Economics versus Politics in Canadian Payroll Tax Policies

In recent years the federal government has increased its reliance on payroll taxes. This approach is revealed most directly in Employment Insurance premiums but also emerges in planned increases for Canada Pension Plan premiums. Economic criteria support these moves to the extent that premiums are strongly linked to benefit entitlements. However, much of the EI and increased CPP premiums are unrelated to benefits and thus constitute general payroll taxes. Such taxes compare favourably in economic terms with some alternative taxes but are regressive when imposed with a ceiling on taxable earnings. These developments appear to be driven by political pressures rather than economic criteria. If the government is politically constrained from raising the rates of other, more visible taxes (such as income tax and GST), then the payroll tax changes may be economically optimal choices subject to the constraint. In the longer run, basic reform of the other taxes and reduced reliance on general payroll taxes would be desirable.