Taxation - Friend or Foe

Courtesy of Dave Dugdale via Flickr.

Courtesy of Dave Dugdale via Flickr.

The tax season is upon us and it's a great time to take a hard look at our yearly earned income summaries and ask ourselves "Is the next incremental dollar in wages worth my time?".

It's an important question because, all else being equal, there are diminishing returns to making each additional dollar in earned income when it comes to taxes. As we move up each individual income bracket, taxes and other deductions take an increasingly large part of our take home pay. As our gross pay gets fatter, so do the government coffers. Once we get to a certain point, the extra money may not be worth the extra time and stress. 

Let's simply compare the percentages withheld for income taxes and mandatory deductions for income insurance programs (employment insurance and the national pension plan). The exact increments will differ depending on where you live (province or country) and what I present is only an illustration for your consideration.

The list below shows what percentage of your take home pay you get to keep for each incremental dollar you make through earned income if you live in Manitoba, Canada. It does not including the impact of tax deductions you become ineligible for as your gross income increases, which can be substantial.

Income Tax and Other Taxes by Income Bracket

  • 26% income tax on $0K to $31K + 1.73% EI* + 4.95% CPP** = 32.7% tax***
  • 28% income tax on $31.1K to $43.5K + 1.73% EI + 4.95% CPP = 34.7% tax
  • 35% income tax on $43.6K to $67K + 1.73% EI up to $47.4K* + 4.95% CPP = 40.3%****
  • 39% income tax on $67.1K to $87K + 4.95% CPP = 44%
  • 43.5% income tax on $87.1 to $135K + 4.95% CPP up to 95.2K = 44.3%*****
  • 46.5% income tax on income over $135.1K = 46.5%

The jump from the first income bracket to the the next is a minor 2% increase. Making an additional $12.5K does not work that much against you, understanding you don't get an additional basic personal exemption on the next wedge of earnings. However, once you move beyond $43.5K, you pay 40 cents on the dollar for each additional dollar you earn. That is a 5% increase in tax rate but an 8% reduction in take home pay! 

65 cents on the dollar down to 60 cents on the dollar = 5/65 or 8% cut in take home pay

For the next bracket, the result is a loss of 7% in take home pay: 

60 cents on the dollar down to 56 cents on the dollar = 4/60 or 7% cut in take home pay. 

As you can see, what is equally, if not more, important than increases in your current salary is the after tax value of each subsequent dollar you earn based on your marginal tax rate. If you are not making significantly more money per hour and/or if the work is no easier on a per hour basis as you move up each income bracket, it may not be worth your time and energy to make that additional income.

Taxation makes you consider the opportunity cost of that additional income. It makes us consider what brings significant non-monetary (aka priceless) value to our lives. The energy you could put to increasing earnings might be better spent investing in your quality of life in ways that don't include making more net take home pay: 

  • Spending time with family and friends
  • Furthering your education
  • Pursuing a hobby
  • Playing sports
  • Traveling to low cost destinations
  • Learning a new skill that can help you in areas such as home repair, personal care and the like.

If the additional income is worth it compared to the time and additional effort to make it, then the question becomes how to maximize the use of that income for your present and future self. We'll leave that question for a future post.

May Tax Man be kind to you this year.



*EI = Employment Insurance

**CPP = Canadian Pension Plan

***This taxation percentage does not take into account a personal exemption of $9,574.

****Used 16% of 1.73% EI, given only that portion of the total range is taxed at 1.73%. If you are at the lower end of the tax range, you will pay more than 16% of the 1.73%.

*****Used 17% of 4.95% CPP, given only that portion of the total range is taxed. If you are at the lower end of the tax range, you will pay more than 17% of the 4.95%.

All information above sourced from the Canada Revenue Agency.