Canadians like cash benefits delivered through the tax system. Finance Minister Jim Flaherty likes dispensing them.

Social activists are less enamoured of the tax credits and income supplements that have become a hallmark of federal budgets. They would prefer affordable housing, subsidized child care, decent pensions and reliable public services.

Now an unlikely ally has weighed in on their side. The C.D. Howe Institute, financed primarily by business, has concluded after a thorough analysis of the tax system that Ottawa should switch back to investing in social programs.

Economists Alexandre Laurin and Finn Poschmann found that the more a working family earned, the more it lost in clawed back benefits and higher taxes. Low-income families were the hardest hit. Their marginal effective tax rate — the amount they owed on each additional dollar — could be as high as up to 60 per cent (80 per cent in Quebec.)

“There are better alternatives aimed at supporting low-income families through universal in-kind programs such as neighbourhood facilities and services aimed at target communities,” they said.

For the market-friendly think-tank, this was a departure. It normally applauds tax reductions and promotes individual choice. But in this case, the combination of higher taxes and forgone benefits created such a strong deterrent to work that it urged the government to go no further before conducting a review of the tax and benefit system.

The study’s findings are not altogether new. Economists have known for some time that low-income Canadians are reluctant to move from welfare to work, sacrificing their drug and dental coverage and putting their eligibility for social housing at risk. They’ve even coined a name for the phenomenon: the welfare wall END.

But last week’s report, Treading Water: The Impact of High Marginal Effective Tax Rates on Working Families in Canada, went a step further. It followed the poor into the labour market and found they were penalized for extra effort. The more they earned, the more benefits they lost. The three big ones were the Canada Child Tax Benefit, which is phased out as a family’s income rises; the GST/HST Credit, which likewise diminishes as income rises; and the Working Income Tax Benefit, which starts to decrease at a family income of $15,509 and falls to zero at $27,489.

To make their numbers relevant to laymen, Laurin and Poschmann created a hypothetical couple, Peter and Marie Thompson, with two children living in a rented apartment. He worked full-time and she worked part-time. Together they brought in $40,000 — just enough to make ends meet. Marie was considering a switch to full-time work to earn extra money. But once the couple weighed the costs and benefits, they realize she’d lose almost much in benefits as she’d make in income. (Her marginal effective tax rate was 68 per cent).

Well-off couples are spared this double whammy. If one of the parents worked longer hours, it might push the family into a higher tax bracket, but it wouldn’t result in lost cash benefits because most are targeted at low-income earners.

Where a family lives also makes a difference, the two economists found. In Alberta, which has few income-tested tax provincial benefits, only 5 per cent families pay a marginal effective tax rate above 45 per cent. In Newfoundland, it is 9 per cent. In Ontario, it is 31 per cent. And in Quebec, it is 56 per cent.

Laurin and Poschmann were deliberately vague about what neighbourhood facilities and community services they would propose in place of tax benefits, but there are two obvious candidates if the objective is to support workforce participation. The first is affordable child care. The second is efficient, reliable public transit.

It is unlikely that Flaherty or his boss, Prime Minister Stephen Harper, will abandon tax benefits anytime soon. From a political point of view, they are the perfect giveaway. The cost is hidden. The gains are tangible. Best of all, they appeal to voters.

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There is the small matter of the hypocrisy. The government exhorts the poor to work, then penalizes them when they apply themselves. But that can easily be taken care of with some clever campaign rhetoric.