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Under Canada’s income tax act (ITA), income tax covers personal, corporation, business, and trust income. The Canada Revenue Agency (CRA) determines income tax due by multiplying the taxable income by the applicable tax rates.
The CRA is in charge of federal income taxes. In Canada, income tax administration is a complex affair because different income levels have different tax rates, which the CRA calls a marginal tax rate system. For instance, people in the lower-income band pay lower taxes compared to those in the upper-income bands. Despite the complexity, this marginal tax rate system appears to be quite fair.
Though, the CRA’s structured tax rates are not difficult to understand. We will see how this works in a while, but before that, let us first understand tax rates’ definition and nature. A tax rate represents the amount – as a percentage of income – that the taxation agency will deduct from an individual’s or corporation’s income.
In this illustration, we shall use fictitious figures. Most important is the concept that we hope will become clear to you at the end. The table below shows the income brackets and their corresponding tax rates.
| Taxable income ($) | Tax Rates (%) | ||
|---|---|---|---|
| From | To | ||
| $ - | 10,800 | - | |
| 10,801 | 15,619 | 15.00 | |
| 15,620 | 20,600 | 39.70 | |
| 20,601 | 35,000 | 23.70 | |
| 35,001 | 45,020 | 29.50 | |
| 45,021 | 75,169 | 35.00 | |
| 75,170 | 100,000 | 36.30 | |
| 100,001 | 140,970 | 41.80 | |
| 140,971 | 155,972 | 43.30 | |
| 155,973 | 200,365 | 46.62 | |
| 200,366 | 236,501 | 47.62 | |
| 236,502 | over | 51.30 | |
In the table above, the taxation agency has specified the lower band and upper band of income brackets into which each level of taxable income falls. For example, earners of income from zero to $10,800 do not pay any taxes, but those who earn $236,502 and over surrender 51.30% of their pay to the tax agency as tax.
The fact that the tax rates that CRA applies change annually add to the complexity of the system. The question is this; why does the CRA change the tax rates every other year?
The short answer is inflation. The long answer is that the CRA adjusts tax rates and increases tax bracket thresholds each year, which take effect on January 1 and July 1 of the following year (or any other applicable year). This is called indexation adjustment.
But what is this indexation all about?
The CRA tracks the economy’s inflation rates – based on the Consumer Price Index (CPI) data that Statistics Canada reports every year. Recall that inflation is a form of indirect tax because it reduces the purchasing power of money. As such, the CRA indexes tax rates to inflation figures to reduce the burden that Canadians would have to endure otherwise.
Due to inflation, the CRA has raised the indexation rate by 1.0% to account for inflation. The indexation increase is lower this year compared to 1.9%, 2.2%, and 1.5% for 2020, 2019, and 2018. From this information, one can deduce that underlying inflation is lower this year compared to the previous three years.
The tax rates’ changes have increased the amount of tax-free annual income by $579 to $13,808. In other words, Canadians who earn $13,808 or lower in 2021 will be exempt from income tax.
The CRA made several other changes, including increasing the Canadian Pension Plan (CPP) premiums by 0.20% to 5.45%. The Canada Child benefit (CCB) has also been raised to $6,833 from $6,456 for every child aged six and below, while CCB for children in the six-to-17 age bracket has been raised to $5,765 from $5,708.
Learn how Child Tax Benefit loans work and how to get approved for one.
However, the Employment Insurance (EI) premium stays at 1.58%, the same level as it was in 2020.
The indexation adjustment implies that the tax brackets that defined taxable income have been raised by 1.0%. CRA makes the adjustments to enable Canadians to keep the pace of the CPI. Unfortunately, the CPI that CRA tracks are reckoned at a federal level means some people, especially those living in expensive cities, may not benefit as much. While some households will benefit from the changes, the budgets of those that experience a higher cost of living will not keep up with inflation’s pace.
Usually, the CRA increases the amount of non-taxable income at the pace of inflation. This year, the $579 seems higher; in fact, it represents a difference of 4.37%. As such, more people who earn meager income will be exempt from income tax going forward.
Marginal tax rates refer to the concept of levying progressive tax rates on incremental income. For example, a household that earns $13,808 or less does not pay tax, but one that earns $216,511 or more annually pays 33% in income tax.
Tax brackets are computed based on annual income.
The Canadian tax system is progressive, which means people in different tax brackets pay different amounts of tax. You can find out about your rates by checking the government website (https://www.canada.ca/)
No. Tax brackets at the province level vary.
Tax brackets indicate the range in which your income falls and tell you the tax rate charged. For example, the tax rate for people earning from zero to $13,808 is nil, meaning their income does not reach the threshold of taxable income.
