The Corporate Capital Tax: Canada's Most Damaging Tax

It has been called the most damaging and detrimental tax in Canada. This wealth and income killing tax is little known outside the circles of academia, tax-planning, and corporate boardrooms. However, the corporate capital tax is by far the most destructive and growth-inhibiting tax imposed by Canadian governments.

As the Fraser Institute’s study, The Corporate Capital Tax: Canada Most Damaging Tax confirmed, there are both absolute reasons based on its cost and complexity, and relative reasons grounded in the fact that few other industrialized countries use such a tax, explaining why it must be eliminated immediately.

For those outside of academia and tax planning, the capital tax, put simply, is a tax on the capital of large corporations. It generates revenue for governments by assessing a levy on corporations based on the amount of capital (essentially debt and equity) employed, regardless of profitability.

There are two major categories of corporate capital taxes in Canada: financial institutions and non-financial or general. The rates vary from zero in Alberta, to 0.64 percent in Quebec for non-financials and 4.0 percent in Newfoundland for financial institutions.

There are a number of absolute problems with the capital tax, not the least of which is its relatively high economic cost. Different types of taxes impose different economic costs. Consumption taxes, for instance, impose much lower costs on the economy than capital-based taxes. Several major studies have concluded that raising revenues based on capital is much more costly than raising the same amount of revenue using a consumption or labour-income base.

In fact, the seminal US study on the cost of taxation concluded that capital-based taxes were nearly 4 times as costly to the economy as sales taxes. These US estimates were buttressed by Canadian estimates which found an even greater magnitude of cost for capital-based taxes compared with sales or labour-based taxes.

Another problem with capital taxes in Canada is that they artificially penalize firms in the financial services sector. This is achieved through a special sector-specific capital tax levied on financial companies. In other words, if two firms have the same amount of capital but one operates in the financial industry and the other doesn’t, the one operating in the financial sector will face much higher capital taxes.

A final problem with the capital tax is that it is overly complex and imposes a rather heavy administrative and compliance burden on corporations. One study estimated that firms are required to account for roughly 103 items in order to simply calculate the capital tax payable in one jurisdiction. Imagine the level of complexity and administration required for firms operating across Canada or indeed internationally.

In an absolute sense, the capital tax is a poor way to raise revenues for government because it is inefficient, biased against certain sectors, extremely complex, and ultimately impedes economic growth by discouraging investment and economic development.

The story on the capital tax, unfortunately, gets worse. Canada is relatively unique in its use of capital taxes. Canada is one of only three countries in the OECD, the group of 30 industrialized countries, which levies a direct tax on the capital of corporations at the federal level. The other two OECD countries which impose capital taxes are Germany and Japan, but they do so to a much lesser extent.

The United States does not assess a capital tax at the federal level although several US states levy a minor tax equivalent to a capital tax. The amount levied and the accordant economic affect are negligible. Canada''s capital tax is by far levied at the highest rates, extracted from the broadest bases, and administered with the greatest degree of complexity compared with the few other OECD countries using capital taxes.

Our own study on the capital tax measured usage by the provincial and federal governments based on four indicators to assess internal usage. The indicators of usage were: capital tax as a percent of: (1) own-source revenue, (2) business profits, (3) gross domestic product (GDP), and (4) corporate income tax.

Saskatchewan and Quebec were easily the highest users of capital taxes in Canada, achieving the ranks of first and second exclusively in all four measures. Manitoba and British Columbia followed, although British Columbia’s usage of capital taxes should dissipate significantly as it eliminates its general capital tax later this year.

Alberta was consistently the lowest user of capital taxes in the country. In fact, Alberta is the only jurisdiction to have completely abandoned the use of such taxes—it eliminated the use of corporate capital taxes completely in mid-2001. Prince Edward Island, Newfoundland, and the federal government are also relatively low users of capital taxes. This relatively low use of the capital tax at the federal level should not confuse the fact that its presence is extremely damaging due to its rarity internationally.

Given the high and unnecessary costs associated with using capital taxes coupled with their rarity, it is imperative for all Canadian-jurisdictions, both the federal and provincial governments to follow the lead of Alberta and eliminate their use. At the very least capital taxes should be replaced with more efficient taxes such as payroll and/or sales taxes. However, the best option for every Canadian jurisdictions is the outright elimination of capital taxes in the form of a tax reduction rather than a tax replacement, as was achieved in Alberta.