In our next issue of Breaking Tax and Investment News we will bring you articles on Curling Tax Woes, US Estate Tax and a Checklist for RDSP Investors (Part II).
The Long Term vs The Short Term
By Evelyn Jacks
In preparing to comment about the January 27, 2009 federal budget, my research activities took me to a number of excellent papers written over the past decade about the effects of public monetary policy and specifically debt and deficit spending on the wealth of nations.
A particularly excellent study I came across was done in January 1998 by Douglas W. Elmendorf or the US Federal Reserve Board and N. Gregory Mankiw of Harvard University and NBER. Their paper was prepared for the Handbook of Macroeconomics.
Some excellent points, very relevant to the analysis of this budget were made. I'd like to share some of these with you:
On Taxes and Spending Patterns:
Current patterns of taxes and spending are unsustainable in most industrialized countries over the next twenty-five years.
The primary causes of this situation are the aging of their populations and the rising relative cost of medical care.
Between 1990 and 2030, longer lifespans and continued low birthrates will sharply increase the ratio of retirees to working adults.
In most countries, health care has absorbed an increasing share of national income over the past several decades.
The aging of the population and the increasing cost of health care will put a significant strain on government finances over the coming decades. The numbers show a marked deterioration in the fiscal situation of almost every country.
On the Effect of Debt on the Economy:
In the Short Run: an increase in demand will raise national income; this being a common justification for a policy of cutting taxes or increasing government spending by running deficits when the economy is faced with a possible recession.
In the Long Run: temporary increases in aggregate demand which matter in the short run are less important in the long run. Consider:
A country with a large debt is likely to face high interest rates. Monetary policy may reduce interest rates in the short run, but in the long run will leave real interest rates roughly unchanged and inflation and nominal interest rates higher.
A country with a large debt may have difficulty financing an ongoing deficit through additional borrowing and may be tempted to produce more money to finance it. This could lead to inflation.
A country with large debt loses the ability to use tax revenue for service requirements (ie health care and pensions) to service the debt.
The interests of future taxpayers are not be represented.
Fiscal flexibility of government is lost.
Government debt makes the economy more vulnerable to a crisis of international confidence.
Foreign investors could lose confidence in dollar-denominated assetsócapital flight would therefore sharply depreciate the dollar.
Diminished political independence or international leadership could result.
The authors conclude that a temporary change in taxes has only a small effect on the consumption of forward-looking consumers. Further, the most important long-run effect of government debt is to reduce national wealth.
Baby boomers planning for retirement are certainly forward looking, and concerned about their wealth, and that of the country poised to cover their needs in old age. For them, the question to consider is whether temporary tax reductions and deficit spending serve them and their heirs well in the long run?
Evelyn Jacks is President of The Knowledge Bureau and author of Master Your Taxes
Boomers and Deficits
Deficit Spending and Debt
Sober Economic Indicators
It's About Financial Literacy
Technical Provisions: Some Highlights
For Employees And Their Employers:
For Seniors:
For Home Buyers
Business Tax Provisions
What was Missed
Finance Minister Jim Flaherty brought down what some might consider the most important federal budget this century, taking steps to stimulate the economy in unprecedented difficult times. In the midst of what is now called a broad-based recession that began in the fourth quarter of 2008, one that is expected to last at least three quarters, deficit spending is a reality again for the first time in a decade.
Boomers and Deficits. Today's deficits will surely become the taxes of tomorrow. This trend is of particular significance to the ten million or so baby boomers who make up approximately one third of our population and just under 50% of our tax filers.
By the year 2011, the first boomers will reach age 65. According to Infrastructure Canada, those age 65 and over are the most intensive users of the health care system, a financing burden yet to come for Canadian governments. (For more information link here).
At best, this budget will require taxpayers to ask hard questions, not only about the financial state of the nation, but about their own ability to fund retirement income and health care costs, if governments are stretched by new financing costs.
What effects will deficit spending today have on public pensions and the health care system? How will deficits affect taxation on after-tax retirement income or wealth transition in the future? How will incomes of boomer offspring fare on an after-tax basis?
Now is a good time to revisit retirement income plans, family succession and estate plans in an attempt to better understand financial needs for a future, which could certainly include tax increases on income or capital.
Deficits Lead to Accumulated Debt. Canadians are poised to lose the progress they have made in paying down their collective public debt throughout the past decade.
Projected Deficit Spending Per January 27, 2009 Federal Budget:
2008-09
$1.1 Billion
2009-10
$33.7 Billion
2010-11
$29.8 Billion
2011-12
$13.0 Billion
2012-13
$7.3 Billion
2013-14
$0.7 Billion
Spending in the budget has been focused in the following areas to support the fallout of difficult economic circumstances for workers, families and businesses:
SPENDING SUMMARY:
Infrastructure $12 Billion
Tax Reductions: $20 Billion
Housing Construction and Renovations $7.8 Billion
Financial Security: $200 Billion
Skills Training $8.3 Billion
Business Support $7.5 Billion
According to Statistics Canada, in 1995 federal governments had been spending more than they collected for 25 consecutive years leading, with interest costs eating up 26% of the entire budget by that time. This paved the way to the highest net federal debt in our history--$588 Billionóby 1997.
However, with a reduction in program spending and a growing economy, Canada recorded a surplus for the first time in 28 years in 1997/98; and with consecutive surpluses continuing into the new century, the net federal debt had been reduced to $457.6 billion in 2007/08.
Now, the accumulated federal debt will go back up to $542 Billion dollars, close to its 2001 level of $545 Billion. What will be important to watch is the cost of servicing this debt. Should increases in interest rates be part of our future, they will eat more of the revenues Canadian taxpayers can raise, potentially cutting into health care and pension funding ability.
SOBER ECONOMIC INDICATORS. It may be a good time to buy a home or a commercial building; however returns on investments will languish for a while yet.
The Economic Indicators in this budget are also more sober than in prior budgets: The outlook for nominal GDP growth in Canada has been reduced to -1.2 percent from 0.8 percent in November. The tax base for government revenue will be $25 Billion lower in 2009 and $30 Billion lower in 2010 than originally anticipated in the fall.
Short-term interest rates are expected to fall to 0.8 percent in 2009 and 1.7 percent in 2010. The outlook for long-term interest rates has also been revised downward to average 2.8 percent in 2009 and 3.4 percent in 2010, from 3.7 percent and 4.2 percent, respectively, at the time of the November 2008 Economic Statement.
Slower economic growth is expected to increase the unemployment rate in Canada to 7.5 percent in 2009 and 7.7 percent in 2010, compared to 6.9 percent in 2009 and 6.7 percent in 2010 as forecast in the Statement.
PRIVATE SECTOR FORECASTS, JANUARY 27, 2009 FEDERAL BUDGET
Table 2.1Average Private Sector Forecasts
2008
2009
2010
Average2011ñ14
(per cent, unless otherwise indicated)
Real GDP growth
February2008 budget
1.7
2.4
2.9
n.a.
November2008 Economic and Fiscal Statement
0.6
0.3
2.6
2.8
January2009 private sector forecast
0.7
-0.8
2.4
3.0
GDP inflation
February2008 budget
1.8
1.9
1.8
n.a.
November2008 Economic and Fiscal Statement
3.8
0.5
1.8
2.1
January2009 private sector forecast
4.1
-0.4
1.7
2.2
Nominal GDP growth
February2008 budget
3.5
4.3
4.7
n.a.
November2008 Economic and Fiscal Statement
4.4
0.8
4.4
5.0
January2009 private sector forecast
4.8
-1.2
4.2
5.2
Nominal GDP level (billions of dollars)
February2008 budget1
1,590
1,659
1,738
n.a.
November2008 Economic and Fiscal Statement
1,603
1,615
1,687
1,914
January2009 private sector forecast
1,609
1,590
1,657
1,893
3-month treasury bill rate
February2008 budget
3.2
3.8
4.5
n.a.
November2008 Economic and Fiscal Statement
2.4
1.9
2.7
4.2
January2009 private sector forecast
2.3
0.8
1.7
4.0
10-year government bond rate
February2008 budget
3.6
4.2
4.8
n.a.
November2008 Economic and Fiscal Statement
3.7
3.7
4.2
5.1
January2009 private sector forecast
3.6
2.8
3.4
5.0
Consumer Price Index (CPI) inflation
February2008 budget
1.5
1.9
2.0
n.a.
November2008 Economic and Fiscal Statement
2.6
1.7
1.9
2.0
January2009 private sector forecast
2.4
0.7
1.9
2.0
Oil price level (US dollars per barrel)
February2008 budget
82.1
79.8
82.3
n.a.
November2008 Economic and Fiscal Statement
102.5
72.0
79.0
89.7
January2009 private sector forecast
99.9
50.2
63.8
82.9
Exchange rate (US cents/C$)
February2008 budget
98.0
95.5
95.5
n.a.
November2008 Economic and Fiscal Statement
94.9
85.6
88.7
96.0
January2009 private sector forecast
94.1
81.2
85.5
94.4
Unemployment rate
February2008 budget
6.3
6.4
6.2
n.a.
November2008 Economic and Fiscal Statement
6.1
6.9
6.7
6.2
January2009 private sector forecast
6.1
7.5
7.7
6.4
U.S. real GDP growth
February2008 budget
1.5
2.4
3.0
n.a.
November2008 Economic and Fiscal Statement
1.4
-0.4
2.1
2.9
January2009 private sector forecast
1.2
-1.8
2.1
3.1
1 Nominal GDP levels have been adjusted to reflect May 2008 revisions to Canada's National Income and Expenditure Accounts.Source: Department of Finance survey of private sector forecasters.
IT'S ABOUT FINANCIAL LITERACY.
Financial literacy is the ability to understand personal and broader financial matters, apply that knowledge and assume responsibility for one's financial decisions. The federal budget defined financial literacy as an important life skill that empowers consumers to make the best financial decisions in their particular circumstances.
The government plans to establish an independent task force, which will make recommendations to the Minister of Finance on a cohesive national strategy on financial literacy, to enable Canadians to take better control of their own financial futures.
Financial advisors who themselves work as educators as they manage wealth together with their clients make a significant contribution to the best financial decision-making for the family.
TECHNICAL PROVISIONS. The Notice of Ways and Means Motions detailed changes to amend the Income Tax Act discussed below:
BROAD-BASED TAX RELIEF: The Budget has introduced minor broad based tax changes, meaning they will apply to everyone reaching the following income levels:
The Basic Personal Amount has been increased to $10,320, retroactive to January 1, 2009.
The top income threshold for the 15% lowest-tax bracket has increased from $38,832 to $40,726
The top income threshold of the next tax bracket (22%) has increased to $81,452 from the projected $77,664.
Normal indexation will apply to the new basic personal amount and bracket thresholds for future years.
TARGETED TAX RELIEF: Targeted tax relief in this budget focuses on employees, seniors and home owners, as well as business owners.
FOR EMPLOYEES AND THEIR EMPLOYERS:
Employment Insurance Benefit Changes. EI premium rates will be frozen at $1.73 per $100 for both 2009 and 2010. This is good news for the plans contributors: employees and employers.
Working Income Tax Benefit Changes. This credit, currently set at $510 maximum for a single taxpayer, is a bridge from welfare to the workforce. The new budget proposes to enhance it to provide a refundable tax credit of 25 percent of each dollar of earned income in excess of $3,000, reaching a maximum benefit of $925 at $6,700 of earned income. Once income exceeds $10,500, the benefit would be reduced at a rate of 15 percent of each additional dollar, until the benefit is fully phased-out at an income of $16,667.
The WITB thereby reduces average effective marginal tax rates on earned income between $3,000 and $10,000. The WITB clawback however, increases these rates on earned income between $10,000 and $20,000, as it is being phased out. Despite this increase, it is the government's hope that the WITB ìstrengthens incentives to find and keep a job, by increasing the net returns from work.î
EI Benefit Changes And Training Initiatives. For those about to lose their jobs, some help from Employment Insurance:
For the next two years all regular Employment Insurance (EI) benefit entitlements will be increased by five extra weeks to 50 weeks from 45 weeks.
EI income benefits will be extended for two years to Canadians participating in longer-term training, benefiting up to 10,000 workers.
Work-sharing agreements will be extended by 14weeks, to a maximum of 52 weeks, so more Canadians can continue working.
Wage Earner Protection Programs will be extended to cover severance and termination pay owed to eligible workers impacted by employers' bankruptcy. EI is also to be changed to allow earlier access to EI benefits for workers who received severance packages if they use some or all of their severance pay to purchase skills upgrading or training.
Consultations will begin for the development of options to provide self-employed Canadians with access to EI maternity and parental benefits.
Increased funding for training delivered through the Employment Insurance program by $1billion over two years.
$500 million will be invested over two years in a Strategic Training and Transition Fund to support the particular needs of individuals who do not qualify for EI training, such as the self-employed or those who have been out of work for a prolonged period of time.
$55 million will be provided over two years to help young Canadians find summer jobs.
Older workers and their families will receive an additional $60 million over three years for the Targeted Initiative for Older Workers and the program will be expanded to include workers in small cities.
Skilled labour shortages will be addressed with $40 million a year to launch the $2,000 Apprenticeship Completion Grant.
$50 million will be provided over two years for a national foreign credential recognition framework in partnership with provinces and territories.
An additional $100 million over three years in the Aboriginal Skills and Employment Partnership (ASEP) initiative, expected to support the creation of 6,000 jobs for Aboriginal Canadians.
$75 million will be invested in a two-year Aboriginal Skills and Training Strategic Investment Fund.
An additional $87.5 million will be provided over three years to temporarily expand the Canada Graduate Scholarships program. And an additional $3.5 million will be provided over two years to offer an additional 600 graduate internships through the Industrial Research and Development Internship program launched in Budget 2007.
FOR SENIORS: There is some good news in the budget for seniors:
Age Credit rises for seniors: Seniors aged 65 or more will benefit from a $1,000 increase in the Age Credit, which rises from $5,408 to $6,408, with indexing thereafter.
Age Credit Clawback: The age credit is phased out at $32,312 (no change from prior rules) and is completely phased out at $75,032, an increase from the prior $68,365.
RRIF Recontributions. The Government will also be proceeding with the proposal announced in the November 2008 Economic and Fiscal Statement to reduce the required minimum Registered Retirement Income Fund withdrawal for 2008 by 25 percent to recognize the impact of the deterioration in market conditions on retirement savings.
RRSP or RRIF losses after death. The amount of post-death decreases in value of these plans will be carried back and deducted against the income included in the year of death.
FOR FAMILIES WITH CHILDREN:
Child Tax Benefit Threshold Increases: Low-income families can earn an extra $1,894 and still receive the maximum National Child Benefit supplement, providing additional benefits of up to $436 annually.
Toronto, Ontario. The Financial Forum held its first of a series of national accredited wealth management workshops by The Knowledge Bureau and its faculty Doug Nelson, John Poyser and Jim Ruta, together with President and Program Director Evelyn Jacks at the Toronto Convention Centre, playing to rave reviews from its audience.
ìWe have found that investors are not looking for a cookie cutter approach; rather, they want to be able to focus on their own specific needs.î said Mrs. Jacks. ìBoomers, especially, are looking for specific answers on how to address their own problems in these difficult times, and the advisors in these sessions discovered new ways to develop inter-advisory wealth management services in the areas of retirement, succession and tax planning.î
The first of the accredited advisor sessions was delivered by retirement income planning specialist Doug Nelson who played to rave reviews in his Master Your Retirement Process as he discussed tax efficient retirement income planning with attendees from the ranks of financial planning, accounting and life insurance industries:
ìDoug did a tremendous job showing risk and return in a different light with a great sense of humorî. Stephen Osborne
ìA powerful message, outstanding presenter!î Monica Weissmann
John Poyser was also highly effective in discussing Business Issues in Succession Planning as he spoke to a highly appreciative audience of financial planners.
ìVery knowledgeable. A great session.î Robert Martin.
ìGreat presentation, lots to take away; appreciated humour in a complex subject.î Alison Crowdis
The Financial Forum and its education partner, The Knowledge Bureau, will next deliver in Vancouver February 27 and 28 and Calgary March 13 and 14. Advisors can download a pdf to review the program (link) or enroll online or call 1-866-953-4769 for assistance.
The RDSP is a new savings plan designed to accumulate funds for the benefit of a disabled person which took effect in 2008. Generally RDSPs will function in very much the same way as RESPs do now. This important new investment opportunity for Disability Tax Credit-eligible Canadians will generate government grants and bonds for the 2008 tax year if deposits are made before March 2, 2009. However, only a few institutions are ready to take your deposits, with BMO being the first out of the gate to do so.
The Registered Disability Savings Plan (RDSP) may be established for an individual who has a severe and prolonged physical or mental impairment and qualifies for the disability tax credit during the year of establishment, or would have if the restriction for the attendant care amount were disregarded. Contributions may not be made to the plan in years for which the individual is not DTC-eligible. In that case the plan must be terminated by the end of the year following the year in which the beneficiary ceases to be DTC-eligible.
Eligibility Any person eligible to claim the Disability Amount can be the beneficiary of an RDSP and the plan can be established by them or by an authorized representative. Anyone can contribute to an RDSP ñ they need not be a family member.
Tax Treatment Contributions are not deductible. Income accumulates in an RDSP tax free. Contributions withdrawn from an RDSP are not taxable, but all other amounts ñ accumulated investment income, grants and bonds (discussed below) ñ are taxable in the hands of the beneficiary as withdrawn.
Contributions There is no annual limit on contributions but lifetime contributions cannot exceed $200,000. Contributions are permitted until the end of the year in which the disabled beneficiary turns 59.
Withdrawal The beneficiary must start to withdraw funds from the RDSP in the year he or she turns 60. Maximum annual withdrawal amounts are to be established based on life expectancies but an ability to encroach on capital is also to be provided. Only the beneficiary and/or the beneficiary's legal representatives can withdraw amounts from an RDSP. Contributors can never receive a refund of contributions.
Sweeteners. The Federal government will provide financial assistance to RDSPs in two ways.
1. Canada Disability Saving Grant will match RDSP contributions as follows:
Family Net Income
Family Net Income
Up to $75,769*
Over $75,769*
First $500 ñ 300% (maximum $1,500)
First $1,000 ñ 100% (maximum $1,000)
Next $1,000 ñ 200% (maximum $2,000)
Therefore: $1,500 contributed to RDSP generates $3,500 CDSG
Therefore, $1,000 contributed to RDSP generates $1,000 CDSG
*2008 levels; to be indexed annually, based on upper income limit of the 22% tax bracket
Family income is calculated in the same manner as it is for Canada Education Savings Grant purposes except that in years after the beneficiary turns 18 family income is the income of the beneficiary and their spouse or common law partner.
There is a lifetime maximum of $70,000 that will be funded under the CDSG and an RDSP will not qualify to receive a CDSG from the year in which the beneficiary turns 49.
2. Canada Disability Savings Bond. Unlike the CDSG, there is no requirement that a contribution be made to a RDSP before a savings bond contribution is available.
Next week: Part II of the RDSP Checklist for Investors
On January 12th, 2009 the CRA announced the revocation of the charitable status of another organization, this time The Millennium Charitable Foundation, a Toronto area charity.
When a charity has its charitable status revoked, it can no longer issue donation receipts and is no longer considered a qualified donee under the Income Tax Act. In addition, the charitable organization is no longer exempt from income tax and it may be subject to tax on the full value of its remaining assets (unless it is a non-profit organization).
In the recent past, several donation investment offerings have been created, many of which include the "flipping" of art or other items in return for charitable donation receipts which provide a tax benefit on the investment. The offerings usually worked like this:
A promoter gives a person the opportunity to purchase one or more works of art or another item of speculative value at a relatively low price. The proposal is that the promoter will work with the person to make arrangements for donating the works of art or other items to a Canadian registered charity or other specified institution.
The person donates the art or other item and receives a tax receipt from the charity or other specified institution that is based on an appraisal arranged by the promoter. The appraised value of the art is substantially higher than the cost paid by the person.
When the person claims the receipt on his or her next tax return, it generates a tax saving that is higher than the amount paid for the art in the first place.
CRA takes a dim view of these offerings. To date over 100,000 taxpayers have learned first hand that the Canada Revenue Agency considers the donation schemes a sham, and they want their money back. It is CRA's view that the appraisal generated by the individual associated with these schemes may not represent the fair market value of the acquired property. If it did, then the property would not be sold at the lower price. On December 5, 2003 new legislation was introduced (changes to S. 248) to limit the eligible amount of a gift made after December 5, 2003 to the cost of the property to the taxpayer if the property was acquired within three years of donating it and the property was acquired for the purposes of the donation (i.e. it was acquired under a gifting arrangement as defined in S. 237.1).
CRA advises that anyone considering entering into a tax shelter arrangement should obtain independent professional advice before signing any form of documents related to the donation and:
know who they are dealing with, and request the prospectus or offering memorandum and any other documents available in respect of the investment and carefully read them;
pay particular attention to any statements or professional opinions in the documents that explain the income tax consequences of the investment. Often, these opinions will tell the investor about the problems that can be expected and suggest that the investor obtain independent legal advice;
not rely on verbal assurances from the promoter or others -get them in writing; and
ask the promoter for a copy of any advance income tax ruling provided by the CRA in respect of the investment. Read the ruling given and any exceptions in it.
Individual taxpayers should be aware that their tax return can be reassessed up to three years after the date of assessment. Even if the benefits of the tax shelter were accepted upon initial assessment this should not be interpreted as acceptance of the claim, it may still be subject to audit by the CRA.
Evelyn Jacks, President, The Knowledge Bureau: www.knowledgebureau.com For free information about Breaking Tax and Investment News, self study courses on tax and personal finances, or books on personal finance. Call: 1-800-953-4769.
In our next issue of Breaking Tax and Investment News we will bring you articles on Curling Tax Woes, US Estate Tax and a Checklist for RDSP Investors (Part II).
