Bridging the gap
Cuts to business taxes in yesterday’s budget will help Canadian GDP catch up to U.S. levels --and close the prosperity gap
National Post, Ottawa Citizen, and Calgary Herald
By Roger Martin And James Milway
In our recent report, “Agenda for Canada’s prosperity,” the Institute for Competitiveness and Prosperity urged Canadians to take up the challenge of realizing our prosperity potential. By our estimates, our annual under-performance amounts to $9,200 per capita. This is how much we trail our counterparts in the United States in gross domestic product, which measures the value we add to our endowment of human, natural and physical resources through our work efforts, skills, ability to innovate and our firms’ global competitiveness. GDP translates into personal income and tax revenue to fund important social programs and public investments for future prosperity.
By our estimates, eliminating this $9,200 prosperity gap would mean $11,900 more in after-tax personal income for the average Canadian family. And it would mean an extra $108-billion in government revenue—per year. This would fund all the major initiatives that have been proposed recently—Kyoto, early childhood education, infrastructure and increases in healthcare spending, as well as a massive tax cut for Canadians.
Worse, the prosperity gap is growing. As recently as 1980 the gap stood at $3,300, just over a third of the current difference. And without action, it is not unrealistic to expect the gap to widen to $17,000 per capita by 2020. In our report we set out an ambitious agenda to reverse the worrisome trend.
How does the budget compare against this agenda? Pretty well.
Governments at all levels in Canada have been shifting spending away from investment in future prosperity—education, infrastructure—toward consumption—health care and social services. In 2004, for every dollar of government consumption across Canada we had only 44¢ of investment. But this budget allocates at least 64¢ of investment in education, infrastructure, and work effort for every dollar of consumption over the next two years. This is a welcome change in direction.
Leading the way, the budget provides about $2-billion more in post-secondary education and research expenditures. It strengthens registered education savings programs—thus helping Canadians invest in their own skills. Post-secondary education is the most important investment Canadians can make in themselves and so these are positive initiatives.
The budget continues the federal government’s commitment to making Canada’s taxes on new business investment the lowest of the G8. Currently Canada is among the world’s highest in taxing business investment. The budget increases the speed at which businesses can write off investments for tax purposes by making capital cost allowances more in line with the true life of assets.
The major improvement opportunity in our taxation of business investment continues to be at the provincial level. Six of the provinces still tax capital assets and this raises business taxes on business investment. The federal government has offered to help provincial governments eliminate their capital taxes before 2011. Some provincial governments impose sales taxes on new investments. They need to fix this by harmonizing sales taxes with the federal GST.
Reducing taxation of business investment should improve our businesses’ abysmal record in investing in machinery and equipment for their future competitiveness. But they are already earning very high profits as a percentage of GDP. They need the pressure of more competitive markets to encourage investment. The budget has some useful initiatives. It is establishing an expert panel to review Canada’s competition policy. While a panel often means delay, at least it must make its recommendations before next year’s budget. The budget also commits the government to bilateral trade deals—which will increase competitiveness and innovation in our businesses. And it fixes the Canada- U.S. tax treaty to make it easier for U.S.-based venture capitalists to invest in Canada for the benefit of our young, innovative firms.
The budget attacks the “welfare wall”—the punitive effective tax rates for lower-income Canadians trying to climb the prosperity ladder. Through clawbacks of income-tested transfers and increasing tax rates, a single parent with one child has an effective marginal tax rate of 78% as earnings reach $10,000. This budget introduces the working income tax benefit to supplement the earnings of low-income workers. The benefit is modest—a maximum of $500 for singles and $1,000 for single parents and couples. But it’s a start. In the United States, where a similar program has been in place for 30 years, its benefits have grown. It can be very helpful to the working poor in our urban centres and large-city mayors should get behind it, rather than demanding federal and provincial largesse for municipal governments.
All in all, this budget is a welcome step in reversing Canadians’ underinvestment in our prosperity.
- - -
- Roger Martin is the dean of the Joseph Rotman School of Management at the University of Toronto and chair of the Institute for Competitiveness and Prosperity. James Milway is the institute’s executive director.
