How Low Can Canadian Business Taxes Go?

Canada has the third-lowest business taxes of ten countries examined in a study released as part of KPMG’s 2008 Competitive Alternatives report. The spin from KPMG has been that “If the provinces follow the federal lead and reduce their rates as well, Canada’s advantage will be enhanced.”

Canadians should be asking a different question. If we already have a substantial “tax advantage” for business, why should governments further reduce business taxes?

Canada’s third-place ranking understates the magnitude of KPMG’s findings. It calculated a Total Tax Index of the corporate income taxes, other business taxes, and payroll taxes that model businesses would face in each country over the coming decade. Canada’s score was very close to the two lowest-tax countries and far below the other countries:

 

One of the C. D. Howe Institute’s favourite arguments is that, even if Canadian taxes are competitive now, we need to continue cutting to keep pace with foreign tax cuts in the future. KMPG demonstrates that, considering all tax changes announced for the next decade, Canada is essentially tied for the second-lowest taxes.

Another C. D. Howe Institute chestnut is that, despite Canada’s relatively low corporate income taxes, other factors (such as the application of some provincial sales taxes to some business inputs) drive up Marginal Effective Tax Rates. However, KPMG confirms that Canada’s low corporate income and payroll taxes more than offset our relatively high other business taxes.

In fact, KPMG’s figures validate what I wrote a year ago. Canada could refrain from implementing some announced corporate tax cuts and still retain our “tax advantage” compared to other G-7 countries.

However, the federal government is using its ostensible goal of the lowest business taxes in the G-7 to push even more cuts. Jim Flaherty calls on all provincial governments to slash their corporate income tax rates to 10%. (The Liberal Green Shift even proposes to shave another 1% off the federal rate.)

Regarding other business taxes, the federal government is lobbying to exempt all business inputs from all provincial sales taxes. Payroll taxes, which are tied to the funding requirements of the Canada Pension Plan and Employment Insurance (EI), could conceivably go either way depending on economic conditions. However, the new EI regime creates a bias toward premium cuts (as opposed to benefit improvements) by requiring that any new funding surpluses be used to lower these payroll taxes.

As the Government of Canada teeters on the brink of deficit, it has a decision to make. Is it content with the lowest mix of corporate income, other business, and payroll taxes in the G-7? Or must we duke it out with the likes of Mexico and Russia for the lowest taxes on Earth?

UPDATE (July 30): Right on cue, the C. D. Howe Institute released a commentary today calling for:

1. Cutting provincial corporate income tax rates to 10%.

2. Removing targeted tax measures for manufacturing and forestry.

3. Harmonizing provincial sales taxes with the federal GST.

4. Cutting personal income taxes.

As I argued yesterday, the first and third proposals are unnecessary because Canada already has significantly lower business taxes than other G-7 countries. I would make the same case regarding personal income taxes, particularly given the somewhat precarious state of Canadian public finances.

However, the second proposal is particularly interesting in light of KPMG’s numbers. The table above shows the overall results. However, the sectoral breakdown on page 22 of KPMG’s study indicates that Canadian taxes for the service sector are the second-lowest and far below most other countries. Canadian taxes for manufacturing are the third-lowest and closer to most other countries.

Relative to international competitors, Canada’s service-industry taxes are already below our manufacturing taxes. Eliminating tax measures that support manufacturing therefore seems like an odd way to maintain or enhance Canada’s tax competitiveness.