On April 28th, 2025, Prime Minister Mark Carney was (re)elected to office. As his first signed order with the new cabinet, he has signalled that his government will prioritize passing a middle-class tax cut. This plan impacts nearly 22 million Canadians and aims to save two-income families up to $825 a year by reducing the marginal tax rate on the lowest tax bracket by 1%. So, what are benefits of this cut for tax payers in Canada, what will it cost the government, and what is the economic reasoning behind it?
In Canada we have a progressive tax system, meaning as your taxable income increases, so does your marginal tax rate. To do this, federal tax rates are split up into several brackets starting at 15% and progressively going up to 33%. Importantly, the tax cut would only apply to the first bracket; or up to your first $57,375 at 15%.
Every Canadian tax payer is also entitled to a non-refundable tax credit that ensures you can earn a minimum amount of income before having to pay federal income taxes, also known as a basic personal amount (BPA). In 2025, this amount is $16,129 (this number will be handy for our savings calculations).
Regarding the economic reasoning and models behind the middle-class tax cut, the following provide a basic and fundamental understanding. Of course, economics is a much more complicated topic, with numerous things to take into account. As such, for a greater understanding, we encourage you to continue your research!
$C=a+bY_d$
Using this model, we can see that if taxes (T) decreases, $Y_d$ increases, leading to greater consumption.
Multiplier Effect:
$$ MPC = \frac{\Delta C}{\Delta Y} $$
A small tax cut can have a magnified effect on GDP if the MPC (proportion of additional income that an individual consumes) is high. Since middle-class households typically have a high MPC, they are more likely to spend rather than save the extra income. This means that their consumption would increase more proportionate to upper-class households.
The IS-LM model helps us understand how the whole economy works in the short run, especially how interest rates and total spending (output) are connected.
The IS curve is defined by the equation
$$ Y=C+I(i)+G+NX(Y) $$
where $Y$ represents output (real GDP), $C$ represents the Consumption Function above, $I(i)$ represents business investment decreasing as a function of the real interest rate, $G$ represents government spending, and $NX(Y)$ represents net exports (exports minus imports) decreasing as a function of income (decreasing because imports are an increasing function of income). This model assumes that all demand ($C+I(i)+G+NX(Y)$) is being met by output ($Y$).
As we can see, consumption ($C$) is a part of the IS curve, so if $C$ increases from a tax cut, the IS curve shifts right. This raises output ($Y$) but also interest rates ($i$) in the short run.
Increased interest rates make borrowing more expensive, leading to people being less likely to take out loans and instead more likely to save. As a result, consumer demand would go down, meaning that the increased consumption from the tax-cuts would be unsustainable.
The LM (Liquid preference-Money supply) Curve shows all combinations of income (Y) and interest rate (i) where the money market is in equilibrium. Adjusting it usually requires action from the central bank. but since we are strictly regarding government decisions, we will assume that the central bank does not get involved. (If you would like to learn more, this provides a good explanation.)
So, from our equation $Y=C+I(i)+G+NX(Y)$, we can see that if $Y$ remains the same while $C$ increases, there becomes an imbalance in our model (3=2+2, instead of 3=1+2). To adjust for this, the government can either: