Punitive Taxes Cramp Productivity

Canada faces a serious productivity challenge and, unfortunately for Canadians, productivity has thus far been the forgotten election issue.

Productivity is, of course, not the easiest sell. Polling has indicated that many Canadians dislike the P word or simply do not understand what it means and why it matters. Ignoring the problem poses a serious threat to our future living standards. Immediate action is required.

We propose an ambitious $60-billion business tax relief initiative to spur capital investment critical to improving productivity.

The data reveal just how poorly Canada has performed. Internationally, Canada ranks 18th among 24 industrialized countries in average labour productivity growth over the past 10 years. Ireland ranked first with an average labour productivity growth rate of 4.7 per cent, three times greater than that of Canada. Furthermore, the productivity of Canada’s workforce has fallen from 89.9 per cent of that in the United States in 1985 to 82.8 per cent in 2004.

Increases in income come about by either working longer hours or increasing the amount produced for each hour worked. In other words, the choice is between working harder and working smarter.

Productivity, producing more for each hour worked, is largely about working smarter. Workers who become more productive are able to earn higher wages. Increased productivity also makes Canadian companies more profitable and competitive. A more productive economy also provides greater economic output from which governments can raise revenues to fund social programs.

As a result of Canada’s disappointing productivity performance, Canadian incomes have fared poorly compared to those in the U.S.

For instance, Gross Domestic Product per person, the most commonly used measure of living standards, has declined from 87.9 per cent of that in the U.S. in 1985 to 84.7 per cent in 2004. Hitting closer to home, average after-tax income per person declined from 80.4 per cent of that in the U.S. in 1985 to 66.9 per cent in 2004.

One of the primary reasons for Canada’s poor productivity growth, and hence the growing gap in living standards, is a tax regime that discourages capital investment: Canada has one of the highest tax rates on capital investment in the industrialized world.

Increasing the amount of capital that workers have at their disposal is one of the principal drivers of productivity growth and increased living standards. A review of academic research indicates that business taxes significantly influence the incentives for capital investment.

Jurisdictions with high business taxes reduce the after-tax rate of return on investment. Lower returns reduce the incentives for investment and leave firms with less money to reinvest.

The most effective means of increasing productivity in Canada lies in creating an environment that is conducive and indeed encouraging of capital accumulation.

Our plan proposes to reduce corporate income tax rates significantly and to eliminate Canada’s most damaging tax, the corporate capital tax. Specifically, we recommend:

• A reduction of the federal corporate income tax rate to 12 per cent from 21.

• A 30-per-cent reduction in provincial corporate income tax rates.

• Complete elimination of corporate capital taxes at both levels of government.

• The exclusion of business inputs from provincial sales taxes.

All told, our five-year federal-provincial initiative to reduce business taxes amounts to an estimated $59.1 billion with the federal measures representing nearly half ($28.8 billion.)

Many jurisdictions would also benefit from broadening their tax bases by eliminating tax incentives that favour one type of investment over another. Eliminating such incentives would increase the fairness of Canada’s business tax system in addition to reducing the total cost of the proposed plan.

For example, the net cost of the proposed federal tax cuts would decrease to $11.5 billion from $28.8 billion if a series of preferential tax policies would eliminated.

Some Canadians will naturally be skeptical about our plan’s affordability, even with these base-broadening measures.

However, consider that over the past five years Canadian governments have increased program spending $42.8 billion above the level needed to accommodate population growth and inflation, resulting in marked increases in real per-capita spending.

If greater control of spending were exhibited, every government in Canada could accommodate the recommended tax cuts.

The data is unambiguous that Canada faces a serious productivity challenge. The federal and provincial governments must deal with Canada’s punitive business taxes. The $60 billion in business tax relief would be a good place to start.

Doing so will reverse the current productivity decline and result in real and meaningful increases in Canadian incomes and living standards over the long term.