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Finlayson & Peacock Op-Ed: Retooled U.S. tax regime could erode Canada’s competitive advantage (Business in Vancouver)

As U.S. President Donald Trump settles into office and the Republican-controlled Congress begins work on its legislative agenda, it is clear that sweeping changes are in store for U.S. policies in several areas. Overall, the direction of change is likely to pose some significant economic challenges for Canada.

To start, President Trump and Republican congressional leaders have promised to slash the U.S. corporate income tax rate to 15% to 20% from 35% as part of a larger overhaul of America’s outdated business tax regime. They are also contemplating new incentives to encourage American multinationals to repatriate some of the $2.5 trillion in profits they currently hold in foreign subsidiaries. These steps, if implemented, should bolster U.S. economic growth, thereby increasing the demand for Canadian exports. But they also suggest that Canada’s existing competitive advantages over the United States in business taxation could soon disappear, raising the prospect that capital investment will leak out of the country over time.

Trump and the Republicans also plan to reduce personal income taxes, including by lowering the top federal marginal tax rate to 33% from 40%, making the U.S. a more attractive location for high-level managerial, professional and technical talent. With state income taxes added, the top combined federal/state income tax rate will be under 40% across most of the U.S., compared with 50% to 54% in seven Canadian provinces. This tax gap increases the odds of a renewed brain drain from Canada. And if the Justin Trudeau government decides to hike capital gains and dividend taxes on our side of the border, an accelerating brain drain is a near certainty.

A final possible shift in American tax policy is even more worrisome. Many Republicans are pushing for a “border adjustment tax” (BAT) as a plank in their tax reform agenda. A BAT would make imports of goods and services taxable, while exports from the U.S. would no longer be subject to corporate income tax. The idea is controversial because it would boost the prices Americans pay for many consumer products. But a BAT of some kind may materialize; if it does, Canada must seek an exemption. A recent Deutsche Bank report estimates that a 20% BAT applied to U.S. imports would slice 4% from Canada’s gross domestic product. It would also tilt the competitive landscape toward investing in America rather than in countries that export to the U.S. An American BAT would compel many firms in Canada to reassess their production, supply and distribution strategies.

Turning to trade, President Trump has announced America’s withdrawal from the Trans-Pacific Partnership (TPP) agreement to which Canada and 11 other nations are parties. And he has notified Canada and Mexico of his intention to renegotiate the North American Free Trade Agreement (NAFTA) – or to scrap it entirely, if a revised agreement cannot be achieved. The death of the TPP is a setback for Canada, given years of effort by our government to deepen trade and investment ties with Asia-Pacific markets. At the same time, some of the gains that Canada won under NAFTA could be in jeopardy. Two-thirds of Canada-U.S. merchandise trade consists of “intermediate inputs” – semi-processed goods, parts and materials that eventually find their way into finished goods. Ending NAFTA’s tariff-free treatment of business inputs along with final products would damage the competitiveness of most industries now operating in North America.

On energy, Trump is committed to expanding domestic oil and gas production and lightening the regulatory and fiscal burdens on the U.S. energy sector. Coupled with the continued American rejection of national carbon pricing and the likelihood of steadily escalating carbon prices in Canada, the Trump administration’s energy strategy is destined to draw capital and management attention in the oil and gas sector away from Canada, in favour of investment opportunities stateside.

A more positive story for Canada might lie in the domain of immigration. If America becomes less welcoming to newcomers, Canada can attract talent that otherwise would migrate to the United States. Already, the CEOs of dozens of leading American technology companies are voicing alarm over a scenario of tougher restrictions on working visas, fewer foreign students in U.S. universities and stepped-up immigration enforcement. Such measures will hurt the quality of the labour pool available to American businesses and academic institutions, particularly in fields like engineering, information technology, the natural sciences and health care. In this situation, Canada may be able to benefit from America’s self-inflicted wounds.

Add it all up, and the era of Trump is set to present Canadian policy-makers and business leaders with plenty to ponder and a number of emerging risks to manage. 

Jock Finlayson is the Business Council of British Columbia’s executive vice-president and chief policy officer; Ken Peacock is the council’s chief economist.

As published in Business in Vancouver.