The Knowledge Bureau (one of Canada’s leading online educator in all things tax and finance related courses), recently conducted a poll of whether a tax refund is a good thing or not. The votes were pretty much split down the middle – 58% no, 42% yes from a total of 266 votes. The comments however, revealed something a bit more interesting. Most of the comments were saying that having taxpayers receive such large refunds means that the government is getting significant interest-free loans from taxpayers.
To break this down a bit further, we have to dive deeper into behavioral science – plain and simple, taxpayers look forward to receiving a refund and actually go one step further and factor them into their financial planning each year whether it’s sound planning or not. To change this way of thinking, many advisors would have to reprogram their clients way of thinking and their approach to money management; something that may not be very effective.
Many Canadians are unaware of what actually generates a refund with some believing that a refund is just the governments way of giving us money (tax free). Let’s break it down:
Let’s say you earn a middle class salary throughout the year; pay your taxes; and have no investments (no RRSP’s etc). When you go to file your tax return, you input (or have someone else input) your T4 (Salary, CPP, EI, Income Tax Deducted boxes all filled out) and surprise, you’re getting a refund of $x.xx! Where did this money come from? It’s simple – there was too much tax being taken off of your return and it’s basically an “Oops, we took too much, here is a refund”; that’s why it’s called a refund. CRA is refunding you an amount in excess of what they took off.
Now let’s say you earn a middle class salary and have investment income (RRSPs). When you file your return and enter your slips, you are almost guaranteed a refund because of the RRSP giving you a tax deduction (as opposed to a tax credit). Tax deductions decrease your taxable income, therefore give you a refund amount (tax credits take the amount and multiplies it by your tax rate and applies that to the amount of tax you paid – a credit towards your income tax). You can max out tax credits but you cannot max out tax deductions (there are exceptions to this though which we are not going to discuss in this post). So in this scenario, you get a refund.
Refunds are NOT because CRA thinks you are poor or deserving of money; refunds ARE because you paid too much tax throughout the year and they are just giving it back to you.
Wait. Stop and think about this for a minute. If CRA is taking too much tax each pay cheque, why not just take less?
It’s a valid question that can be answered in three ways:
First, if CRA took less off and you had something occur during the year to incur a tax owing at the end of the year, CRA would have to collect on that amount whereas if they took the same amount, you may not have a tax owing and CRA wouldn’t have to collect anything; you just may not be getting a refund.
Second, CRA looks at the psychology behind finances in people. If they took less tax off and assumed you would take that money and invest it, then that would be the case; but they know better (we know better). Generally speaking, if someone has an extra dollar left over, they will look for ways to spend it (except for those who like planning for their future) not realizing that they may need to spend that dollar in 10 years or 20 years. People tend to have a spend now and save tomorrow mindset.
Lastly, CRA uses this extra money to earn interest and to invest in Canada. If they took less, they wouldn’t have the money and they would have to find it elsewhere. CRA is getting an interest-free loan from taxpayers to do with as they see fit then at the end of the year, refund it back to us after they’ve made money off of it (potentially).
In our experience, decreasing taxes on a paycheque to paycheque basis wouldn’t solve anything. Most people would end up owing money at the end of the year and have to figure out how to pay for that tax bill. Keeping the taxes the way they are, gives Canadians a small glimmer of money at the end of a long and tiring year.
So which is better – receive a refund or decrease the income tax deducted off of each paycheque? We will let you decide. Drop us a comment below and give us your opinion.
Accountable Value Financial Services is here to help you with your taxes. We can do some tax planning to see if your current retirement plan is the best for your tax return, or if you should tweak it to give you a better tax refund at the end of the year. We can also help you decide if you should reinvest your refund into something that can benefit you tax wise next year. Have questions about your payroll or income tax deductions? We can answer those too! We offer payroll, bookkeeping, tax prep, and employee benefits to help keep your dollar in your pocket.