According to a study by PricewaterhouseCoopers, the negative impact of US tax reform on Canada’s economy could be 1o times greater than the potential fallout from a NAFTA termination.
US tax reform puts a number of Canadian capital-intensive sectors at risk
The negative impact of US tax reform on Canada’s economy could be 10 times greater than the potential fallout from NAFTA termination, a PricewaterhouseCoopers Canada (PwC) study suggests.
Late last year, US lawmakers approved a sweeping overhaul of the US tax code. Among other changes, the reform bill cut the corporate tax rate from 35 to 21 per cent and allowed companies to immediately deduct from their tax bills the full cost of capital spending.
Proponents of the tax package predicted it would spur business investment in the United States and encourage US companies to repatriate money they previously held abroad.
The PwC Canada study supports that assessment. It says the US tax bill “has eliminated one of Canada’s main competitive advantages” and in particular has made the United States “a substantially more attractive place to locate capital-intensive businesses”.
Capital-intensive industries are those in which companies must invest large amounts of money in machinery and infrastructure – for example, an automotive or petrochemicals plant – in order to make a profit.
According to PwC, the capital-intensive sectors most at risk in Canada from US tax reform are chemicals, machinery manufacturing, plastic and rubber manufacturing, and transportation manufacturing. Mining and food manufacturing are also likely to be affected, although to a lesser degree. The impact on oil and gas extraction would be relatively small, PwC says, but the sector is so large that the consequences in terms of lost jobs and economic activity would be substantial.
“All else being equal, these sectors as a whole would likely face a significant shift in investments from Canada to the US over the next 10 years,” the study says. Ontario, Alberta and Quebec would be most hurt because of their relatively high concentrations of capital-intensive businesses.
The PwC study was commissioned by the Business Council of Canada, a non-profit, non-partisan association composed of 150 chief executives and entrepreneurs of leading Canadian companies.
Taking into account the direct impact on affected sectors and the indirect impact on Canadian suppliers, the PwC study estimates that US tax reform puts at risk:
- $85 billion in annual economic activity, or 4.9 per cent of Canada’s gross domestic product (GDP)
- 635,000 jobs, or 3.4 per cent of Canadian employment
- $47 billion in labour income
- $20 billion in government revenue from personal and corporate taxes and other payments.
“Putting these figures in perspective, the Conference Board of Canada predicts a 0.5 per cent decline in Canada’s GDP, and the loss of about 85,000 jobs, if the North American Free Trade Agreement is terminated,” PwC says.
The report’s authors also examined the potential impact of US tax reform on Canada’s ability to attract and retain high-skilled workers. The gap between average after-tax incomes in Canada and the United States is already substantial as a result of higher US wages and lower personal tax rates. According to PwC, the tax reform bill exacerbates the income gap in the high-tech sector by a further seven to 10 per cent, increasing the incentive for highly skilled Canadians to relocate south of the border.
“This report underlines the need for the federal government to respond to U.S. tax reform with a comprehensive plan to strengthen Canada’s economic competitiveness,” said The Honourable John Manley, President and CEO of the Business Council of Canada. “Failing to respond to U.S. tax reform puts Canadian jobs and prosperity at risk at a time when Canada is already wrestling with rising protectionism.”
To counteract the negative effects of US tax reform, PwC identifies a number of policy options, including:
- gradually reducing the combined federal/provincial statutory corporate tax rate to 20 per cent from the current average of close to 27 per cent;
- introducing a temporary 100 per cent depreciation allowance for business spending on equipment, structures and “acquired intangibles” such as patents, trademarks and copyrights;
- increasing Canada’s federal personal income tax brackets to more closely align with U.S. personal tax brackets;
- enhancing Canada’s system of tax credits for business spending on research and development;
- introducing a special tax incentive (known as a “patent box”) for innovative companies that locate their research and development operations in Canada.
PwC based its estimates of the impact on Canada of the US Tax Cuts and Jobs Act by identifying sectors that may be at risk of capital flight, assessing the drivers of investment in those sectors, and calculating the implications of reform on their long-term economic viability.