The $60 billion in tax cuts announced October 30th in the federal government’s Economic Statement should be seen as an important step in improving Canada’s fiscal competitiveness and economic incentives. More is needed though and it would be a mistake to think of the tax cuts as an end instead of a beginning.

The Economic Statement included tax cuts spread over six years, including critical reductions in corporate income tax rates to 15 percent by 2012 ($14.1 billion), a 1-point reduction in the GST to 5 percent in 2008 ($34.2 billion), and an increase in the basic exemption and a reduction in the bottom personal income tax rate to 15 percent ($10.8 billion) for 2007 (retroactively). There were also small changes to EI premiums and an accelerated decrease in the small business tax rate to 11 percent next year.

The business tax reductions will yield significant benefits to Canadians in the form of improved competitiveness and attractiveness for investment. The other tax cuts, however, contain far fewer improvements in economic incentives and thus result in less economic benefits. The key taxes for decision-making and the incentives for effort, savings, investment, and entrepreneurship are marginal taxes. In other words, what matters is the tax rate people and businesses face on the last dollar of income earned.

In this respect, very little was accomplished in the Economic Statement outside of the business tax cuts. For example, the reduction in the bottom personal income tax rate and the increase in the basic exemption does nothing to reduce marginal tax rates for the bulk of workers in Canada who earn incomes above the threshold for the lowest tax rate – currently $37,178. In addition, the 1-point reduction in the GST to 5 percent does nothing to improve economic incentives, reduces the country’s use of our most efficient tax (GST), and moves us further away from most of our competitors in terms of our reliance on consumption taxes (GST) compared to income and profit taxes.

More clearly needs to be done. Specially, the 2008 budget should include personal income tax rate reductions and/or increases in the level of income at which the rates apply for middle and upper income Canadians. Such changes will improve the economic incentives for productive behaviour such as savings and entrepreneurship by increasing the amount of money earners keep at the margin.

Two further changes are required regarding business taxes. First, the federal government should use part of the expected surplus for 2007-08 (now $11.6 billion after the tax cuts) to finance a transitional fund to facilitate the harmonization of provincial sales taxes with the GST in British Columbia, Saskatchewan, Manitoba, Ontario and Prince Edward Island.

Harmonization with the GST would exempt business inputs such as machinery and equipment from provincial sales taxes. Currently, these much needed investments are subject to sales taxes which raises the cost of investment. It would also reduce the compliance costs for businesses and individuals since they would deal with one sales tax system instead of two.

The second change is to further reduce the corporate income tax rate from 15% to 11% by 2012. The reason for the reduced target rate is to eliminate the difference between the small business tax rate (11% in 2008) and the general corporate income tax rate. As a number of studies have shown, the enormous increase in the tax rate borne by businesses as they grow and develop results in a significant barrier to growth.

There are also a series of smaller measures (in dollar terms) that should also be included in the spring budget. Elimination of the capital gains tax, further reducing taxes on dividends and interest income, eliminating contribution limits for RRSPs and pensions, and creating a prepaid tax savings account would all improve the investment climate in Canada. Savings and the related investment are critical foundations for a successful, thriving economy.

While many will be wary of another round of large-scale tax relief, there are a number of factors that should mitigate resistance. First, by improving incentives and making Canada more attractive to investment, the federal government will yield greater revenues from increased rates of economic growth. Second, the government’s own figures show a cumulative five-year surplus of $39.2 billion (2008-09 to 2012-13) after implementing the tax cuts announced in the Economic Statement. Third, the federal government has consistently underestimated revenues by roughly 4.5 percent per year since 1997-98, amounting to a cumulative underestimate of almost $80 billion.

There is no doubt that Canada is enjoying a strong economic period. The key to future success is to avoid resting on current ones. The Economic Statement included important tax relief but more is needed. The spring budget should take the next step by implementing additional tax relief aimed at improving competitiveness and economic incentives.