The Effect of Inflation on Taxes

Evelyn Jacks

Aside from the news on personal and corporate tax changes, Knowledge Bureau’s Special Budget Report on tomorrow’s November 5, 2026 Federal Budget will keep a keen eye on two of the most prolific eroders of taxpayers’ wealth, taxes and inflation. Together, these two create a permanent reduction in income and wealth for taxpayers, and a big win for government. Working with tax and financial specialists, trained to defend against that erosion is key in times like these. Here’s the backdrop:

Why Government Budget Days are Important. This annual public accounting by the federal government, moved last year from Spring to Fall, summarizes how much revenue will be collected from taxpayers in all categories, in return for services and benefits they need. It also outlines how elected representatives plan for cost-of-living outcomes over a five-year forecast period, by announcing policies on taxation, economic development and fiscal management.

Largest Revenue Line Item: Personal Tax Revenues. The largest revenue line item for the federal government, is personal income taxes. According to the Parliamentary Budget Office (PBO) Economic and Fiscal Outlook, released in October 2026, these personal income tax revenues are projected to increase by 24.07% (growing at an average annual rate of 3.6%) over the five-year projection period from 2025–26 to 2030–31.

Add the Hidden Tax – Inflation. Back in August 2023 the C.D. Howe Institute published a fascinating study on this topic. Called Double the Pain: How Inflation Increases Tax Burdens. Authors William B.P. Robson and Alexandre Laurin did a terrific job of breaking down the reason inflation acts like a tax. It’s worth the full read, but following are a thoughtful points, important in assessing whether government policies adequately address the affordability crisis.

Recall that the year-over-year increase in the Consumer Price Index (CPI) rose above the Bank of Canada’s 2 percent inflation target in March of 2021. It then hit a high of 8.1 percent in June of 2022 – the highest level in four decades. It came down nicely since then. 

Yet today we are starting to see a rising inflationary trend again. Statistics Canada reported in mid October that CPI rose 3.1% year over year in September, following a 3.0% increase in August. This was largely driven by higher gas prices in September (up close to 28%); even higher than in August, when they were up close to 23%. To date there has been little relief for taxpayers, with the exception of short-term boosters for low income earners, such as the Canada Groceries and Essentials Benefit, to take the sting out of the regressivity of rising excise taxes on heating and other essential spending. 

With winter coming, will the Budget initiate more relief?

Inflation: Taxes with a Lack of Transparency. Inflation, as mentioned, is a stealth tax. It reduces purchasing power now and on savings for the future. Acting like a hidden tax, it also has very little transparency or legislative oversight on our tax burden, as Robson and Laurin point out. 

Here’s why: Inflation weathers away the real value of today’s tax brackets and other income-testing thresholds, deductions and exemptions. When a taxpayer’s income rises into the next tax bracket, because the bracket is unadjusted or not fully adjusted to inflation, taxes payable increase and/or refundable and non-refundable tax credits and social benefit supports decrease. 

The result: both inflation and taxes have eroded take home pay and the real returns on investments. In short both workers and investors suffer real net losses.

What Government Can Do to Help. There is much government could do, without adding a lot of complexity to an already overly complex Income Tax Act, to relieve some of this real economic pain taxpayers are experiencing. 

By example, the C.D. Howe study calculates the eye-popping real value that some of today’s most commonly used tax provisions should have risen to, if they had been indexed to inflation (based on 2023 factors), resulting in hidden taxes across several categories:

• The$1000 Personal Use Exemption for Capital Gains        Indexed: $7,244
• The GST/HST Small Supplier threshold - $30,000              Indexed: $56,750
• The Small Business Deduction - $500,000                          Indexed: $684,300
• The CPP Basic Exemption – currently $3500                      Indexed: $6,100

You don’t have to be a math wizard to understand the real dollar savings (and red tape reductions) that would have resulted, if these thresholds had been indexed over the years. 

The authors of the study rightly conclude that income tax thresholds that have not been indexed for decades, like the $2000 pension income amount and the $5000 transfer of tuition fees from student to supporting spouse, parent or grandparent, urgently need to be updated to reflect today’s fiscal realities. 

Full annual indexation for inflation would go a long way immediately to fix some of the affordability crisis households, students and small businesses face.  

Inflation Tax on Investors. How we tax long term investors also requires close scrutiny, especially if we want to “Build Canada Strong”. Most investors will hold on to important assets like real estate, businesses and securities for many years. When inflation is high their real dollar gains, frankly, can be an illusion. 

Currently capital gains, when realized on an actual or deemed disposition, are taxed at an income inclusion rate of 50%. That may somewhat compensate for inflation over the holding period. But not necessarily all of it.   

Robson and Laurin point out: “. . . the history of the inclusion rate shows no correlation with inflation. Whether the inflationary component of any particular capital gain is large or small, capital gains tax at the 50 percent inclusion rate applies to all of it.”

Others would say that the issue boils down to the lack of indexing of the cost base of the asset. In fact, according to the U.S. based Tax Foundation, “indexing the purchase price (or cost base) for inflation would provide savers some relief for this type of tax on fictitious income.” In other words, without indexing, the gains on the sale of capital assets do not always equate to a real increase in wealth.

That’s why federal or provincial budget announcements are important. In the absence of full indexation of tax brackets, deductions, exemptions, and income-tested measures, savvy taxpayers and voters will quickly be able to set their own priorities, to proactively defend against high marginal tax rates as a quick and easy fix to the affordability crisis. 

Working with a specialist holding the RWM™ designation, will bring Real Wealth Management to the forefront: the accumulation, growth, preservation and transfer of both income and capital, after taxes inflation and fees.

Bottom Line: There is no doubt that inflation acts like a hidden tax when government pause or ignore indexing. Both federal and provincial governments have understood that phenomenon.

Manitoba, for example, stopped indexing its 2024 tax brackets in 2025 and 2026. This hidden tax is transferring more income and wealth from workers, retirees and investors to government, resulting in a real loss of purchasing power over time.

Taxpayers need to defend against this erosion, and ultimately, decide on their acceptance of taxation policies that ignore inflation, when they next vote.

Additional Educational Resources: Enrol in the RWM™ Designation Program

Evelyn Jacks is a best-selling Canadian financial author and podcaster. Listen to Real Tax News with Evelyn Jacks and Friends to understand your tax system better. Go to podcasts@learn.knowledgebureau.com