Income Splitting and Anti-Avoidance Legislation: Evidence from the Canadian 'Kiddie Tax'

Abstract

We examine whether “kiddie tax” legislation in Canada, effective as of 2000, deters income splitting between parents and minor children by taxing at the top marginal rate certain types of non-labour income received by children. OLS estimates based on cross-province and time-series data reveal that the share of dividend income reported by children aged 19 and under declines by 86% after the introduction of this anti-avoidance rule. The estimates also reveal that the share of capital gains (income not covered by the legislation) reported by minor children increases by 70% in the post-legislation period, suggesting that parents are switching to an alternative income splitting technique. However, the latter percentage effect is on a small base, and thus the decrease in dividend income is much larger than the increase in capital gains income. Hence, our analysis suggests that the “kiddie tax” is an effective method to deter income splitting.