Canada's reputation as a low-tax destination for business investment is poised to take a hit as key provinces balk at further cuts, just as plans heat up in Washington to slash much-higher U.S. corporate rates.
Federal Finance Minister Jim Flaherty has steadily cajoled provincial governments to cut business taxes since 2007, with the goal of bringing the combined national corporate tax rate to 25 per cent. Now at just over 26 per cent, the minister's target appears in reach – but the campaign is suddenly losing steam.
British Columbia announced in this week's budget that it may raise its corporate tax rate from 10 per cent to 11 per cent in 2014. It also cancelled a planned drop in the small business tax rate. The move comes as Ontario, too, is expected to shelve plans for further corporate tax cuts.
Yet in the U.S. capital on Wednesday, President Barack Obama unveiled a proposal that would cut the top U.S. corporate tax rate to 28 per cent from 35 per cent, while offsetting lost revenue by closing tax loopholes.
The prospect of the U.S. lowering its corporate tax rate and simplifying its tax code will raise further questions about Canada's capacity to compete in a fast moving global economy. Even with its current advantage on corporate taxes, the Bank of Canada says Canadian companies are largely uncompetitive internationally, representing one of the biggest constraints on economic growth. The thrust of the U.S. debate on taxes could force Canada's government to rethink its own approach.
The Obama administration's announcement makes a lower corporate tax rate a bipartisan issue, as all four men competing for the Republican presidential nomination have said they would reduce the statutory rate on business profits. Mitt Romney, the front-runner, would drop the rate to 25 per cent.
No change is likely until after the election, but with support for a change strong in both parties, it's reasonable to expect the U.S. will overhaul its tax code once the November vote determines which party enters negotiations with the upper hand.
"If it's only about rates, people can match you very easily," said Glen Hodgson, chief economist at the Conference Board of Canada and a former Finance official. "If it's about designing a tax system that promotes growth, that's harder to match."
Canada's labour movement insists slashing corporate taxes is no example to follow. Canadian Auto Workers president Ken Lewenza points to the fact that companies are posting large profits even while workers pay the price through heavy job losses in manufacturing. He said this year's closure of a London, Ont., locomotive manufacturing plant – leaving 700 people out of work – shows corporate incentives don't protect jobs.
"Everybody's using the carrot. Nobody's using the stick," he said. "If people want to just continue to trust that these corporations are going to invest and are going to make a commitment to our communities like London – like the Caterpillar situation – all of the statistics would prove that that's just a falsehood."
Canada's slight change in direction marks the apparent end of a long trend. Since 2000, the federal rate has dropped from 28 per cent in 2000 to 15 per cent as of Jan. 1, 2012, which is the last of a series of promised cuts.
The issue of corporate tax cuts has been hotly debated in federal and provincial campaigns, with NDP opposition leaders in Ontario and Ottawa promising to pay for new spending through higher corporate tax revenues. But the historical numbers show the connection between the tax rate and revenues is not black and white.
For instance, in 1970 when the federal corporate tax rate was 40 per cent, Ottawa's corporate tax revenues were 2.7 per cent of GDP, or 15.8 per cent of Ottawa's total revenue. In 2006 – when the rate was 21 per cent – the revenues were 2.6 per cent of GDP and 16 per cent of the total.
By 2010, the rate was 18 per cent, and corporate tax revenues were 1.8 per cent of GDP and 12.6 per cent of total revenue. The 2010 numbers – the most recent available – were affected by the recession and the drop in corporate profits.
Economist Don Drummond, who recently provided detailed cost-cutting advice to Ontario in advance of its provincial budget, was not allowed to recommend higher taxes in his report. However, he did call for Ottawa and the provinces to work on closing corporate tax avoidance loopholes.
The report warned that Ottawa and the provinces need to curb "aggressive tax planning" by corporations that are shifting losses across Canada to reduce or avoid taxes in the province where income is earned.
"All of these activities can unduly reduce provincial tax revenue," the report stated, estimating that closing these loopholes could raise an additional $200-million a year for Ontario alone.
In a statement to the Globe, Mr. Flaherty urged provinces to keep working to lower business taxes.
"The Obama administration's proposal [Wednesday]reflects the reality of competitive taxes creating economic growth and jobs," he said.