Tax reform should play crucial role in COVID recovery

While the COVID-19 pandemic continues, the focus will eventually turn more fulsomely to ensuring a robust economic recovery. Decisions about taxes will play a key role, as governments grapple with large amounts of new debt from COVID-related spending. While the federal government may want to raise taxes as we emerge from the pandemic, it should be fully aware of the consequences of doing so.

Among the many taxes in Canada, business taxes, personal taxes and capital taxes are especially important for economic growth. Among other things, these taxes affect incentives to invest, innovate and start new businesses. They also affect Canada’s ability to attract foreign investment, star scientists and other high-skilled professionals. Hence, these activities remain crucial to the growth of productivity and the incomes of Canadians.

Unfortunately, as noted in our new analysis, Canada’s current tax structure is out of step with comparable countries in many areas. With regard to business income taxes, Canada fared relatively well compared to its OECD peers as recently as 2017. However, its position has since deteriorated and Canada now has the 10th highest corporate tax rate (out of the 36 OECD countries). For capital gains taxes, Canada currently ranks below average and risks being among the highest-taxed countries if rumoured government changes to the tax are implemented.

Worse yet, Canada has the seventh-highest top combined (federal and provincial) personal income tax rate in the OECD. Several provinces currently have top combined tax rates exceeding 50 per cent, which is substantially higher than the majority of U.S. states and most other OECD countries.

Not all taxes are created equal. Business, personal and capital taxes are the more productivity-damaging types of taxation when compared to consumption taxes such as the GST. In fact, Canada relies relatively more heavily on these more damaging forms of taxation compared to most other OECD countries.

Rather than simply raise taxes as a part of the recovery plan, Ottawa should consider structural reforms of the tax system. Specifically, making Canada’s tax rates more competitive for investment in physical and human capital with other countries and U.S. states.

Finally, several recent public opinion surveys have highlighted an appetite among Canadians for a four-day workweek. If government reduced high marginal tax rates and shifted more of the tax burden towards consumption rather than production, it would promote productivity growth and higher wages, which in turn would enable Canadians (over time) to achieve a four-day workweek. Indeed, research has found that a four-day workweek would be economically feasible if governments pursue policies that improve productivity growth (i.e. policies that encourage investment, entrepreneurship and innovation). Getting Canada’s tax structure right is key to creating the conditions for this opportunity.

As Canada works toward an economic recovery from COVID, crucial decisions will be made on tax policy. To attract investment, people, businesses—and potentially unlock a four-day workweek—the federal government must address Canada’s status as a high-tax jurisdiction.