Jack Mintz: How we lost our corporate tax edge

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Voters almost everywhere support corporate tax hikes. They also worry about jobs. Unfortunately, many of them do not see the connection between higher corporate taxes, lower investment and lost employment income.

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After 2000, Canadian federal and provincial governments of all stripes reduced corporate tax rates, broadened the corporate tax base, eliminated capital taxes for non-financial companies and harmonized their retail sales taxes with the GST to boost economic growth following the miserable 1990s. These changes succeeded in improving Canada’s competitiveness for global investment.

As Philip Bazel and I show in our 2020 Tax Competitiveness report, just released by the School of Public Policy at the University of Calgary, we have now completely lost the corporate income tax advantage built up over those years. By 2005, our corporate income tax rate had fallen from 43 per cent, highest in the OECD, to 35 per cent. As shown in the nearby figure, by then our combined federal-provincial corporate tax rate gave us a one-point advantage over the GDP-weighted average corporate tax rate among OECD countries. Further reductions by the Martin and Harper governments turned that into a seven-point advantage by 2012.

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From 2013 on, however, we generally stopped reducing our corporate tax rates (Quebec and Alberta were exceptions) even as other countries, including Britain, France and the U.S., continued to cut theirs. As a result, by 2020 our corporate tax advantage was completely gone: our rate of 26.1 per cent was now slightly above the OECD average of 25.7. True, the Biden administration is pushing for much higher corporate tax rates in the U.S. but higher rates there are a mixed blessing for us: they will make us more competitive but will also slow down the American economy and our exports to it.

Our investment performance reflects our shifting tax competitiveness. During the 1990s, private, real, non-residential investment averaged only 13 per cent of GDP. But after that it began to pick up, averaging 17 per cent from 2005 to 2015. That acceleration reflected the resource boom of those years, but it was also aided by our more competitive investment tax. By 2019, however, investment rates were back to 1990s levels and our per capita economic growth had virtually stalled.

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Today, Canada has the tenth-highest corporate tax rate among the 34 OECD countries. Of 94 countries we study, fully 64 have a corporate tax rate below ours. In this election, the Liberals propose a discriminatory hike of three points on selected financial institutions while the NDP favours a three-point hike on all companies. If our rate did rise to 29 per cent, that would put us just below Japan’s 30.6 per cent, second highest in the OECD, and Germany’s 30 per cent, third highest.

In part to offset our uncompetitive corporate tax rate, governments have provided a host of different tax incentives, such as temporary accelerated depreciation, investment tax credits and concessionary tax rates. Our tax on marginal investments — those earning returns just high enough to attract investors – will be 19.5 per cent once temporary accelerated depreciation is phased out. After accounting for these incentives, we do still have a global tax advantage in mining, forestry and manufacturing but not in most services, oil and gas or finance. This leads to a misallocation of capital in the economy as companies pursue tax reductions, not just the best economic opportunities.

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Nor do we have a tax advantage for large-scale investments in technology, logistics or pharma. Compared to what profitable companies can get in the rest of the world, our high corporate income tax rate leaves less on the table for them.

Should voters therefore celebrate higher corporate tax rates? Not at all. Higher taxes will discourage the investment that is critical to innovation and improving our standard of living, about which we should already be more than concerned. As we show in our paper, the correlation between labour productivity and the average wage rate is two-thirds: industries with higher investment have higher labour productivity and pay higher salaries.

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The complexity and distortions involved in our corporate tax are also worsening. We estimate that corporate tax distortions have more than doubled since 2015, making corporate income tax the most economically damaging of all taxes.

The public might think the rich and powerful pay the corporate tax but in fact the opposite is typically true. Studies have shown that corporate taxes lead to higher consumer prices and lower wages. They also erode the value of assets in pension plans. They thus hurt the lower classes most.

Many voters are rightly concerned about continuing to fund public services like health care, so revenues are important. Canada’s corporate taxes currently yield an impressive 3.8 per cent of GDP. But they also did that even as corporate tax rates fell. How? Because lower rates made it more attractive to keep profits in Canada and, with fewer tax incentives, tax revenues remained buoyant.

Canada can re-establish its competitive standing by following the strategy used in the tax reform of 1986: reduce tax rates and at the same time make the corporate tax system fairer, simpler and more efficient by eliminating tax preferences, thus broadening the tax base. It worked in the past. There’s no reason it won’t work again in the future.