Canada and US Tax Reform

With a lot of news coming in on the political front in Ontario, most of my blogs have been short ones trying to keep up, but this will be about another pertinent issue that needs our attention. For good or ill, Trump has made big changes to the U.S. tax code, and as our largest trading partner, the question becomes: how will this impact us, and how do we need to react? There are three taxes I want to discuss in particular: the carbon tax, corporate taxes, and personal income taxes.

Many are calling on Justin Trudeau to scrap the carbon tax as it makes Canada less competitive because the U.S. doesn’t have one. While I believe the carbon tax will hurt our competitiveness somewhat, governments need to raise revenue in order to provide the programs we want without running big deficits. Massive spending cuts aren’t necessary, and going into deficit like the U.S. will be in order to finance their tax cut is a bad idea. So, the then question becomes: which types of taxes are least harmful? Most economists say consumption taxes are the least detrimental to economic growth, and since the carbon tax is a form of a consumption tax, I am okay with it, provided 100% of the revenue raised goes towards income and corporate tax cuts, not more government spending. On a side note, it appears BC and Alberta are at loggerheads over the Kinder Morgan pipeline, but since it’s still the early days on this, I feel it would be better to discuss in a separate blog. I do not, however, support the current structure of the carbon tax in either province, as neither are revenue- neutral. I did support the BC Liberal version, the version the Ontario PCs are proposing, and Michael Chong’s proposal from the Conservative leadership race, as all three are revenue- neutral and that is the key.

On corporate taxes, Canada used to have a strong advantage, as ours were much lower than in the U.S., which is why some U.S. companies, like Burger King, decided to locate their headquarters here. With the U.S. corporate tax rate dropping 14% permanently, we have lost that competitive advantage. Canada’s corporate tax rate is not much higher, although it varies by province and state, but it is not lower anymore, and thus no longer incentivizing for big companies to be located here. Certainly, the fact that our corporate taxes have been slashed quite a bit since 2000 (from 28% federally to only 15%) makes me skeptical of further cuts, but with almost all other developed countries cutting them, we could go from having one of the lowest rates five years ago to having one of the highest in the not too distant future. Yes, some will say it shouldn’t be a race to the bottom, but capital is highly mobile, and if ours is no longer competitive, firms will go elsewhere. Trying to convince others to raise their taxes (like Trudeau is on high income earners) will likely fall on deaf ears, so my suggestion is leave the corporate rates at current levels for now, but monitor the situation closely and cut them if necessary. This gives us all the more reason to bring the deficit under control, so we can afford to cut them if necessary.

For personal income taxes, the combined top marginal rates range from 37% to 50.3% in the U.S., while in Canada they are between 47.5% and 54%. Our top rates can be a little higher, but not this high, as they can incite a brain drain. I’ve found from past experience, if it’s less than a 5% difference, it’s unlikely to have an impact;, if it’s 5-10% it causes a minor brain drain; when it exceeds 10%, it becomes problematic. After the Trump tax cuts, we are getting close to that 10% mark. While I oppose the idea of anyone paying over half their income to the government on principle, that is a totally separate issue I’ve blogged about previously. In this case, I think we should drop the top rate back to 29%, which would put top rates between 43.5% to 50% and thus make us more competitive. The other option would be to have the current top bracket kick in at a much higher level. The gap is even more problematic than it looks at first blush, since the U.S. top rate kicks in at a much higher level than it does in Canada; a person entering the top bracket in Canada is still not in the top bracket in the U.S., which would result in an even bigger tax gap. California has a top marginal rate of 50.3%, whereas in BC, it’s 49.8%. These rates are pretty similar, but there is one key difference:; the top rate in California kicks in at 1,000,000 U.S. dollars (almost 1.25 million Canadian dollars) while ours kicks in at $200,000 (about $150,000 U.S.). In other words, if you are a rich CEO, there is no advantage to re-locate to the U.S., but for a doctor or engineer, there would be a strong tax advantage to re-locate. And let’s remember, BC has the third lowest top rate and California has the highest, so when comparing ourselves to the rest of the states, the disadvantages of our tax system become even more apparent.

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