TAXATION

High taxes choking off investment

Canada's rates hurt its ability to compete with fast-growing China, India, study says

By STEVEN CHASE

The Globe & Mail

Wednesday, September 21, 2005 Page B9

OTTAWA -- Canada is trailing all but one of its international peers when it comes to a competitive tax system for attracting investment, the C.D. Howe Institute says in a new report that calls on all leading industrialized countries to lighten the tax burden to compete with Asian economies.

Canada has the second-highest overall tax rate on capital investment -- the lifeblood of economic growth -- among 36 leading industrialized and developing countries in the world, the institute says in a report released yesterday.

It's a particularly dismal statistic for a country that's struggling to cope with new competition from fast-growing China and India and has seen its share of foreign direct investment sag in recent years.

The institute said that while taxes in some countries, such as the United States and the United Kingdom, seem low compared with their annual economic output, their overall tax regimes still discourage investment.

The only country that's higher than Canada when it comes to what the CD Howe Institute calls the effective tax rate on capital is communist-led China, according to the think tank's 2005 Tax Competitiveness Report: Unleashing the Canadian Tiger.

Examples of countries with low effective tax rates on capital include Singapore at 6.2 per cent, Hong Kong at 8.1 per cent and Sweden at 12.1 per cent. Canada's free-trade partner, Mexico, has a rate of 16.7 per cent, the think tank's study shows.

"Heavy taxes on investment discourage businesses from buying the new-vintage capital and latest technologies that improve labour productivity," the study says.

"In the absence of such modernization, production processes age, businesses fall behind, and they have difficulty increasing their employees' incomes . . . Lowering taxes on capital investment holds the key to growth."

Canada's effective rate of tax on capital is 39 per cent, while China's is 45.8 per cent, the study found, when all taxes are taken into account including corporate income taxes and other taxes on capital including sales levies.

By comparison, the United States' is 37.7 per cent.

The think tank's report comes just as Ottawa and the provinces are drawing up plans for their spring 2006 budgets, and Finance Minister Ralph Goodale has been talking up the need to fix Canada's weak productivity growth.

The institute says Canada is holding back economic growth with remarkably high effective marginal tax rates -- tax on the last dollar earned -- that are "well above 50 per cent" here for employment and investment income. "Marginal tax rates, averaged across provinces, often [reach] 80 per cent on investment income and 60 per cent on employment income earned by people with modest [pay]."

It's calling for an across-the-board redesign of the Canadian tax system by both Ottawa and the provinces, reducing the average combined federal-provincial corporate income tax rate to 25 per cent from 34.3 per cent -- the sixth highest among industrialized countries.

It says Ottawa and the provinces have to create a "Canadian advantage" for businesses to locate in this country as a gateway to the North American free-trade area.

"Investment is attracted to large markets and low costs -- the United States has the former and Mexico has the latter," the study said.

"Policy initiatives are the only way that Canada can create a distinct advantage for itself."

The institute said attracting more investment could prompt businesses to spend more on new technology. Today, Canada's annual private investment spending per worker lags behind the United States by $2,000.

It called for all provinces to slash taxes on companies, pointing out that Saskatchewan and Ontario have the highest effective tax rates on capital while Newfoundland, Nova Scotia and New Brunswick have the lowest effective rates.

"Business taxes vary considerably by business activity, with [the] burdens greatest for construction, communications, trade and services industry."

The report says Ottawa and the provinces must encourage people to work harder and longer so they can provide the economic stimulus and tax revenue necessary to pay the bills of an increasingly elderly population. "As the population ages, workers will be increasingly difficult to obtain and Canada's current advantage will be lost."