Called the “biggest individual and business tax cut in American history,” this week's long-anticipated U.S. tax reform announcement had four stated goals: growing the U.S. economy and creating “millions of jobs,” simplifying the “burdensome” U.S. tax code, providing tax relief to middle-income American families and, perhaps most significantly, lowering the U.S. business tax rate from one of the highest in the world to one of the lowest.
Let's take a look at how the new, proposed U.S. tax changes compare to our Canadian tax system for individuals.
The U.S. plan promises tax relief “for American families, especially middle-income families,” which sounds pretty similar to the wording used by Justin Trudeau's Liberal government when it introduced the middle-income tax cut back in 2016, which reduced the tax rate for middle-income earners by 1.5 percentage points.
President Trump's tax cuts are more dramatic and reach further. His plan calls for a reduction in the number of U.S. federal income rate brackets from the current seven brackets to only three: 10 per cent, 25 per cent and a top rate of 35 per cent. That top rate is down nearly 5 points from the current top rate of 39.6 per cent.
By comparison, in Canada, for 2017, we have five federal tax brackets: zero to $45,916 (15 per cent), $45,916 to $91,831 (20.5 per cent), $91,831 to $142,353 (26 per cent), $142,353 to $202,800 (29 per cent), with anything above that being taxed at 33 per cent.
You'll recall that in Canada, our middle-income tax cut is being paid for by that new 33 per cent high-income bracket, which represented a four percentage point increase (from 29 per cent) in our top rate, applicable to Canada's top 1 per cent of income-earners. Mr. Trump, on the other hand, is lowering the top U.S. rate by nearly 5 per cent, although how he plans to pay for this and the other tax cuts announced as part of his plan is anyone's guess.
Under the U.S. personal tax system, filers can choose to claim either a “standard deduction,” or choose to “itemize” and claim various eligible expenses, such as medical expenses, charitable donations, mortgage interest expense and even state and local taxes paid, as deductions from their income. Taxpayers can choose whichever filing method results in the least amount of tax owing.
The tax plan announced this week called for a doubling of the “standard deduction,” which is currently US$6,350 for a single person or US$12,700 for a married couple filing jointly. As national economic director Gary Cohn said at the White House briefing on Wednesday, “in essence, we are creating a zero tax rate, yes, a zero tax rate for the first $24,000 that a couple earns.”
In Canada, we don't have to choose between itemizing and claiming a standard deduction — we essentially get to do both, although instead of a “deduction,” each Canadian can claim a non-refundable federal credit equal to 15 per cent of the basic personal amount, which for 2017, is $11,635. That means a couple filing Canadian taxes could earn $23,270 (albeit in Canadian dollars) without paying federal taxes, assuming the income was equally distributed between the couple, since Canada doesn't allow joint filing of tax returns.
The Trump plan also calls for a simplification of the U.S. tax system which would see the elimination of various itemized tax deductions, including potentially deductions for home office expenses, employment expenses, state and local taxes, qualified medical expenses and even gambling losses. The plan did say, however, that the two most popular deductions, mortgage interest and charitable donations, would be protected.
Canada's system is somewhat different in that we have both deductions that reduce taxable income, as well as tax credits which reduce our taxes payable. For example, we can deduct our RRSP contributions from our taxable income but medical expenses are eligible for a 15 per cent non-refundable credit. We generally can't write off our mortgage interest in Canada, unless the mortgage is on a rental property.
Over the past two years, the Canadian federal government has also taken steps towards tax simplification by cancelling a number of the so-called “boutique tax credits,” such as the children's fitness and arts credits, the education and textbook amounts and, most recently, the public transit credit. A federal study is currently underway of other tax expenditures which may lead to further tax simplification in Canada as well.
Finally, the U.S. plan announced the repeal of the estate tax, which currently applies to the fair market value of a U.S. person's assets upon death. The current exemption of US$5.49 million means that very few estates actually owe any estate tax.
The Urban-Brookings Tax Policy Center estimated that, with the exemption so high, in 2017 there will be only about 11,000 estate tax returns filed, of which 5,200 will be taxable. The U.S. Population Division of the Bureau of the Census projects that 2.7 million people will die in 2017, meaning that only 1 in 243 estates will file a return, with only 1 in 517 owing any estate tax.
The Center estimates the 2017 total estate tax liability to be US$19.7 billion after credits. If the repeal of the estate tax is effective for 2017, then this loss of revenue will further add to the cost of Mr. Trump's tax reform plan.
Of course, Canada doesn't have an estate tax on death. Instead, we tax only the unrealized appreciation of assets (other than your principal residence) upon death as well as the fair market value of your RRSP/RRIF.