Opinion: TFSAs help boost the rich

A Tax Free Saving Account is a flexible, general-purpose savings vehicle that allows Canadian residents 18 or older to have a full tax exemption on investment income including interest, dividends and capital gains. They were introduced in 2009.

While all residents, regardless of income, are eligible to participate in the program, recent data show that the program seems to be working mostly for the rich.

Since the tax break on a TFSA account can be substantial, there is an annual limit on contributions. The limit in 2020 is $6,000, but importantly, any unused room from previous years can be carried forward. Hence, Canadian residents who have never contributed to a TFSA and were at least 18 years old in 2009 have $69,500 in unused TFSA room as of this year.

Over the past decade, the program has grown in popularity and, as of 2017, there are collectively $276 billion invested in TFSA accounts. This makes the program very expensive. Its overall cost during its first 10 years is estimated at $6.3 billion in forgone tax revenue, and in 2020, it will cost an additional $1.3 billion. That cost will continue in future years.

With such a high price tag, it is important to explore who mostly benefits from the program.

First, only half of eligible Canadians actually have a TFSA. According to 2016 census data, there were about 28 million individuals in Canada who were at least 18 years old, and in 2019, there were 14.1 million individual account holders.

Secondly, among TFSA holders, only a small fraction reached the contribution limit. In fact, only 1.4 million, or about 10 per cent, maxed-out their contribution room in 2019.

Who are the lucky ones who managed to contribute higher amounts? You guessed right - the rich. A breakdown of TFSAs data by income levels shows a clear pattern: Those who make more money use more of their contribution limits and enjoy significantly higher tax breaks.

For example, Canadians who make $50,000 to $55,000 in annual income, have on average $20,000 in their TFSA accounts and an unused contribution room of $32,000. In contrast, those who make $250,000 yearly or more have an average balance of $43,000 and an unused contribution room of only $16,000.

Based on this, we have to conclude that TFSAs are effectively a regressive tax measure, offering the greatest tax breaks to those with the most money.

This needs to be fixed.

The U.S. has a somewhat similar program to our TFSA - the Roth Investment Retirement Account (Roth IRA). But surprisingly, the legislature in our capitalist neighbouring country decided to grant eligibility to Roth IRAs only to those who make less than a certain threshold.

That's right - the financially more fortunate cannot take advantage of additional financial benefits.

As Wall Street guru Jim Cramer puts it: "The Roth IRA may be the single greatest thing our government has done for low-income families." Our government should consider a similar approach.

Alternatively, two restrictions could be imposed on TFSA accounts.

The first should be a lifetime cap on the contribution room. To make things simple, the current maximum contribution room of $69,500 can be used and indexed annually for inflation.

The second should be a cap on the overall market value of the account that is tax exempt. This could be set at $250,000 per individual. If an account reaches a higher value, the difference would be taxed like a regular investment account.

This measure will prevent the wealthier from speculating in their TFSA account and investing in ultra-high-risk securities that generate high returns.

This is something that low-income individuals cannot afford to do.

Ten years into the TFSA program, it's clear the program needs an urgent fix to ensure wealthier residents will not be getting disproportionately high tax breaks, and the overall cost of the program can be dramatically reduced.

The billions of dollars saved would help all Canadians, not just the financially fortunate.

Amir Barnea is an associate professor of finance at HEC Montréal.

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