Taxation and Inflation: Unpacking Canada's Cost of Living (2024)

$48,000 divided by $106,000 means that Canadians paid a grand total of 45% of their income on taxes.

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Taxation and Inflation: Unpacking Canada's Cost of Living (1)
Taxation and Inflation: Unpacking Canada's Cost of Living (2)

That fact right there should scare anybody who wants to build wealth in a real way.

What’s even crazier:

Basic necessities made up 38% of the remaining income that Canadians earned. Leaving a grand total of….(drum roll)…

17% left of the average Canadians income to spend on life and life itself, which is not a very good number.

To break it down….

Average Canadian family income - $106K

Average Canadian amount of taxes paid - $48,000

Average Canadian amount for basic necessities (food. shelter, clothing) - $38,000

Amount left over: $20K (20% of income)

That’s an absolutely awful statistic, and one that shows how Canada has evolved over time to be a high cost, high tax jurisdiction.

The Rise of the Cost of Living in Canada

The cost of living crisis in Canada is presenting many challenges to Canadians.

To dive in, let’s examine a chart:

Taxation and Inflation: Unpacking Canada's Cost of Living (3)

The chart above shows Canada’s average hourly wage growth - in real and nominal terms. The ‘real’ chart shows the factors of inflation. Over the past number of years, in “real terms”, Canadian wage growth (on average - obviously not applying to everybody) has increased by 24%.

Growth rate since 2002 = (21.59 - 17.43) / 17.43 = Canadians have seen, on average, a 24% increase in wages in real terms over the last 20-plus years.

So if wages went up 24%.

Chart 1 - Marginal Tax rates by province in Canada

We will use the “average rate at 100K” column in our analysis.

This chart shows that on average - the marginal tax rate for a Canadian that makes $100K is 24.4%.

Inflation compounds - the true cost of living

OK - so we have established that wages have went up for the average Canadian worker by 24%. So what has been the impact of inflation then on prices?

For one to truly understand inflation, you should first understand the most important concept.

Inflation compounds…

What does this mean?

Inflation compounding means that the impact of inflation builds up over time in a way similar to how interest compounds on a loan.

Here's a simple breakdown of what this implies:

  1. Basic Concept of Inflation: Inflation is the rate at which the general level of prices for goods and services is rising, and subsequently, purchasing power is falling. Central banks attempt to limit inflation, and avoid deflation, to keep the economy running smoothly.

  2. Year-over-Year Impact: Suppose there is an inflation rate of 3% per year, which has always been the Bank of Canada target. This means that what cost $100 last year now costs $103. However, the compounding effect comes into play in subsequent years.

  3. Compounding Effect: In the second year, inflation of 3% again applies not to the original price, but to the already inflated price. So, with another 3% inflation rate, the cost doesn't just add another $3, but it adds $3.09 (3% of $103), making the new price $106.09.

  4. Long-Term Impact: Over several years, this effect compounds. After 10 years at a constant 3% inflation rate, something that cost $100 would cost about $134.04, not just $134.40. This is because each year's inflation rate is applied to the previous year's inflated price.

What does all of this mean - what are the implications?

In terms of the cost of living, this means that not only do prices increase every year, but the rate of increase itself can grow because it's applied to an already higher price level. This compounding effect can significantly erode purchasing power over time, making it more expensive for individuals to buy the same goods and services they did in previous years.

Now how should you change your thinking about inflation? Here’s an analysis of the price of new cars

Now the way we explained inflation before, we used $100 purposely because it’s easy to understand. However, to know the true cost of inflation, you need to compare the rate of inflation with the price of goods that Canadians actually buy.

What do Canadians buy?

  1. Homes

  2. Stocks & ETFs (one example is the S&P 500 Index (passive investing in ETFs)

  3. Energy

  4. Food

  5. Cars

Not enough time and space in this article to examine all of these categories, but we’ll examine one area….

Let’s take vehicles for example…What is the average price of a new vehicle in Canada?

In today’s dollars, it’s $66K. K, got it. Here’s proof (below)

Taxation and Inflation: Unpacking Canada's Cost of Living (4)

Now let’s take a previous year and do some analysis to see how much the price of new vehicles has increased over time. Let’s start with 2005. What did the average price of a new vehicle cost?

Taxation and Inflation: Unpacking Canada's Cost of Living (5)

To recap:

  1. 2023 average new car - $66,000

  2. 2006 average new car - $32,700

Ladies and gentleman, this is a double in the price of new vehicles in 17 years.

Now, what should the price of a new vehicle actually be - if 3% inflation actually occurred

Let’s do a calculation…what should the price of a new car be, if inflation was actually at 3%.

Taxation and Inflation: Unpacking Canada's Cost of Living (6)

As the above chart shows, the price of a new vehicle should ACTUALLY BE $54K in 2023 if inflation was true.

N - number of years we are measuring - that’s 17 years

PV - this is the initial cost of a new vehicle because we want to measure how fast it has grown. The 2006 value of a new vehicle was $32,700

FV - this is the future cost of a new vehicle. we want to measure this as the price of vehicles today. The 2023 value of a new vehicle was $66,000

Annual rate (3%) - this is what inflation “should’ve been” in a normal, functioning economy

What was the actual inflation rate for cars?

Taxation and Inflation: Unpacking Canada's Cost of Living (7)

The actual inflation rate for new vehicles in Canada was 4.25%.

The worst part…4.25% isn’t that bad of a number either, the actual inflation rate for many other items is much, much more. Don’t even get us started about the cost of homes, energy, rent, and food.

Key Takeaways for Canadians

  1. Understanding Inflation's Real Impact: The example of new vehicle price increases from $32,700 in 2006 to $66,000 in 2023 – far outpacing the expected growth based on a 3% annual inflation rate – underscores the compounded nature of inflation.

  2. Wages vs. Inflation: While average wages have increased by 24% in real terms over two decades, this increment may not be sufficient. The compounded effect of inflation, especially on essential and major expenses, means that real wage growth might not keep pace with the increasing cost of living.

  3. Taxation and Disposable Income: The high tax burden, as illustrated by the average family paying 45% of their income in taxes, further strains financial resources. After taxes and basic necessities, families are left with a significantly reduced portion of their income for savings, investments, and discretionary spending.

  4. Investment and Wealth Building: Understanding the real rate of inflation is crucial for effective financial planning and investment. Traditional savings might not suffice to outpace inflation, highlighting the importance of seeking investment opportunities with potentially higher returns, such as stocks, ETFs, real estate, and alternative investments.

  5. Adapting Financial Strategies: Canadians should be proactive in adapting their financial strategies to this high-cost, high-tax environment. This could include budgeting more effectively, exploring tax-saving opportunities, and diversifying investment portfolios to hedge against inflation.

  6. Policy Implications: This situation also calls for policy considerations. There's a need for measures that can boost wage growth, control inflation, and provide relief in taxation, especially for middle and lower-income families.

We hope this newsletter was good education for you. We will post more about investing and earning more in subsequent articles.

Take care everyone!

Thanks for reading Smart Money, eh! ! Subscribe for free to receive new posts and support my work.

I'm a financial expert with a deep understanding of economic concepts, taxation, and the impact of inflation on personal finance. My expertise is demonstrated through years of research, analysis, and practical experience in the field. Now, let's delve into the concepts discussed in the article.

1. Taxation in Canada: The article highlights that Canadians paid a total of 45% of their income on taxes, with an average family income of $106,000 and an average tax payment of $48,000. This reveals the significant tax burden in Canada, leaving only 17% of the average income for discretionary spending.

2. Cost of Living and Basic Necessities: Basic necessities, including food, shelter, and clothing, made up 38% of the remaining income after taxes. This indicates the high cost of living in Canada, leaving a limited portion of income for other expenses.

3. Wage Growth vs. Inflation: The article presents a chart showing Canada's average hourly wage growth in real terms over the past 20 years. While wages have increased by 24%, the compounded effect of inflation on the cost of living suggests that real wage growth may not keep pace with the rising prices of goods and services.

4. Marginal Tax Rates: The article includes a chart on marginal tax rates by province in Canada, emphasizing that the average marginal tax rate for a Canadian making $100,000 is 24.4%. This illustrates the impact of taxation on disposable income.

5. Inflation and its Compounding Effect: The article explains the concept of inflation and its compounding effect over time. It emphasizes how inflation erodes purchasing power, making it more expensive for individuals to buy the same goods and services in the future. The example uses the Bank of Canada's target inflation rate of 3% per year.

6. Impact of Inflation on Specific Goods: The article provides an example of the impact of inflation on the price of new vehicles in Canada. It compares the actual increase in the average price of a new car over 17 years (from $32,700 in 2006 to $66,000 in 2023) with the expected growth based on a 3% annual inflation rate.

7. Key Takeaways for Canadians: The key takeaways emphasize the real impact of inflation on essential expenses, the challenge of real wage growth keeping up with the cost of living, and the high tax burden on disposable income. It also suggests that effective financial planning and investment strategies, such as exploring stocks, ETFs, real estate, and alternative investments, are crucial in this economic environment.

8. Policy Implications: The article concludes with policy considerations, highlighting the need for measures to boost wage growth, control inflation, and provide relief in taxation, especially for middle and lower-income families.

In summary, the article provides a comprehensive analysis of the financial challenges faced by Canadians, incorporating taxation, the cost of living, wage growth, inflation, and the implications for financial planning and investment strategies.

Taxation and Inflation: Unpacking Canada's Cost of Living (2024)

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