Arthur Cockfield is a professor with Queen’s University Faculty of Law. He is the author of NAFTA Tax Law and Policy.
The government of Justin Trudeau is understandably focused on the NAFTA negotiations, as the government struggles to save a deal tied to Canada’s economic prosperity. Yet, there is another area that should be getting more traction from our federal government: using Canada’s tax system to compete with and undercut the U.S. tax regime.
The challenge for Canada is that the Trump administration reformed the U.S. tax system last year by lowering the corporate income tax rate to 21 per cent and abolishing taxes on most foreign business profits. As a result of these moves, the Canadian tax system has become relatively unattractive.
The U.S. tax reforms also took place at a time when Canada’s record for attracting foreign direct investment is a poor one compared with countries such as Australia. This is bad news for Canada because foreign investment creates new jobs, makes Canadian businesses more globally competitive and leads to a host of other benefits for the Canadian economy.
A tax-friendly reform agenda could help turn the tide on these trends.
In fact, the Canadian government has been trying to do this since 2002, when the Department of Finance under prime minister Jean Chrétien began touting the “Canadian tax advantage” over the United States. Since this time, Canada has adjusted its tax system, including continuing corporate income tax rate reductions, to make it more attractive to foreign investors compared with the U.S. system.
Moreover, the Canadian reforms will not trigger a “race to the bottom” in which each side continues tax rate reductions in a never-ending battle. My prior research has shown that the North American free-trade agreement can be likened to a three-player game with one giant player – the United States. Owing to its economic size, the U.S. government is indifferent to tax reforms by Canada and Mexico, leaving these two countries free to match and undercut U.S. tax reforms without fear of retribution.
What should the Canadian government do? It should begin by reducing the federal corporate tax rate to 10 per cent from 15 per cent. With average provincial corporate tax rates at 10 per cent, the combined Canadian federal and provincial corporate tax rate would be 20 per cent, which is less than the new U.S. federal rate. Some U.S. states also apply a corporate income tax, which would make Canadian investments even more tax attractive. Reducing this rate also encourages something called income shifting, in which corporate tax planners place more paper profits and taxable revenues in the lower taxed jurisdiction. It is a sneaky but effective way for Canada to attract more tax revenue from international transactions involving related U.S. companies.
To make up for any revenue losses associated with lower corporate rates, the Department of Finance should enact a “diverted profits tax” such as the ones recently implemented in Britain, Australia and the United States itself. The point of the tax is to counter aggressive international tax planning that diverts taxes and revenue away from Canada. It should be designed to counter the planning strategies used by the U.S.-based FAANGs (Facebook Inc., Amazon Inc., Apple Inc., Netflix Inc. and Alphabet Inc. subsidiary Google). These tech titans engage in tax planning to ensure very few of their profits are taxed in Canada – despite the fact that millions of Canadian consumers are helping make these companies rich.
While we’re at it, the harmonized sales tax (HST) should be reformed to apply to cross-border services such as Netflix subscriptions. The fact that, under current law, Canadian companies charge and collect the HST for similar domestic services provides U.S. companies such as Netflix with an unacceptable competitive advantage over the Canadian competitors.
Tax reform would also be an important signal to the global investment community. While the U.S. administration appears hostile to global trade and investment, Canada can demonstrate that it offers an investor-friendly climate with a stable legal, tax and business environment.
Using the Canadian tax system to compete against the American one is not just good policy advice: In an era where the Trump administration is challenging the value of free trade with our country, it is also the patriotic thing to do.