Continuous Income Smoothing

Photo: Denis Collette. Flickr Canadian landscapes. Creative Commons License.

More and more, we seem to live multiple lives. Few people (and even fewer into the future) tread a linear path of education, career, family, and location.

Basically, nobody knows what the future will bring, as has become more keenly evident during the global pandemic of 2020. In this type of uncertain environment, a key advantage for the individual is financial flexibility. The ability to control one’s destiny is much enhanced if one has more options with which to respond to a changing world.

One innovative policy that Canada could adopt to alleviate some of this uncertainty is to create continuous income smoothing for tax purposes.

In Canada, we have a progressive tax system wherein those who earn more pay a higher marginal rate, and most of us agree that this is the right policy. Our suggestion is that the Federal and Provincial Governments smooth income tax payable throughout one’s lifetime and make tax refunds payable monthly and instantly when one is not working, or is earning less. This would act as an automatic individual and overall macro-economic stabilizer, providing much more flexibility for people to join and leave the workforce – a huge positive impact on flourishing. Not only would this allow career changes and re-training during the good times, but also it would alleviate some of the pressure during catastrophes such as the economic catastrophe of Covid-19.

Here is how it would work:

• Tax payable would depend on average earnings from the age of 18.
• For periods in which you’re not working, the average amount of tax paid would be declining, because the average earnings per period since age 18 is declining.
• So, for an individual who, say, works from 18-28 and then decides to go to college, the government would owe them a refund of part of the previous taxes paid for each month they are out of the labour force. 
• This needs to be done on a monthly basis, so that when you leave the labour force, or earnings are reduced, the next month you start to receive the benefits of the smoothing scheme. This would have provided extra immediate assistance to the millions who could not work during Covid-19 and would have been provided to ALL tax-payers, not to segments on a piecemeal basis as the government figured out who was falling through the cracks of hastily created assistance schemes.
• Of course, when you re-enter the labour force, your tax payable may be higher than the headline rates because the smoothing calculation works both ways.

Basically, this policy works as an automatic saving mechanism for individuals. There would have to be adjustments for inflation, but that’s easy to calculate.

We believe that this type of tax smoothing scheme would have an enormous positive impact on flourishing.