Advanced Canadian Taxation

High taxes on business tend to discourage companies from expanding by investing in new capital. This matters because capital deepening is an important source of labour productivity growth, and a substantial share of innovation is diffused through the economy via the technology embodied in new machinery and equipment. Although they often attract considerable attention, statutory corporate tax rates are not generally a good indicator of the overall tax environment faced by businesses. Marginal effective tax rates (METRs) on capital provide a more useful comparative measure of the incentive structure that the taxation system produces.

Most countries have recognised the harmful effects of high corporate taxation and have reduced effective average and marginal tax rates over the years (Devereux and Sørensen, 115-126). Canada has made considerable progress towards reducing corporate taxes since 2000 when the combined average METR for medium and large firms was estimated at almost 45% (Finance Canada, 69-78). Even so, Canada still had the highest estimated METR in the OECD in 2005. Some cuts already announced have long phase-in periods, and the projected METR in 2010 will still be almost 32%, only very slightly lower than the average estimated METR in 2010 for the United States. But this would still leave Canada with a higher rate in 2010 higher than the rate applying in most other OECD countries today.

Both federal and provincial governments impose taxes on business, and there are significant differences across the country. These reflect both the federal Atlantic Investment Tax Credit and provincial tax variation. Where provinces levy sales taxes on business inputs, these add significantly to METRs. One key advantage of imposing value added taxes such as GST instead is that they do not apply to capital equipment, thus avoiding this anti-investment bias. Indeed, the five provinces concerned could cut their METRs on business investment by between 7 and 12 percentage points by eliminating such sales taxes (Finance Canada, 10-25). They could do this in a revenue-neutral fashion by following the example of the other provinces and switching from sales taxes to provincial value added tax.

Eliminating remaining capital taxes would also provide a sizable reduction in METRs. Taxes on the total capital assets of firms above a threshold are still a feature in Canada, although federal capital taxes have been abolished from 1 January 2006. Six provinces also impose capital taxes, although New Brunswick, Nova Scotia, and Saskatchewan have announced their phase-out between now and 2010.

Ontario's capital tax is scheduled to be phased out by 2012 but its elimination will be accelerated to 2010 if the fiscal position of the province permits. Quebec is reducing its capital tax and Manitoba has announced that it plans to reduce its capital tax if balanced budget requirements are met. These taxes were originally motivated by a desire to ensure that all corporations do pay tax, even those managing their finances so as to shift profits to another jurisdiction. But they bear no relationship to the profitability of the business and discourage expansion. Few, if any, other countries ...