Tax Expenditures and Evaluations

Yesterday, Finance Canada released “Tax Expenditures and Evaluations 2006.”

The tax-expenditure figures confirm Andrew’s suggestion that the partial inclusion of capital gains now costs the federal government about $3 billion per year of forgone personal taxes: the 2006 projection is $3.1 billion. This partial inclusion cost an additional $3.4 billion of forgone corporate taxes that year. By comparison, the research-and-development tax credit cost $3.1 billion of forgone corporate taxes.

The document also contains an evaluation of “Taxes on Business Investment: An International Comparison of Marginal Effective Tax Rates in the Manufacturing Sector.” It explains, “The focus is on manufacturing because it represents a large share of Canada’s inbound foreign direct investment [FDI] and because manufacturing investment is particularly sensitive to international differences in rates of return. . . . In contrast, most service sector industries are oriented to the domestic market, making FDI in these industries less sensitive to international tax differentials.”

Manufacturing is undoubtedly much more exposed than services to international competition. However, Finance Canada’s acknowledgment of this point seems inconsistent with the thrust of recent corporate-tax reform, which was to lower rates for the service and resource sectors down to the same level as manufacturing. Indeed, the Mintz report argued that reducing taxes on the service sector should be the priority in a “knowledge-based economy.”

The Harper government and the C. D. Howe Institute have been pushing provincial governments to harmonize their sales taxes with the GST in order to exempt business inputs. This evaluation repeats the call for harmonization, but concedes that “the five provinces that levy retail sales taxes generally offer some exceptions for capital inputs, particularly for machinery and equipment used in manufacturing, that substantially reduce the effective sales tax rate on capital goods in the manufacturing sector. As a result, retail sales taxes raise the Canadian METR [for manufacturing] by approximately 2.5 percentage points, compared to the 9 percentage points that would prevail in the absence of any exemptions.”

The implication is that the impact of provincial sales taxes on Canada’s overall METR mostly relates to sectors other than manufacturing, which are less subject to international competition. In other words, such taxes have less effect on Canadian competitiveness than is often argued.


  • Harmonization of provincial sales taxes with the GST seems to be a sensible thing to do, though the economic impact would not be huge. Are there any good arguments against doing so?

    I asked a rep of the Canadian Federation of Independent Business what they thought about this one, and they were resistant to it. This is because they represent a number of restaurant and other service sectors currently exempt from the (BC) PST and would thus have to pay it under a harmonized regime.

    While we are at it, let’s require that retailers post the full price inclusive of sales taxes. No other country seems to have this daft system where the ticketed price is different from the final price.

  • I’m inclined to agree but – because there is an effective incidence of provincial sales tax on capital inputs such as trucks and computers – harmonization would mean increased taxation of individuals. That could eb fixed by changing the balance of taxes on business. I think it is smarter to tax profits than capital inputs.

  • One argument against harmonization is that it would cost (some) provincial governments significant amounts of revenue. For example, Saskatchewan’s Business Tax Review Committee recently recommended sales-tax harmonization as being good for business, but recognized that it would be prohibitively expensive.

    The federal government has implied that provincial governments could raise their sales taxes, in the wake of the GST cut, to help solve the “fiscal imbalance.” On the other hand, it is calling for harmonization, which would reduce provincial sales-tax revenues.

    I agree that it might make more sense to tax business profits than business inputs. A good solution would be for the federal government, which faces less tax competition than provincial governments, to raise corporate income taxes. The additional revenues could then be transferred to all provincial governments, allowing those that currently tax business inputs to exempt them.

    However, I do not expect the current federal government to pursue such an approach. To this government and to the C. D. Howe Institute, the call for sales-tax harmonization is simply another front in the war for tax cuts.

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