Tax Penalties on Fluctuating Incomes: Estimates from Longitudinal Data Daniel V. Gordon and Jean-François Wen Department of Economics, University of Calgary March 11, 2015 Abstract PRELIMINARY AND INCOMPLETE Progressive personal income taxes imply that individuals with fluc- tuating incomes will pay more taxes over time than individuals with constant incomes of the same average value. The implicit tax penalty violates the principles of horizontal and vertical equity and may also harm efficiency by discouraging risk-taking activities, such as entre- preneurship. The aim of this paper is to estimate the average size of the tax penalties in Canada using longitudinal data. The results are presented by income groups and separately for unincorporated and in- corporated self-employment and wage/salary employment. A further analysis shows the contributions of the two sources of the tax penalty: the size of income volatility and the shape of the schedule of effec- tive marginal tax rates. The paper then shows the effect that various income averaging policies would have on the size of the tax penalties. 1