Now is the time for broad tax reform
Canada needs more than selective targets
Attempting to soften up public opinion for the fall economic update, the finance minister has been furiously signalling two contradictory messages. On the one hand, the government will address business concerns at the sudden deterioration of Canada’ s positionin the competition for international capital in the wake of sweeping U.S. tax reforms put into effect at the start of the year. On the other hand, no it won’t.
Rather than deep, across-the-board cuts in corporate tax rates to restore the now vanished Canadian tax advantage — where once Canada’s marginal effective tax rate on corporate income, federal and provincial combined, was roughly half the equivalent U.S. rate (17.5 per cent to 34.6 per cent) it is now slightly higher (21 per cent to 19 per cent), according to calculations by the economist Jack Mintz — Bill Morneau has indicated he will confine himself to a few “targeted” changes. In other words, the same tinkering about that gave us the current tax mess.
Speculation has suggested Morneau might simply adopt a particular element of the U.S. tax bill, under which businesses can deduct the full amount of investments in machinery and equipment in the year they are made, rather than over the life of the investment, as is more usual. This might have something to recommend it as part of a comprehensive tax reform, such as the cash-flow tax many economists have proposed to replace the corporate income tax. On its own, however, it threatens to add new distortions to a tax system already riddled with them.
This is hardly the time for such narrow reforms, in any event. It isn’t just the United States we are falling behind. As a recent report by the Chartered Professional Accountants of Canada (International Trends in Tax Reform: Canada is Losing Ground) explains, most of Canada’s major trading partners have either already implemented sweeping tax reform or are in the process of doing so. These include Australia, Belgium, Japan, the Netherlands, France and Norway.
Neither are the calls for reform coming only from Canadian business. The government’s own Advisory Council on Economic Growth is among those saying the time is ripe, 30 years after the Mulroney tax reforms and 50 years after the Carter Commission. The OECD called for a similarly comprehensive review in its last Economic Survey of Canada.
The need for tax reform is clear enough in the long term: Canada’s historically sluggish productivity growth can no longer be offset, as it was in the recent past, with rapid labour force or high commodity prices. As the population ages and more and more of the population leaves the workforce for retirement, growth in coming decades is projected to be anemic at best — even as the costs of looking after all those retirees escalates. Faster productivity growth will require much higher rates of capital investment — higher than Canada’s meagre supply of domestic savings can support. Hence the need to keep Canada’s tax rates competitive, to ensure the country remains attractive to footloose international capital.
Still, the U.S. reforms have added fresh urgency to the issue. PricewaterhouseCoopers raised a lot of eyebrows — and maybe rolled a lot of eyeballs — with its recent study for the Business Council of Canada, claiming that the loss of tax competitiveness could cost as much as 4.9 per cent of Canada’s GDP, or as many as 635,000 jobs. But when I ran these numbers past a well-known public sector economist, without such an obvious axe to grind, he did not blanch. The study’s methodology was credible, he said.
Of course, we’d do well to avoid cutting taxes in quite the way the U.S. did, that is without accompanying measures to broaden the tax base, sufficient to stanch any loss of revenue. Trillion-dollar deficits are no one’s definition of responsible tax reform, especially at the top of the business cycle. Each — cutting tax rates, and closing tax preferences that distort investment decisions — would be desirable in itself, but also makes a compelling case for the other.
If the U.S. experience, cutting rates without closing preferences, offers one sort of cautionary tale, the Liberals’ first ill-fated foray into tax reform, the attempt to rein in the tax advantage enjoyed by owners of small private corporations, is another. With such a narrow focus, and without compensatory tax cuts, the whole thing was perceived as at best a tax grab, at worst an assault on small business. Broad-based tax reform is less likely to be perceived as unfair, and creates winners as well as losers.
There is another reason why reform might be timely. The Liberals are gingerly approaching their own Jan. 1 deadline for implementing a national carbon tax, likely without the help of most of the provinces, and all too aware of the risk that public opinion could turn hostile. There is speculation they will try to soften the blow by mailing out cheques to every household, in amounts sufficient to make up for the cost of the tax.
This would be unfortunate. Lump-sum payments, unlike tax cuts, offer no incentive for higher investment or productivity. The Liberals may fear that tax cuts would not be large enough, or visible enough, or too hard to implement, at least politically. (Would taxes be cut more in provinces that do not price carbon than in those that do? Would a uniform national tax cut be enough to compensate for the cost of the carbon tax in high-emitting provinces?)
But what if the carbon tax was implemented in tandem with broad-based tax reform? Could the two reinforce each other? Not only would there be that much more in the way of revenues with which to make meaningful cuts in corporate and personal tax rates, but the cuts might then be deep enough to make possible a more radical reform of the tax code than might otherwise be attempted. Sometimes the best policy is also the most practical.