Business Tax Reform Key to Boosting Investment, Raising Living Standards, Study Says

Bay Street, Toronto's financial district, is shown in a file photo. The Canadian Press/Kevin Frayer

Ottawa could boost business investment, and raise living standards, by making some reforms to the business tax structure, according to a recent study by the non-profit think tank Fraser Institute.

Boosting Canada’s Competitiveness by Reforming Business Taxation looks at three changes the institute says Ottawa could make to the business taxation system and make the country more attractive to investors. By improving investment, productivity will increase and so will the standard of living for Canadians, says the report.

“The lack of business investment in Canada is alarming, but reforming our business taxation model is one way the country can begin to dig itself out of this crisis,” report author Trevor Tombe says.

Statistics Canada said in August that the country’s per capita GDP has dropped for five consecutive quarters, something noted by Tombes, while U.S. per capita GDP has risen by 2.6 percent since 2023, and 4.5 percent since 2022.

“Had Canada simply matched US growth, for example, our economy would be 8.5 percent larger today. That is roughly equivalent to $6,200 more annual income per Canadian,” Tombe said in the report.

The gap between Canada and the United States is the widest it has been in nearly 100 years, he said. “Reforming Canada’s approach to business taxation is a critical part of the solution.”

The report recommends three main reforms: stop taxing business profits and target dividends, bonuses, and share buybacks instead; reduce the marginal effective tax rate; and encourage B.C., Saskatchewan, and Manitoba to harmonize their provincial tax with the GST.

Stop Tax on Profits

Instead of taxing business profits, the government should focus on taxing profit disbursements of corporations, like dividends and bonuses, the report said. This would allow companies to reinvest profits into the business without a tax penalty. “Any profits withheld by the corporation to invest in operations, equipment, buildings, and so on would face no tax at all.”

The current tax system discourages smaller companies from growing, said the report, since the tax rate for larger businesses is six percentage points higher.

“This may create an incentive to remain small to take advantage of this favourable treatment. It may also create an incentive for more smaller and less productive firms to enter, which is a drag on growth.”

Cut METR

Ottawa should also reduce the marginal effective tax rate (METR), which Tombe said can be seen as a measurement of investment returns lost to taxation. For example, a company earning 8 percent profit after taxes could have earned 10 percent without taxes, he said, resulting in a marginal effective tax rate of 20 percent.

He warned that the METR is projected to increase from its current 14 percent to 17 percent in four years.

“While this may not seem like a significant jump, evidence suggests each percentage point increase in the METR [lowers] investment by around 1 percent or more,” said the report.

Lowering the incentive to invest slows down productivity growth, “negatively impacting the purchasing power of our income.”

The federal government says Canada’s average METR of 14.5 is the best in the G7, which averages 24.8, “and far more advantageous than in the U.S.” at 19.7. “Maintaining a competitive METR is important for Canada’s attractiveness as an investment destination,” said the Finance Department backgrounder published earlier this year.

Harmonize PST to GST

Ottawa should encourage British Columbia, Saskatchewan, and Manitoba to harmonize their provincial sales taxes with the federal GST, an adjustment other provinces have already made, Tombe wrote.

“Such a move would significantly improve business tax competitiveness by removing sales taxes on input purchases, lowering compliance costs, and eliminating administration and enforcement expenses,” the study said.

“As a small, open economy in an increasingly uncertain world, ensuring Canadian economic and tax policy is as growth-oriented as possible must be a priority,” Tombe wrote. “While we cannot control global developments, getting our business tax policies right is within our grasp.”