Innovators needed for an innovative Canada

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Appeared in the New Brunswick Telegraph-Journal, March 29, 2017
Innovators needed for an innovative Canada

One of the pillars of the federal government’s laudable focus on improving the economy, particularly for middle-class Canadians, is an emphasis on innovation and entrepreneurship. Indeed, it was a centrepiece of the recent federal budget.

Unfortunately, some of the actions and signals of the government run contrary to a more innovative, entrepreneurial Canada. Specifically, if we want to be more innovative and entrepreneurial, we need to retain and attract entrepreneurs, investors and innovators.

In 2016, Ottawa increased the top marginal personal income tax (PIT) rate to 33 per cent for income over $200,000. This federal tax increase came on top of other increases implemented by various provinces. As of 2016, the top combined federal-provincial PIT rates varied from a low of 47.7 per cent in British Columbia to a high of 54.0 per cent in Nova Scotia. Ontario had the second highest combined PIT rate at 53.5 per cent. Put simply, the top PIT rate in every province (including the federal tax) ranged from slightly less than half to slightly more than half.

These increases exacerbated an already existing problem for Canadian competitiveness—high PIT rates that take effect at comparatively low levels of income. For instance, in 2016, seven of the 10 highest top PIT rate jurisdictions in North America were Canadian provinces (again including federal taxes).

Canada’s comparatively (and some would argue absolutely) high personal income tax rates are compounded by the fact that they’re effective at relatively low levels of income. For example, the top PIT rate in most U.S. states kicks in at roughly C$550,000; some are quite a bit higher such as California ($1.2 million) and New York ($2.5 million).  In Canada, on the other hand, Alberta has the highest income threshold—the top PIT rate kicks in at $300,000—while the remaining provinces range from roughly $200,000 to $220,000.

A growing and rather compelling body of research has shown that high personal income taxes adversely affect entrepreneurship by changing the risks and rewards associated with it. For instance, noted economists William Gentry and Glenn Hubbard found marked adverse effects on entrepreneurial activity when top marginal personal income tax rates were raised in the United States.

One need not delve into empirical economics though, as NDP Leader Thomas Mulcair eloquently explained the effects of raising top personal income tax rates in the leaders’ debate in 2015. Mulcair criticized the Liberal plan to increase the personal income tax rate for Canadians earning more than $200,000 by correctly explaining that such a tax increase would affect people’s decision-making with respect to both work and investment.

Intuitively this makes sense. By reducing the rewards to additional investing, or building a new business (entrepreneurship), or perhaps taking on an extra contract, governments in Canada, particularly the federal government, have discouraged the very activity they profess to want to encourage. If we want more entrepreneurs, more innovators, and more investors then at the very least we shouldn’t be increasing the taxes they face. Indeed, there’s a strong argument to be made that if want more of these activities then we should actually reduce marginal tax rates.

Moreover, the federal government did nothing in the recent budget to quell the speculation that they’re planning to increase taxes on capital gains, which will particularly and adversely affect entrepreneurs.

Tax hikes and other policies have already dampened the Canadian economy. Economic growth expectations have consistently declined since the fall of 2015. In addition, several reports have shown consistent declines in business investment in Canada. Simply put, the Canadian economy is not improving.

There again seems to be a disjoint between the aspirations of the federal government and its actions. Stronger economic growth and a more prosperous economy are commendable goals and ones with which we fully agree. However, history has repeatedly taught us that punishing success through higher marginal personal income tax rates does not result in a stronger, more prosperous economy. If we want more innovation and entrepreneurship then we need more innovators and entrepreneurs. One easy policy is not to punish them when they’re successful.