Ontario imposes tax on the ìhigh incomeî

In an effort to win opposition NDP members' support for its 2012 budget, the Ontario government agreed to impose a "Deficit-Fighting High-Income Tax Bracket.î As a result, 20,000-30,000 Ontarians who earn more than $500,000 annually ó or 0.2% of Ontario tax filers ó face what amounts to a 2% surtax on personal income.

According to an Ontario government press release, when fully implemented, the top statutory Ontario income tax rate on taxable incomes over $500,000 will be 13.16%, up from the current 11.16%, and will remain at that level until the budget is balanced in the fiscal year ending March 31, 2018. For 2012, the Deficit-Fighting High-Income Tax Bracket will be 12.16%, one-half of the increase in the rate, with the full 2% increase effective in calendar 2013.

This means that the combined federal and Ontario top marginal tax rate will increase to 49.53% from 46.41% in 2013.The government estimates an average incremental tax bill of $19,000 once the tax is fully implemented.

Ontario says this change will generate additional revenue of $280 million in 2012/13, $470 million in 2013­/14, and $495 million in 2014­/15. "All of the additional revenue raised by this proposed measure would be used to reduce the provincial deficit,î said the government press release, "and accelerate Ontario's plan to eliminate the deficit by 2017/18.î In fact, a $500 million surplus is expected in 2017/18.

Unfortunately, the increased revenue from the tax was not enough to appease credit rating agencies. Standard & Poor's put Ontario on a negative watch ó with a 33% probability of a credit rating downgrade within two years. Moody's then lowered Ontario's rating a notch to Aa2. As TD Bank Group economists Craig Alexander and Sonya Gulati point out in a report, since 2009, all three major rating agencies (DBRS, S&P and Moody's) have downgraded Ontario because of concerns about its "deficit profile, growing debt burden and deficit reduction efforts.î

"Credit-rating scores and the risk premium associated with holding provincial debt have important implications for debt-servicing costs,î say Alexander and Gulati in their report. The two economists list some disturbing figures:

ï Ontario's net debt as share of the economy will peak at 41.6% in fiscal 2014/15; five years ago the provincial debt burden stood at 26.8%.

ï In the current low borrowing environment, interest costs consume about 8¢ of every $1 spent.

ï Given the status-quo, in a few years, interest rate payments will inch up to 11¢ of every $1 spent.

"If markets demand more of a premium to hold Ontario debt given credit rating agency unease,î say Alexander and Gulati, "Ontarians could see less money directed toward actual programs and services.î

CIBC economist Warren Lovely does see some upside as a result of the new tax. In a CIBC report, he notes that every $1 of improvement in Ontario's budget balance will lessen the amount the province has to borrow. "So, for the current 2012/13 fiscal year,î Lovely says, "the long-term borrowing requirement has been lowered to $34.9 billion from $35.6 billion. The province has raised $1.6 billion toward that target since April 1.î