NEW REPORT. Responding to the Trump Cuts: Canadian Tax Policy

By Daniela Stratulativ & Andrew Cardozo

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CANADIAN TAX POLICY

FOLLOWING THE TRUMP TAX CUTS

A report from three roundtables in 2017 and 2018

 A priority issue in the Pearson Centre’s ECON4TMRO series

 

By Daniela Stratulativ & Andrew Cardozo

October 2018

The Pearson Centre would like to thank the speakers at our three roundtables: Craig Wright, Iris Evans, Peter Donolo, Francesco Sorbara MP, Pam O’Connell MP, Jack Mintz, Heather Evans, Hon. Wayne Easter MP, Francis Fong, and Toby Sanger for their insights and contribution to this project.

Summary

What is the impact of the US tax reform on Canada, how can Canada maintain her competitiveness? What should our response be, and what can we advocate that is good for Canada?

As part of the Economy4Tomorrow series, the Pearson Centre has hosted three roundtables on what Canada needs to do on tax reform in response to the Trump cuts, on September 13, 2017, February 20 and July 26, 2018.

For many years Canada has relied upon a tax advantage vis-à-vis the United States, advantage that now no longer exists, due to the significant tax cuts recently passed by the US Congress. There is a compelling need for Canada to analyze the implications of the US tax reform and to find solutions to regain our competitiveness. In addition, we should identify what makes Canada attractive – what Heather Evans referred to as the narrative of the Canadian advantage.

While dropping Canadian tax rates to a level below the United States is a first point that is raised, it seems generally too simplistic. Lowering tax rates naturally means a significant drop in government revenues and therefore government services.

Four key recommendations:

  • Canada should implement accelerated deduction on capital expenses to promote business investment
  • Canada should look broaden the base of tax revenues, including closing loopholes
  • Canada shuold better put forward the competitive case for Canada – that we have a strong economy, with an improving debt to GDP ratio, and a society with strong health services, public education and a highly skilled international workforce.
  • The Government of Canada should conduct a comprehensive tax review in light of the changing economy and inequality, establishing a special taskforce or commission.

 

Policy questions to regain competitiveness

The issues discussed during these roundtables focused on seven areas:

  • Deducation on caital expenses:  Should Canada should implement accelerated deduction on capital expenses to promote business investment and prevent MNEs from moving to US? Should we also implement measures that support all businesses to increase productivity and competitiveness?
  • Corporate tax rates: Should Canada consider reductions in the corporate income tax to be close to the low-tax US states in order to remain attractive to business investment. Can the budgetary impact of the lower tax rate be at least partially offset through stricter thin capitalization rules to discourage foreign multinationals from artificially shifting income from Canada to other jurisdictions through the use of debt?
  • Personal tax rates:  Do we need to lower the average personal tax rates by increasing the income threshold for tax brackets?   Our personal tax rates are not very different than the US personal tax rates, but apply at much lower income thresholds.
  • Consumption taxes:  Should the government ake another look at consumption taxes as we did in response to the 1986 US Tax reform? All provinces could harmonize to (i) reduce the administrative burden managing multiple taxes and (ii) create consistency between provinces on what is subject to sales tax.
  • Entrepreneur taxes: Should we review the tax provisions for entrepreneurs announced in the summer of 2017 which attempt to close some of the loopholes.
  • Comprehensive tax review:  Should we conduct comprehensive tax reviews in light of the changing economy and inequality. We need to have a more comprehensive discussion that involves Canadians and broader stakeholders, rather than a narrow group of tax experts and align with business interest.
  • The competitive case for Canada: What are the competitive aspects of Canada – our quality of life, stable economy, skilled workforce and social programs?

What Canada should do in response to US tax reform

At the first roundtable held in September 2017, when American tax cuts were just being predicted, there was a consensus that Canada needs to develop and introduce an appropriate response to protect and advance its economic interests. Most significantly the US tax cuts threaten to undermine our competitive advantage and protecting the Canadian competitive advantage on the global scale is a key responsibility of the federal government. It was an issue that had little traction in Canada, but as Craig Wright, Chief Economist of RBC remarked, it is never too early to get ready for a loss to our competitive advantage. He also listed a number of advantages that Canada has, besides tax competitiveness, such as low inflation, our fiscal consolidation and low debt to GDP ratio, our highly educated workforce with the highest post-secondary education levels among OECD countries, the two-year write-down depreciation for equipment, and the R&D tax credits, which are attractive to companies and also assist in advancing technology and purchase of technology. Beside the tax issue, our very proximity to the United States makes us attractive to investors from around the globe.

Pearson Centre Chairperson Sandra Pupatello talked in detail about the concerns related to tax changes and the strengths of the Canadian economy. Also discussed were the need for better coordination on tax policy between federal and provincial governments, and the reduction of inter-provincial barriers to trade.

Iris Evans, former Alberta finance minister, pointed to the concern in her province of the federal changes to small business tax policy announced last summer, changes that lead to a perception of the government being out of touch with the needs of business.

The second roundtable held in February, just after the cuts became reality, brought together Professor Jack Mintz, President’s Fellow at the University of Calgary’s School of Public Policy, and Heather Evans, CEO, Canadian Tax Foundation.

The keynote speakers at the roundtable in July were Hon. Wayne Easter, MP, Chair, Standing Committee on Finance, House of Commons, Francis Fong, Chief Economist CPA Canada, and Toby Sanger, Incoming Executive Director, Canadians for Tax Fairness. Both sessions were moderated by Sandra Pupatello, Chairperson of the Pearson Centre. The following aspects were discussed.

Every country and every company with US operations, or wanting to be in a market with 20% of world GDP is looking very much into this reform and looking into whether they should shift more capital expenditure, change supply chains, and invest more into US than what they had before.

The investment record by Canadians has been low, for the past few years especially, and there is a view that we need to increase private investment, otherwise we will have serious problems in terms of growth. A competitive tax system is important when it comes to capital investment.

There was a suggestion that Canada’s relatively high regulatory costs make it riskier for investors, while US has become more attractive from a tax and regulatory perspective. The US also has a large pool of labour and a big market. Although there are regulatory differences between states, once a company is in US, it is efficient to do business there. Now that we have lost that business tax advantage, all other aspects, like the market size and labour pool size, become more relevant. If NAFTA stalls or falls apart it will make trade with the US more challenging.

There are interesting issues from a tax planning point of view. In the past there have been high corporate income tax rates in the US, in addition to which US multinationals (MNEs) had to pay tax repatriation of income back to the US. High corporate income tax rates discourage foreign multinationals from earning income in the US, while taxes on worldwide income upon repatriation kept income earned by US multinationals outside the US.

The American changes

With the significant reduction in the US corporate income tax rates and a move from taxation or worldwide income to the territorial taxation system, both the US and foreign multinationals will be incentivized to shift income and capital to the US, which hurts other economies including Canada.

The US is bringing in limitations on the use of losses, meaning that post 2017, operating losses can only be written off up to 80% of their income in any year. To avoid the impact of the Base Erosion and Anti-Avoidance Tax (BEAT), companies will try to report their taxable income as higher in the US, of their affiliate if they are foreign companies.

The new tax – Global Intangible Low-taxed Income (GILTI) – is intended to make it more difficult for MNEs to push IP outside US and to actually bring it back home to be subject to taxation. The foreign derived income attributed to intangibles (FDII), which is a concessionary tax on holding intangible income in US, will cut back the value of R&D tax credits in Canada.

Another major change benefits S-corporations which are small businesses owned primarily by Americans. US offers much more tax incentive now to be in US than in Canada, on the small business side.

Simplifying and modernizing our tax code could spur new investment, promote job creation and significantly reduce the cost to governments of administering the tax system.

 

The following recommendations were suggested during the discussions:

Implement accelerated deduction on capital expenses

We should respond in kind on the immediate deduction for capital expenses, at least as a near-term measure. This will support the goal of promoting business investment and act as a good starting point to show that Canada indeed is responding to US tax policy changes. The measure will keep MNEs from moving to US. As a policy is not without limitations, since it does little for small businesses and startups that do not have a lot of current income from which to make deductions. It focuses on capital intensive industries and not necessarily on knowledge-based industries. We should think of measures that increase productivity and competitiveness for all businesses. We should focus more on clusters and do a lot more on collaboration between industry, employers and academics to develop those clusters and increase competitiveness.

Finding the solution for the deduction for capital expenses will not solve the competitivenss problem. There are much broader issues Canada needs to consider, from attracting top talent to more specific issues about the complexity of the tax code and how it is administrated. The entire system needs to be looked at, if we want to tackle Canada competitiveness problem – from personal tax rates to the income brackets the rates are applied against, corporate tax rates, our HST system, tax expenditures, how we consider small business income, how we are administering income with an eye on growing inequality pressures. All these can be or are barriers to growth and investment.

The immediate expensing of machinery and equipment will not have a sustained economic impact, since investment will be much more influenced by tariffs and trade considerations. A lot of new economic investments are intangibles which do not qualify for this.

The US introduced a lower tax rate for foreign-derived intangible income to bring that back to the US. We need to fight that, so instead of providing what we have now as the tax advantage for foreign internet and eCommerce companies, we should apply the same taxes to those imports as we apply to Canadian firms.

 Lower the corporate income tax rate and use base broadening

Canada needs to have at least some reductions in the corporate income tax. Lowering the corporate tax in the United States would attract more capital there, as returns would be higher in relative terms. Because capital complements labour, there would be less demand for labour and slower accompanying wage growth in Canada. Lower levels of investment also mean slower productivity growth, which also results in slower wage growth. Workers would bear a large share of the burden of lost competitiveness, while the rest would be divided among business owners and homeowners, who would see the value of their homes fall.

To ensure Canada remains attractive for business investments, it was recommended that federal and provincial corporate income tax rates be reduced by two points each so that Canada’s corporate income tax rate at 23% would be close to even low-tax U.S. states. We have lost the business tax advantage that we built up over the past 15 years. If we lose access to the large US market on trade that can be a very serious problem, given our small market size. In US, some of the states have no corporate income tax, for example Texas and Ohio. An Alberta company would have incentives to move to Texas, or a manufacturing company would look at Ohio versus Ontario. A difference of 5% in tax makes a significant difference in transfer pricing, for example. Other countries, like Sweden, tax the mobile basis – the capital – at a very low level, because this is what you need in your country. A lot of countries have concessionary rates towards capital to ensure they have capital investment.

To disincentivize companies to move their debt into Canada, we need to target capitalization. Studies on accelerated depreciation for investment in capital show that we can lower the corporate tax rate without hurting government revenues, by eliminating small business deductions.

If the rates are really high, that encourages companies to try tax avoidance, and also makes it difficult for administrators. The more complicated we make our tax system, the more it encourages tax evasion.

 

Lower personal tax rates

Reforms to the personal tax system can make it fairer, more efficient and less susceptible to tax avoidance. The existing system of refundable and non-refundable tax credits, which disproportionately benefit higher income taxpayers, could be simplified and reformed.

The personal tax rates should be lowered by increasing the threshold for tax brackets. Looking at most of the states in the US, we find that rates are not dissimilar to Canada, but the threshold at which the maximum rate is applied is fundamentally different. Canadians now pay more than 50% in most provinces. As Jack Mintz details in the National Post “The top rate in the United States applies at US$500,000 (for individuals) or US$600,000 (for couples). In Canada, the highest rate kicks in at a measly US$165,000. And there should be no one paying more than 50% as there is now, whether it’s top earners or low-income Canadians whacked by high marginal rates from income-tested benefits and personal taxes as they’re trying to get ahead. Both federal and provincial corporate income tax rates should be reduced by two points each”.

Review consumption taxes

The government has to look at the consumption taxes to find some options. The 1986 US Tax reform spurred changes on both the corporate tax side and the personal tax side. Canada did a number of deregulations and we made it more attractive for businesses to invest in Canada. The changes led to the introduction of GST and adoption of HST. Some provinces should look to adopt a sales tax harmonized with the GST to remove taxes on capital and intermediate purchases. Alberta can create a whole new Alberta tax advantage by slashing income taxes and replacing them instead with a provincial sales tax. (Or at least use revenues from the carbon-tax grab to lower personal taxes — or to lower corporate taxes, giving back to businesses who have lost competitiveness due to the government’s imposed higher energy costs.) (Jack Mintz, 2018)

Review tax provisions for entrepreneurs

We also need to look at our provisions in the tax system that are not working out well and are hurting the venture capital markets. The rich may be the ones holding most passive assets but their capital is fuel for new businesses. Instead of raising taxes on entrepreneurs — who might already be tempted to move to the U.S., the U.K., or other jurisdictions with lower personal tax rates — we should look at removing tax disadvantages, not increasing them (Jack Mintz, 2018).

We should try to have similar tax burden on all industries and not favour one over the other. The government should not pick the industries where we would have a comparative advantage. There is an argument to subsidizing research, since companies cannot capture all the returns on innovation. R&D is not just a matter of creating ideas, but also adopting ideas. However, picking sectors to subsidize is not necessarily the best approach, since we do not know where the technology is going to develop, who is going to do well in the future. We have to create our comparative advantage by doing things well and efficiently as a business sector.

We can consider switching more to grants from tax credits, so we do not get called back by the tax on the global intangible low tax income (GILTI).

Conduct a comprehensive tax review

We should take action against the downward spiral of international tax competition leading to greater inequality worldwide. It does not lead to a significant increase of overall investment and productivity, while also depriving governments of revenue they need to provide better public investments and public services.

In regards to the proposed comprehensive tax review we need to think in terms of the changing economy and inequality. We need to have a more comprehensive discussion that involves Canadians and broader stakeholders, rather than a narrow group of tax experts and align with business interest.

While such a review takes a long time, a review by a special review taskforce or commission over the course of a year or so would be opportune

 

THE CANADIAN ADVANTAGE

Our strengths include skilled and flexible workforce, a strong immigration policy with a strong merit-based component which brings in highly skilled workers (through the points system), our natural resources, research and superclusters, as well as our effective health and social policy programs.

Our strong education system and the immigration based on merit play a major role in having a highly skilled workforce. Natural resources have been our huge comparative advantage resulting in strong domestic and international investment in these industries. Canada supports business-led innovation, and the quality of our scientific research is ranked among the highest in the world. In addition, we are have a good social policy system that is one of our major advantages.

Most panelists recommended that Canada does not react in haste, since it takes time to assess the implications of the US tax reform. There is uncertainty around regulations in Canada. However, it would be a mistake not to take the opportunity to reflect on some of the measures that Canada could take to regain our competitive position and not just relying on tax. A race to the bottom of tax rates is not the right answer. What are our strengths? There is a compelling story to tell about Canada’s competitiveness, and we have to craft the global narrative around Canada’s advantages.

Skilled workforce

Canada’s good education system produces a highly skilled workforce. In addition, we have a great immigration policy, which is less family-based and more merit-based, and contributes to our high education per capita.

This year World Economic Forum Global Competitiveness Report ranks Canada 7th in labour market efficiency, driven mainly by the efficient use of talent. The report also shows we have a highly skilled workforce of scientists and engineers. In addition, the quality of the education system and the quality of our management schools are among the highest in the total of 137 countries ranked.

Resources

Canada has a strong resource-based economy. Natural resources give us huge comparative advantage. While we are not the only country that relies on resources, there is a lot of investment in high tech in these industries as well.

Research

The Innovation Superclusters Initiative of the Government of Canada will invest up to $950 million between 2017 and 2022 to support business-led innovation superclusters We should use our real estate to locate different companies based on a healthy comparative advantage and create more clusters, and move from extraction based economy into more high tech oriented.

The World Economic Forum Global Competitiveness Report ranks the quality of scientific research among the highest.

Economist David Macdonald of CCPA has noted in an article in February on the 2018 Federal Budget states that Canada’s research granting councils (SSHRC, NSERC and CIHR) will get an average $650 million boost in funding per year over the next five years, which will be especially important to the National Research Council (NRC). Unfortunately, the Industrial Research Assistance Program (funding for private research instead of public university research) is receiving more than the NRC.

Social program and social equality

Compared to US, we have a much more grounded and beneficial social policy. Personal tax rates are where they are because pay for all the social requirements that are met here.

Some suggest that if you want to live the American dream you have to move to Canada, since it offers a higher chance of moving out the lower quartile income! Therefore, social equality often play a role in where companies choose to invest.

In summary, Canada has many strengths to draw upon that we need to leverage to regain our competitive advantage.

 

 

 

Appreciation:

The Pearson Centre would like to thank several experts for their contribution at three roundtables on tax policy:

ROUNDTABLE #1:

Canadian Tax Policy and the Trump Agenda

RBC Towers, Front Street, Toronto; September 13, 2017; 8:00 to 10:00 am

Craig Wright, Senior Vice President and Chief Economist, RBC (Co-Host of the Roundtable)

Sandra Pupatello, Chairperson, Pearson Centre; Former Economic Development and Trade Minister in Ontario

Iris Evans, Board Members, Pearson Centre; Former Alberta Finance Minister

Comments from Members of the House of Commons Finance Committee:

Jennifer O’Connell, MP (Pickering-Uxbridge) and

Francesco Sorbara, MP (Vaughan-Woodbridge).

Moderator:   Peter Donolo, Vice Chairman, Hill+Knowlton Strategies Canada

 

ROUNDTABLE #2

Canadian Tax Policy following the Trump Tax Cuts (Part 1)

 Tuesday, February 20, 2018; 3:00 to 5:00 pm; Location: University Club of Toronto (President’s Suite), 380 University Avenue, Toronto

With

Keynote: Professor Jack Mintz, University of Calgary

Commentary: Heather Evans, CEO, Canadian Tax Foundation

Moderator: Sandra Pupatello, Chair, Pearson Centre (Former Ontario Minister for Trade and Economic Development)

 

ROUNDTABLE #3

Canadian Tax Policy following the Trump Tax Cuts

E-Roundtable:  Thursday, July 26, 2018; 2:00 to 3:00 pm (ET)

With

Keynote: Hon. Wayne Easter, MP; Chair, Standing Committee on Finance, House of Commons

Commentary: Francis Fong, Chief Economist CPA Canada and

Toby Sanger, Incoming Executive Director, Canadians for Tax Fairness

Moderator: Sandra Pupatello, Chair, Pearson Centre (Former Ontario Minister for Trade and Economic Development)

 


 

Related links:

We list a few sources here, notably some experts who have written for the Pearson Centre, whose work is on our website.

David Macdonald, February 27, 2018, “An ambition constrained budget”

http://behindthenumbers.ca/2018/02/27/ambition-constrained-budget/

Mathieu Bédard , September 13, 2017Trump’s Tax Plan and Ours – Bédard, available at: http://www.thepearsoncentre.ca/platform/donald-trumps-corporate-tax-plan-should-make-us-reconsider-ours%e2%80%a8/

Robin Boadway , September 13, 2017, Tax Policies for a Fair & Productive Economy – Boadway; available at: http://www.thepearsoncentre.ca/platform/tax-policies-for-a-fair-and-productive-canadian-economy/

Allison Christians, September 13, 2017, Corporate Income Tax & US Policy Changes – Christians; available at: http://www.thepearsoncentre.ca/platform/corporate-income-tax-and-potential-us-policy-changes/

Brian Kingston, September 13, 2017, Tax Reform and Trump – Kingston; available at: http://www.thepearsoncentre.ca/fr/platform/brian-kingston-on-tax-reform/

Jack Mintz, Jan 25, 2018 National Post – “If Trudeau ever accepts reality, here’s how he can save Canada’s competitiveness”

http://business.financialpost.com/opinion/jack-mintz-if-trudeau-ever-accepts-reality-heres-how-he-can-save-canadas-competitiveness

Trump tax reform leads U.S. entrepreneurs in Canada to consider … https://www.theglobeandmail.com/…/trump-tax…canada-to…/article37762472/

World Economic Forum, Global Competitiveness Report, 2017-2018

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