U.S. tax reform: What your business needs to know about its impact on the Canadian economy
February 1, 2018
At the tail end of 2017, President Trump signed the Tax Cuts and Jobs Act, bringing a $1.5 trillion-dollar tax reform into effect as of January 1, 2018.
Given the amount of economic activity between Canada and the United States – estimated $1.4 trillion economic relationship (2014) – and the mobility of global investments, any change to the U.S. corporate tax structure has the potential to impact Canada’s economy.
Here is what your business needs to know about the largest U.S. tax reform in several decades, and how our policymakers should respond.
The 3 key changes you should take note of
While there are many details, there are three main changes to U.S. corporate tax laws that could impact both U.S. and Canadian business competitiveness.
- The U.S. federal corporate income tax rate has been reduced from 35% to 21%. This move brings the U.S. combined federal-state rate below that of Canada’s.
- U.S. businesses are now allowed to fully expense their investments in machinery and equipment for at least the next five years.
These first two changes are clear incentives to attract and increase the amount of capital investment in the United States.
- The taxation of income earned outside of the United States. The U.S. will be moving from a “worldwide system” of taxation, which taxes domestic and foreign income of businesses with U.S. headquarters, to a “territorial system” that taxes business income earned within the United States.
How will US tax reform impact Canada’s economy?
This Bill will eliminate the relative corporate tax advantage that Canada has enjoyed over the U.S.
The new combined U.S. federal-state corporate income tax rate will fall significantly from 39.1% to 26%, slightly lower than Canada’s federal-provincial corporate income tax rate of 26.7% (calculation is weighted by GDP for states and provinces). When considering corporate income tax rates and deductions, sales taxes on capital purchases, and other capital-related taxes, the U.S. will see a significant drop in their marginal effective tax rate (METR) on new investment.
According to tax experts from EY, “the US aggregate METR will drop significantly from the current 34.6% to only 18.8%. Compared to Canada’s current aggregate METR of 20.3%.”
This reform could encourage capital to be invested in the United States rather than in Canada. Canadian policymakers should take this very seriously, as capital investment is a key factor that fuels long-term economic growth, productivity, and wage growth.
While Canada’s competitive standing relative to the U.S. has taken a hit, U.S. tax reform does not necessarily spell doom for Canada’s economy. In fact, U.S. economic growth tends to benefit the Canadian economy by increasing demand for Canadian goods, and U.S. investment into Canada. Furthermore, the lower rate could benefit the many Canadians who save and invest south of the border. While it is possible that the tax reform will shift the slices of the economic pie in favour of the U.S., it could also encourage the growth in the size of the pie, potentially benefiting all of North America.
These tax changes will impact Canada’s relative advantage for attracting global investments. How these changes impact Canada’s economy over the long haul, however, will largely depend on our policy response.
How should Canada’s policymakers address US growing competitiveness?
The U.S. tax bill, which reduces the burdens of running a business, has been enacted during a time where Canadian policies have been doing exactly the opposite.
According to the Calgary Chamber’s Business Leaders Market Perceptions Survey, among all the challenges business currently face, government regulations and taxes are the most frequently mentioned. In fact, more businesses (31%) indicated government regulations and taxes as a challenge to their business than any other factor.
If all levels of Canadian government continue to layer costs on the business community, discourage investment, and reduce regulatory certainty, it is likely that Canadians will lose out as a more attractive U.S. business environment encourages potential talent and investment to shift away from Canada over time.
There is potential, however, for Canadians to benefit from the growing U.S. economy – just as we have throughout our history. But this will likely require reforms of our own, specifically, Canadian governments must reverse the trend of increasing business costs and discouraging investment.
By undertaking our own tax system reforms, recycling greater carbon pricing revenue through lower taxes, expanding market opportunities, reducing trade barriers within North America including our own internal barriers, and streamlining our regulatory environment, we can not only benefit from U.S. growth, but complement it.