Embracing a Growth Oriented Tax System
Advances in communications and information technologies, and liberalization of trade and investment policies are accelerating the pace of global economic integration. Skilled workers, businesses and capital move easily across national boundaries, seeking the best economic opportunities. In response, even as the recession ravaged public finances, many countries have continued to overhaul their tax systems to improve their global competitiveness.
According to PricewaterhouseCooper and the World Bank Group, between June 2008 and June 2009, 45 economies reduced the tax burden, broadened the tax base and/or made it easier to pay taxes, a twenty-five per cent increase from the previous year.
In recent years, Canada has moved to meet the challenge with a remarkable transformation in the business tax landscape. Federal and provincial business taxes have been substantially reduced, with further changes legislated. By 2012, Canada will have the lowest statutory corporate income tax rate in the G7 group of industrialized nations, and already has the lowest effective tax rate on new business investment in the G7. These measures have made Canada a more attractive location for new investment and have helped existing businesses compete.
In a recent speech about how we can succeed in the global marketplace, Bank of Canada Governor Mark Carney pointed to our progress to date in improving our tax competitiveness and encouraging trade openness. According to Mr. Carney, “staying the course in these regards is likely the single most important contribution of the public sector.”
Improving tax structure
As Canada emerges from a global recession, our political leaders are searching for strategies to balance the books. Unless policies change, Canadians and businesses across the country will be hit by a series of increased payroll taxes, starting in 2011 when the current employment insurance (EI) premium freeze ends. This will make it harder for large and small businesses to maintain their current employees, let alone hire new ones. The government should keep EI premium rate increases at manageable levels by balancing the EI account over the business cycle of up to ten years.
In light of the expected rise in EI premiums, delivering on planned business tax relief is even more important. Backtracking can seriously harm business and investor confidence just as the economic recovery takes hold and makes it difficult for businesses to plan their affairs. Meanwhile, other countries continue to improve their tax competitiveness and we will fall behind.
Internationally competitive firms generate jobs. They attract the best and brightest people to Canada and ensure that our young people can have a bright future here at home. Business tax cuts not only give employers greater flexibility, but can also benefit consumers as firms pass on the savings. Additionally, as lower corporate taxes improve the long-term earnings outlook for companies and increase stock values, they help Canadians who own equity through pension plans, RRSPs and mutual funds.
In contrast, higher business costs make our country less attractive as a place to invest, expand and innovate. They drive companies from Canada to low tax-rate jurisdictions.
Finally, a lower statutory corporate income tax rate would reduce the differential between large and small business tax rates. The combined federal-provincial tax rate is about sixteen per cent on small business profits and thirty-one per cent on large business profits, a fifteen percentage-point difference. The current business tax structure undermines growth by imposing higher taxes on businesses as they grow.
Cutting rates is important, but it is also essential that we create a more neutral business tax structure. While Canada has made tremendous progress in reducing effective tax rates on new business investment, rates vary widely by industry. The services sector—retail and wholesale trade, communications and construction, for example—remains highly taxed. This is concerning because services are a major source of job creation, and are increasingly exposed to international trade and competition.
The tax base should be as broad as possible to enable lower tax rates for businesses and individuals. Targeted tax relief (including exemptions, deductions, credits or rebates) favours specific economic activities so to compensate for lost revenue, other areas are taxed more heavily. Piecemeal changes and endless tinkering with the tax system undermine its internal consistency, introduce unnecessary complexity, have unintended consequences, create opportunities for avoidance, and may not achieve their intended purpose.
The Canadian Federation of Independent Business (CFIB) estimates it costs businesses $12.6 billion annually to comply with their tax obligations, the lion’s share of the burden ($11.4 billion) carried by small- and medium-sized businesses (SMEs). Average tax compliance costs range from $3,928 per employee for very small firms (i.e. those with fewer than five employees) to an average of $481 per employee for firms with 50 to 499 employees.
According to PricewaterhouseCooper and the World Bank Group, Canada ranks 28th best among 183 countries for its ease of paying taxes for small- and medium-sized businesses, 30th in the time it takes to comply with various laws (i.e. prepare and file returns and pay taxes) and 21st in the number of tax payments required annually.
The federal government has announced it will explore the possibility of implementing a formal system of loss transfer or consolidated reporting for corporate groups. This would make the tax system function better, significantly ease compliance, and strengthen international competitiveness. More than two-thirds of OECD member countries offer group taxation. Canada is the only country in the G7 with no tax consolidation regime.
The future for Canadian taxes
Canada has much to gain by using the tax system optimally to promote employment, productivity and living standards. Forty-nine per cent of total tax revenue in Canada is generated from income and profit taxes compared to thirty-six per cent among OECD countries. Corporate taxes are the most economically destructive for long-term economic growth followed by personal income taxes. That is why twenty-six of the thirty OECD companies rely less than Canada on high-cost income and profit taxes and more on less economically damaging consumption-based taxes, like the GST. As long as we have taxes, we need to ensure that their mix and structure are as efficient as possible.
Canada’s personal income tax system has undergone sporadic change, but there is still much unfinished business. We must get our fiscal house in order to gain the economic flexibility needed to reduce high marginal personal income tax rates (especially as they apply to individuals with modest incomes) that reduce the incentive to work, save, invest in human capital, and act entrepreneurially.
Going forward, economic growth and business success will depend very much on the availability of talent and the productivity of the workforce. We need to ensure our personal income tax is competitive to entice high-tech skilled workers, upper management, entrepreneurs and professionals to Canada in the light of the projected slowdown in the labour force.
The need for strategic planning and smart policy has never been more important. Reducing our heavy reliance on economically-damaging income and profit taxes, broadening the tax base, creating a more neutral business tax system, and reducing compliance costs for taxpayers can significantly boost Canada’s international competitiveness, stimulate innovation and job creation, and promote and enhance flexibility so that our economy and small to large businesses can readily adjust and adapt to changing circumstances now and in the future.
Tina Kremmidas is the Chief Economist of the Canadian Chamber of Commerce.