US President Donald Trump with his hands apart

U.S. President Donald Trump. (Win McNamee/Getty Images)

Analysis | From Pivot Magazine

Trickle-down Trump

U.S. tax reform could be devastating to Canada. We need a strategy. And soon.

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For all the uncertainty swirling around Canada’s economic relationship with the United States, one critical issue has come into clear focus in recent months. The sharp cuts to the corporate tax rate south of the border, approved into law by President Donald Trump last December, have wiped out the advantage Canadian firms have enjoyed since Stephen Harper’s Conservative government began reducing corporate taxes almost a decade ago.

Canada’s average corporate income tax rate has been in the 26 to 27 per cent range since 2012, with an estimated 20 per cent marginal effective tax rate (i.e., incorporating deductions, credits, and other tax provisions). The cuts in the U.S. that came into effect for 2018 will bring their federal statutory rates down from 35 to 21 per cent, with a marginal effective rate estimated by economist Jack Mintz to be roughly 19 per cent. As Mintz observed earlier this year, “U.S. tax reform has changed everything.”

21%: New U.S. corporate tax rate, down 14 percentage points

What’s also been overlooked—and it’s going to be a big deal—is that the new U.S. corporate tax laws will allow most firms to write off 100 per cent of equipment purchases as in-year expenses for the next five years, with the rule phased out gradually thereafter.

While the benefits of these shifts will vary from sector to sector, firms in many important industries will be able to increase their dividend payments to shareholders and repatriate profits and debt held overseas. As well, the provision allowing the expensing of equipment will amplify profit gains by providing firms with a time-limited incentive to accelerate investments in productivity- enhancing technologies and equipment.

And Canada’s response? In the run-up to the February, 2018, budget, Finance Minister Bill Morneau insisted there was no need to respond impulsively, although his messaging shifted somewhat by the time his government brought down its fiscal plan. The government, he said at the time, would be carrying out a “deep dive” on the competitive threats posed by the reduced U.S. corporate rate. “What I can tell you is that we are doing our analysis now,” he told BNN on budget day.

Morneau needs to finish this competitive analysis quickly so Ottawa can be in a position to make informed policy choices in a timely manner. It’s critical that policy-makers better understand the new landscape and determine what changes, if any, are required. That said, the impact could be far reaching, especially given all the anxiety over the future of NAFTA these past several months. Combine that with buy-American procurement policies and the new rate could provide Canadian exporters with sufficient incentive to move from selling into the U.S. to establishing operations there.

What’s more, if a renegotiated NAFTA tips the balance on the trading relationship, it’s not difficult to imagine that a more advantageous corporate tax rate could become an important factor when multinationals make decisions about foreign direct investment, as numerous studies have shown.

“Mobility of capital tends to be higher than labour,” said a February 2018, TD Economics report, “which along with growing NAFTA uncertainties, increases the likelihood of a slow bleed of investment from Canada to south of the border.” TD’s analysis, in fact, showed the U.S. law puts the marginal effective tax rate below Canadian levels in most sectors, except manufacturing, oil/ gas and some services.

The consequences could ripple through the economy, with reductions in corporate tax revenue impairing the federal government’s ability to make important productivity-enhancing investments in infrastructure, post-secondary education and research. While corporate income taxes only account for 14.4 percent of federal revenue, there are also potential knock-on implications for other income sources, such as personal tax revenues, which could also be negatively impacted by an exodus of firms.

In its recent submission to the Senate Finance Committee, CPA Canada argued that a comprehensive review of the country’s tax system, last undertaken about 50 years ago, is not only long overdue, but would speak directly to the issue of keeping our economy competitive. In our recent Business Monitor survey of CPAs in business leadership positions, 84 percent of the respondents said an assessment of U.S. tax reforms is urgently needed, with 93 per cent saying its findings should be made public.

With a federal election looming next year, it seems reasonable to expect the Liberal government to explain to voters how it plans to address this new normal. It’s certainly good to know that the finance minister is preparing to take a deep dive to assess the consequences of U.S. tax reform. But Morneau should make sure he resurfaces quickly so Canadian businesses won’t be left holding their breath, waiting to find out what Ottawa will do next.