RESP's - going to be tax deductible?

[msj]

Came across this post in Garth Turner's blog.

It appears to be about private members bill C-253.

It would appear that the parent(s) would be able to deduct the RESP contributions against their income (i.e. equivalent to putting in tax free money) and the kid would get to take the money out of the RESP when he/she goes to school which would be taxable to the child.

Of course, the kid would likely be non-taxable (RESP income plus summer work being less than the kids' basic exemption) or would pay a lower tax rate than the parents received on the deduction.

Either way, we are talking some potential serious tax savings for those with kids who plan on staying in school.

But I wonder why the CPC is against it?

Turner states:

So, why did the Conservatives all oppose? First, unlike all the other MPs in the House, the Tories were instructed how to vote, and not allowed free will.

Second, the government MPs tried to kill this because it makes the new Tax-Free Savings Plan (TFSP) look like yesterday’s Kraft Dinner. Now that you

can put $5,000 a year aside for your kids, have it grow tax-free, and get a couple of thousand bucks back on your income taxes, why would you stick money in a savings plan that has zero immediate tax benefit?

Edited March 6, 2008 by msj

[YEGmann]

Came across this post in Garth Turner's blog.

But I wonder why the CPC is against it?

I heard a private member bill cannot involve budget spending.

As for the plan, it is not clear how the taxes will be paid. From withdran amount? from accrued interest? If the former is the case this plan is much worse than the existing scheme, IMHO. This will rob your child twice: at the time of deposit and at the time of withdraw. If the taxes will be paid on interst only - it is still worse for your child but better for you. If it is all tax deductible and tax-free - too good to be true. And lost revenue to the budget.

[August1991]

A tax deductible RESP is a very different proposition from an RRSP or a TFSA.

McTeague's proposal essentially makes some of the college or university costs of a child deductible from a parent's income. It seems rather odd to raise tuition fees on one hand and then to offer to subsidize them indirectly on the other - a subsidy that is granted in larger proportion to higher income parents than to others.

RRSPs, TFSAs and the GST are all designed to correct for a distortion in an income tax. With an income tax, savings are taxed double and people are encouraged to spend rather than save.

McTeague's proposal is merely a tax-credit lollipop to rich parents with children. Our governments subsidize and transfer funds between us in myriad ways. McTeague's proposal is just another wrinkle to our subsidy system.

Edited March 6, 2008 by August1991

[msj]

I heard a private member bill cannot involve budget spending.

I thought so too. But it appears to be going to the Senate.

Maybe because it is not directly related to spending but is related to a deduction?

As for the plan, it is not clear how the taxes will be paid. From withdran amount? from accrued interest? If the former is the case this plan is much worse than the existing scheme, IMHO. This will rob your child twice: at the time of deposit and at the time of withdraw. If the taxes will be paid on interst only - it is still worse for your child but better for you. If it is all tax deductible and tax-free - too good to be true. And lost revenue to the budget.

It would have to be from the withdrawn amount. But with increases to the basic exemption this would still keep many kids non-taxable.

Even then, assuming this went through and the provinces allowed a deduction on their end too (not sure on that detail), then you could have daddy getting a 44% deduction while his daughter pays tax at 10-14% effective rate (the marginal rate would be ~20-21% but the basic exemption would lower the average rate downward).

Throw in the time value of money (deduction happens now while the taxes are paid later) and this could be a pretty good deal.

Edited March 6, 2008 by msj

[geoffrey]

There is already a tax break for tuition... in fact, you don't pay any tax on tuition, and you get a huge credit every month your in school. You can see a few thousand in tax savings easily. An RESP would be tax deductable twice. Or, if like an RRSP, you'd be contributing in low tax years (when your younger) and withdrawing in your highest tax years (generally, when your kids move on to university).

Bottom line, there should be little incentive from the government for kids to go to post secondary. If you don't want to fork out the $20k needed or don't think it's worth $20k, then don't go and keep a spot open for someone that can.

I need not be subsidizing liberal arts degrees and having people pursue their life passions. No reason to. If it's worth it, people will buy it.

[msj]

A tax deductible RESP is a very different proposition from an RRSP or a TFSA.

It is like a RRSP in that you get to deduct the contribution and, therefore, are effectively investing pre-tax, or tax free, dollars.

It is like a TFSA and a RRSP in that earnings within it accrue tax free.

It is like a RRSP in that the principal and earning would be taxed upon withdrawal.

It is unlike a TFSA in that a TFSA only allows for after tax investment but with the benefit of not paying tax upon withdrawal.

So, no, this RESP idea isn't really that different.

McTeague's proposal essentially makes some of the college or university costs of a child deductible from a parent's income. It seems rather odd to raise tuition fees on one hand and then to offer to subsidize them indirectly on the other - a subsidy that is granted in larger proportion to higher income parents than to others.

RRSPs, TFSAs and the GST are all designed to correct for a distortion in an income tax. With an income tax, savings are taxed double and people are encouraged to spend rather than save.

The best way to "correct" distortions in the income tax system would be to reduce marginal tax rates.

McTeague's proposal is merely a tax-credit lollipop to rich parents with children. Our governments subsidize and transfer funds between us in myriad ways. McTeague's proposal is just another wrinkle to our subsidy system.

McTeague's proposal is actually a tax deduction which is not the same thing as a tax credit.

A tax deduction leads to a taxpayer getting to deduct an amount against total income or net income, therefore, reducing taxable income. As such, if a person has a marginal tax rate of 44% then he reduces his tax by $440 for every $1,000 deducted.

A tax credit occurs at the tax credit amount which is usually the lowest federal and provincial tax rates (with exceptions where only the federal rate is applied as provinces have not followed the CPC down the tax credit path to complexity). As such, the person who may get a tax deduction at 44% above would only get a tax credit of ~21% so he would only reduce his tax by $210 per $1,000.

[msj]

There is already a tax break for tuition... in fact, you don't pay any tax on tuition, and you get a huge credit every month your in school. You can see a few thousand in tax savings easily. An RESP would be tax deductable twice. Or, if like an RRSP, you'd be contributing in low tax years (when your younger) and withdrawing in your highest tax years (generally, when your kids move on to university).

Bottom line, there should be little incentive from the government for kids to go to post secondary. If you don't want to fork out the $20k needed or don't think it's worth $20k, then don't go and keep a spot open for someone that can.

I need not be subsidizing liberal arts degrees and having people pursue their life passions. No reason to. If it's worth it, people will buy it.

People pay tax on tuition in so much as they must earn $10,000 to pay $3,000 in tax to pay $7,000 in tuition (or in so much as they must earn after-tax dollars to repay student loans).

The tax credits from tuition, the education amount, and the textbook amount, do not lead anywhere near to a refund of the tuition amount since they are applied at the tax credit rate of 21%.

A typical tuition slip would show tuition of, say, $8,000 (which would be tax creditable), a full time attendance worth a $4,000 tax credit and text book credit worth $650. Take the total of $12,650 * 21% tax credit rate and you get a tax savings of ~$2,650.

Clearly the $8,000 tuition cost is greater than the $2,650 in tax savings.

Not sure where you get the idea of the RESP being tax deductible twice - clearly the parent gets the deduction for the initial contribution just like an RRSP. It would not be deducted again by anyone.

Presumably, the child pays tax on any withdrawal from the RESP as long as the w/d is eligible (or, rather, the child is attending school to make it eligible).

[August1991]

There is already a tax break for tuition... in fact, you don't pay any tax on tuition, and you get a huge credit every month your in school. You can see a few thousand in tax savings easily. An RESP would be tax deductable twice. Or, if like an RRSP, you'd be contributing in low tax years (when your younger) and withdrawing in your highest tax years (generally, when your kids move on to university).

Bottom line, there should be little incentive from the government for kids to go to post secondary. If you don't want to fork out the $20k needed or don't think it's worth $20k, then don't go and keep a spot open for someone that can.

I need not be subsidizing liberal arts degrees and having people pursue their life passions. No reason to. If it's worth it, people will buy it.

This proposal is in line with these tax deductions (but can tuition deductions be used by parents or just the students?)

It is like a RRSP in that you get to deduct the contribution and, therefore, are effectively investing pre-tax, or tax free, dollars.

It is like a TFSA and a RRSP in that earnings within it accrue tax free.

It is like a RRSP in that the principal and earning would be taxed upon withdrawal.

It is unlike a TFSA in that a TFSA only allows for after tax investment but with the benefit of not paying tax upon withdrawal.

So, no, this RESP idea isn't really that different.

The best way to "correct" distortions in the income tax system would be to reduce marginal tax rates.

msj, the best way to correct a distortion is not to reduce taxes. The best way to reduce taxes is to reduce taxes.

The Manufacturer's Sales Tax was a bad tax because it created distortions. The income tax contains a similar distortion - that is corrected through RRSPs. Distortions are costly to an economy because people make wrong decisions. They don't see the world as it is but rather how the tax system falsely portrays it. In this sense, the GST, RRSPs and TFSAs are good things because people see the world more accurately.

McTeague's proposal means that a person can save money tax-free and then a child can withdraw the savings without having to pay the tax. IOW, a parent can make a tax-free gift to a child in post secondary education. I'd call that a subsidy to PSE and not the correction of a distortion. It's the same as granting subsidies to hybrid car buyers or to Canadian movie makers. It's a lollipop and it may be politically popular.

BTW, I agree that it should be called a tax deduction and not a tax credit since that seems how McTeague has structured it.

[msj]

This proposal is in line with these tax deductions (but can tuition deductions be used by parents or just the students?)

msj, the best way to correct a distortion is not to reduce taxes. The best way to reduce taxes is to reduce taxes.

The Manufacturer's Sales Tax was a bad tax because it created distortions. The income tax contains a similar distortion - that is corrected through RRSPs. Distortions are costly to an economy because people make wrong decisions. They don't see the world as it is but rather how the tax system falsely portrays it. In this sense, the GST, RRSPs and TFSAs are good things because people see the world more accurately.

McTeague's proposal means that a person can save money tax-free and then a child can withdraw the savings without having to pay the tax. IOW, a parent can make a tax-free gift to a child in post secondary education. I'd call that a subsidy to PSE and not the correction of a distortion. It's the same as granting subsidies to hybrid car buyers or to Canadian movie makers. It's a lollipop and it may be politically popular.

BTW, I agree that it should be called a tax deduction and not a tax credit since that seems how McTeague has structured it.

1) Tuition is NOT deducted. It is a tax credit with up to $5,000 (about $1,050 in tax savings) being transferred to certain relatives (spouse, parents etc).

2) Reducing tax rates reduces tax distortions because it minimizes the impact of taxes and allows the government to rid the tax system of unnecessary tax credits and tax deduction.

3) RRSP's hardly correct any distortion - the government forces people to pay tax on higher than necessary withdrawals thanks to the RRIF system.

4) Now that we have pension splitting to mitigate #3 I would argue that RRSP's are further distorting the system as people are encouraged to make contributions to RRSP's in order to ensure an easy and effective way to split income with their spouse when one spouse reaches 65 and can convert part or all of the RRSP into a RRIF to take advantage of the pension splitting.

5) It is strange that you think charging GST on consuming something is not a distortion, nor is getting a tax deduction of 44% on a RRSP contribution, but, hey, income tax may create distortions but we better not reduce them... kind of silly.

6) Anyway, back to the topic.

Sure, it is the equivalent of a subsidy. What do you think the TFSA is?

You honestly think that people not paying any tax on the income earned within the TFSA are not getting a subsidy?

A RRSP? Ever heard of time value of money?

The real point of a RRSP and pension splitting is to allow people to deduct the RRSP contribution at high tax rates 38-44% while then paying tax on the w/d at lower rates 25-33% (the pension splitting helps primarily be reducing/eliminating the OAS clawback).

And this doesn't sound like distortion to you?

Get real.

[August1991]

6) Anyway, back to the topic.

Sure, it is the equivalent of a subsidy. What do you think the TFSA is?

You honestly think that people not paying any tax on the income earned within the TFSA are not getting a subsidy?

A RRSP? Ever heard of time value of money?

I'm sorry to belabour this point but a consumption tax corrects a distortion of the income tax. The GST or an income tax combined with RRSPs or TFSAs amount to consumption taxes.

msj, it appears that you approach this question from the standpoint of a tax accountant. In public policy debates, it would be better to view taxes from an economic perspective.

This article makes the distinction (in an easy to read, non-technical manner):

Perhaps the single most important tax policy decision is the choice between an income tax and a consumption tax. The topic has been discussed and argued over since at least the time of Hobbes (1651) and Mill (1871) without apparent resolution. Consumption and income taxes both represent substantial sources of revenue in all modern economies.

This paper considers the choice between an income tax and a consumption tax focusing on an argument made by Anthony Atkinson and Joseph Stiglitz in 1976 (AS 1976). AS 1976 shows that taxes should be imposed on all commodities at the same rate – taxes should be neutral. For reasons illustrated below, this conclusion implies that a consumption tax is superior to an income tax. AS 1976 has recently attracted substantial attention in the technical economics literature but, perhaps because the arguments are technical, it has yet to receive any attention in the legal literature.

Our task here is to explain the intuition behind AS 1976 and explore how applicable the model is to the real world. Our conclusion is that consumption taxes are superior to income taxes.

[Pat Coghlan]

The best way to "correct" distortions in the income tax system would be to reduce marginal tax rates.

There should be only 2 tax brackets for singles and 2 (slightly wider) for families. Essentially there would be one rate for income above a certain (luxury) threshold, and another for all income below that thereshold.

Objective: ensure that very high income individuals/families pay a higher rate than low-to-middle-income individuals/families, and also ensure that everyone else pays the same rate. This stuff of paying 15/22/26/29 percent federal tax rates depending on your income level is meaningless.

[Riverwind]

This has to be among the stupidest decisions ever.

The only students who benefit are those with rich parents that can afford to have no income during unversity.

Students with parents with low income lose the $500 matching grant. If they work/earn scholarships during university they will be saddled with punative marginal tax rates.

[msj]

This has to be among the stupidest decisions ever.

The only students who benefit are those with rich parents that can afford to have no income during unversity.

Students with parents with low income lose the $500 matching grant. If they work/earn scholarships during university they will be saddled with punative marginal tax rates.

I'm not so sure that the grants aren't still part of the package. Though I'm sure the CPC will put through legislation to get rid of those if RESP's are allowed to be deducted.

BTW, scholarships generally are not taxable.

[msj]

I'm sorry to belabour this point but a consumption tax corrects a distortion of the income tax. The GST or an income tax combined with RRSPs or TFSAs amount to consumption taxes.

msj, it appears that you approach this question from the standpoint of a tax accountant. In public policy debates, it would be better to view taxes from an economic perspective.

This article makes the distinction (in an easy to read, non-technical manner):

Interesting article. I'll probably finish it after audit season is over in August.

I do not deny that a consumption tax is better than an income tax. In fact, I'm all for it and the CPC's reduction to the GST is enough to make me never vote for them.

However, I also do not deny reality: people don't like consumption taxes.

Also, there is more to tax policy than efficiency/distortion considerations.

And, I highly doubt the authors of that paper would really regard our GST as being anywhere near being a neutral tax (with all the tax exempt, zero rated, and rebates involved).

Edited March 7, 2008 by msj

[Riverwind]

I'm not so sure that the grants aren't still part of the package. Though I'm sure the CPC will put through legislation to get rid of those if RESP's are allowed to be deducted.

That is what any rational government would do.

The CESG grant system was adopted to address the problem of RRSPs where wealthy families benefit disproportionately from the tax deduction. If the RESP are now tax deductable then the CESP will likely have to go because something has to be cut to pay for the cost of giving all those tax deductions.

The opposition has no business passing this kind of measure outside of a budget.

[Keepitsimple]

Two issues - one has been mentioned in passing:

1) Let's not forget the Provinces - if up to $5000 is non-taxable, that means that you don't pay Federal and you also don't pay Provincial tax....so all Provinces will be losing significant revenue as well. I suspect we'll be hearing from them shortly.....or perhaps the Senate will go to bat for them (fat chance).

2) The "matching" grant of 20% up to $500 is especially useful for lower incomes. Put in $1000 and you automatically get $200. That's 20% on your investment right away. The Liberal RESP is much more favourable to higher-incomes because they save more tax. The rich get richer. Let's not forget that we're not just talking University. There's trade schools and colleges as well.

It's a bad idea. Sounds all warm and fuzzy on the surface but it benefits the rich much more than the little guy, is confusing to manage, and both the Feds and Provinces are stuck with the bill.

Edited March 7, 2008 by Keepitsimple

[msj]

Two issues - one has been mentioned in passing:

1) Let's not forget the Provinces - if up to $5000 is non-taxable, that means that you don't pay Federal and you also don't pay Provincial tax....so all Provinces will be losing significant revenue as well. I suspect we'll be hearing from them shortly.....or perhaps the Senate will go to bat for them (fat chance).

2) The "matching" grant of 20% up to $500 is especially useful for lower incomes. Put in $1000 and you automatically get $200. That's 20% on your investment right away. The Liberal RESP is much more favourable to higher-incomes because they save more tax. The rich get richer. Let's not forget that we're not just talking University. There's trade schools and colleges as well.

It's a bad idea. Sounds all warm and fuzzy on the surface but it benefits the rich much more than the little guy, is confusing to manage, and both the Feds and Provinces are stuck with the bill.

1) Garth Turner seems to think that the 20% grant will still apply (in a response in the comments section on his blog linked in the original post).

I don't see why it won't still apply (at least until the CPC change that rule) since the private members' bill did not address the grant part of RESP's.

2) Re: the rich.

Of course the "rich" get a bigger deduction - because they pay tax at a higher marginal tax rate in the first place because they make more money in the first place.

The rich person makes $1,666, pays $666 in tax, puts the $1,000 net in and gets $400 of tax back; the poor person makes $1,250, pays tax of $250, puts the $1,000 in and gets $200 of tax back.

Notice the rich person is still out $266 of tax on a gross of $1,666 whereas the poor person is out $50 on a gross of $1,250.

3) I agree that this is a bad idea - it further complicates a system that should be simplified.

Edited March 7, 2008 by msj

[jdobbin]

I oppose it as another complication of the tax system. I would prefer if the Liberals pushed for better support on student loans, bursaries, grants and the like. That puts the onus more on the student.

I have no problem with provinces offering rebates on post-secondary after graduation like Manitoba does. However, I would be curious to see an accounting of the program after about five years to see how effective it is.

Tuitions should be allowed to rise and the levels of government should be supportive of the loans business and not be an impediment to worthy students getting into school.

[daniel]

...

It's a bad idea. Sounds all warm and fuzzy on the surface..

Here are some real examples of warm and fuzzy:

1) $1000/yr Child benefit - which is taxable;

2) GST cuts - which amounts to nothing beneficial to the average consumer but reduces Federal revenue;

3) tax incentive for hybrid vehicles - that are so restrictive it can't be used;

4) personal income tax reduction - that actually resulted in personal tax increases;

5) Tax-Free Savings Plan - that amounts almost nothing at the end of the year

RESPs benefit middle income families and helps students by relieving them from alot of debt. Here's something that's truly of value to average Canadians and lower income Canadians who can scrape up some money and the Conservatives are against it. Just shows you that Conservatives are against students and middle-class families.

Edited March 7, 2008 by daniel

[August1991]

This has to be among the stupidest decisions ever.

The only students who benefit are those with rich parents that can afford to have no income during unversity.

Students with parents with low income lose the $500 matching grant. If they work/earn scholarships during university they will be saddled with punative marginal tax rates.

I think you nailed it Riverwind. However you slice this, that's the end result.

The Conservative government wants the Senate to help it defeat a private member's bill that would make contributions to registered education savings plans tax deductible.

The bill, which was first put forward by Liberal MP Dan McTeague two years ago, passed the House of Commons on Wednesday night with a narrow margin of 34 votes.

Because the bill doesn't call on the government to spend money, it was ruled appropriate for private member's bill, but Conservatives say its fiscal implications are steep enough that it should be blocked.

CBC

The irony is that the Tories have to use the Senate to stop this. And how did this get so far anyway? It makes the Tories look incompetent.

[August1991]

On second thought, I hope the Liberals in the Senate pass this law and it becomes an election issue. McTeague's proposal is so dumb, and Liberal support is so arrogant, that Harper will win a majority.

If this law passes, Stephen Harper is guaranteed to win a majority. Riverwind's assessment above is correct and in a campaign, it would become obvious to all.

[scribblet]

The Liberals may have hit political pay dirt on this one, they propose tax cuts then can blame the government for screwing up the economy as this could put the country into a deficit position.

It's just a minor detail that this will reduce the fed's revenues by hundreds of millions, which most

Canadians will ignore. Therefore the Grits get all the political benefits of proposing a tax cut, without the minor detail/inconvenience of having to balance the budget.

It is nice though that the Liberals are pushing a conservative agenda of lower taxes LOL but it does beg the question: should the opposition be able to set tax policies through private member's bills?

[jdobbin]

On second thought, I hope the Liberals in the Senate pass this law and it becomes an election issue. McTeague's proposal is so dumb, and Liberal support is so arrogant, that Harper will win a majority.

If this law passes, Stephen Harper is guaranteed to win a majority. Riverwind's assessment above is correct and in a campaign, it would become obvious to all.

I think the right wing is a little arrogant that this is going to be the issue that turns the election.

[Argus]

On second thought, I hope the Liberals in the Senate pass this law and it becomes an election issue. McTeague's proposal is so dumb, and Liberal support is so arrogant, that Harper will win a majority.

If this law passes, Stephen Harper is guaranteed to win a majority. Riverwind's assessment above is correct and in a campaign, it would become obvious to all.

You're joking, right?

Let's look at the most obviously stated point here

"It looks warm and fuzzy on the surface."

That's really as far as you need to go. It really doesn't matter if it's a dumb idea under the surface because the great majority of voters will never LOOK beneath the surface.

[daniel]

... this is going to be the issue that turns the election.

It'll just show everybody how the Conservative's carrot-on-a-stick polices are just nothing more than a smoke screen. This new bill will really benefit middle-class parents and the Conservatives are against it. They had $14 billion surplus and they say the RESP bill is too expensive?