U.S. income tax reform may take a page (or three) from Canada
This week’s Three Amigos Summit, capped off by an address to Parliament by U.S. President Barack Obama, further demonstrated the close relationship between Canada and the U.S.
While we often complain about our tax system, with its increasingly higher personal marginal income taxes, complex system of deductions and credits and recently curtailed TFSA contribution limit, Canada’s tax structure may actually be a model for the recent major U.S. personal income tax reform.
In a 35-page report released last month by a House Republican task force on tax reform titled “A Better Way: Our Vision for a Confident America,” the House Republicans outline numerous proposals to lower U.S. corporate and personal tax rates, among other ideas, many of which seem to take a page right out of Canada’s Income Tax Act. Here are three of the proposals that may sound familiar.
1. The Report suggests reducing the number of personal federal income tax brackets and lowering the rates. Currently, the U.S. has seven federal brackets, which range from 10 per cent for income up to US$9,275 to as high as 39.6 per cent for income over US$415,051. Canada has five brackets, starting at 15 per cent for income up to $45,282 to the newly introduced top rate of 33 per cent for income over $200,000. The Republican proposal has the number of brackets dropping to three and would lower the top rate to 33 per cent — the same as Canada’s.
2. The Republicans seem to be interested in exploring a U.S. equivalent to our TFSA to help solve the problem associated with the double taxation of savings. Under an income tax, income from savings or investment is subject to double taxation, since investments are made with after-tax earnings and the returns on those investments are also taxed. The report discusses the creation of a general savings vehicle called a “Universal Savings Account,” using the existing tax-deferred retirement accounts as a model. As proposed, account holders could withdraw both contributions and earnings at any time, and for any reason, without penalty.
3. The report also recommends reforms to the taxation of investment income, not dissimilar to the Canadian system, to further accomplish the goal of eliminating the double taxation of savings. While the current U.S. system partially addresses this problem by providing a special, preferred lower tax rate structure (up to 20 per cent, with an additional 3.8-per cent “Obamacare” surtax on net investment income) for certain types of investment income, such as dividends and capital gains, it doesn’t fully address the problem.
Instead, the Republican blueprint would replace these preferred rates with a 50 per cent income inclusion rate on all investment income, including net capital gains, dividends and interest income, “as part of the move in the direction of a cash-flow tax.”
While Canada currently taxes capital gains at the same 50 per cent inclusion rate, it has a much more complicated dividend gross-up and tax credit system for Canadian dividends, and taxes foreign dividends, as well as all interest income, at full marginal rates. A 50 per cent income inclusion rate for all investment income is an idea that may warrant further discussion here in Canada.