Why You Should Notice The Government Is Withholding Money From Your Paycheques

My son’s first paycheque after he landed his first decent-paying job in the career he had long studied for resulted in a phone call. “Dad, the company didn’t pay me correctly. I was supposed to receive a much higher amount.” I smiled to myself, recognizing a teaching moment when I heard one. “Take a screenshot of your pay stub and send it to me,” I told him. He did.

Sure enough, the income tax, Canada Pension Plan and employment insurance withheld were entirely normal. I phoned him back to walk through it line by line. My teachings throughout his childhood about taxes and money had been fairly prominent, but the rubber didn’t truly hit the road until that phone call.

That was a good acorn-planting moment: a small act that could grow into something much bigger, a lifelong understanding of money and taxes. It was a rare one, too. My son learned something only because a number surprised him enough to pick up the phone. Most Canadians never get that jolt. Their pay stub looks the same, cheque after cheque, and the withholding line fades into the wallpaper and no acorn ever gets planted.

Economists have a name for this phenomenon: fiscal illusion. It occurs when governments structure taxation so people don’t fully experience its cost, making future increases politically easier. Few features of modern taxation illustrate fiscal illusion better than payroll tax withholding.

The modern withholding system has a curious pedigree. During the Second World War, a young Treasury economist named Milton Friedman was part of a small technical team that designed the United States’ system of automatic payroll withholding in search of a way to finance an enormous wartime tax burden without triggering the runaway inflation the country had suffered financing the First World War largely through debt.

Withholding solved that: it collected tax continuously as income was earned instead of waiting for taxpayers to settle up after the fact.

Friedman came to regret what he had helped build, saying that while he had no apologies for proposing withholding under wartime pressure, he considered its survival into peacetime a mistake and wished there was some way to abolish it.

In his memoir, he said his wife “repeatedly chided” him for helping create a system that made it easier for governments to grow because taxpayers no longer experienced the full pain of writing a large cheque to the government.

Consider what just happened on July 1. The Canada Revenue Agency issued its mid-year update to the T4127 payroll deduction formulas, incorporating provincial changes effective this month. Those changes include British Columbia’s lowest personal tax rate increase to 5.6 per cent from 5.06 for all of 2026, prorated to 6.14 per cent for the second half to catch up on the retroactive increase.

This increase by B.C. is horribly misguided. Prince Edward Island increased its top provincial personal income tax rate to 20 per cent from 19 per cent — prorated to 21 per cent for the balance of 2026 — by introducing a new bracket for taxable income over $200,000, while retaining the 19 per cent rate for income between $142,520 and $200,000. Again, this increase is terrible taxation policy.

There are other provincial tax changes, but those two are the ones that affect payroll withholdings. Unlike my son, most employees in B.C. or P.E.I. won’t have a confused phone call moment. The change will register, if it registers at all, as a marginally smaller direct deposit and a payroll department quietly updating a formula.

It doesn’t have to work this way. In some countries, withholding isn’t the default; taxpayers pay the government themselves, which guarantees an acorn moment for every taxpayer, whether they want one or not.

For example, Hong Kong doesn’t withhold salary tax at source. Instead, individuals directly pay the government on a provisional basis: an estimate based on prior income, paid in two instalments and reconciled against a final assessment once actual income is known. Twice a year, every taxpayer confronts an actual number they must personally remit.

Switzerland offers another version of the same idea, split cleanly by residency status.

Foreign nationals without permanent status have tax withheld monthly from their pay, same as Canada. But Swiss citizen and permanent resident taxes aren’t withheld at all. Instead, they receive provisional tax bills directly from their canton through the year and settle the final balance, or receive a refund, only once their return is assessed.

For most of the population, tax is something they’re billed for and have to actually pay, not something that quietly disappears from a pay stub.

Canada’s withholding system isn’t going anywhere soon. Our federal and provincial governments are too invested in the current regime and addicted to the regular cash injections.

But genuine tax reform, the comprehensive kind this country has needed for years, could open the door to more transparency even within a withholding system.

The United Kingdom has already shown one version. Since 2014, its government has mailed every taxpayer a personalized annual summary showing exactly what they paid in income tax and national insurance and a plain breakdown of where it went: health, education, defence and debt interest. Canada could do something similar since governments should never fear taxpayers understanding what government actually costs.

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My son got his acorn moment because he picked up the phone. Every government in this country, federal and provincial, has had decades to plant that moment for Canadians on purpose. None of them have bothered. So, plant it yourself by asking what you actually pay and demand your governments finally show their work.

Better-informed Canadians make better decisions with their money, families, careers and votes.

Kim Moody, FCPA, FCA, TEP, is the founder of Moodys Tax/Moodys Private Client, a former chair of the Canadian Tax Foundation, former chair of the Society of Estate Practitioners (Canada) and has held many other leadership positions in the Canadian tax community. He can be reached at kgcm@kimgcmoody.com and his LinkedIn profile is https://www.linkedin.com/in/kimgcmoody.

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