Fred O’Riordan is national leader, tax policy, EY Canada.
The warning signs have been there for some time. Canada is losing its international competitiveness and largely as a direct result, its attractiveness as a place of investment. What is less clear is whether governments are listening. There is little visible evidence at this point that they are, beyond a belated comment from Finance Minister Bill Morneau that his fall economic statement will address business taxation – but with a caveat that it will focus on lowering the cost of new investment rather than cuts in the corporate tax rate.
First, some context. A major determinant of productivity and competitiveness is the rate of new business investment, in particular capital formation in plant, machinery and equipment. Statistics Canada has been charting quarterly rates of real Canadian business gross fixed capital formation since the early 1960s. Ignoring peaks and troughs, business fixed investment has been steadily declining over that period. Recent annualized rates of growth are about half what they were at the beginning of this period. Adding to these woes, in 2017 foreign direct investment hit its lowest level since 2010 while cross-border mergers and acquisitions generated a net withdrawal of funds from Canada for the first time since 2007 (when these data started to be compiled).
To make matters worse, new threats to our competitiveness and sustained economic growth are being posed by actions taken by the Trump administration on a number of policy fronts having cross-border tax, trade or regulatory implications, including U.S. tax reform, the North American free trade renegotiations and U.S. deregulation. U.S. tax reform alone has completely eliminated the significant corporate tax advantage that Canada had enjoyed over the United States since 2006.
At the same time as trade protectionism is growing in the United States, many Canadian tax and regulatory policies are moving in an opposite direction – one that may be unfavourable to business investment and growth here. After a period of calm, interprovincial trade disputes also appear to be flaring up, further balkanizing our already small domestic market and making it harder for Canadian companies to grow and realize the economies of scale and other efficiency attributes of larger international competitors.
Taken together, these policy developments could negatively affect business confidence in Canada, capital formation, job creation, inbound investment and, ultimately, our international competitiveness.
To shed light on how Canadian businesses are reacting to these developments, EY Canada commissioned Abacus Data to survey a broad cross-section of 165 Canadian business leaders representing companies of different sizes, sectors and regions to gauge the impact these policy shifts are having on their business operations and future capital allocation plans. Views were also sought on what policy responses the federal government should be considering.
A majority of those surveyed say Canadian tax, regulatory and fiscal policy, as well as the NAFTA renegotiations, are already having or will have an impact on their own business plans. About half say U.S. tax reform and U.S. deregulation are having or will have an impact. Strikingly, 59 per cent of respondents expect domestic Canadian tax, and regulatory and fiscal policies to have a negative competitive impact on their companies. This question also garnered the lowest “unsure/unclear as yet” response (10 per cent).
More than half of those surveyed (54 per cent) anticipate that U.S. tax reform will result in a shift of corporate revenues out of Canada and into the United States, resulting in lower tax liabilities in Canada and higher ones in the United States. This proportion rose to 60 per cent for firms with revenues above $500-million, and 64 per cent for companies with more than 500 employees.
Asked what best describes the likely impact on their business plans, half say they will likely increase investment in the United States, another 29 per cent said they will shift investment from Canada to the United States, and 22 per cent said decisions will be deferred because of uncertainty – at least for the time being. Among businesses currently operating in the United States, 33 per cent foresee cutting investment in Canada and increasing it in the United States, and another 53 per cent anticipate increasing their investment in the United States.
Changes to personal tax burdens and regulations affecting labour mobility are also affecting Canada’s ability to attract and retain top talent. The majority of Canadian business leaders now feel the United States has the advantage (57 per cent) compared with Canada (20 per cent), while 22 per cent feel that the countries are equally competitive.
Respondents feel the Canadian government has been taking an acceptable approach in dealing with NAFTA renegotiations and tariff discussions with the United States, but a clear majority (56 per cent) say not enough is being done to ensure competitiveness with the U.S. regulatory changes. An even larger majority (64 per cent) feel more needs to be done to maintain our tax competitiveness with the United States. That number rises to 71 per cent among firms currently operating in the United States.
Almost two thirds (62 per cent) believe business tax rates should be reduced, while 58 per cent believe reductions in red tape and regulations are required. Fully 90 per cent believe that Canada needs a comprehensive tax policy review, with many respondents citing the U.S. tax reforms as a significant new impetus for such a review. An overwhelming majority of respondents (80 per cent) prefer this review to be done at arm’s length by an outside commission of tax experts appointed by the government rather than in-house by the Department of Finance (20 per cent). In their recently released economic reports for Canada, both the IMF and the OECD also recommend a comprehensive review of the tax system.
The policy choices facing governments in Canada are not easy. But standing pat is clearly not an option when world events are as dynamic and disruptive as they are today. The current Canadian federal government has an ambitious and aspirational social policy agenda. The challenge is to ensure that as a country we continue to attract the investment, create the jobs and earn the national income needed to pay for it.
Canadian businesses and governments have an opportunity to collaboratively question current and traditional policy barriers that impede growth and competitiveness. In disruption there is risk, but also opportunity for those who seize the moment.