Saving NAFTA not enough

Last week, Canadians were confronted by several U.S. policy disruptions. The Trump administration proposed countervailing duties on Canadian lumber exports to the United States. The president also challenged unfair Canadian practices that discriminate against U.S. dairies. Trump even raised the possibility of cancelling NAFTA altogether if Canada and Mexico do not negotiate a better deal.

And the Trump administration laid out its (halfbaked, so far) tax-reform package, which — if it prevails — will have a significant impact on U.S. competitiveness by adopting much lower personal and corporate income tax rates.

Trump’s “Make America Great Again” theme has thus upended Canada’s carefully crafted growth strategy of three decades. The strategy has had two parts: ensuring access to the North American market for businesses located here, and improving Canadian competitiveness to induce businesses to locate here and access a North American market of nearly 500-million people.

The first objective was fulfilled by the historic 1987 free-trade agreement with the United States, and later, NAFTA. The second was achieved in part by creating a tax advantage for businesses locating here, to overcome our otherwise economic disadvantages of a small geographically dispersed domestic market and limited-sized labour pool.

Our tax reforms from 1985 to 2012 were especially impressive. To remove taxes on business costs that impaired our ability to export, Canada adopted the GST in 1991 to replace the antiquated manufacturer’s sales tax. The old MST was embedded in the prices of business inputs such as steel, computers and buildings, raising production costs. With the GST, businesses were refunded the taxes paid on their inputs, lowering their costs to better compete in export markets.

For the same reason, Atlantic and Central Canadian provinces replaced their retail sales taxes (which also added substantial cost to business inputs) with a provincial tax harmonized with the GST.

Federal and provincial governments also reduced corporate and personal income taxes rates and broadened tax bases during two phases. The Mulroney government cut personal income rates in 1987 in response to Reagan tax reforms in the U.S. in 1986. supportive of free trade in recent years (especially among Republicans).

Even though an economic strategy to attract business to Canada still prevails, federal and provincial governments have increased taxes on new investment since 2012 by either raising corporate tax rates or reducing incentives.

Today, the tax burden on new investment is almost one-sixth higher than it was five years ago.

Trump is proposing a federal corporate income tax rate of 15 per cent. Combined with state tax rates, that will total roughly 21 per cent. For the first time two decades, the proposed U.S. average corporate income tax rate will be below the average Canadian combined federal-provincial rate of 27 per cent. A lower rate in the personal taxes on mobile skilled labour that will hurt our competitiveness, too. The average combined federal-provincial top personal income tax rate is 53 per cent on incomes above $202,800, now seventh highest among OECD countries.

U.S. personal taxes are much lower. Its federal-state top rate of 46 per cent isn’t applied until incomes hit $556,000 or above for single filers (in Canadian dollars). Now Trump is proposing to reduce it further. Given our integrated market, the high Canadian personal tax will have our best and brightest moving to a resurgent U.S. economy.

Canada is now confronted with two unhappy circumstances: A more business-friendly tax and regulatory regime in the U.S., and its hawkish Buy American/ Hire American trade stance. We can’t change the latter, except remind Americans of the value of free trade in North America.

That is what Ottawa has been trying to do. But if it wants to be a virtuous free trader, the federal government should not be defending our own trade restrictions such as supply management, aerospace subsidies and foreignownership restrictions. Otherwise, we are no better than other countries’ economic nationalists.

Even if Canada can convince the U.S. to maintain a strong integrated North American economic region, we still have too many policies hurting our competitiveness.

If we still want businesses moving here, instead of there, we are going to need our own campaign of deregulation and tax reform.