Lessons in Economic Recovery – Business Growth and Canadian Taxes

It is election season and the public debate over taxes is as sweltering as the July heat waves sweeping the nation. While there are varying opinions on how best to use the U.S tax system to overcome America’s continuing economic woes, there is widespread agreement that rebuilding the economy means fostering business growth and investment and creating jobs. Federal (as well as state and local) taxes affect these priorities, and to understand the potential impact from different approaches, it is important to look beyond campaign speeches to the real-world examples found in countries around the world.

Europe is pursuing austerity to mitigate its debt crisis and major manufacturing locations like China and Japan are using lower tax rates to boost competitiveness. There are important insights that can be found in their experiences, but another country with lessons for America is much closer to home – Canada.

There are many important decisions that go into an effective economic recovery, but past changes to the Canadian tax system can shed light on the current American debate over how best to spur commerce and national profitability.

From Bust to Boom

Some 20 years ago, Canada faced economic challenges whose impact rivaled those America faces today. In the early 1990s, Canada was emerging from a deep recession. Debt payments consumed about a quarter of the federal government’s entire budget. The unemployment rate was high, 9.6 percent on average for the decade after the country’s recession. Canada’s monetary policies drove inflation, forcing down the value of the Canadian dollar, which came to be worth less than US $0.65.  To make the situation more difficult, Canada faced these economic issues at a time when globalization and other international forces meant governments and companies of all countries had to adapt to new world business and political realities.  

These were serious challenges to Canada’s prosperity and future, and they required not only decisive choices to put the country on a positive economic trajectory, but the right choices. Today, Canada is remarkably different. The Canadian dollar is worth about the same as the U.S. dollar (actually, about 1 to 2 cents more, at the time of this writing). The unemployment rate is 7.2 percent, a full 1 percent lower than that reported in the United States. Additionally their national debt is about $587 billion, chump change compared to the more than $15 trillion U.S. debt.

To be sure, the United States and Canada are different in many respects. Beyond America’s $15 trillion gross domestic product (Canada’s GDP is less than $2 trillion), the U.S. population is nearly 10 times larger than Canada’s.   Furthermore, the United States plays a prominent international role in terms of its military force, financial aid, political clout and cultural leadership that is unmatched by any other country. Nevertheless, Canada’s steady climb into prosperity is evidence that the country made several good choices in its darkest economic hours. America’s current economic circumstances are no less serious, and we would do well to learn from the successes of our northern ally and closest trading partner.

A Profitable Chain Reaction

There were many elements and decisions that contributed to Canada’s economic turnaround. The private sector plays a leading role in any nation’s economic growth. (After all, governments don’t make money; they spend it). Changes to the tax system in the ‘90s made possible private sector growth that continues today.

In the late 1980s, Canada levied a 13.5 percent Manufacturers’ Sales Tax (MST), which increased the overall cost of exported goods. In a globalized world, where businesses compete on an international level, this made Canadian products less competitive abroad. Seeing the folly in making it more difficult for the country’s manufacturers to sell internationally, the MST was removed.

To replace the MST revenue, Canada implemented a Goods and Services Tax (GST) in 1991. This value-added tax on most Canadian purchases could be rebated on exports. While politically controversial when passed, and mostly modest in the tax revenue garnered, the switch to the GST did help Canadian manufacturing competitiveness abroad and business profitability overall. This contributed to Canada’s stronger economic footing at the turn of the century, which made possible an even more effective tax change.

Canada’s statutory tax rate was incrementally cut over the last decade, reduced to 15 percent by 2012. Like U.S. states, Canada’s provinces implement additional corporate taxes. When the average of these is added to the federal rate, Canadian businesses pay about 25 percent in taxes on corporate income. This is in line with the European Union average (22.75 percent) and the OECD average (25 percent) and is competitive with many of the world’s manufacturing powerhouses, such as China.

For Canada, the overall tax environment is more favorable than in decades past, and it is on par with much of the world. Canada still faces challenges to innovation and human capital (issues common to many countries), but with lower taxes, the private sector is in a position where it can address and overcome those challenges because the tax burden is lighter. In a recent study, the Aspen Institute concludes:

“The combination of the creation of the Goods and Services Tax in the early 1990s and fiscal discipline later in the decade created the fiscal room for corporate income tax cuts, giving Canadian firms a double competitive edge: falling corporate tax rates that reduce obstacles to investment and the existence of a value-added tax (the GST) that is rebatable on exports.”

Tax changes generally spur public debate, and Canada’s experience is no different. Considering the substantial economic about-face, however, it seems clear Canada’s tax adjustments helped the country. Perhaps more important than the approach was the intent and strategy – helping the private sector grow by easing the tax burden.

Canadian Lessons for American Law Makers

The lesson for the United States is certainly not to impose a value-added tax at the federal level, as Canada did with its GST. Indeed, whenever the possibility of a U.S. VAT has been raised, experts, businesses, and voters alike have responded strongly with a resounding, “NO.” (This happened most recently in 2009 when then-Speaker of the House Nancy Pelosi said a VAT was worth considering; the suggestion found little public support.)

Yet, easing the tax burden on businesses (including manufacturers) strengthens competitiveness, increases profitability, and supports investment and jobs. With clear examples around the world of how lower taxes can put a country on a more stable economic footing, it is curious that the United States continues to hold the highest corporate tax rate in the world. American businesses need stronger international competitiveness and investment, and the population needs jobs. We need look no farther than our northern neighbor to see how reduced corporate taxes can help the private sector.

Many U.S. citizens are struggling to pay their bills and find good jobs. It is one reason why the individual tax rate is dominating political headlines. Yet, the issue of fostering U.S. private sector competitiveness is potentially the more critical decision at hand. If the goal is to raise individual financial standing, consider Canada. The average Canadian household is for the first time ever wealthier than the average American household. That fact, more than any argument or political persuasion, speaks volumes about where government leaders might best focus their attention.Tax approaches are important, but Canada’s economic growth encompasses a variety of issues. With its proximity to the United States, its wealth of natural resources, its growing private sector, and its lessons in fiscal responsibility and growth, Canada has a lot to teach us and a lot to offer.

 To better understand and capitalize on these insights and opportunities, on July 31, 2012, the National Chamber Foundation is presenting the next installment of its Business Horizon Series, entitled Canada: The Northern Light: A Partner in Growth and Opportunity. The event will feature a revealing discussion with Perrin Beatty, president and CEO of the Canadian Chamber of Commerce, and U.S. Chamber of Commerce president and CEO Thomas Donohue. There will also be panel discussions on cross-border opportunities, taxes and trade, energy, and many other important topics. The Honorable Rob Merrifield, member of the Canadian Parliament and Chair of the House of Commons Standing Committee on International Trade will offer the keynote address, discussing the lessons learned from the North American Free Trade Agreement.

Attendance will be high. Be sure reserve your seat for this compelling and important event. Register online today