Category: Financial Education

Canadian Income Tax Act: Watershed Moments

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Tax on income at the Federal level began in Canada in 1917.  It was introduced as a means to fund war time spending, and as such was called the Income War Tax Act.  It was then described as a temporary measure, but as we know today, it became a permanent and important source of tax revenue thereafter.  For example, in 1917, tax on income provided approximately 2% of all federal revenue, whereas a century later, it is providing over 50% of all federal revenue.  (See Fraser Institute Infographic) What happened?  I present for you here a sampling of what I consider are watershed moments in the history of our income tax system.

1941 – Up until now, the provinces had the right to levy provincial income tax for their own spending needs.  In 1941, the provinces surrendered that right to the federal government in exchange for “rental” payments from the federal to the provinces.

1942 – Pay-as-you-earn income tax is introduced.  Employers are now required to withhold tax from employee earnings and remit these amounts to the federal government each period.

tax return 1949

(Click thumbnail to open a 1949 Income tax return in new window)

1949 – The Income War Tax Act is renamed, Income Tax Act, the first indication that income tax is no longer considered temporary.

1964 – “Social Insurance Numbers” replace “Unemployment Insurance Numbers” as the means to identify taxpayers.

1966 – Canada Pension Plan (CPP) is launched and “premiums” are added to the income tax system.  Maximum annual premium is $79.20, or 1.8% of the maximum insurable earnings of $4400.

1988 – “Personal Deductions” changes to “Non-Refundable Tax Credits”.  Instead of using these deductions to reduce your taxable income (at your highest marginal tax rate), these same deductions become credits, which can only be used to reduce your income tax at one flat tax rate (the lowest marginal tax rate).

What’s next?

2016 – New requirement to report the sale of a principal residence (your home).  Is this the precursor for a new tax?  Will there soon be tax levied on the “gain” from the sale of your home?

A government’s only source of revenue is taxation.  The bigger it grows, the more it taxes.  Watershed moments are taxation growth leaps or signals of a leap in the making.

Can Investments be Overdiversified?

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A well-known investment adage is, “don’t put all your eggs in one basket.”  The literal translation is, if the one and only basket falls, then all your eggs will be broken.  But if you kept your eggs in several baskets, then the fall of one basket will not destroy your entire stock of eggs.

Applied to financial investing, the rule is, don’t put your entire savings into one company’s stock.  If that one company fails, then all of your savings will be gone.  The solution is to diversify – spread your investment dollars over several unrelated businesses and industries.

Unfortunately, many Canadians apply the “one basket” rule to financial institutions.  That is, they “diversify” by spreading their investment savings over two or three different financial institutions.  Not only is this NOT an application of the rule, but by doing so, the savings might actually end up in the same basket!

Each financial institution may not be aware of what the other financial institutions are recommending for the client’s portfolio.  As a result, the client may end up with the same stocks in all of their investment accounts.

Sometimes, overdiversification can lead to no diversification.

Yikes! The Stock Markets are Falling!

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Or, Yay! Stocks are on sale!

Watching stock markets decline is uncomfortable.  Real losses to our savings can occur when we give in to fear and withdraw our investments (sell).  We have all heard of “Buy low, sell high” but putting that advice into practice is another matter altogether.

On the other hand, professional investors, as in fund managers, can and do apply that investment advice.  These pros are delighted to see stock prices fall and eagerly go on a buying spree.  They keep a cash reserve in their funds for this purpose.

Think of a market decline the way professional investors do.  Your mutual or segregated fund has a professional investor who is buying up quality stocks at bargain prices.  So, when the markets recover (they always have, they always will), your own portfolio will have benefited.

Teach Your Children to Save as if Their Lives Depended on it

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Our parents or grandparents who grew up during the Depression, learned to save as if their lives depended on it.  Reality is an effective teacher.  Yet the harsh lessons that scarcity taught have served this generation very well as many of today’s older seniors are self sufficient financially speaking.

But what if reality is deceiving us with its perception of plenty?  Statistics have shown that personal savings rates have been in a freefall since 1990, dipping to rates below zero by 2005.  Why?  Survey respondents report that saving is not a priority and readily admit to using debt for such spending as dining out, vacations and other impulse spending.  Car purchases typically top the spending list.  Such spenders are often in denial about their debt.

The problem for debt spenders is that any personal or economic event is devastating.  For examples, financial ruin can arise from interest rate increases, wage loss from disability or unemployment, and falling housing prices.

The best way to escape the debt trap is not to get into it in the first place.  Even in the midst of prosperity, teach your children to save 10 to 20 percent of what they earn.  Like the Depression-era generation, we should save as if our lives depend on it because, frankly, our lives do.