What is a Progressive Tax System And how Does it relate to Tax Brackets

Hello All,

As we get closer to the tax deadline, I thought it would be a good idea to talk about some tax concepts, over the next few newsletters,and address some of the more frequent questions that I get. The most fundamental of these concepts, and one that is largely misunderstood, relates to how income is taxed in Canada.

Progressive Tax Brackets

Canada has a progressive tax system, which according to the IRS:

A progressive tax takes a larger percentage of income from high-income groups than from low-income groups and is based on the concept of ability to pay

In other words not every dollar of income earned is treated equally. Rather, taxation rates gradually increase as your income increases. This means that those who earn more not only pay a greater amount of tax in number of dollars, but they also pay a higher rate of tax as a percentage of income.  As an example someone who earns a $50,000 salary in Ontario will pay approximately $7,500 in income taxes (this does not include CPP and does include the basic personal exemption on which no tax is paid) while someone with $100,000 salary will pay $23,000, which is more than double the tax if we simply had a flat tax system.

Tax Brackets

To further break this down, it is helpful to understand tax brackets. A tax bracket is a basically a range and all income that falls within this range is taxed at the rate that applies to that tax bracket. In Ontario all earnings up to approximately $45k are taxed at about 20%. If you earn $50k, then only the additional $5k will be taxed at higher rate that applies to the next tax bracket which is about 29% (somewhat, as federal and Ontario tax brackets are different, but you get the point). Consequently your average tax rate will only be slightly higher than 20% since only the $5k is being taxed at the higher rate. To put it another way, you will never receive a lower net pay after tax as a result of an increase in earnings. One of the biggest misconceptions that people have is that if they accept a raise or work overtime, they will somehow earn less. While you will pay a higher percentage of tax on each dollar that you earn as your earnings increase, you will always receive more in after tax dollars for every dollar that is added to your wage or salary.

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