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Posted Thursday March 14, 2019


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Commentary

US Tax Changes should Trigger Bold Reform in Canada

In “Tax Policy Next to the Elephant: Business Tax Reform in the Wake of the US Tax Cuts and Jobs Act,” authors Kenneth McKenzie and Michael Smart argue US tax reform provides Canada an opportunity to make a bold move toward a corporate tax system that is grounded in sound tax policy principles, is less distortionary, promotes economic growth and prosperity, and restores Canada’s tax competitiveness.

The authors explore the effects of the new US tax measures on domestic and US foreign investment in Canada, and estimate it will have a negative long-term effects – including Canadian affiliates of US companies shifting back between 8 percent to 28 percent of their profits, and annual revenue losses in the range of $744 million to $2.4 billion.

“Ottawa, in its 2018 Fall Economic Statement, duplicated in part some aspects of the US reforms in accelerated depreciation for new capital expenditures,” say the authors. “While we think that this short-run response is reasonable in light of the fiscal constraints facing the government and the uncertainty regarding the impact of the Tax Cuts and Jobs Act (TCJA), we do not think that the work is done.”

The report argues that in looking to respond to tax changes south of the border, cutting statutory corporate tax rates, as some economists propose, is not the best answer. More effective in boosting investment would be a fundamental change to the taxable income base, regardless of the rates.

The authors propose a cash-flow tax, or what economists call a tax on economic “rents” which would involve the immediate write-off of all capital expenditures coupled with the elimination of the debt-interest deduction. The idea is to replace the corporate income tax with a tax that applies only to above-normal return on investment and is, therefore, neutral with respect to business investment and financing decisions.

In fact, the authors note that such a cash-flow tax would reduce the business cost of capital investment by roughly 20 percent – offering a much greater boost to capital investment than statutory rate cuts.

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