While U.S. President Donald Trump has just reiterated his intention to reduce corporate taxes, Finance Minister Bill Morneau wants to raise taxes on entrepreneurs. Ottawa would be better off focusing on Canada’s tax competitiveness with its neighbour by adopting, for example, a proportional tax rate of 10.5 per cent for all corporate earnings.
Mr. Trump is looking to lower the federal corporate tax rate in the United States from 35 per cent to 20 per cent. Such an abrupt reduction, or even a more modest one, would have serious consequences for the Canadian economy.
In terms of how easy it is to conduct business, Canada tends to fare poorly compared with its southern neighbour. According to the World Bank, Canada is ranked 22nd worldwide, while the United States is ranked 8th. Paying taxes is the only category in which Canada outshines the United States (17th vs. 36th). This advantage has been important in attracting investment to Canada in recent years. Presently, the highest combined (federal and provincial) marginal corporate tax rate in Canada stands at 31 per cent. This is below the lowest combined top rate (federal and state) for the United States at 35 per cent and well below the upper threshold of 47 per cent.
The proposed U.S. reform would make Canada much less competitive in terms of taxation. The new maximum rates that would apply to economically important states like Texas (20 per cent) and Ohio (20 per cent) would be well below the lowest marginal combined rate in Canada, currently at 26 per cent. In Michigan, the rate would be 26 per cent and in New York, 26.5 per cent. Canada’s advantage would disappear.
If such a reform were to be adopted in the United States, both Canadian workers and companies would suffer, since the United States would attract more capital in search of higher relative returns. Indeed, thanks to technological advances, capital now changes hands – and countries – more and more easily.
Workers, however, are less mobile. As a result, with less capital and less investment, there would be less job creation. As such, workers would bear a large share of the effects of Canada’s relatively higher corporate taxes.
To avoid this problem, the federal government could abolish its top income tax rate of 15 per cent and conserve only the lower rate of 10.5 per cent, which currently applies exclusively to small firms. This would bring Canada more in line with the proposed reform in the United States, and would help preserve Canada’s tax competitiveness.
Even if U.S. cuts do not materialize, Canada would still benefit from the adoption of a proportional corporate tax rate. This would encourage business growth, while the existence of multiple (i.e., progressive) rates of taxation tends to discourage business growth. Firms are also encouraged to legally divide their activities in order to reduce their tax burden, a bureaucratic waste of time and energy that could be put to productive use. Moreover, studies have shown how, before an earlier reform of corporate taxation, a larger proportion of companies limited their growth in order to pay a lower tax rate.
Of course, if combined with the federal measure described above, provincial efforts to lower their own rates would go even further toward preserving, and even increasing, Canada’s tax competitiveness.
It goes without saying that several elements of this proposal could bear further study, such as the sensitivity of investment to corporate taxes – especially in the case of small businesses – the effect of tax optimization strategies already put in place by many companies or the effect of reduced tax revenue for the Canadian government.
But none of these nuances would change our central observation, which is that the maintenance of the current tax system, in the event of U.S. reform, would entail a loss of tax revenue when business investments – and the resulting earnings – cross the border.
By acting now, the Canadian government would be sending a clear signal to companies that Canada is a good place to do business and will continue to be a good place to do business, regardless of American reforms.
Mathieu Bédard est économiste à l’Institut économique de Montréal et l’auteur du Point « Le Canada doit baisser l’impôt des entreprises et adopter un taux d’impôt proportionnel ». Il signe ce texte à titre personnel.