On April 18, a number of witnesses appeared before the Senate Standing Committee on Banking, Trade and Commerce to report on the recent tax changes in the U.S. and the implications for Canada. Following is the testimony of Charles Lammam, Director of Fiscal Studies at the Fraser Institute. 

Charles Lammam, Director, Fiscal Studies, Fraser Institute:  Thank you to the committee for the opportunity to present my thoughts on the recent tax changes in the U.S. and the implications for Canada. My comments today reflect my own opinions and observations and not necessarily the views of other Fraser Institute staff, affiliated researchers or our board of directors. I hope you find my comments helpful and informative as you deliberate on these important public policy issues.

There are many factors that affect Canada’s ability to attract and retain investment, entrepreneurship and skilled workers. Some of them, such as global swings in commodity prices, are not within the government’s direct control. But government policies can and do shape Canada’s investment climate and therefore governments can affect how attractive our country is for work and business. And tax competitiveness is an important component of the investment climate.

Prior to recent sweeping tax reforms in the U.S., Canada enjoyed nearly a two-decade-long business tax advantage over the U.S. In fact, the gap between our statutory general corporate income tax rates was quite large. In 2016, according to OECD data, Canada’s federal-provincial combined statutory corporate tax rate was approximately 27 per cent compared to 38 per cent in the U.S.

Of course, it’s important to consider the effective tax rate. Based on the marginal effective tax rate, which is a broader measure of business tax competitiveness, as it includes input taxes, credits and deductions, Canada’s tax advantage was actually more pronounced in 2007, with a rate of approximately 21 per cent versus 35 per cent in the United States, according to calculations by the University of Calgary economist Jack Mintz.

This long-standing tax advantage helped Canada attract and retain investment vis-à-vis the U.S. One high-profile example was Burger King’s recent merger with Tim Hortons and subsequent move to Canada. But as of this year, Canada has completely lost its business tax advantage over the U.S. Reforms south of the border lowered the federal statutory corporate income tax rate from 35 per cent to 21 per cent, allowed for immediate expensing of capital investment and created incentives to move overseas profits to the U.S. Together, these reforms have dramatically reduced the effective tax rate on new investment in the U.S. from approximately 35 per cent to 19 per cent, which is much lower than Canada’s current rate of 21 per cent.

With Canada’s business tax advantage gone, it will become harder to compete with the world’s largest economy for investment dollars.

With Canada’s business tax advantage gone, it will become harder to compete with the world’s largest economy for investment dollars. In addition to business tax changes, the U.S. has reduced its federal top personal income tax rate from almost 40 per cent to 37 per cent. Prior to this change, Canada was already highly uncompetitive internationally and specifically relative to the United States as our combined top federal-provincial income tax rate was just under 54 per cent versus the 46 per cent in the United States. And crucially, Canada’s top rate generally applies to a much lower level of income, exacerbating our highly uncompetitive top rate.

The gap between Canada’s top rate and that of the U.S. has widened considerably due to the reduction in the American top rate but also because of federal and provincial increases in Canada’s top rate in recent years. These developments further undermine Canada’s tax competitiveness. Higher personal tax rates make it harder for Canada to attract and retain high-skilled workers, including entrepreneurs.

So while the U.S. federal government is making America more attractive for skilled workers and investment through tax and regulatory changes, Canada is doing the opposite.

So while the U.S. federal government is making America more attractive for skilled workers and investment through tax and regulatory changes, Canada is doing the opposite. Ottawa and several provinces have undermined Canadian competitiveness with an assortment of policies that discourage investment. This includes higher tax rates on personal income, corporate income and payroll; persistent budget deficits that risk higher tax rates in the future; new regulations on carbon, resource projects and labour; and higher costs of doing business through minimum wage and energy price hikes and now, as we’re seeing with the Kinder Morgan Trans Mountain Pipeline expansion, increased uncertainty about the rules and policies affecting economic and resource development in Canada.

The cumulative effect of such policies, along with a strong anti-business rhetoric from many governments in Canada, has struck a harsh blow to the country’s investment climate… investors are turning their backs on Canada.

The cumulative effect of such policies, along with a strong anti-business rhetoric from many governments in Canada, has struck a harsh blow to the country’s investment climate. U.S. tax reform, plus uncertainty surrounding NAFTA negotiations and access to the U.S. market, only rub salt in Canada’s self-inflicted policy wounds. It’s no wonder investors are turning their backs on Canada. There are several high-profile examples of major companies withdrawing investment from the country, a worrying sign that Canada is increasingly being viewed as a place not to invest. As the Royal Bank of Canada CEO recently put it, in real time, “we’re seeing capital flow out of the country.”

But Canada’s investment problem is not simply anecdotal. The overall data paint a concerning picture. Business investment, excluding residential structures, is down nearly 20 per cent since the third quarter of 2014 after accounting for inflation. And there are no signs of improvement in the year ahead. Statistics Canada’s latest survey on investment intentions for 2018 found that private-sector investment is slated to fall yet again, the fourth consecutive annual decline. Meanwhile, foreign direct investment in Canada has plummeted since 2013.

Declining business investment, coupled with the fact that Canada now has the second-lowest level of business investment as a share of our economy among a group of 17 advanced countries, should be of great concern to policy-makers given the positive effect investment has on economic growth and overall living standards. If investment in Canada keeps falling, Canadians will be economically worse off in the future.

Declining business investment, coupled with the fact that Canada now has the second-lowest level of business investment as a share of our economy among a group of 17 advanced countries, should be of great concern to policy-makers given the positive effect investment has on economic growth and overall living standards. If investment in Canada keeps falling, Canadians will be economically worse off in the future.

Unfortunately, despite negative comments from a chorus of business leaders about Canada no longer being a desirable place to invest and the aggregate data pointing to a major investment problem, the federal Finance Minister has said the impact of U.S. tax reform requires further study.

There is a clear need for federal and provincial governments to take steps to improve Canada’s investment climate, not just in response to reforms in the U.S. but more broadly in light of faltering investment. This would not only make Canada more attractive to investors, but it will also send a powerful signal that Canada is indeed open for business and a welcoming place for entrepreneurs and investors.