THE LAST TIME WE LOST THE U.S.
U. S. tax reform has changed everything — even if the prime minister refuses to believe it. Justin Trudeau evidently missed the news that companies in the U. S. have been using the sudden shift to l ower corporate taxes to shower bonuses and raises on workers, and plowing yet more investment into new productivity and growth. In his speech to the World Economic Forum in Davos Tuesday, he offered his own ill- informed approach, saying he would refuse to try competing with U. S. business tax cuts because “People have been taken advantage of, losing their jobs and their livelihoods … (as) companies avoid taxes and boost record profits with one hand, while slashing benefits with the other.”
T hi s is no t i me for clapped- out anti- corporate cant. If Canada fails to respond to America’s resurgent competitiveness, it’s at our peril. The old rules no longer apply. Pre-2018, companies looking to invest in North America knew they had a business tax advantage in Canada, even though it suffered from having smaller market than the U.S., a weaker labour pool and colder climate. With NAFTA, businesses operating in Canada could also count on decent access to the U.S. market, despite all the border frictions that come from dealing with two different regulatory systems.
Now, there’s no certainty that NAFTA access is going to last, while there’s absolute certainty that U.S. tax reform is real, it’s here, and its impact has turned Canadian tax competitiveness upside down. Our recent lower- tax advantage has become a higher-tax handicap.
We now tax large corporate investments by about 10- per- cent more compared to the U. S. Our personal income and sales taxes are higher. And we’re increasing levies on energy, which was already being taxed higher than in the U. S. Small and medium- s i z e d business owners in the U. S. will be paying lower taxes than ours by a wide margin.
We aren’t just about to lose a whole lot of business. Our governments can expect to see revenues take a long slide. Tax reform turned already competitive corporate tax rates in states like Ohio, Washington and Texas into a much better deal than what Canada offers, which will encourage companies to shift corporate profits south.
Limits in the U. S. on deducting interest costs as well as loss limitations will encourage multinationals to shift costs out of the U. S., relocating deductions to Canada. And we’ll see American-owned companies start transferring money from Canada to U.S. headquarters. They’d rather use it down there to pay down debt, reinvest in the U. S., buy back shares, and — as companies from Apple to Walmart have already begun doing — raise wages to compete in the tight American labour market.
What should Canada’s governments do? So far, they’ve been ignoring their new and sudden l ack of competitiveness, but that’s no strategy. As the Economic Advisory Council convened by Finance Minister Bill Morneau reported last year, Canada was already suffering from lacklustre investment before U. S. tax reform came along.
Step One: Put a halt to planned but ill- advised tax hikes, such as Morneau’s planned squeeze on small businesses operating as Canadian controlled private corporations, which will damage private equity and venture capital markets. The rich may be the ones holding most passive assets but their capital is fuel for new businesses. Instead of rais- ing taxes on entrepreneurs — who might already be tempted to move to the U. S., the U. K., or other jurisdictions with lower personal tax rates — we should look at removing tax disadvantages, not increasing them.
Step Two: Lower personal taxes by raising the threshold for tax brackets. The top rate in the United States applies at US$ 500,000 ( for individuals) or US$ 600,000 ( for couples). In Canada, the highest rate kicks in at a measly US$ 165,000. And there should be no one paying more than 50 per cent, as there is now, whether it’s top earners or low- income Canadians whacked by high marginal rates from income-tested benefits and personal taxes as they’re trying to get ahead.
Step Three: To ensure Canada remains attractive for business investments, both
federal and provincial corporate income tax rates should be reduced by two points each so that Canada’s corporate income tax rate at 23 per cent would be close to even low-tax U.S. states. Some of the lost revenue could be made up by dumping pointless incentives — a recent paper by John Lester at Calgary’s School of Public Policy calculated that there are billions of dollars in subsidies that do more harm than good among the four biggest provinces and at the federal level.
Canada also has relatively weak thin- capitalization rules that make it easy for companies to dump debt into Canada. We could further tighten up on these given that the new U.S. rules discourage debt financing. Other countries like Australia have developed approaches we should consider.
Step Four: If we’re feeling really bold, we can shift from income- based taxes to consumption- based levies. Removing income taxes on savings would help liberate stock and bond markets. Making greater use of GST/ HST is sensible as a replacement for high marginal personal tax rates.
Step Five: Get the provinces into the act. Their l and-transfer taxes are highly distortionary and impossible to apply properly on hard- todefine commercial property purchasers. Some provinces should look to adopt a sales tax harmonized with the GST to remove taxes on capital and intermediate purchases. Alberta can create a whole new Alberta tax advantage by slashing income taxes and replacing them instead with a provincial sales tax. (Or at least use revenues from the carbon- tax grab to lower personal taxes — or to lower corporate taxes, giving back to businesses who have lost competitiveness due to the government’s imposed higher energy costs.)
These are all smart tax policy ideas regardless of what the rest of the world is doing. But now that the U.S. has completely flipped the competitiveness equation with its tax- reform bombshell, they sound smarter than ever.
And they’ re certainly a better plan than sitting on our hands and watching businesses and tax revenue drain away to Donald Trump’s U.S.A.
IF CANADA FAILS TO RESPOND TO AMERICAN RESURGENCE, IT’S AT OUR PERIL.