of reforms that resulted in a reduction in the number of brackets, a lowering of rates and a broadening of the base, recent federal tax policy has taken the first steps towards both higher rates and more brackets.
And so, 100 years after its introduction in Canada, personal income tax continues to change federal public finances and Canadians’ lives.
Livio Di Matteo is a senior fellow of the Fraser Institute and professor of economics at Lakehead University.