As America rises, Canada sits

The Trump administration’s economic agenda is evolving as planned, remarkably. Some of it for the good and some of it for the worse. But just as remarkable is that Canadian policy-makers have yet to show they’re preparing to adapt to the dramatically changing economic situation to the south.

The good parts of the Trump agenda are deregulation and tax cuts and reform, which will generate more growth and higher incomes for Americans. The bad parts are increased trade actions. Some of those actually challenge protectionism in other countries, but the overall effect hurts growth for the U.S. and its trading partners.

It was one of Trump’s first executive orders back in January that got the growth ball rolling by requiring two existing regulations to be eliminated for every rule being added, while prohibiting adding regulatory costs to businesses. In past administrations, new regulations were introduced if they passed a net-benefit test, but that’s more of an art than a science (I enjoy teaching cost-benefit analysis, but I know its pitfalls). Little was done to drop regulations that were ineffective, redundant or obsolete. Opponents decry the elimination of some regulations aimed at protecting the public interest, but there’s no doubt that too many rules impose economic costs well in excess of their benefits.

But now the biggest boost to growth will come with the final passage of Tax Cuts and Jobs Act, being finalized in negotiations between the House and Senate. And there is little reason to believe that the Republicans won’t succeed in making it law. Before the Senate passed its version of the reform bill on the weekend, I wrote here that I gave it two-to-one odds that reform would pass. Now I give it eight to one.

The most important part of the reform is a renewed President Donald Trump speaks at a recent fundraising breakfast at a restaurant in New York. corporate tax system. Both the House and Senate bills reduce the federal corporate income tax rate from 35 to 20 per cent (but the Senate delays the adoption to 2019). Both introduce expensing rather than depreciation of machinery and equipment expenditures for the next five years (with the Senate proposing a phase-out over the following five years). And both provide a significant reduction in tax on sole proprietorships and partnerships.

Most importantly, the House and Senate bills introduce a dividend exemption system for U.S. multinationals with new anti-abuse rules to protect the American tax base. That is aimed at fixing the current system, which badly shrunk the tax base by prompting American companies to park frequently-massive incomes in tax havens abroad, or inverting to become nonU.S. companies (see: Burger King).

The tax reform will also reduce personal income tax rates for middle-income Americans (although the Senate version eventually rescinds them in order to satisfy the peculiar “Byrd Rule” that puts time limits on legislation that increases the deficit). The doubling of the minimum standard deduction will free large numbers of taxpaying Americans from paying income tax.

Despite the Democrats claiming these bills are a gift to the rich, in fact the combined federal-state-local top rate will rise by a Trudeaulevel average of three to four percentage points, because the bill makes state and local income and sales taxes no longer deductible from federal income. This specific change is probably one of the most important personal tax reforms, as it stops letting higher-tax state and local governments shift part of their tax burden onto the federal government. There is a long list of other reforms in both bills that will generally improve and simplify the system.

It’s those business tax changes, however, that now stand as the major challenge to the rest of us. Taking into account the major features of both the House and Senate bills (which in this case are mostly identical), the new tax reform will result in the U.S. having an effective tax on new investment well below most regions of the world, except for the Middle East and Europe (many Canadians would likely be surprised to learn that the socialist European countries tend to have low taxes on capital compared to labour). Within the NAFTA region, both Canada and Mexico will now have heavier taxes on investment than the new effective U.S. rate.

Of course, U.S. tax reform could benefit both NAFTA partners. More American investment and higher incomes increase the demand for our products and services. But higher barriers to trade from a disruptive American withdrawal from NAFTA will make it even more appealing for businesses to locate in a competitive U.S. economy rather than Canada and Mexico to serve the North American market.

In a world where the U.S. is making big waves on deregulation, tax reform and trade disruption, Canadian politicians cannot afford to keep taking our competitiveness for granted, as they have been. It might be popular to soak companies and entrepreneurs with new taxes in the name of offering a middle-class tax cut (which the middle class lost to other tax increases, anyway). But if Canada wants to take advantage of the big boost coming to U.S. growth, our federal, provincial and municipal governments have got to start giving us some competitive regulatory and tax policies