Big News Is No News on the Corporate Capital Tax

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posted October 3, 2002

There was a lot of political noise emanating from various provincial capitals over the last year regarding capital taxes, tax essentially assessed on the debt and equity of a company. BC boldly announced it would eliminate its general corporate capital tax. Quebec committed to more than halving the applicable rate. Saskatchewan, the country’s largest user of capital taxes announced it would increase the threshold at which it applies. And yet, after looking at the most recent data, the most striking feature is how little things have changed in 2002.

Prior to looking at the new numbers, it’s useful to quickly review the findings of The Fraser Institute’s study (The Corporate Capital Tax: Canada’s Most Damaging Tax) into capital tax usage in Canada. The study found that the capital tax was one of, if not the most damaging tax used in Canada for a variety of reasons, including the fact that Canada is one of only three OECD countries to use such a tax.

In addition, capital-based taxes were found to be much more costly to the economy than other taxes such as consumption or payroll taxes. Also, Canada’s capital tax is complicated and imposes significant administrative costs on businesses and government. Finally, capital taxes are profit insensitive, meaning they are imposed regardless of whether or not companies are profitable. This profit-insensitivity means that the tax can destabilize companies when they are most vulnerable. All in all it is very difficult to find any reason why we should continue to raise revenues using such a tax.

Looking at the new data one is struck by how little things have changed considering the amount of crowing and back patting about capital tax relief. Consider Saskatchewan. Throughout the twelve-year period examined in the previously mentioned study, Saskatchewan led the nation in capital tax usage. The 2001/02 data indicates that it still leads the nation in its use of capital taxes, ranking first in all three measures: capital taxes as a percentage of own-source revenues (6.6%), capital taxes as a percent of GDP (1.12%), and capital taxes as a percent of corporate income taxes (272.1%).

In addition, Saskatchewan’s usage of capital taxes extends far beyond that of Quebec, Canada’s second highest user of capital taxes. Specifically, Saskatchewan’s dependence on capital taxes for revenues is 83.3 percent higher than Quebec’s reliance on capital taxes, the burden it places on the economy is 55.6 percent higher than in Quebec, and as a percentage of corporate income tax receipts, Saskatchewan raises 311.0 percent more than Quebec. Saskatchewan is un-mistakenly the largest user of Canada’s most deleterious tax.

This is not to say that Quebec is not a heavy user in and of itself. Quebec ranked second in all three measures of usage. Specifically, it raised 3.6 percent of its revenues from capital taxes representing 0.72 percent of GDP and 66.2 percent of corporate income tax receipts.

Manitoba, Ontario, and British Columbia follow in terms of overall rankings in the use of capital taxes, the same as was recorded in the previous study.

What is particularly astonishing about the top five rankings is the fact that three of the provincial governments generated a great deal of hoopla over changes to the capital taxes. And yet as discussed, the most up-to-date data indicates very little has changed. Part of the explanation is that the changes announced were not immediate. For instance, British Columbia announced last year that the general corporate capital tax would be eliminated in September of this year.

In a similar vain, very little has changed at the other end of the rankings. Alberta, not surprisingly, ranks last in its use of capital taxes since it is the only Canadian jurisdiction to have completely eliminated their use. Prince Edward Island and Newfoundland follow in terms of low usage although their low ranking is more the result of a lack of a base upon which to levy such a tax than any specific strategy to avoid using capital taxes, as witnessed by their relatively high corporate income tax rates.

The changes implemented or committed to are commendable but do not constitute the ’best’ and most effective tax policy. Given the rare use of capital taxes in industrialised countries coupled with their high economic costs and complexity, the only prudent policy is to completely eliminate their use. Regardless of where particular Canadian jurisdictions rank, the complete and immediate elimination of capital taxes must be budget priority one this coming budget season. The complete elimination of this damaging tax would be a significant boost to savings and investment, risk-taking, innovation, and entrepreneurship, all things Canada needs more of.

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