Author: Kenneth McKenzie
This paper examines the competitiveness of the business tax regimes in Canada’s four western provinces. The discussion focuses on the tax burden imposed on investment, as measured by the marginal effective tax rate (METR) on capital. With all of the provinces employing essentially the same corporate income tax base, determined by the federal government, differences in the taxation of capital across the provinces can arise for five basic reasons. The first, and most obvious, is differences in provincial corporate income tax rates. The second is differences in capital tax rates across the provinces. The third is differences in the effective sales tax rate levied on business inputs. The fourth is differences in federal tax credit incentives for targeted investments which may differ across the provinces. The fifth is differences in provincial tax credit incentives for targeted activities, such as R&D.
The computation of the METR on capital allows all of these differences to be taken into account in a straightforward manner. Comparing the METR on capital across Canada’s provinces and internationally across eighty countries, the paper concludes that Canada as a whole, and the western provinces in particular, do not have a particularly competitive business tax regime internationally, though things are improving. In keeping with the “going for gold” theme of this series of papers, it is clear that Canada in general, and the western provinces in particular, are not currently even “on the podium.” While some provinces are achieving “personal bests,” in an international context we are falling somewhat short. While scheduled reductions in the federal and some provincial corporate income tax rates will move the country, and the provinces, closer to the podium, there is still substantial room for improvement. If the western provinces are truly going to “go for gold,” they will have to be more aggressive in addressing some of the current difficulties with their business tax regimes.
Several reforms that can take place within the context of the current tax regime are suggested. Most important are a reduction in the provincial corporate income tax rates and the harmonization of provincial sales tax systems with the federal GST, particularly in BC, Saskatchewan and Manitoba. It is argued that reducing the corporate income tax rates in the western provinces would increase investment, growth and the standard of living, and would not, in the long run, have a substantially negative impact on government revenue. The harmonization of provincial sales taxes with the GST would remove a significant impediment to investment resulting from the taxation of business inputs under the existing systems.
Another approach would be to undergo a more fundamental, some might call it “radical,” reform of the taxation of businesses in western Canada. There are several options in this regard. One approach, proposed in previous work by Richard Bird, Ken McKenzie and Jack Mintz, would be to implement a completely different approach to business taxation—a business value tax (BVT).
The idea behind the BVT is to lower the taxation of business capital by expanding the corporate tax base away from “income” toward business value added. Businesses add value by combining labour and capital with other purchased inputs. The value added by labour is the cost of labour (wages) while the value added by capital is the cost of capital (both debt and equity). In broad terms, the BVT base consists of revenues, less purchases of current inputs except labour, less depreciation allowances, less royalties paid to the Crown. In general terms, the BVT base can be calculated simply by adding back the appropriate amounts of interest and wages to the CIT base as it is currently calculated. The BVT base is thus considerably broader than the CIT base, and therefore requires a much lower rate to generate the same revenue.
Previous work suggests that the METRs on capital under a BVT would fall by from 6 to 10 percentage points from the levels under the existing corporate income tax. This would result in a significant reduction in the taxation of capital in western Canada, and would make the tax regime very competitive by international standards.
Implementing a BVT at the provincial level in the western Canadian provinces would obviously be a significant departure from the current approach to taxing businesses. However, if western Canada wants to take a bold step towards “going for gold,” the BVT would be one way of accomplishing this goal.