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U.S. corporate tax cuts blunt Canada's competitive edge amid trade worries

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Wednesday, January 17, 2018 – Page B1

A big drop in the U.S. corporate tax rate along with growing worries about cross-border trade threaten to undermine Canada's competitiveness.

The United States slashed its corporate tax rate in December to 21 per cent from 35 per cent as part of reforms that include repealing the alternative minimum tax and lower income taxes for some people.

This compares with Canada's federal tax rate of about 15 per cent, one of the lowest in the developed world. However, once state and provincial taxes are included, the corporate tax rates in both countries are about 26 or 27 per cent.

The U.S. tax reduction undercuts Canada's tax advantage amid growing doubts about the future of the North American free-trade agreement and tarifffree access to the U.S. market, said Douglas Porter, chief economist at Bank of Montreal.

"At least on the surface, we've gone from having significantly lower tax corporate rates than the U.S. to having the same if not a little bit higher than the U.S. So one big potential attraction of investing in Canada has essentially been removed with a stroke of a pen," Mr. Porter said.

"If [the U.S. tax cut] happened in isolation I would not be overly concerned about it. But the fact that it comes at a time when the core of our trading relationship with the U.S. is at question is what really concerns me," Mr. Porter said.

To be sure, the U.S. tax cut is not expected to spur a flood of Canadian businesses across the border, given the narrowness of the tax difference and the high costs of moving a company. Also, Mr. Porter noted, Canada has other key advantages that include publicly funded health care, a more open immigration system that helps employers fill job openings, and a more sound fiscal picture.

Kevin Milligan, an economics professor at the University of British Columbia, said he doubts Canada will suffer any immediate hit from the U.S. tax cut. "But I think we should take note. We've lost a tax advantage that we've had over the past 20 years. So that's not good. But there are other sources of advantage."

He noted that with the U.S. cuts, the corporate tax rates in the two countries are now "pretty much at the same level." But he argues against Canadian lawmakers making their own tax cuts in an attempt to restore Canada's upper hand.

"If the United States was clearly below us, I'd be quite worried that there would be a growing incentive to shift profits out of Canada," he says. "But that's where we are. We're about tied."

Gavin Semple, chairman of Reginabased farm-equipment maker Brandt Group, isn't as sure. He said the tax cut makes the United States an even more attractive market in which to operate.

In December, privately held Brandt announced the purchase of a 200,000square-foot plant in Illinois. Since then, the company has been hiring workers and retooling the factory to produce crop-handling machines for growers in the U.S. grain belt.

With all levels of governments combined, Canada and the United States have comparable corporate tax rates, Mr. Semple said. But at the state and local levels, there are tax credits and rebates that are unmatched in Canada, he said.

For instance, some states have no corporate taxes, while others, including Illinois, give employers a tax credit worth 5 per cent of their total payroll. This reduces Brandt's state tax rate to 4.5 per cent from 9.5 per cent.

Mr. Semple, speaking from Florida, said the Canadian government's efforts to reform the tax system appear to be adding to the burdens faced by businesses.

"There is no doubt in my mind if we continue on the road we are on in Canada, wealth will move, capital will move from Canada to the United States," he said. "We see the U.S. going in one direction, namely tax reductions and reduced regulations, improved business environment to attract business and in Canada the federal government is going in the opposite direction, increasing taxes and making it more difficult."

Dennis Darby, chief executive officer of Canadian Manufacturers and Exporters, said companies that make, process and exports goods are most affected by the U.S. changes. That's because they compete for investments and market share with U.S. counterparts.

"You can't underestimate the impact of this kind of change," Mr. Darby said.

Spending on manufacturing plants and equipment has fallen by 40 per cent since 2008, and risen by a similar amount in the United States in the same period, Mr. Darby said.

The industry group, which represents more than 10,000 companies, has asked the Canadian government to reduce the combined federal and provincial tax rates to 20 per cent, from about 27 per cent currently.

"Companies that are domestic and foreign owned have not been investing.

That's worrisome in itself," Mr. Darby said.

But Ray Simmons, president of Torontobased industrial caster and wheel manufacturer Darcor Ltd., argues that the U.S. tax cut could actually be good news for Canadian manufacturing exporters - especially those with high exposure to the U.S. market.

"It may, in fact, benefit us, if it helps strengthen the U.S. economy," Mr. Simmons said. "We do about 65 per cent of our business in the U.S.

If this creates an investment atmosphere down there, and manufacturers are growing, and growing their investment in capital equipment - that's going to expand our market down there. So there may actually be more of a silver lining in it. ... I'm excited about that possibility," he said.

Canada has reduced its federal general corporate tax rate nine times this century - cutting it almost in half in the process, from 28 per cent in 2000 to 15 per cent today. Yet critics say that the cuts have done little, if anything, to stimulate corporate investment in this country.

Business investment, as a share of gross domestic product, has been essentially flat in that time, and is among the lowest in the Organization for Economic Co-operation and Development.

David Macdonald, an economist at Canadian Centre for Policy Alternatives, said recent history shows there is little connection between corporate tax cuts and capital investments.

The Ottawa-based think tank points to data that shows corporate taxation and business spending on machinery and equipment have remained at the same respective levels since the mid-2000s.

During the same period, after-tax profits have risen by 50 per cent.

"Lower taxes lead to higher profits, but those profits have not found their way into machinery and equipment," Mr. Macdonald said.

Instead, he said, businesses have invested in commercial real estate, the stock market and corporate acquisitions.

"I suppose businesses are just like regular Canadians that don't want to pay tax.

They'd like to keep all the money they make," said Mr. Macdonald.

"The issue unfortunately for government is that governments provide services that Canadians use and make Canada an attractive destination for business and Canadians to live, like health care and infrastructure and so on.

So while nobody wants to pay taxes, everybody benefits from taxes."

One possible corporate tax reform that could spur investment, UBC's Mr. Milligan suggests, would be to allow businesses to immediately expense their investments in capital assets, rather than depreciate them gradually over multiple years of tax bills.

This, he argues, would increase the incentive for companies to invest, by rewarding them with immediate tax relief.

"That's the kind of thing that you could imagine a Canadian government looking at, to try to focus our tax efforts on what we want - which is productive investments. If you just cut the rates, you're rewarding past investment, you're rewarding economic rents, you're rewarding monopoly profits ... If you focus on the depreciation angle, you focus our tax efforts where we want them," he said.

"The bigger picture is that it's clear we have lost a tax advantage that we had; we're now tied. We want to think about ways to ensure that businesses want to start and grow and invest in Canada."

Huh? How did I get here?
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