The Fiscal Status Quo is not Good Enough

Jean Chretien, the Prime Minister of Canada and John Manley, the newly minted Minister of Finance have taken every opportunity possible over the last week to reiterate that the departure of the former Minister of Finance, Paul Martin will in no way change Canada’s economic policies. Both have stated that the government remains committed to balanced budgets, reducing debt, tax relief, and strategic investments—although one suspects not in that order.

The constant and consistent message delivered by the Prime Minister and the new Minister of Finance since Paul Martin’s abrupt firing (or resignation depending on with whom you speak) have apparently worked as the dollar has remained relatively stable vis-à-vis the US dollar.

But maybe the status quo isn’t enough for Canada. Perhaps, what this country needs, given our economic problems, which include but are not limited to, a falling standard of living relative to our southern neighbours, lagging productivity, a national currency on life support, and insufficient investment capital, is a more dramatic economic plan based on tax relief. In other words, what the federal government should do given this unique opportunity is announce a plan of tax relief aimed at solving this country’s economic problems.

The federal government is well positioned to enact substantial tax cuts given estimates that the 2001/02 surplus will be roughly $10.0 billion—a rather large surplus for a period of rather slow economic growth. In addition, Canada as a whole still bears a 36 percent higher tax burden overall than our US counterparts.

There are a number of potential tax cuts that could be included in a broad package of tax relief. Given the nature of the problems facing Canada, however, the bulk of any tax relief package should focus on business taxes.

A recent analysis indicated that Canada maintains the highest effective tax rate on capital of the G-7 countries in the service sector and the second highest effective tax rate in the manufacturing sector. Put differently, the taxation of capital in Canada is not competitive with our main trading partners.

The first and most important business tax cut Canada can implement is the complete elimination of the corporate capital tax. A recent study by The Fraser Institute concluded that the corporate capital tax is by far the country’s worst tax. Canada is essentially the only industrialised country to use such a tax to any great extent—Germany and Japan use a similar tax but only marginally.

The failings of the corporate capital tax are numerous, however, the main disadvantages outside of its rarity are its high economic costs, profit-insensitivity, complexity, asymmetric treatment of certain industries, disincentives for investment and risk-taking, and ultimately the fact that it inhibits economic growth.

In 2000/01, the federal government raised roughly $1.1 billion from corporate capital taxes, roughly 0.6 percent of the total revenues raised. The federal government could eliminate the most damaging and growth inhibiting tax in Canada and affect less than 1 percent of its revenues. The Canadian economy and ultimately the Canadian people would be well served by using a mere one-tenth of the expected 2001/02 surplus to eliminate the corporate capital tax.

Another contender for consideration is accelerating the already announced corporate income tax rate reductions and implementing additional cuts. The corporate income tax reductions announced in 2000 are estimated to cost the treasury $1.8 billion this year (2002/03). The federal government, given the projected surplus is in a position to aggressively accelerate the schedule of corporate income tax rate reductions and indeed go beyond the previously announced reductions.

Eliminating the corporate capital tax and reducing corporate income tax rates further and faster than previously scheduled would improve Canada’s performance in many of the areas we currently face difficulties.

Specifically, reducing the taxation of capital would make Canada a more competitive destination for investment, both domestic and foreign. Such investment ultimately increases productivity, incomes, and economic growth. These are the types of objectives which the federal government should be striving to achieve instead of accepting complacency and the status quo.