Proposed US cuts to tax rates would reduce Canada’s competitiveness in attracting investment, workers and entrepreneurs.
Prime Minister Justin Trudeau’s father once famously compared living next to the US to sleeping with an elephant. A twitch or a grunt south of the border can have big consequences for Canada.
US President Donald Trump’s proposed tax plan is considerably more than a twitch.
Trump proposes significant cuts to business and personal tax rates. That would reduce Canada’s competitiveness in attracting investment, skilled workers and entrepreneurs – which all contribute to a dynamic and growing economy.
The Trudeau government should take action. But with an expected $28.5-billion budget deficit and red ink as far as the eye can see, what can be done in a fiscally responsible manner?
The answer lies in the Liberal Party of Canada’s past during the Chrétien era.
When Jean Chrétien became prime minister in the early 1990s, Canada was in a much worse competitive position than today. It had been more than two decades since the last balanced federal budget. The resulting debt accumulation created a great deal of uncertainty, hobbling investment. Nominal federal debt increased from $20.3 billion in 1970-71 to $527.9 billion in 1993-94.
And relatively high personal tax rates encouraged many of Canada’s best and brightest to move elsewhere – a phenomenon often referred to as Canada’s brain drain. In response, the Chrétien government implemented a series of critical spending and tax reforms.
Starting in 1995, they reduced federal program spending by nearly 10% over two years. This along with crucial program reforms helped the federal government eliminate the deficit for the first time in a generation.
A virtuous cycle ensued, including a string of budget surpluses that allowed Ottawa to chip away at its mountain of debt, which fell by $30.5 billion over Chrétien’s tenure. Paying down debt meant lower interest payments on the debt, freeing up resources for major reductions to personal and business tax rates.
In short, the government pursued historic reforms that made Canada more attractive for investment. The underlying focus was more prudent spending, balanced budgets, debt reduction and competitive tax rates. That, along with similar reforms at the provincial level, paved the way for a decade of prosperity, with Canada outperforming other industrial countries on economic growth, job creation and business investment.
The lessons from the Chrétien era can be applied today, particularly in response to Trump’s tax plan. Prudent spending, debt reduction and tax rate cuts would make Canada a more competitive location for investment and skilled labour, and help foster the prosperity Canadians enjoyed following the Chrétien reforms.
This, however, would mean a dramatic change in course for Trudeau’s government. In contrast to the Chrétien era, this government has moved away from proven policies and instead embraced significant deficit spending and debt accumulation. Indeed, the Department of Finance’s projections suggest decades of deficits and debt accumulation are imminent.
Trudeau has also acted contrary to his predecessor by raising tax rates on skilled workers and entrepreneurs. Combined with provincial tax rates, Canada’s top personal income tax rate is now 53.5% for someone living in Ontario, while the federal-state top tax rate in the US is 46.3%. This raises the spectre of a new brain drain to the US, particularly given Trump’s plan to reduce the top tax rate by 4.6 percentage points.
Trump’s plan (if implemented) will also make Canada less competitive on business taxes. His proposal reduces the average federal-state corporate income tax rate from 39% to 21%, lower than the 26.5% federal-provincial combined rate in Ontario.
While it may run against the grain for the Trudeau government, the Chrétien reforms provide a road map on how to make Canada’s economy more competitive in a Trump era.
Co-writer Hugh MacIntyre is policy analyst at the Fraser Institute. Distributed by Troy Media. © 2017