Charting a Course Through Rough Waters: Recommendations for the 2009 Federal Budget

August 15, 2008

EXECUTIVE SUMMARY

The next federal budget must strike a delicate balance.  The global economic outlook is threatening.  The volatility of the Canadian dollar, the high cost of energy, the slowing United States and global economies, continued uncertainty in international financial markets, relentless delays at the Canada-United States border: all are sapping the vitality of Canadian enterprises from coast to coast, in sectors ranging from manufacturing to tourism.  The damage being done to the financial health of the private sector already is affecting government tax revenues as well, and the pressure on the public purse is likely to intensify.

The next budget must reinforce the ability of Canadian businesses to survive and grow in an intensely competitive global environment, but do so in a way that is fiscally responsible and in particular avoids the temptation to return to deficit financing. 

No single policy instrument is sufficient to address the complex economic challenge that Canada faces today.  What is needed is a broad and coherent strategy that will reinforce Canada’s strengths as a superb location in which and from which to do business globally. 

The central recommendation of the Canadian Council of Chief Executives to the Standing Committee on Finance therefore is to implement the comprehensive competitiveness agenda laid out in Compete to Win, the  June 2008 Report of the Competition Policy Review Panel, with special emphasis on measures that will encourage the international growth of Canadian-based enterprises.

THE NEED FOR FISCAL PRUDENCE

Canada’s economy and government finances are in far better shape than when the country last slipped into recession in the early 1990s, but manufacturers are being especially hard hit by a combination of slowing demand in the United States, a high dollar, high energy prices and intense competition from new powerhouse players such as China, India and Brazil.   Key service sectors such as tourism are also suffering, leaving a sharp divide between resource-intensive provinces and the rest of the country.  The economic outlook would dim further if inflationary pressures cause the Bank of Canada to raise interest rates.

Job losses and falling profits already are hurting government revenues.  Canada may avoid a full-blown recession, but there is a high risk that tax revenues will fall below budget while the demand for public services expands.  The government therefore must remain prudent in its fiscal management.  In particular, it must keep a lid on new spending, and accelerate its expenditure review program so that necessary new or expanded initiatives can be funded primarily through the reallocation of existing spending.

BUSINESS INVESTMENT AND  INNOVATION

The shaky economic outlook and intensely competitive global environment reinforce the need for public policy to encourage business investment and innovation.  The Canadian Council of Chief Executives has engaged in several initiatives over the past year aimed at improving Canada’s ability to compete for such investment. 

These initiatives include:

• Research on the impact of foreign takeovers on head office jobs;
  
•  A joint project with Industry Canada on private-sector innovation;
  
•  Work with PricewaterhouseCoopers to develop a comprehensive picture of the tax contributions of large corporations;
  
•  Development of unprecedented consensus across the business community on key principles for addressing climate change;
  
• Relentless efforts to make the Canada-United States border more efficient, bilaterally and through the North American Competitiveness Council; and
  
• Collaboration with our private sector counterparts in the European Union and India in support of new bilateral trade and investment initiatives. 

Different aspects of the competitiveness challenge are linked in many ways.  Fighting climate change will require the development and deployment of new technologies.  To spur greater private sector investment in research, Canada must fix weaknesses in its regulatory and intellectual property (IP) regimes.  Reducing unnecessary regulatory differences and strengthening IP protection is important to making North America as a whole more competitive globally.  The efficient movement of people and goods within North America has a significant impact on where companies locate head-office jobs.   
 
THE CRITICAL ROLE OF BUSINESS TAXATION

One policy lever that affects every aspect of Canada’s ability to compete for investment and jobs is that of taxation, and specifically its taxation of business investment.  Canada has reduced its statutory corporate income tax rate considerably since the beginning of this decade, but other countries around the world are moving in the same direction.  International capital flows are so sensitive to differences in taxation that lower rates can lead to higher tax revenue — as Canada has seen consistently since it began cutting corporate tax rates at the beginning of this decade.

Large, internationally engaged enterprises are Canadian leaders in productivity and innovation.   Work by PricewaterhouseCoopers (PwC) published in May 2008 shows that large enterprises also contribute hugely to government revenues.  The Total Tax Contribution study found that federal and provincial corporate income tax are only two of 49 taxes that large Canadian enterprises either pay directly or generate through their activities.  For every dollar paid directly in corporate income taxes, the participants in the PwC study paid an average of 82 cents in other taxes and 67 cents in additional levies such as resource royalties, and also collected and remitted to governments a further $3.41 cents in other taxes from employees and customers.

In 2006, the 39 companies covered by the PwC study paid or collected more than $30 billion in revenue for Canadian governments, while also paying an average salary to employees of $60,428, about 60 percent higher than the national average.  Within this sample, the ten largest tax contributors (25 percent of the participating companies) accounted for 64 percent of taxes borne and 68 percent of taxes collected.  Governments that seek to foster more high-paying jobs and generate growing tax revenue must recognize the impact of tax policy on the investment decisions of large, globally engaged businesses.  They also must encourage the establishment and growth of more such enterprises in Canadian communities.

As the CCCE recommended in July 2008 to the Advisory Panel on Canada’s System of International Taxation, federal and provincial governments should work together to continue to reduce the combined corporate income tax rate, complete the elimination of capital taxes and replace remaining provincial sales taxes with value-added taxes, preferably harmonized with the Goods and Services Tax.  The federal government also should reverse its 2007 restrictions on the deductibility of interest on money borrowed in Canada to invest in foreign affiliates and take additional steps to strengthen international tax rules including elimination on a reciprocal basis of withholding taxes on dividend payments between affiliated companies.

THE NEED FOR A COMPREHENSIVE STRATEGY

A relentless focus on using tax policy to make Canada a more attractive destination for investment must be part of a broader strategy.   The federal government recognized this need by launching its Advantage Canada strategy in 2006, but the June 2008 report of the Competition Policy Review Panel suggested that Canada needs to move further and faster in this direction.  Much of what the Panel recommended reflects a broad and well-established consensus on what needs to be done.  The central challenge now is to get on with the job of making Canadian communities superb places in which and from which to do business globally.