A Proposal for a “Big Bang” Corporate Tax Reform
In the 2020 Tax Competitiveness report (Bazel and Mintz 2021), four conclusions were reached about Canada’s investment climate and corporate tax system.
- Despite accelerated depreciation and other tax preferences introduced in recent years, the existing corporate income tax is failing to spur Canada’s investment performance, which has been virtually flat since 2015 even before the pandemic.Overall, business investment has lagged most countries even in some resource-based economies with 2015-19 investment cumulative increases being stronger in Norway (16 percent), New Zealand (14 percent) and Russia (8 percent). As a result of weak labour productivity and per capita GDP growth in Canada, companies pay lower labour compensation.
- Canada’s corporate tax system is attractive to encourage investment in marginal projects although it has become much more distortionary and non-neutral due to incentives, thereby undermining the productive use of resources.
- Canada has a relatively high corporate income tax rate than most countries, thereby making Canada less attractive for greenfield projects with high economic rents from intangible or resource investments.
- Some countries have benefited from significant growth in capital investment from 2015 to 2019 especially Ireland (112 percent) Hungary (40 percent) and Estonia (37 percent) with competitive corporate tax systems that are quite different than other countries.Major tax reforms have also spurred stronger investment responses from 2015 to 2019 including France (16 percent), United States (14 percent) and India (24 percent).
Canada could pursue further its corporate tax reforms by lowering rates and broadening tax bases to reflect economic income. However, this common approach to reform, which has been focus for Canada since 1985, seems to have reached its limit in reducing corporate tax distortions.
Instead, a fundamental tax reform could help tilt the playing field towards Canada to boost investment, reduce tax distortions and simplify administration and compliance, without a significant loss in revenue. I call this a “big-bang reform”. As explained below, the basic proposal is to convert the corporate tax into a tax on distributed profits that would improve static and dynamic efficiency in the corporate tax system. It is not a perfect system, but it could be a practical approach to boost growth and make the corporate tax more efficient and fairer.
As shown below, there are some important advantages to the approach, particularly reducing tax distortions that discourage investment especially for the service sectors in the economy. The proposed structure would also be compatible with international tax systems and continue support for small businesses. It does have one disadvantage – it would potentially be distortionary in financing decisions by favouring retained earnings over other funding sources. Recommendations will be made to the taxation of share buybacks and capital gains that would create potentially greater neutrality among financing sources compared to the existing system.
Much of this detail will be explained further below. The paper begins with a discussion of the current problems with the corporate income tax in Canada. This will be followed by a description of the proposed corporate tax on distributed profits, including a review of both the positive and negative aspects of the proposal. A rent-based approach to the taxation of corporate distributions is considered, which would be consistent with a personal tax reform along the lines of the expenditure approach, as explained below.
 Our proposal could also be adjusted to tax only corporate rents by redefining the tax base as distributed profits net of the new equity financing (although this would require a substantially higher corporate income tax rate to make up for the loss of revenues). This approach would be appropriate if the personal income tax is also reformed to remove the tax on savings. We will discuss this further below.
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