November 19, 2015 – Canada faces a deep long-term fiscal challenge, as its population ages and its labour force growth slows, states a new report from the C.D. Howe Institute. In “Tax Reform Priorities for Canada: Creating More Wealth to Go Around,” authors Craig Alexander and Alexandre Laurin address how the superior approach to meeting Canada’s long-term fiscal challenge is to look for ways to boost productivity and competitiveness, and zero in on the tax system as a place to start the examination of boosting productivity.

“The focus on meeting Canada’s fiscal challenges should be on increasing the income pie so there is more fiscal room to maneuver,” says Alexander. “Oliver Wendell Homes Jr. said that “Taxes are the price we pay for a civilized society,” and, this is absolutely true,” he adds. Report co-author, Alexandre Laurin, finds that “the core issue is finding the most efficient mix and structure of the tax system that complements the goals of supporting economic growth and job creation, while providing the revenues governments require.” The authors recommend four ways Canada can meet this challenge.

Keep Business Taxes Low and Competitive: Some have argued that higher corporate taxes could be a source of additional revenue to meet future fiscal commitments, but higher corporate taxes would hamper investment, job creation and growth. Moreover, economic analysis shows that the burden of higher business taxes is largely borne as lower wages for workers. As it stands, Canada has an internationally competitive corporate tax regime. Business taxes should be kept low to compete internationally, but efforts should be made to shift the tax system towards treating businesses more equally.

Tax Consumption Instead of Incomes: Economic efficiency would be enhanced by shifting the taxation base from personal income to consumption, thus putting a greater weight on consumption taxes – ideally harmonized between the federal and provincial governments. A common criticism is that consumption taxes are not progressive, but there are ways to minimize the adverse distributional effects. There is an important role for policymakers in educating voters and showing leadership in putting more emphasis on consumption taxes.

Avoid Targeting High-Income Earners, which is an Inefficient Way to Raise Revenues and Address Inequality: Some may feel that the increased progressivity of the tax system can reduce income inequality. However, the math doesn’t work. The effect of cutting the middle-income tax rate and putting in a new tax rate on income over $200,000 will barely change the Gini coefficient – the benchmark for income inequality. The new high income tax rate is also inconsistent with the drive to promote more entrepreneurial activity in Canada, and could weaken the ability to retain high talent workers in Canada as well as weaken the ability to attract talent from abroad. Moreover, the federal government is overestimating the amount of revenue that the new high income tax bracket will bring in because the higher tax rate will likely cause high income earners to take actions to reduce their tax liabilities. The most effective way to address inequality is to remove barriers to opportunity, which would reduce income inequality in a constructive way.

Rebalance Federal and Provincial Taxation: No discussion of tax reform would be complete without mentioning the current practice of raising federal taxes in order to pay for transfers to the provinces. This is highly inefficient tax policy. Governments should be held accountable for the money they raise and how it is spent. It would be more efficient and productive if federal business and personal taxes were cut, providing room for provinces to pick up the fiscal room to pay for the economic and social priorities they are responsible for.

In this E-Brief, the first in a series of reports on national priorities for 2016, the authors conclude that “the bottom line is that the size and source of tax revenues has a significant impact on the economy.” If Canada is to deliver on its future spending commitments, the current federal, provincial and municipal tax system should be reviewed for opportunities to simplify it and rebalance it to incent stronger productivity growth.

Click here for the full report.

The C.D. Howe Institute is an independent not-for-profit research institute whose mission is to raise living standards by fostering economically sound public policies. It is Canada’s trusted source of essential policy intelligence. Distinguished by research that is nonpartisan, evidence-based and subject to definitive expert review, it is widely regarded as Canada’s most influential think tank.

For more information contact: Craig Alexander, Vice President, Economic Analysis, C.D. Howe Institute; or Alexandre Laurin, Director of Research, C.D. Howe Institute;; 416-865-1904, or email: amcbrien@cdhowe.org.