Editorial: Why Canada still needs tax reform

The big tax cuts in the recent fiscal and economic update might come as a surprise but they don’t go far enough.

Everybody loves a tax break. And the fiscal and economic update delivered by Finance Minister Jim Flaherty on Oct. 30 certainly looks like it delivered the goods. The federal government is right to commit to providing broad-based tax relief for both individuals and corporations, rather than engineering policies geared to specific demographics or industries. So, in general, Flaherty is moving in the right direction on taxation. After all, what’s not to like about a total of $60 billion in cuts over the next five years?

Well, a few things. As much as we welcome tax reductions, the finance minister should stop for a moment to check his bearings. Because if the idea is to make the economy more competitive, the government is moving the right way down some wrong roads — and not far enough down the right ones.

The biggest wrong move was honouring a campaign commitment to cut the GST by yet another percentage point. The fact that Flaherty did this was a surprise to absolutely no one, but that doesn’t make it less of a disappointment. VATs like the GST, which tax consumption, not earnings, are (with suitable exemptions) fair levies that probably do the least damage to productivity. In that, they are unlike Canada’s personal income tax system, which at the lower end of the income stream still encourages people not to work, and at the upper end hands high-income earners an incentive to leave the country. At any rate, Flaherty missed an opportunity to tie the GST cut to harmonization with those provinces (like Ontario) that still apply sales taxes to business investments. The tax point in the GST cut could have been assumed by those provinces to compensate for any revenue lost to harmonization.

Granted, the personal tax cuts in the update are welcome. But the government could have gone much further if it had not cut the GST. In fact, when you factor out the cost of the GST cut — nearly $30 billion over five years — the tax-relief package doesn’t look that impressive. Much-needed corporate tax cuts, for instance, do not kick in fully until 2012. And they rely on the provinces to play along to get the combined federal-provincial rate down to an average of 25%.

Still, Flaherty said that if that target is hit, Canada “will have the lowest business taxes in the major industrialized world.” And that’s true. Maybe. At 25%, our corporate tax rate in 2012 will be below the 2006 OECD average of 28.3% and among the lowest in the G7 — if the rest of the world stands still. Chances are it won’t, because it hasn’t been.

Earlier this year, the United Kingdom cut its corporate rate from 30% to 28% — lower than the current combined rate anywhere in Canada. Australia’s corporate rate, at 30%, is lower than Canada’s. The European Union’s average rate at the start of this year was less than 25%, according to KPMG. Hong Kong’s rate is 17.5%. Ireland’s is 12.5%. Right now, Canada’s corporate tax rates look good in comparison to those in only a handful of countries, most notably the United States, which has an effective rate of about 40%. That’s second only to Japan’s. Then again, the U.S. is the world leader in loopholes.

Finally, Flaherty’s $60-billion gift bag includes an accelerated reduction in the small-business tax rate, from 13.12% now to 11% by 2008. From one point of view, this is a misstep. Yes, small businesses are the wellspring of a healthy economy. But as tax policy guru and Canadian Business columnist Jack Mintz has pointed out, the small-business tax break has two significant pitfalls. One is that it provides an incentive for Canadians to avoid personal taxes. The other, Mintz says, is that the lower rate “imposes a penalty on growth” by rewarding companies for staying small.

Despite what some corporate leaders argue, the lesson from the recent spate of foreign takeovers isn’t that we need to protect our big companies; it’s that we should be growing more big companies. What governments at all levels should be doing is removing disincentives to growth. Continuing the disparity between business tax rates does just the opposite. The only good news is that by 2012 the gap between the federal corporate tax rate and the small business rate will have shrunk to four percentage points from nine. If the long-term policy goal is to have a single, low business tax rate for all — and that is a laudable goal — then one can see this shrinking gap as at least a move in the right direction.

In remarks to media after his update, Flaherty made it clear that Canadians shouldn’t expect more broad-based tax cuts in the spring budget. That’s too bad. We were hoping he was only getting started.