Income from all investments should be taxed at a flat rate and tax rates on the highest income earners should be increased, a wide-reaching report on tax reform says.

Income is currently taxed progressively in Canada. That means that the more you make, the higher your tax rate is on each additional dollar of income. There are now four main federal tax brackets, with marginal rates that rise with each income bracket

The report, published by the C.D. Howe think-tank, says one of the problems that’s increasingly apparent is that it’s becoming easier for the wealthiest Canadians to respond to higher tax rates with manoeuvres that lower the amount of income subject to those higher rates.

The author argues that Canada’s tax system need to be reworked to reflect the global reality. The main problem, according to the report, is that the benefits of recent tax reforms, such as reductions to corporate taxes, have tended to go to those with the highest incomes.

Rather than reversing corporate tax cuts, which the report says enhance growth, the government should consider reforming the entire income tax system – specifically, by bringing in a dual income tax structure.

Dual tax system

The report recommends that wages continue to be taxes progressively, but investments should be taxed at a low, uniform rate — a flat tax.

As part of the reform process, the report suggests that the tax treatment of stock options be tightened. It notes that stock options, which make up a large part of the compensation packages for many executives, now get special tax treatment. The report urges that stock options be treated like other labour compensation, such as wages, and to tax them at full rates as soon as practical.

Ottawa should then transform the Canadian tax system to a dual tax system, it recommends. Under this scenario, Canada would move to a flat tax rate on all forms of capital income, including interest and other investment income.

The report also calls for higher taxes on high income earners. Currently, the highest federal tax bracket – 29 per cent – kicks in at income of $136,270. It suggests a higher bracket of 32 per cent for employment income above $250,000 and 35 per cent above $400,000.

This attempt to "clean up" the tax system would also require an end to some boutique tax breaks, like the children's fitness tax credit, the public transit tax credit and the volunteer firefighters’ amount.

"It goes without saying that fitness, transit and firefighting are admirable things, but loading the tax system with such measures enhances neither efficiency nor fairness," says the report. "If these and other things are worthy of support,

policymakers could find a way to do so outside the tax system."

It is a call for a major rethink in the way Canada taxes income, but the report's author says it's worth it.

"Enacting these reforms would bring two large benefits to the Canadian economy and society,” says UBC economics professor Kevin Milligan.

“It would restore the ability of the tax system to respond to increasing income concentration by taxing more those whose incomes have grown the most,” he writes.

“This, in turn, would open the door to beneficial reforms of consumption taxes, environmental taxes and corporate taxes that might otherwise remain closed because of concerns about who benefits most from economic growth.”

Milligan’s report was published by the C.D. Howe Institute in partnership with the Chartered Professional Accountants of Canada. But both groups say the report is meant to stimulate discussion and is not the official position of either organization.