Trump’s tax bombshell

While Canada debates hiking taxes on small businesses, the Trump administration and Congress launched a tax-reform process Wednesday that could make the United States one of the most competitive countries in the world. Much is still left to Congress to sort out, such as scaling back credits and deductions to offset some of the lost net revenues of US$2.2 trillion over a decade. And who knows if a final deal will be made despite the enormous pressure on Republicans to deliver a tax-reform package after the demise of health-care reform.

If significant tax-rate reductions occur as contemplated, Canada will be distinctly offside, especially when it comes to retaining entrepreneurs. The call to “go south, young enterpriser” could well be the end result if we continue to tax more heavily the skilled population who pay a hefty price to support public budgets in Canada.

Using 2015 statistics, the top income earners with more than $100,000 (7.8 per cent of taxpayers) paid 50.8 per cent of federal and provincial personal income taxes (corporate taxes on private corporations would be on top of that).

Wednesday’s White House announcement calls for significant reductions in U.S. federal income tax rates for the middle class. Seven brackets will be reduced to three with rates of 12 per cent, 15 per cent and 35 per cent (the current federal top rate is 39.6 per cent at incomes in excess of roughly US$415,000). The standard deduction will be doubled and mortgage interest and charitable contributions will remain deductible. Retirement-income incentives will be enhanced. It will be up to Congress to decide on a fourth bracket for the highest incomes and about limiting other preferences. Ivanka Trump’s enhanced child tax credits are also included. The alternative minimum and estate taxes are to be repealed.

With Canada’s top personal tax rates varying between 48 per cent in Alberta to 54 per cent in Nova Scotia on incomes above roughly US$160,000, mobile, skilled workers may well be attracted to move to a business-friendly United States for tax reasons. A repetition of the 1990s brain drain with a low dollar and high personal tax rates could be in the making if our tax-and-spend governments don’t change their ways.

On the business tax side, the U.S. reform could create significant pressures for Canada. The White House’s proposed federal rate of 20 per cent, combined with deductible state income taxes, will result in the U.S. corporate tax rate falling by a point and a half below the combined federal-provincial corporate rate in Canada, which is about 27 per cent.

The U.S. proposal would also enable machinery and equipment expenditure to be fully written off instead of depreciated. In the first time in a decade, Canada would lose its competitive business-tax advantage for large corporate investments with most industries except for communications, mining and oil and gas being more heavily taxed.

The U.S. plan also includes a minimum tax on the US$2.5 trillion of multinational profits that are sitting outside of the United States, which could raise significant revenue. But, more importantly, it will let bring companies bring those profits home subject to no additional U.S. taxes over what taxes have already been paid abroad. This is a game-changer for a country like Canada as it could lead to a significant outflow of cash to the United States, depressing our dollar and potentially pushing up interest rates.

And that is not all. The U.S. package proposes a much lower federal rate of 25 per cent for noncorporate business income of so-called S corporations — small businesses — partnerships and proprietorships to be taxed at a federal rate of 25 per cent, instead of higher personal income tax rates. This would result in a significant reduction in the effective tax rate on small-business investment by up to a third. That would put it well below Canada’s corporate and personal tax burdens on small business profits that are now subject to tax rates potentially over 50 per cent. One can hear the giant sucking sound for startup companies from Canada as we burden small businesses with higher taxes while the U.S. goes in an opposite direction.

U.S. tax reform is not all bad news for Canada. A more vibrant U.S. economy will help push up our exports.

The only question is whether we can keep businesses here to export to a U.S. market that becomes increasingly protective yet more attractive with lower taxes and less regulation. What is striking is that the U.S. tax policy is focused on growth, while ours is aimed at soaking the job creators.

IF THESE U.S. TAX RATES HAPPEN, CANADA WILL BE DISTINCTLY OFFSIDE.