Who cares about competing, anyway?

With the economic update released on Wednesday, we discover that the federal government’s main response to Canada’s competitiveness problem is to tinker with depreciation schedules. It seems the Liberal government is uninterested in fixing Canada’s competitiveness since it much prefers the option of spending heavily in next year’s pre-election budget, rather than reducing the tax burden on families and businesses.

This fiscal update does the minimum possible to ensure Canada attracts more private investment and entrepreneurship. It makes some attempt by allowing temporary accelerated depreciation. But that is wholly lacking in addressing the serious competitiveness, innovation and productivity issues facing Canada arising from burdensome regulations, our inability to get goods to tidewater, new levies on carbon, property and payroll, and high personal taxes on families and highly skilled, high-income workers.

The temporary accelerated depreciation allowance for investments in machinery and structures for a swath of industries (which will be phased out after 2023) apes the expensing provisions in the recent Republican tax changes in the U.S. The major difference, however, is that the U.S. also brought in tighter rules for interest and loss deductions as part of a large tax-reform package to take the wind out of expensing that would otherwise be too generous. Facing a 2019 election in Canada, the federal government was not in the mood to introduce serious tax reform.

Yes, accelerated depreciation will reduce the corporate tax burden on new investment. It has been used in the past to boost investment, but it has never delivered the promised impact. Canada has had accelerated depreciation for manufacturing and processing equipment from 1972 to 1988 and from 2006 to today. Yet manufacturing jobs have declined as a share of job force anyway (in fairness, it would have been more so if the incentive was not available).

So why does accelerated depreciation have limited impact? To answer that, we just need to go back to the 1970s, when the Liberal government of Trudeau Sr. tinkered with accelerated depreciation and investment tax credits. Many companies ended up not paying any corporate income taxes since they could not earn enough profits to absorb all the deductions and credits made available to them. Then, markets, doing what they do, figured out complex ways of transferring unused deductions to other companies who could write them off against their own profits. At the time, those were the big banks. Bank tax rates and revenues dropped precipitously, which created a political headache for the Liberal government at that time.

The corporate tax system became so unstable that the Mulroney government in its first budget of 1985 introduced reform that would eliminate general investment tax credits, accelerated depreciation and other preferences in favour of lower corporate tax rates. This not only improved Canada’s investment climate but also reduced the heavy hand of government intervention in business capital-allocation decisions. Subsequent corporate tax reforms at federal and provincial levels eventually made Canada a friendly place for investment and profits.

And yet, here we go again. Accelerated depreciation is being brought in but in a way that favours manufacturing and clean energy over other industries — at least for those companies that make profits and pay taxes. As it stands, about threefifths of Canadian corporations do not pay corporate taxes, according to the Canada Revenue Agency’s recent corporate tax statistics (a breakdown by sector or size of companies is not available). This will surely grow into a larger number with accelerated depreciation, leading to a 1970s-style unstable corporate tax system once again. And with the government playing favourites, expect more special preferences in the future for its pet industries.

While any tax relief is helpful, it is also important to understand that tinkering with depreciation schedules deals little with much bigger competitive issues arising from U.S. tax reform.

Lower personal taxes on skilled labour and profits earned by small and medium-sized businesses now make it much more attractive for business investors to set up shop in the United States than in Canada. Canada has managed to lure some investment from massive technology companies like Facebook and Amazon, but many of their jobs up here pay half of what they pay their top American workers. Why would any Facebook engineer or Amazon executive earning US$200,000 or more in the United States want to live in Canada with a combined federal-provincial marginal tax rate of over 50 per cent? American tech companies will be happy to hire our young, energetic Canadians with their publicly subsidized educations — and move the best and brightest of them to San Francisco, Seattle or New York, where the real money is.

Further, U.S. tax reform with its base-broadening measures and low 13.25-percent federal tax rate on intellectual property, marketing and service activities will put Canada behind the eight ball. Companies will shift costs to high-tax countries, and leave profits in the low-tax U.S., meaning more tax revenues for Washington, and less for Ottawa and others.

Canada is now has one of the highest corporate income tax rates among OECD countries at close to 27 per cent. Many of our peers are reducing corporate rates. France and Belgium will drop to 25 per cent in the next couple of years and Japan — which has the highest rate at 31 per cent — is implementing policies that will see companies paying 21 per cent if they meet hiring conditions. Our high tax rate not only discourages investment but also result in corporate tax-base erosion as companies move operations and profits elsewhere. Reducing tax rates is also far better than accelerated depreciation in that it creates less distortion for capital allocation decisions.

All this suggests a more comprehensive approach is needed to address both corporate and personal tax reform. And given the changing mix of taxes with increased future reliance on “sin taxes” on carbon and cannabis, opportunities are available to significantly reform the tax system.

Minister of Finance Bill Morneau should have proposed a tax-reform panel to report after the election. If smart policy-makers were given the chance to come up with a comprehensive approach for tax reform, it’s not likely that Wednesday’s accelerated-depreciation announcement would be part of that plan.