Canada needs a bold response to more competitive U.S. business tax regime

According to a recent statement by Finance Minister Bill Morneau, the upcoming fall federal budget update will finally outline Ottawa’s plan to respond to major business tax changes by the Trump administration in the United States.

Unfortunately, Ottawa took a long time to even acknowledge we have a business tax competitiveness problem, let alone propose a solution. U.S. tax changes have been in effect since the start of this year and serious discussions about it happening have been in the works since Trump became president in January 2017. The Trudeau government should have tackled this crucial economic issue a long time ago.

And yet, based on Morneau’s statements so far, it seems unlikely his government will take the bold action needed to restore Canada’s competitive edge on business taxes. In fact, Morneau has suggested that reducing the federal corporate income tax rate will not be a part of the Canadian response. Instead, it seems likely his government will pursue some form of targeted investment incentives such as expanded tax credits or business expense write-offs.

This is the wrong approach—here’s why.

While targeted investment incentives can lower the effective tax paid by businesses, expanded tax credits or write-offs only apply to certain types of business expenses. Consequently, they distort the economy by favouring businesses that operate with these types of expenses, while doing little or nothing for other businesses. Beyond that, tax credits further complicate an already convoluted tax system, requiring yet more resources spent to simply comply with the tax code.

In contrast, reducing the corporate tax rate is a neutral policy that does not distort economic decisions or add complexity to the tax system. Incidentally, if Morneau reduced the corporate tax rate, it wouldn’t be the first time a Liberal government pursued this policy. In the 2000 budget, Jean Chrétien’s Liberals announced a five-year plan to reduce the federal rate from 28 per cent to 21 per cent—a policy expanded by Stephen Harper’s Conservatives, who reduced the rate further to the current 15 per cent. During the 2000s, provincial Liberal governments in Ontario, British Columbia, New Brunswick and even NDP governments in Saskatchewan and Manitoba also cut corporate tax rates (in addition to pursuing other pro-growth tax reforms).

Why did governments of different political stripes cut corporate taxes? Because it’s sound economic policy. Much research has shown that lower corporate taxes produce significant economic benefits including stronger economic growth and increased investment—both of which Canada desperately needs right now. And when businesses invest more in machinery, equipment and technology, average Canadian workers benefit through higher wages and increased economic opportunities.

But with Ottawa facing an $18.1 billion budget deficit, there are important fiscal concerns about whether the federal government can afford to cut corporate taxes. However, Canada could make business tax reductions budget neutral simply by reducing corporate welfare to offset reductions in the corporate tax rate. This could simultaneously restore the Canadian corporate tax advantage while also eliminating subsidies that prop up less-productive businesses, making our economy more competitive and providing more opportunities for Canadians.

Moreover, cutting the corporate tax rate would contribute to lowering Canada’s overall effective tax rate on new investment, a broad measure of business tax competitiveness that accounts for corporate income taxes, capital taxes and other investment-related taxes. Currently, Canada’s effective rate is 20.9 per cent, higher than the comparable U.S. rate of 18.8 per cent (down from 34.6 per cent since the Trump reforms). An effective tax rate significantly below the U.S. would allow Canada to regain its business tax advantage and provide a much-needed boost because Canada is already hampered by relatively higher personal income tax rates on professionals and entrepreneurs, a growing regulatory burden, proliferation of other anti-investment policies, and structural hurdles including a smaller market relative to the U.S.

If Morneau is serious about addressing the challenges posed by U.S. tax reform, reducing the corporate tax rate should be a part of the plan. So far, that seems unlikely, and Canadians will be worse off as a result.