To be able to sustain broadly based economic growth in the rapidly changing global economy, Canadians must improve productivity. This will be difficult if Canada's tax burden puts us at an economic disadvantage. Comparisons with the United States, our neighbour to the south, demonstrate our need for improved competitiveness in various areas of taxation. Total Canadian taxation by all levels of government accounts for almost 47% of our gross domestic product, compared to just over 32% in the United States. How long can the Canadian economy and standard of living withstand this inequity?
The Canadian economy has a significant international dimension. Accordingly, Canada's tax system must be viewed in relation to the world economy, with particular attention to the United States, with which we conduct over 70% of our foreign trade. Almost 40% of our gross domestic product is derived from exports and about 20% of capital for our businesses is provided by foreign investors.
As the global economy becomes more integrated, competition among countries has intensified. Those nations that can are acquiring the human skills, capital and technology to produce leading-edge knowledge-based goods and services. In the global economy, factors of production, most significantly human capital and investment capital, are becoming increasingly mobile and will naturally seek lower tax environments. The cost to Canada of maintaining its current tax burden will only grow as international mobility is enhanced.
Our current Canadian tax system requires improved competitiveness. With our federal budget in a surplus position and most provinces (see endnote 1) moving in that direction, the time is ripe to initiate a sustainable tax reduction strategy. The level of government debt, the uncertainties of economies in other parts of the world, the impact of events such as the Asian financial crisis, and currency and interest rate fluctuations dictate that the timing of tax reductions must be flexible and spread over a number of years.
The key element is that Canadians and those investing in Canada must know that significant Canadian tax cuts are on the way. They also must be convinced that the tax reductions are structurally sustainable and will not be reversed. Personal tax cuts must cross all income levels and meaningfully reduce taxes for individuals at the top marginal rates. Government commitment to reduce our tax burden and move us toward a more competitive tax system is critical for Canada and all Canadians.
Corporate Income Tax Rates
Earlier this year, the Technical Committee on Business Taxation ("the Mintz Committee" - see endnot 2) issued its report on the impact of the Canadian business tax system on economic growth, job creation, fairness and compliance. The Mintz Committee report focused on deficiencies in our national corporate tax structure. The deficiencies included:
- For non-manufacturing corporations, our general combined federal-provincial income tax rate averages 43%, compared to United States rates generally in the 35% to low 40% range for large corporations and rates in the rest of the world that are near the United States level or lower. Our higher income tax rates discourage the location of business operations in Canada, thereby reducing economic growth and job creation.
- Taking into account federal and provincial income, capital, payroll, sales and excise taxes on capital inputs, the Mintz Committee found that important industries (especially communications, utilities, wholesale trade and services) were taxed more highly than similar activities in the United States. These activities include the knowledge-based sectors of the economy where high taxes tend to reduce the potential for Canadian businesses to use the evolving technologies - some of which arise from research funded by governments through grants and tax incentives.
The Mintz Committee's recommendations, aimed in part at enhancing the competitiveness of our business tax structure, were pushed aside by the Minister of Finance. They were filed in the government's "examination of policy issues" bin despite the fact they would have been revenue neutral through appropriate transitional measures. On the positive side, the Minister's response to the Mintz Committee report included an undertaking to build further on his minimal personal tax reductions proposed in the 1998 federal budget.
Personal Income Tax Reduction an Imperative
Personal tax reduction is an imperative if Canada has any hope of attracting and retaining the people with the intellectual capacity and energy required to make our country more competitive in the world economy. Our middle and upper income earners suffer a tax burden higher than those in many other jurisdictions. Our neighbours in the United States have significantly lower taxes that, when compared to Canada's, help to push our skilled and mobile workers south.
Canada has a higher top marginal tax rate than many of our competitors. Even more importantly, this top rate is applied at a significantly lower level of income than in many other countries. The top federal rate in Canada (before adding surtaxes) kicks in at $59,180, while the comparable threshold in the United States is the equivalent of Cdn$350,000.
Impact of Personal Tax Burden
Our personal tax burden has significant implications for the Canadian economy. Today, highly trained skilled professionals, managers and entrepreneurs are increasingly mobile. A recent C.D. Howe Institute study (see endnote 3) found that Canada lost an average 2,689 professionals and 1,756 managers to the U.S. annually throughout 1990-96. This outflow was a 50% increase over the 1982-89 period. Current statistics, when available, will undoubtedly show the trend - "the brain drain" - continuing to grow.
When business people choose to leave Canada, we lose not only their incomes and skills, but also all the money invested in educating them and developing their skills. The C.D. Howe Institute study estimated this education cost alone over the 1982-96 period to have been $6.7 billion! In a business context, Canada has made the investment, but the United States is getting the return. One cannot ascribe our brain drain to a single cause, but there is little doubt that the most influential factor is the heavier burden of personal income taxes in Canada. The Organisation of Economic Co-Operation and Development ("OECD") in its 1997 Economic Survey of Canada recommended that we consider the adverse locational effects that higher tax rates have on the highly skilled and entrepreneurial portion of our workforce. The OECD also warned of the negative consequences for economic performance of high marginal personal income tax rates. We should heed the warning of a bad situation that will grow worse without any tax reductions.
While the brain drain issue may catch the media's attention, all Canadians are feeling the crunch of our tax burden. Income taxes consumed an average of 16.3% of total family income in 1985. By 1996 the figure was 20.2%. Since 1988, income taxes have increased in real terms every year by "bracket creep" - the failure to adjust tax brackets and credit limits for the full impact of inflation. This has pushed 1.9 million Canadians from the lowest tax bracket into the "middle income rates" and moved 600,000 from the middle into the top rate bracket. Many have advocated the return to full indexation of the brackets to stop the annual hidden tax increase that affects all taxpayers. Perhaps this annual hidden tax increase should be eliminated as the first step in any government's personal tax reductions.
Commit to Sustainable Reductions Now
Our current fiscal situation together with the uncertainties of future global impacts, dictate that the tax rates be lowered in a sustainable way so that they will not have to be raised again.
Our level of government debt remains high and is subject to global interest rate fluctuations. Even with today's comparatively low interest rates, federal debt charges consume over 25% ($40 billion) of revenue. Tax reductions that may have to be financed in the future by increased government borrowings (or more likely require a reversal of the deficit cuts) will not be politically or financially prudent for Canada or our government leaders. On the other hand, vague political promises of further undisclosed tax cuts sometime in the future are no longer acceptable.
The Business Council on National Issues ("BCNI") has put forward a proposal for a tax reduction plan (see endnote 4) with cuts being initiated in stages over the next seven years. The Council's proposals would, if fully implemented by 2005:
- Increase basic and spousal deductions by $1500;
- Eliminate all federal surtaxes on individuals;
- Reduce tax rates on incomes under $150,000 (income over $150,000 would likely be taxed at a combined federal and provincial top marginal rate in the low to mid-40% range);
- Restore full indexation of all tax brackets and credits;
- Cut the general corporate tax rate by at least 3%;
- Reduce employment insurance premiums.
The projected total annual relief in personal income tax by 2005 is estimated to be $14.5 billion - an amount the BCNI felt would be sustainable. The more novel aspect of the BCNI's staged implementation is its flexibility. BCNI's tax cut schedule is based on expectations of moderate economic growth. If growth slows, it may be necessary to delay certain elements but, by the same token, periods of more rapid growth would permit the government to speed up the schedule. The timing of tax cuts may shift, but their relative priority would be unchanged.
We support the use of such a strategic framework for tax reduction. It embraces sustainable tax reductions with flexibility to accommodate fluctuations in expected economic growth. With a framework containing appropriate competition-enhancing tax reductions impacting all taxpayers, from low to high income earners, Canada will be able to move toward a more competitive tax system and a stronger economy overall. It is imperative to implement a commitment to a framework that will steadily reduce our tax burden. Government commitment is essential to ensure that the goal of a more competitive tax system will be achieved so we can benefit from the corresponding changes in worker and investor behaviour.
The move toward a competitive tax system requires government commitment to sustainable tax reductions implemented within a flexible framework. The process must begin now.
1. Alberta has had a surplus for a number of years and Ontario has exceeded its deficit reduction objectives notwithstanding the acceleration of tax reductions started in 1996.
2. Mintz, Jack M., et al., "Report of the Technical Committee on Business Taxation", December 1997.
3. DeVoretz, Don and Samuel A. Laryea, "Canadian Human Capital Transfers: The United States and Beyond." Toronto: C.D. Howe Institute (October 1998).
4. "Creating Opportunity, Building Prosperity: A Tax Reduction Strategy for Canadians". October 1998.
The information provided herein is for general guidance on matters of interest only. The application and impact of laws, regulations and administrative practices can vary widely, based on the specific facts involved. In addition, laws, regulations and administrative practices are continually being revised. Accordingly, this information is not intended to constitute legal, accounting, tax, investment or other professional advice or service.
While every effort has been made to ensure the information provided herein is accurate and timely, no decision should be made or action taken on the basis of this information without first consulting a PricewaterhouseCoopers LLP professional. Should you have any questions concerning the information provided herein or require specific advice, please contact your PricewaterhouseCoopers LLP advisor, or:
David W. Steele PricewaterhouseCoopers LLP 145 King Street West Toronto, Ontario M5H 1V8 Canada Fax No: 1-416-941-8415 E-mail: Click Contact Link
For further information on taxation in Canada, enter a text search "PricewaterhouseCoopers" and "Canada" and "Mondaq Business Briefing".
Click Contact Link
PricewaterhouseCoopers LLP is a Canadian member firm of PricewaterhouseCoopers International Limited, an English company limited by guarantee.