With less than a month to go in the federal election, there has been little real debate on the fiscal policies needed to improve Canada’s economic growth and productivity performance. What Canada needs is a fiscal plan focused on economic prosperity that creates and strengthens the incentives for individuals and businesses to engage in productive economic activity.
First and foremost, a prosperity-based fiscal plan would control the growth of federal spending. Consider that since the federal government balanced its books in 1997/98, program spending has increased by an average of 5.9 per cent per year, faster than the average rate of economic growth at 5.7 per cent.
In recent years, the federal government’s spending problem has worsened. For example, federal program spending increased by an average of 7.1 per cent annually under Prime Minister Paul Martin (2003/04 to 2005/06). Since 2005/06, the Conservative government has increased program spending by an average of 7.2 per cent per year. This from a government that promised to hold spending increases to the annual rate of population plus inflation growth, just 3.1 per cent year since 2005/06.
Whoever forms the next government must apply the brakes to spending in order to create the fiscal room needed to provide tax relief.
This brings us to the second essential ingredient of a prosperity-based fiscal plan: promoting investment, hard work, risk taking and entrepreneurship through tax relief that changes incentives.
The key to improving incentives for productive behaviour is reducing marginal tax rates, the rate people and businesses pay on the last dollar of income earned. To that end, Canada’s next federal government should:
Reduce middle and upper personal income tax rates
Canada maintains among the highest marginal personal income tax rates on middle and upper income earners among the G7 countries. The new federal government should reduce the personal income tax burden on middle and upper income Canadians to harness the productive energies of skilled workers, business owners and entrepreneurs across the country.
Regardless of the specific proposal, the federal government’s aim should be to move toward a single-rate personal income tax. A good first step would be to eliminate the middle two personal income tax brackets, and reduce the top rate from 29 per cent to 25 per cent. Incomes between the basic personal exemption ($9,600) and $150,000 would be taxed at 15 per cent and income over $150,000 would be taxed at 25 per cent.
Eliminate the Capital Gains Tax
The capital gains tax is one of the most damaging taxes in Canada. It encourages the owners of capital to hold on to their investments and prevents them from taking advantage of more profitable investment opportunities. In addition, capital gains taxation has a detrimental impact on entrepreneurship by reducing the return that entrepreneurs, venture capitalists, and other investors receive from risk-taking, innovation, and work effort. For these reasons, the federal government should eliminate the taxation of capital gains.
Reduce the Corporate Income Tax
The new federal government should build on the corporate income tax cuts implemented by the Conservative government in October 2007 — the reduction in corporate income tax rates to 15 per cent over the next four years. Despite these reductions, Canada’s marginal effective tax rate on investment will still be the 10th highest among OECD countries in 2012.
Specifically, the new government should further reduce the corporate income tax rate from 15 per cent to 11 per cent by 2012. Doing so would eliminate the difference between the small business tax rate (11 per cent in 2008) and the general corporate income tax rate. As a number of studies have shown, the enormous increase in the tax rate borne by businesses as they grow results in a significant barrier to growth.
Facilitate the harmonization of provincial sales taxes with the GST
The federal government should facilitate the harmonization of provincial sales taxes with the GST in British Columbia, Saskatchewan, Manitoba, Ontario, and Prince Edward Island. Harmonization with the GST would exempt business inputs from provincial sales taxes, reduce the marginal effective tax rate on investment and improve the incentives for business to invest in productivity enhancing machinery and equipment.
Eliminate the capital tax on financial institutions
While the federal government has completely phased-out the general corporate capital tax, a sector-specific capital tax remains on financial institutions. These capital taxes artificially penalize firms in the financial services sector and raise costs for anyone using financial services. The federal government should eliminate the capital tax on financial institutions. It is a counter-productive public policy to maintain this tax distortion on an industry that is a large employer of Canadians and in an area with very mobile capital resources.
Canada needs a fiscal plan aimed at improving our economic performance. A prosperity-based plan would decrease the size of government and reduce taxes to provide the necessary incentives for individuals and businesses to engage in productive activities. Such a plan would result in higher levels of investment, increased productivity and higher incomes; benefits all Canadians can enjoy.