Asleep at the wheel on US tax reform

Clear warning signs yet Ottawa and many of the provinces have done nothing to respond.

US tax reform aims to attract investment to America.
Photo: Fotolia

Former prime minister Pierre Trudeau once famously quipped that living next to the US “is in some ways like sleeping with an elephant.” By this he meant that developments in the US often have an outsized effect on Canada. Like it or not, we must always be mindful of what’s happening south of the border and be flexible enough to respond.

This is particularly true with our comparative standing on taxes. Unfortunately, Pierre Trudeau’s observation seems completely lost on his son, Prime Minister Justin Trudeau, and various provincial leaders.

It’s increasingly likely with the US Senate passing its tax reform bill, America will – for the first time in almost 20 years – soon have a business tax regime that’s significantly more competitive than Canada’s. Crucially, this will divert investment, which drives long-term economic growth and prosperity, away from Canada to the US.

It’s not like our governments can say they didn’t see this coming. For more than a year, there have been clear warning signs the US was serious about tax reform. Yet Ottawa and many of the provinces have done nothing to respond.

This is unfortunate because successive federal governments (starting with Jean Chretien’s Liberals and then Stephen Harper’s Conservatives) – along with provincial governments of various political stripes – undertook enormous reforms to improve Canada’s business tax regime. Major reductions to the statutory corporate income tax rate, elimination of the corporate capital tax and a switch to value-added sales taxes at the provincial level helped give Canada a marked advantage over the US.

For instance, Canada’s combined federal-provincial corporate income tax rate in 2000 was 42.4%, the second highest among industrialized countries and higher than the US federal-state rate of 39.3%. By 2017, Canada’s combined corporate income tax rate dropped to 26.7%, below the US rate of 38.9%.

This advantage will soon be spun on its head. While final details of the US reform package are not yet set in stone, the US will likely move from depreciating capital investment towards full expensing, creating incentives to move overseas profits to the US. And it’s expected to reduce the federal corporate tax rate from 35% to 20%, bringing the combined federal-state rate lower than Canada’s combined rate.

More broadly, the US will gain an advantage when it comes to the overall tax rate on new investment, which includes more than just the corporate income tax. According to University of Calgary economist Jack Mintz, the overall tax rate on new investment in the US will fall from 34.6% to 18.6% (Canada’s current rate is 21.6%). Indeed, Canada will go from having a big advantage over the US disadvantage.

In the wake of this challenge, neither the federal government nor any of the provinces have presented a plan to maintain Canada’s competitive position on business taxes. To the contrary, some provinces in the past two years have actually raised their corporate tax rates, making us less competitive vis-à-vis the US.

Making matters worse, federal finances and the finances of key provinces such as Ontario and Alberta, make it very difficult for our governments to do anything in the short term without having to either run even larger deficits or enact significant spending reforms (which none of these governments seem interested in doing).

Given the widespread economic benefits, improving Canada’s business tax regime is good policy regardless of what the US does. But reform south of the border makes it even more critical for our governments to take action.

When you sleep with an elephant, doing nothing is not a good choice.

Written by Charles Lammam, director of fiscal studies and Hugh MacIntyre, a senior policy analyst at the Fraser Institute ( Distributed by Troy Media © 2018

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