Tax Reform in US Pressures Canada to Up Its Game

Commentary, Ian Madsen, Taxation

A contentious, but mostly growth-boosting tax system overhaul finally passed through the United States Congress shortly before Christmas, and was signed into law by President Donald Trump. While it did not simplify and clean up the Byzantine and incomprehensible US tax code, it did do several things that make the US economy more competitive versus its allies and rivals. This means that Canada and other nations around the world cannot stand still any longer.

As a result of the tax reform, business taxes were lowered dramatically. The top statutory federal corporate tax rate (that applies to private, family owned companies as well as large, publicly traded ones) went from 35 percent to 21 percent, a forty percent drop. While a lot of deductions and credits were also chopped or reduced, companies will continue to have higher profits across the board.

This does two things: companies will have more cash to give pay raises to employees, increase investment, or raise dividends, and lower the threshold at which promising projects or programs become profitable or cash-flow accretive. This will encourage companies to hire new employees, embark on more research and development, and invest in new equipment. Fostering the latter is an additional incentive: making capital investment fully tax deductible ‘full expensing’, in the first year.

Another improvement in the US is the change from a global scheme (whereby a firm is taxed on total worldwide profits) to a ‘territorial’ one. Many  other countries, including Canada, employ this, it allows them to declare taxes paid in the nations  they operate in, and earn money. Firms can also bring back offshore profits under the old system at an attractive, lower (13.5 percent) rate.

Thus, the effective US federal corporate tax rate is now even lower than the equivalent 21 percent it would have been under the old regime. Meanwhile, Canada’s federal corporate income tax rate has not declined for several years now. While 15 percent seems attractive versus the US federal rate, provincial rates have generally risen over the past several years. They range from a low of 11 percent in British Columbia, to a steep 16 percent in Nova Scotia and Prince Edward Island, with 11.5 – 12 percent being typical across the nation.  

Hence, the lowest corporate tax rate in Canada is 26 percent in BC, and the highest is 31 percent in Atlantic Canada. Now that the US allows full expensing, Canada is uncompetitive for new investment or expansion. Several states in the US do not have corporate income tax at all, and only six have a rate of nine percent or more. Canada’s cheap energy and educated workforce only go so far. The US also has cheap energy (shale gas) and now has far lower corporate and personal taxes.  

The US has just become much more competitive. Canada’s federal and provincial leaders need to recognize this, and respond by either gradually or drastically lowering business taxes, if our economy is to remain competitive with our neighbour and largest trading partner.  Corporate taxes were lowered in the past – Canada needs that once more. Status quo is non-optional.