What’s not to like?

This is a huge gift to Canadians that will allow them to accumulate wealth at a much faster rate, since the tax is taken off investment yields. The existing income tax discriminates in favour of consumers and against savers: both consumers and savers pay tax when income is earned, but only savers pay a second tax from invested savings, made even worse since there is no adjustment for inflation.

The idea of having tax-free-savings accounts is not new. Three decades ago, David Bradford of Princeton University and James Meade in the U.K. recommended this approach as one way to remove discrimination against savers under an income tax; the United States already uses both RRSP-like and TFSA-like approaches. Now, Canadians have an opportunity to shelter their savings from tax in two types of plans. In all likelihood, most lower- and middle-income Canadians will no longer be paying high taxes on their savings.

The big question facing investors is whether they should put their money first into an RRSP or TFSA. The advantage of the RRSP over the TFSA is that a taxpayer is able to reduce current taxes when making a contribution. However, the accumulated income and principal is taxed when withdrawn. If the investor expects the tax rate to be lower in the future, the RRSP remains a better investment than the TFSA.

The RRSP is also better when it comes to risky investments likeequities. The government shares not only the cost of the investment put into an RRSP, but also the risk, since the amount of tax collected from withdrawals will depend on the performance of the plan. With the TFSA, the taxpayer is on the hook for both the cost of the investment and any losses from poor performance.

On the other hand, the TFSA is much better than an RRSP if investors expect excessively high taxes on withdrawals from the RRSP. For low-income Canadians, putting money in an RRSP is an especially bad idea, since their withdrawals after retirement might reduce the eligible tax credits and supplementary pension payments — never mind being taxed on withdrawals. Under a TFSA, the saver is much better off by avoiding high taxes on withdrawn savings. Furthermore, people might treat the TFSA as more liquid savings since no tax is paid upon withdrawal.

Flaherty was able to bring in a substantial tax reform at little fiscal cost to the government for the next few years. The real cost will be down the road, when many seniors will have untaxed investment income sheltered in the TFSA. Of course, someone else will be in power by then, and Flaherty’s new account will make life a lot tougher for tax-and-spend governments in the future.