Budget Priority One: Eliminate Capital Taxes

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posted February 7, 2003

As the projected federal surplus continues to swell, the federal government seems poised to initiate a new round of significant spending. If the rumours surfacing come to fruition, the federal government will have concluded that spending additional funds on everything from health care to municipal infrastructure is the priority.

The fact of the matter is that these programs need to be reformed, not given more funding. What Canada actually needs is a government that looks past the special-interest rhetoric and facilitates an environment within which economic activity can occur and indeed thrive. To achieve this end, the priority must be the elimination of capital taxes rates rather than a series of new expenditures.

Eliminating the federal capital tax would yield enormous benefits to the economy as a whole while only costing the treasury roughly $1.4 billion, less than one-fifth of the expected surplus this year.

Most Canadians have never heard of, or even been directly exposed, to capital taxes and yet they impose a significant burden on our economy and impede our nation’s economic prosperity. A capital tax is essentially a fixed tax on the value of a corporation’s assets. It is specifically calculated as a percentage of the value of a company’s debt and equity. Since debt and equity equal the value of a firm’s assets, the capital tax is effectively a tax on a firm’s assets.

There are a host of problems associated with using such a tax and which explain why Canada needs to eliminate this burdensome tax in the upcoming federal budget. First, Canada is only one of three OECD countries to use a capital tax. Japan and Germany are the only other countries that employ such a tax, although they do so to a much lesser extent. The isolated use of capital taxes results in an uncompetitive level of capital taxation in Canada vis-à-vis our competitors.

Perhaps more important in explaining why we need to eliminate the tax is its economic cost. Different taxes impose different costs to the economy. Estimates of these costs indicate that capital-based taxes impose a significantly higher cost to the economy than other, more efficient types of taxes, such as sales taxes and payroll taxes. For example, the Ministry of Finance estimated that sales taxes imposed a cost of $0.17 for every dollar extracted from the economy. This compared with a cost of $1.55 for every dollar extracted in the form of corporate income tax.

It’s also important to recognize the destabilizing nature of capital taxes on businesses. Capital taxes are profit insensitive, meaning they are levied regardless of profitability. They often lead to circumstances where vulnerable companies are made more unstable due to the levying of this tax.

Given the mounting surplus and the continued waste in current federal government spending, the $1.4 billion required to eliminate capital taxes is a drop in the bucket of federal government resources. Its time the federal government started removing hurdles from Canada’s economic prosperity instead of trying to provide stepladders over the hurdles, which cost too much and don’t achieve the intended results. Priority one for the federal government in the up coming budget must be the elimination of capital taxes.

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