Tax Cuts a Boon to Productivity

None of the major parties made productivity a central campaign issue. But Canada’s dismal productivity performance is one of most critical issues facing the newly elected Conservative government.

Canadians have told pollsters they dislike the P word and are unwilling to accept that Canada is falling behind most other industrialized countries. The reality is Canada does not compare favourably with other countries and the time has come to make productivity improvement a top priority. The new government, despite its minority status, has a real opportunity to make it happen.

Perhaps the most useful way to think about productivity is in terms of the value of goods and services Canadians produce per hour worked. Canadian workers who become more productive are able to earn higher wages. A a more productive workforce makes Canadian companies more profitable and competitive. And, a more productive economy provides a greater economic base from which governments can raise revenues to fund social programs.

Not surprisingly, the minority Liberals came to the conclusion that improving our living standards depends on our ability to increase productivity.

Unfortunately, Canada’s productivity record has been dismal. Our productivity growth rates have steadily declined since 1998. Internationally, Canada ranks 18 among 24 industrialized countries in average labour productivity growth over the past 10 years. Furthermore, the productivity of Canada’s workforce has fallen from 89.9 per cent of that of our southern neighbour in 1985 to 82.8 per cent in 2004.

As a result, Canadian incomes have fallen compared to those in the U.S. gross domestic product per person, the most commonly used measure of living standards, has declined from 87.9 per cent of that in the U.S. in 1985 to 84.7 per cent in 2004. Average after-tax income per person has experienced much steeper declines: 80.4 per cent of that in the United States in 1985, dropping to 66.9 per cent in 2004.

One of the primary reasons for Canada’s poor productivity growth is a business tax regime that punishes Canadians and foreigners who invest and develop businesses in Canada. Indeed, Canada has one of the highest tax rates on capital investment (machinery, equipment, plants) in the industrialized world.

To reverse the trends, significant changes are needed. In a recent study, we recommended a $59-billion, five-year provincial-federal plan for business tax relief aimed at encouraging investment and productivity growth. While a tax relief package similar in scope and magnitude to our proposal might be too ambitious for a minority government, improvements appear to be on the way.

In the November 2005 mini-budget, the minority Liberals offered important tax relief measures aimed at improving the incentives for investment. The Liberals proposed to eliminate the corporate surtax, accelerate the elimination of the capital tax and reduce corporate income tax rates from 21 to 19 per cent by 2010.

The Conservatives have pledged to match the Liberals’ business tax cuts, although they would delay them slightly. They also propose the elimination of capital gains for those who reinvest the proceeds.

A minority Parliament coupled with the Liberal party’s need to find a new leader means there is incentive for the parties to find common ground over the next 18 months or so. Clearly, one area in which co-operation would valuable, and possible, is tax policy aimed at improving productivity.

The corporate income tax cut, the elimination of the corporate surtax and the accelerated elimination of the corporate capital tax are all highly probable, given the agreement between the two parties. It’s unlikely a majority of Liberals would vote against a plan they first proposed. The wild card is what happens with the Conservatives’ capital gains tax plan which would arguably be one of the most significant tax changes in the past 30 years. Its fate will largely depend on the bargaining that takes place with the Liberals.

While the proposals offered by the Liberals and Conservatives do not go far enough, enacting them would be an important first step in reducing the level of taxes applied on capital investment. It is to be hoped these measures will spark debate about the need for further tax relief aimed at improving productivity.

Making our business tax system more competitive will make Canada more attractive to investors and ultimately lead to significant improvements in our standard of living.