Former prime minister Pierre Trudeau once famously quipped that living next to the United States “is in some ways like sleeping with an elephant.” By this he meant that developments in the U.S. often have an outsized effect on Canada. Canadians, like it or not, must always be mindful of what’s happening south of the border and be flexible enough to respond.
This is particularly true with our comparative standing on taxes. Unfortunately, Pierre Trudeau’s observation seems completely lost on his son, Prime Minister Justin Trudeau, and various provincial leaders.
With the U.S. Senate passing its tax reform bill, it’s increasingly likely that the U.S. will – for the first time in almost two decades – soon have a business tax regime that’s significantly more competitive than Canada’s. Crucially, this will divert investment, which drives long-term economic growth and prosperity, away from Canada to the U.S.
It’s not like our governments can say they didn’t see this coming. For more than a year, there have been clear warning signs that the U.S. was serious about tax reform. And Ottawa and many of the provinces have done nothing to respond.
This is unfortunate because successive federal governments (starting with Jean Chretien’s Liberals and then Stephen Harper’s Conservatives) – along with provincial governments of various political stripes – undertook enormous reforms to improve Canada’s business tax regime. Major reductions to the statutory corporate income tax rate, elimination of the corporate capital tax, and a switch to value-added sales taxes at the provincial level helped give Canada a marked advantage over the U.S.
For instance, in 2000 Canada’s combined federal-provincial corporate income tax rate was 42.4 per cent, the second highest among industrialized countries and higher than the U.S. federal-state rate of 39.3 per cent. By 2017, Canada’s combined corporate income tax rate dropped to 26.7 per cent, below the U.S. rate of 38.9 per cent.
This advantage will soon be spun on its head. While final details of the U.S. reform package are not yet set in stone, the U.S. will likely move from depreciating capital investment towards full expensing, create incentives to move overseas profits to the U.S. And it’s expected to reduce the federal corporate tax rate from 35 per cent to 20 per cent, bringing its combined federal-state rate lower than Canada’s combined rate.
More broadly, the U.S. will gain an advantage when it comes to the overall tax rate on new investment, which includes more than just the corporate income tax. According to University of Calgary economist Jack Mintz, the overall tax rate on new investment in the U.S. will fall from 34.6 per cent to 18.6 per cent (Canada’s current rate is 21.6 per cent). Indeed, Canada will go from having a big advantage over the U.S. on the taxation of new investment to a disadvantage, as the U.S. rate is cut by almost half.
In the wake of this challenge, neither the federal government nor any of the provinces have presented a plan to maintain Canada’s competitive position on business taxes. To the contrary, some provinces in the past two years have actually raised their corporate tax rates, making us less competitive vis-à-vis the U.S.
Making matters worse, federal finances, and the finances of key provinces such as Ontario and Alberta, make it very difficult for our governments to do anything in the short term without having to either run even larger deficits or enact significant spending reforms (none of these governments seem interested in reducing spending).
Given the widespread economic benefits, improving Canada’s business tax regime is good policy regardless of what the U.S. does. But reform south of the border makes it even more critical for our governments to take action.
When you sleep with an elephant, doing nothing is not a good choice.
Charles Lammam is director of fiscal studies and Hugh MacIntyre is a senior policy analyst at the Fraser Institute.