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By Alex Laurin and Nick Dahir
Looking around the OECD, Canada is an average-tax nation overall but relies far more on income taxes and much less on consumption levies than most other industrialized nations. Leaning so hard on income taxes hurts our economic performance.
Every tax creates economic distortions but some overused taxes are more damaging than others. By raising more of our revenue from the less damaging taxes we could improve economic performance without reducing public services.
The latest C.D. Howe Institute Shadow Budget proposes a simple change in the federal tax mix: raise the GST rate by two percentage points — back to its original rate of seven per cent. At the same time, cut the federal corporate rate by two percentage points and the rate in the second personal income tax bracket by 5.5 points, from 20.5 to 15 per cent. That’s the bracket ranging from $55,867 to $111,733.
Finally, to cover any harm to lower-income Canadians from the increase in GST and also any political blowback from the fact that in the very lowest bracket the income tax rate doesn’t move: double the base amounts for the GST Tax Credit.
Revenue forecasts are always difficult, but our best estimate is that an extra two points on the GST will bring in $26.1 billion next fiscal year, while the corporate rate cut will cost $6.3 billion, the income tax rate cut, $14.9 billion, and the increase in the GST credit, $5.8 billion. Sum those four changes and the federal government ends up short $900 million. In a more than $500-billion budget that’s not a lot.
What are the benefits of this revenue-neutral tax switch?
The corporate tax cut would increase the expected after-tax return on potential business investments, making more opportunities desirable and thus increasing the capital stock and economic activity. It may also shift some multinationals’ profits back into Canada.
Lower personal income taxes would reduce tax avoidance and stimulate greater work effort and participation. Reduced personal taxes would also encourage risk-taking and entrepreneurial activity. And, in a nice feedback loop, the increase in income generated by these effects will result in a roughly three per cent rise in GST revenues.
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As mentioned, we would cut personal income taxes only in the second bracket. Families in the lower-income quartiles would see their relative net tax burden remain relatively unchanged, however, because of our doubling of the GST tax credit.
So why shift taxes around if there’s no gain in revenue? Because raising the same revenue with taxes that harm the economy less makes Canadians better off. Drawing on estimates of the marginal cost of public funds by Bev Dahlby of the University of Calgary and Ergete Ferede of MacEwan University, we figure a tax shift like the one we propose would result in a long-term economic improvement of $4.5 billion annually.
Innovative policy design can boost economic activity and incomes without cutting public services or hurting the most disadvantaged. Business investment in Canada has been lacklustre since 2015, leading to a decline in capital per worker, which is one reason real GDP per person is stagnating. Recent tax reforms have been motivated mainly by a perceived need for redistribution. We now need to tackle the tax system’s adverse impacts on Canada’s economic performance. Federal tax policy can help. Next month’s budget would be a good place to start.
Alex Laurin is director of research at the C.D. Howe Institute, where Nick Dahir is a research officer. This article reflects ideas discussed during the C.D. Howe Institute’s recent two-day conference on tax policy.
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