The Treasury Transfer Effect
The U.S. government taxes American corporations on a worldwide basis. Profits repatriated from other countries are subject to the U.S. federal corporate tax rate minus a credit for taxes already paid to foreign governments. Earlier this year, President Obama announced more rigorous enforcement of this policy.
American corporations account for about one-third of the profits subject to Canadaâ€™s general corporate tax rate. If Canadian federal plus provincial corporate taxes equal or exceed the U.S. federal rate, these corporations do not owe American tax on their Canadian profits.
However, the federal government and some provincial governments are now cutting Canada’s combined general rate from 36% to 25%, far below the 35% U.S. federal rate. This lower corporate tax rate will not help Canada attract more investment from American corporations, which will have to pay the rate difference back to Washington. Planned federal and provincial corporate tax cuts will transfer between $4 billion and $6 billion of annual revenue from Canadian governments to the U.S. treasury.
Commentators of all stripes once acknowledged this strong rationale for keeping Canada’s corporate tax rate at least equal to the U.S. federal rate. Unfortunately, it has been essentially absent from the public debate about recent corporate tax cuts.
Finance Canada has deflected concerns about the treasury transfer effect by arguing that loopholes allow American corporations to avoid facing U.S. tax on their Canadian profits. But Obama plans to close these loopholes. U.S. Internal Revenue Service statistics appear to contradict Finance Canada’s further claim that American corporations will have enough foreign tax credits to meet their U.S. tax obligations despite much lower Canadian corporate taxes.
Canadian federal and provincial governments should enact a combined corporate tax rate of at least 35% to retain revenue that will otherwise be transferred to the American federal treasury. Canada could meet this threshold while staying below the U.S. combined federal-state corporate tax rate, which averages 40%.