Ontario and Quebec once reigned supreme as the economic hub of Canada, but no more. The western provinces of British Columbia, Alberta and Saskatchewan are quickly taking their place.

While strong commodity prices are part of the explanation, the impact of pro-growth tax policy cannot be ignored. Western Canadian governments of all political stripes -- from Progressive Conservatives in Alberta to Liberals in British Columbia to New Democrats (socialists) in Saskatchewan
-- have reduced marginal personal income tax rates and overall business taxes. The tax policies pursued by western Canada over the past few years are quintessentially supply-side. That is, the tax relief is largely focused on improving incentives for work, savings, investment and entrepreneurship.

Alberta led the way in 2000 by creating Canada’s only single-rate personal income tax -- 10%. British Columbia and Saskatchewan soon followed by substantially reducing their personal income tax rates. Top marginal rates in these two provinces were reduced to 14.7% and 15%. Compare that to Ontario’s top marginal rate of 17.4% or Quebec’s 19.2%. Canada’s three western provinces now have the lowest top marginal rates in the country.

The changes to personal income taxes were matched, perhaps more importantly, by reductions in business taxes. All three governments pursued two broad measures: reductions in corporate income tax rates and the elimination of corporate capital taxes, a uniquely Canadian tax that severely punishes investment and development. A corporate capital tax is essentially a fixed tax on the value of a corporation’s assets, and is calculated as a percentage of a company’s debt and equity.

Again, Alberta was the catalyst for change. It completely eliminated the corporate capital tax and reduced corporate income tax rates by 35% from 2000-2006. British Columbia then eliminated its general corporate capital tax and reduced corporate income tax rates by nearly 30%.

More telling of the marked shift in tax ideology in western Canada is Saskatchewan’s recent provincial budget in which it tabled a plan to significantly reduce business taxes over the next three years. Using the Alberta-British Columbia model, Saskatchewan will phase out the corporate capital tax for most firms and reduce corporate income tax rates by 30% over the next two years.

The economic results of tax reform based on improved incentives have been stunning. Over the past three years British Columbia has grown 3.4% a year on average; Alberta 4%; and Saskatchewan 3.5%, all easily outperforming the Canadian average of 2.6% a year over the same period.

Growth in the three provinces also outpaced the U.S. national average for the past two years. Among Canadian provinces and the 50 American states, Alberta ranked seventh in growth, British Columbia ninth, and Saskatchewan 17th. This strong performance occurred within a federal environment that is not as conducive to economic growth and development as that of the U.S.

Similar patterns of success hold for other economic indicators. Western Canada has led the nation in employment growth over the past two years and has outpaced the national averages in both Canada and the U.S. Perhaps most telling is the disproportionate levels of investment being attracted to the western provinces. On a per capita basis, western Canada is leading the country.

The gap between eastern and western growth rates has been facilitated by poor policies in Ontario and Quebec. While western Canada has been busy pursuing pro-growth tax policies, Ontario was busy raising business and personal taxes. Quebec also has continued on its path of timidity with very little change. The result has been sluggish economic performance in absolute terms and stellar underperformance when compared with western Canada.

More recently, British Columbia and Alberta added a second pillar to their
foundation: free trade. Unlike the U.S. with its interstate commerce clause, Canada is riddled with provincial trade fiefdoms that use non-tariff barriers to impede the free flow of goods, services, investment and labor. British Columbia and Alberta recently signed the Trade, Investment and Labor Mobility Agreement to eliminate trade barriers (with a few exceptions) between the two provinces within three years.

This agreement will create the second largest economy in the country. One example of the benefits that will accrue to citizens of the two provinces relates to occupational certification. Similar to the U.S., occupations in Canada are certified at the sub-national level. British Columbia and Alberta have now adopted mutual recognition for all occupations. If you’re a certified nurse in British Columbia, for example, you’re now immediately recognized in Alberta and vice versa. At least two other provinces are reported to be considering joining the agreement.

British Columbia and Alberta, and to a lesser extent Saskatchewan, are establishing themselves as economic beacons in North America. And their growth goes well beyond the resource play. If growth were just about resources, then many of the world’s poorest countries should be its wealthiest. As the western provinces are showing, institutions and policies matter.

Western Canada has created an environment within which all types of economic activity can flourish. This is why the region is benefiting from not only direct resource extraction, but also growth in downstream related industries such as manufacturing and processing as well as in the skilled service sector.

Perhaps the success of western Canada will entice other provinces, the Canadian federal government, and even some of the states to the south that have poor tax structures to join the bandwagon of prosperity by implementing incentive-based tax relief and freer trade.