Finance Minister Jim Flaherty’s business tax relief goals are a welcome start to tax relief, but should be accompanied by a broadening of the corporate tax base to make taxes more neutral and fair and enable future reductions, according to a report from the C.D. Howe Institute. In Flaherty’s Missed Opportunity, Duanjie Chen, George Weston Analyst in Tax Policy, says the federal government’s Economic Statement made good progress in October by promising a reduction in federal business tax rates by 2012, from 22.1 percent to 15 percent. Even after this reduction, however, the Canadian effective tax rate on most services will still be sixth highest among the 30 member countries of the OECD.fiscal policy, corporate tax policy

Duanjie Chen

English

Research Papers in Economics

Flaherty’s Missed Opportunity
e-brief
C.D. Howe Institute
Institut C.D. Howe
December 18, 2007
By Duanjie Chen
The cheerful opening message in Finance Minister Jim Flaherty’s October 30
Economic Statement was that “Canada’s economic and fiscal fundamentals are rock
solid.” To promote capital investment, Flaherty announced a reduction in the
general federal corporate income tax rate to 15 percent by 2012 from its current rate
of 22.1 percent, and indicated he would seek the collaboration of the provinces and
territories to reach a 25 percent combined federal-provincial-territorial statutory
corporate income tax rate.
The Finance Minister’s stated aim is to reduce Canada’s statutory corporate
income tax rate relative to other G-7 countries; yet, while lower tax rates are
welcome, comprehensive tax reforms remain very much needed. The most critical
of these, in business taxation, is broadening the corporate income tax base to
improve tax neutrality and enable future rate reductions, particularly at the
provincial level. It would be regrettable if the federal government regarded the
current proposed tax relief as “mission accomplished” while leaving key reform
opportunities unpursued.
In evaluating current government plans for business taxation, it is
instructive to look at the effective rate on capital investment. Table 1 presents a
comparison of effective tax rates across industries and provinces within Canada,
while Table 2 compares Canada with other OECD member countries for
manufacturing and a broad range of service sectors, excluding primary,
manufacturing and financial industries. Both tables are projections for 2012, based
on what we know about scheduled tax changes in Canada and elsewhere.
1 Tax
jurisdictions are ranked according to their effective tax rates.
A striking point emerges from these comparisons: most service sectors in
Canada will still face much higher effective tax rates than forestry and
manufacturing industries (Table 1). Accordingly, the Canadian effective tax rate on
the broad range of service sectors will be the sixth highest among the 30 member
countries of the OECD in 2012 (Table 2). Hence, the aggregate effective tax rate for
Canada, excluding the resource and financial sectors, will still be the 10th highest
1 For example, our projection for 2012 includes the previously scheduled elimination of capital tax
for all non-financial corporations in Ontario. Therefore, the provincial government’s recent
announcement that it is accelerating such an elimination only for manufacturing and resource
activities does not change the calculations shown in the two tables.Note:  A negative effective tax rate implies a tax saving associated with income from a new capital investment. In reality, this tax saving 
helps offset the tax liability arising from the investor’s overall business income from new and past capital investments. 
Forestry
Manufac-
turing
Construc-
tion
Transportation 
and storage
Communi-
cations
Public
Utility
Wholesale
Trade
Retail 
Trade
Other
services Aggregate
percent
Ont. 21.7  24.1  38.8  25.7  40.8  29.3  34.1  32.6  37.3  31.2 
B.C. 21.2  23.4  36.1  22.8  38.1  27.6  31.8  30.2  33.0  28.6 
P.E.I. -107.6  -33.2  36.5  28.4  46.8  15.8  39.3  36.7  48.9  25.8 
Sask. 14.2  15.3  32.6  20.8  33.9  25.5  30.5  28.6  33.6  23.7 
Man. -21.9  -16.1  36.2  23.2  36.5  27.8  32.6  30.5  34.4  20.2 
Que. 17.9  18.9  24.9  12.8  19.0  19.6  23.3  22.5  21.9  19.5 
Alta. 16.1  17.4  20.1  16.1  17.3  18.0  20.9  20.8  19.8  18.2 
NS -28.6  -17.0  13.5  19.9  22.2  -0.4  26.3  26.1  24.2  7.4 
NL -51.2  -26.9  10.4  18.6  19.1  -5.0  23.2  23.9  22.2  5.2 
NB -33.7  -22.1  10.0  17.6  19.8  -4.3  23.5  23.4  21.6  -2.6 
Canada 15.4  20.0  33.1  20.0  33.6  22.1  30.0  28.8  30.5  25.2 
Canada, assuming a complete retail sales tax and GST harmonization:
13.0  16.8  22.4  15.4  19.4  17.1  23.3  23.2  21.5  18.6 
Table 1: Effective Tax Rates on Capital Investment in Canada by Industry and by Province, 2012
Effective Tax Rates on Capital Ranking
Statutory Corporate
Income Tax Rate 
a Manufacturing Services Average By effective rate By CIT rate
percent
US 38.1 (38.5) 32.7 39.9 36.9 1 2
France 34.4 33.0 31.7 31.9 2 3
Korea 27.5 32.8 31.0 31.5 3 15
Japan 41.9 35.2 30.4 31.3 4 1
Germany 30.2 (37.0) 30.8 29.4 29.7 5 6
UK 28.0 22.7 27.8 26.9 6 14
Australia 30.0 27.7 26.6 26.7 7 7
New Zealand 30.0 (33.0) 27.1 25.4 25.7 8 8
Spain 30.0 (32.5) 27.2 25.2 25.5 9 9
Canada 27.3 (34.2) 20.0 29.2 25.2 10 16
Norway 28.0 25.8 23.2 23.5 11 12
Finland 26.0 22.4 22.9 22.8 12 18
Turkey 20.0 22.7 20.2 20.8 13 23
Luxembourg 29.6 24.1 20.3 20.6 14 10
Austria 25.0 21.6 19.5 19.9 15 20
Italy 31.4 (37.3) 17.6 19.0 18.7 16 5
Iceland 18.0 19.5 17.6 17.9 17 28
Sweden 28.0 19.3 17.5 17.8 18 13
Portugal 26.5 14.8 16.1 15.9 19 17
Netherlands 25.5 18.2 15.0 15.5 20 19
Switzerland 18.2 (21.3) 14.8 15.0 14.9 21 27
Poland 19.0 14.4 15.0 14.9 22 25
Greece 25.0 18.0 13.2 13.8 23 22
Table 2: Statutory Corporate Income Tax (CIT) Rates and Effective Tax Rates on Capital among OECD 
Member Countries, 2012
Table 2 cont’d on page 32 The retail sales tax rates for these five provinces are: 11 percent (P.E.I.), 7 percent (Ontario, British
Columbia, Manitoba) and 5 percent (Saskatchewan)
within the OECD; this, despite a lower ranking of 16th based on the statutory
corporate income tax (CIT) rate. 
This persistent inter-industry tax distortion leaves many growing service
sectors penalized by high effective tax rates, while others find relief through
investment tax credits, fast write-offs and reduced CIT rates in some provinces
(including Ontario) for manufacturing and processing activities. Such inter-industry
tax distortion is even more evident in those provinces where the provincial retail
sales tax imposes a further tax burden on capital investment.
Taking the communications industry as an example, the highest effective tax
rates in Canada are in Prince Edward Island (47 percent) and Ontario (41 percent),
with the next highest rates being in B.C., Manitoba and Saskatchewan. This ranking
parallels that of retail sales tax rates among these provinces.
2 Also note that the
retail sales tax often applies to computers and computerized communication
equipment-capital goods that are essential to the communications sector.
Harmonization between the retail sales taxes and goods and services tax (GST) in
these provinces would reduce the nationwide effective tax rate on investment in
communications from 34 percent to 19 percent (see the bottom row in Table 1).
On the other end of the spectrum, the nationwide effective tax rate is only 15
percent for forestry and 20 percent for manufacturing, compared to the 34 percent
for the communications sector. These significantly lower effective tax rates are due
to accelerated depreciation allowances, investment tax credits and the lower CIT
rate in certain provinces, provided only for manufacturing and processing activities.
In this regard, Prince Edward Island provides an extreme case: despite its CIT rate
Effective Tax Rates on Capital Ranking
Statutory Corporate
Income Tax Rate 
a Manufacturing Services Average By effective rate By CIT rate
Denmark 25.0 16.5 12.7 13.4 24 21
Mexico 28.0 17.1 12.1 13.1 25 11
Hungary 16.0 12.9 12.0 12.2 26 29
Slovak Republic 19.0 13.3 11.7 12.0 27 26
Ireland 12.5 12.7 11.7 12.0 28 30
Czech Rep 19.0 (24.0) 10.0 7.8 8.4 29 24
Belgium 34.0 -6.0 -4.1 -4.5 30 4
Weighted average 
b 34.7 29.3 31.2 30.2
Simple average 26.4 20.6 19.8 19.8
Table 2 (cont’d): Statutory Corporate Income Tax (CIT) Rates and Effective Tax Rates on Capital among OECD 
Member Countries, 2012
Notes: Effective tax rates on capital investments incorporate corporate income taxes, sales taxes on capital purchases and other
capital-related taxes including asset and net worth taxes, stamp duties on securities, and taxes on contributions to equity.
a The number in brackets is the statutory CIT rate for 2007, if higher than scheduled for 2012.
b Weighted by GDP in constant 2000 U.S. dollars for the period 2000-2005.(16 percent) and retail sales tax rate (11 percent) being high compared to other
provinces, its investment tax credit (in addition to the Atlantic investment tax credit)
helps reduce the effective tax rate for forestry and manufacturing to the lowest in
Canada.
The implication of the above findings is clear: our business tax system is far
from neutral. A neutral tax system would treat taxpayers equally, independent of
industry sector or activity. It is distinguished by a single statutory tax rate and a
broad base that leaves few preferential tax treatments for favoured groups of
taxpayers. When measured by the effective tax rate on capital investment, tax
neutrality means similar effective tax rates across all industries.
As illustrated in the communications sector, the non-neutrality of our tax
system can be attributed in part to provincial sales taxes. If all provincial sales taxes
were fully harmonized with the GST, the aggregate effective tax rate for Canada
would drop to 18.6 percent in 2012 (Table 1, bottom row). A sweeping sales tax
harmonization would put Canada at the midpoint on the ranking of effective tax
rates among the 30 OECD member countries.
Sales tax harmonization, however, would not completely eliminate the non-
neutrality of our business tax system. Without harmonization, the gap between the
highest effective tax rate (34 percent) and the lowest (15 percent) is 19 percentage
points. With sales tax harmonization, this gap could be reduced to 10 percentage
points. This gap could be further reduced to less than five percentage points if all
tax preferences for manufacturing and processing were eliminated and provincial
CIT rates were unified at 10 percent.
The tax rankings shown in Table 2 are unlikely to remain constant until 2012.
Other jurisdictions will continue to change their tax systems, and the competitive
goalposts will continue to move. Finally, regardless of the currently solid fiscal
fundamentals, continued tax rate reduction for business sectors may be difficult
without base broadening. Equally, base broadening may be politically difficult
without rate reductions. 
It is unfortunate that the federal government missed an opportunity, with its
recent tax changes, to make some fundamental reforms; in particular, changes to
what and how we tax, not just at what rate. The clearest examples are the failure to
link the accelerated CIT rate reduction to CIT base broadening and to link GST relief
to a sweeping sales tax harmonization. This oversight should not be repeated in
future federal tax changes.
References
Chen, Duanjie, Jack M. Mintz and Andrey Tarasov. 2007. “Federal and Provincial Tax Reforms: Let’s
Get Back on Track.” C.D. Howe Institute Backgrounder 102. Toronto: C.D. Howe Institute.
Mintz, Jack, September 2007. The 2007 Tax Competitiveness Report: A Call for Comprehensive Tax Reform.
Toronto: C.D. Howe Institute Commentary 254. C.D. Howe Institute.
This e-brief is a publication of the C.D. Howe Institute.
For more information contact Finn Poschmann at 416-865-1904, e-mail cdhowe@cdhowe.org. 
This e-brief is available at www.cdhowe.org.
Permission is granted to reprint this text if the content is not altered and proper attribution is provided.

For more information contact Finn Poschmann at 416-865-1904, e-mail cdhowe@cdhowe.org. This e-brief is available at www.cdhowe.org. Permission is granted to reprint this text if the content is not altered and proper attribution is provided.

Flaherty's Missed Opportunity

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