FINA Committee Meeting

STANDING COMMITTEE ON FINANCE

COMITÉ PERMANENT DES FINANCES

EVIDENCE

[Recorded by Electronic Apparatus]

Thursday, June 11, 1998

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[English]

The Chairman (Mr. Maurizio Bevilacqua (Vaughan—King—Aurora, Lib.)): I would like to call the meeting to order. As everyone knows, we are here pursuant to Standing Order 108(2). The committee is resuming its pre-budget consultation process. We have the pleasure to have with us representatives from the Canadian Bankers' Association, the Canadian Vehicle Manufacturers' Association, and the Alliance of Manufacturers and Exporters of Canada.

We will begin with the representative from the Canadian Bankers' Association, Ron Friesen. Welcome.

Mr. Mark Weseluck (Vice-President, Banking Operations, Canadian Bankers' Association): Good morning. I'm Mark Weseluck, the vice-president of banking operations with the Canadian Bankers' Association. With me is Ron Friesen, vice-president of taxation for the Bank of Montreal and chair of the CBA taxation committee.

I think you are just being handed our speaking notes.

On behalf of the banking industry, I would like to thank the House of Commons finance committee for the opportunity to provide our industry's views on the report of the technical committee, otherwise known as the Mintz committee. The banking industry views the report as an important framework for revising the business tax structure.

Given the parameters within which the committee was required to complete its work, it has managed to produce a report that overall provides a constructive and practical approach to achieving its objectives.

The report does not deal extensively with the taxation of the financial services sector, as a thorough analysis has been deferred to a research study commissioned by the technical committee and a task force on the future of the financial services sector in Canada. Nevertheless, the report does note that federal and provincial taxes tend to be higher for this sector than for any other and that substantive distortions on financial transactions are a result.

It recommends that no single sector, in particular the financial services sector, which has been growing and is increasingly facing a competitive and international environment, should bear substantially higher taxes than other corporate sectors.

However, the report suggests that action on rectifying the disproportionately high burden of taxes borne by financial institutions should be deferred until the task force and government have completed their review of the regulatory structure of the financial sector.

Not surprisingly, the banking industry very much agrees with the conclusion that its burden of taxes is substantially heavier than that of other sectors of the economy and that this non-neutrality should be eliminated.

Apart from paying the highest federal and provincial income tax rates of any corporate sector, banks have been targeted with so-called temporary surtaxes. The federal surtax was imposed to help combat the deficit, but remains even though the deficit has been brought under control.

Moreover, the increases in bank income taxes year over year since the imposition of this surtax are many times the amount of the deficit to have been covered by the surtax. For example, for the two fiscal years following the federal government's introduction of its temporary surtax in 1995, the six major banks saw their federal income taxes increase by more than $755 million, over six times the amount collected as a surtax.

Another of the report's key findings, that the growth of profit-insensitive taxes has resulted in a number of businesses being treated in a non-neutral way by requiring them to pay far more in taxes than the cost of using public resources, reflects the experience of banks.

Of these profit-insensitive taxes, capital taxes are particularly problematic. Banks are required by the regulator to maintain high levels of capital for safety and soundness reasons, yet the federal and provincial governments undermine their own public policy objectives by penalizing banks with a tax on the capital they raise.

As few other major countries impose such a tax, Canadian banks are placed at a competitive disadvantage to their foreign competitors through a higher cost of capital. Like other business taxes, these added costs are passed on in some combination to bank customers, shareholders, employees, and suppliers. But if these added costs also mean that Canadian banks lose out on international deals because of a higher cost of capital, this reduced growth will adversely affect economic growth and job creation in Canada.

The need for a competitive tax structure is a theme that is applied by the report to the overall tax system in Canada, given the importance of trade and foreign investment to our economy. The contribution of exports to the expansion of the Canadian economy is one of the reasons traditional exporting sectors, such as the resource and manufacturing sectors, have been taxed at lower rates than the services sector, which has not been viewed as an exporting sector. But, as reference to the diagram on the next page clearly indicates, this view is no longer justified.

The diagram shows that, on average, the six major banks earn approximately 40% of their earnings from operations outside Canada, yet only 16% of the taxes they pay are paid to foreign governments. Eighty-four percent of those taxes are paid to Canadian governments.

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Moreover, this foreign activity helps to maintain 90% of bank jobs in Canada. I would put that against analyses for other services sectors, such as utilities and engineering, which show that their foreign activity helps to support their domestic economic base.

A tax bias against the services sector discourages the types of jobs that governments seek to encourage: highly skilled jobs in a growing knowledge-based sector.

Given the importance of technology to our industry, banks require highly skilled employees to stay competitive. Since 1990 bank employment has grown significantly in the areas requiring higher paid, knowledge-based skills and has shifted away from transaction-based jobs. Today banks employ more than 221,000 people and spend over a quarter of a billion dollars annually on training to keep employee skills up to date with advances in technology and the latest product developments.

A tax regime that penalizes companies because of the type of business they engage in will discourage, not encourage, employment in that sector. This situation is exacerbated by increasing payroll taxes and high personal taxes that encourage better skilled individuals to move outside Canada.

A punitive tax regime also has a carry-over effect on the many suppliers who provide goods and services to the companies in this sector. Canadian banks spend almost $6 billion annually in purchases from domestic suppliers, many in the high-tech area that governments want to foster. This helps to support another 159,000 jobs.

Another perspective from which to assess the adverse consequences of excessive tax rates relative to other sectors and countries is the impact on foreign investment in Canada. In the context of the Canadian banking industry, it is worth considering the impact of a high tax burden on the nature of foreign bank competition in Canada. Although taxation is typically not the sole determinant for location of investment decisions, it often is a key factor and is one that the government can control. For the services sector in particular, technology is a key enabler that allows foreign competitors to leverage off economies of scale at relatively little additional cost.

If you are a financial institution in the U.S. with huge computing capacity to score credit or mine data for credit card applications, why establish extensive operations in Canada when you can sell your services here with no or minimal physical presence while minimizing your exposure to higher tax rates?

Briefly returning to the report's recommendations regarding the financial services sector, the banks do not agree that changes in the tax structure need wait until the task force and government implement regulatory changes. The sector already is intensely competitive and is becoming even more so through the use of technology by niche players with much lower cost structures.

While there are differences within the sector that need to be addressed, particularly between larger and smaller financial institutions, the overall burden borne by larger players in the key financial industries warrants attention for the reasons addressed above.

The reasons for removing non-neutrality space by other service sectors apply to the financial sector equally as well, and probably more so because of the additional taxes and regulatory costs levied on our sector.

It is worth noting that the increase in the temporary surcharge suggested by the Mintz committee is intended to apply only until regulatory changes are implemented. We are strongly opposed to such an increase, even if it truly were to have the effect of fully offsetting any immediate tax savings. As already noted, temporary surcharges tend to get extended beyond their original purpose. But, more importantly, a delay of any tax effects until regulatory changes are implemented would only perpetuate the adverse implications of a punitive tax regime on large financial institutions to the detriment of economic growth and job creation. Therefore, any changes to the business tax structure should apply to the financial sector no later than they apply to other sectors.

I would like to make a few brief comments on some of the more technical recommendations of the report.

The report recommends that provincial capital taxes should not be deductible from corporate income tax following an appropriate transition period. This recommendation is premised on an expectation that governments will reduce their reliance on capital taxes as a consequence of non-deductibility and if the base-broadening measures in the report were adopted.

The report also recognizes that financial manufacturing businesses that pay above-average amounts of capital taxes would be adversely affected if non-deductibility were pursued in isolation. The banks therefore recommend that non-deductibility of capital taxes not be pursued unless capital taxes are reduced sufficiently to at least fully offset the effects of non-deductibility on all businesses affected.

We recognize the reasons for the report's proposal that interest payable to arm's-length non-residents be exempt from Canadian withholding tax, regardless of the term of indebtedness. However, this would disadvantage Canadian commercial lenders relative to foreign competitors, as many jurisdictions, such as the U.S., do not offer similar relief. Rather than making all interest exempt from withholding tax, Canada could negotiate bilateral exemptions through its tax treaties.

The proposal that Canadian taxpayers should no longer be able to claim a current deduction for interest expense traced to investments in foreign affiliates could hinder the ability of Canadian companies to grow. This would require Canadian companies to seek greater financing in other countries, many of which have market constraints on borrowing.

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At a minimum, the threshold for smaller companies should be raised to allow them to establish more of a credit history as support for when they seek financing abroad.

Also, tracing could be administratively onerous and should be assessed from a practicality standpoint.

The report's proposal for the introduction of a partial degree of experience rating for employment insurance is consistent with the banking industry's position on this matter.

In 1994 the CBA supported the use of a limited degree of experience rating in our submission to the House of Commons Standing Committee on Human Resources Development when it was reviewing social security reform.

In conclusion, the banks urge the federal and provincial governments to proceed expeditiously with business tax reform. We recognize that reform of personal taxation has a higher priority for government. Nevertheless, job creation and economic growth remain top priorities for government and are more readily accomplished on a sustainable basis with a hospitable business tax regime.

Given the interrelation between personal and business taxation, it is prudent to consider changes to them at the same time. Implementation of the changes can then be phased in as appropriate.

The Chairman: Thank you very much, Mr. Weseluck.

We will now hear from Mr. David Adams of the Canadian Vehicle Manufacturers' Association.

Mr. David Adams (Director, Policy Development, Canadian Vehicle Manufacturers' Association): Mr. Chairman and committee members, on behalf of the members of the Canadian Vehicle Manufacturers' Association I would like to thank you for the opportunity to appear before you today.

As outlined in our brief, the Canadian Vehicle Manufacturers' Association, the CVMA, has six member companies, namely, Chrysler Canada Ltd., Ford Motor Company of Canada, Limited, Freightliner of Canada Ltd., General Motors of Canada Limited, Navistar International Corporation Canada, and Volvo Canada Ltd. These companies produced 2.1 million of the 2.5 million vehicles built in Canada last year, thus representing a significant portion of the automotive industry, which, by the way, is the country's largest exporting sector, the largest contributor to manufacturing GDP at 12%, employing directly and indirectly over 500,000 Canadians. It was also responsible for more than $20 billion of investment in Canada in the last decade alone.

It is within the context of a major manufacturing sector, a major exporting sector, and a major source of foreign direct investment that we offer our comments today.

The primary focus of our comments is obviously the Mintz committee, the technical committee on business taxation, which was established two years ago with the following objectives: improving the tax system to promote job creation and economic growth in an open economy; simplifying the taxation of business income to facilitate compliance by taxpayers and administration by Revenue Canada; and enhancing the fairness of the tax system by ensuring that all businesses share the cost of providing government services.

The work of the committee, however, as was noted by the previous presenter, had two restrictions imposed upon it, one being the restriction of revenue neutrality and the other being a concept to look at what could be done with respect to business taxation from the federal perspective as opposed to dealing necessarily with implications as far as the provinces were concerned.

Our association has a few difficulties with those two limitations. We fear that they unduly restricted and hindered the recommendations that could have otherwise come out of the report.

The concept of neutrality did not allow the committee to take into account the fact that corporate tax rates in Canada are already competitive with many jurisdictions around the world with which Canada competes for investments and employment, and it thus limited the committee to shuffle the existing tax burden amongst the existing taxpayers.

While the concept of neutrality is egalitarian in a lot of ways, Canada relies on certain sectors of the economy more than others to sustain the economic activity of the country, and some of these key sectors, like auto manufacturing, will be less competitive internationally under the concept of neutrality.

Revenue neutrality, as I believe was also noted in the previous speaker's presentation, may not be as necessary a restriction now that the deficit has been brought into check, and I think the government is certainly to be congratulated for the work it has done on the fiscal front.

The other aspect that the committee report highlights is the fact that 60% of the total taxes paid by businesses, as I alluded to earlier, are being paid by businesses at the provincial level; thus we wonder about the utility, given the role of the provinces in business taxation, of looking strictly at the federal front.

There are numerous initiatives within the overall report that we could support.

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On balance, we would have to look at the report from the perspective that the recommendations comprise a balanced package that will provide opportunities for economic growth and job creation for Canadians. However, the balanced package, in our view, is being funded by base-broadening measures that will negatively impact the manufacturing sector.

The committee itself has indicated that the overall impact of its proposals would be to increase the effective tax rate on marginal investments of the manufacturing sector. Therefore, the CVMA cannot and does not endorse the committee's recommendations as a whole. It will hurt the international competitiveness of the manufacturing sector and in particular the automotive industry.

Having said that, there are some specific recommendations that the CVMA can support, which I will itemize, and perhaps questions will allow us to further elaborate.

The sharing of losses for tax purposes is a specific recommendation that our association can support. Additionally, the non-resident withholding tax exemption for all interest payments to non-resident lenders for all indebtedness, regardless of term, is an initiative our association can support.

Certainly the approach is to improve tax coordination, tax harmonization, between the federal government and the provinces with respect to a neutral base for income and capital taxes, and the adoption of a method of allocating these income and capital taxes is desirable.

Like the previous presenter, the Canadian Vehicle Manufacturers' Association would support the concept of experience rating for employment insurance. Indeed, when we looked at this issue several years ago our three major members were making contributions of $200 million more than the benefit their employees, despite utilizing the system, were receiving.

A 1990 study done by the Canadian Labour Market and Productivity Centre revealed that the automotive industry had a benefit/contribution ratio of .65, meaning that for every dollar that was contributed to the UI system at that point in time, 65¢ was taken out.

While there are numerous recommendations made within the context of the report that can be supported by the members of the CVMA, we remain equally concerned that there are numerous other recommendations that would not be helpful in achieving the above-noted objectives of the committee. This would be especially true where such recommendations could be taken out of context of the whole concept of the report as being a balanced approach. There is a certain amount of fear that recommendations that exist in the report could be cherry-picked by future governments, future initiatives, rather than viewing the recommendations as part of an entire report as they exist now.

One of the areas that we would have disagreement with would be the reduction of the capital cost allowance. That would make the manufacturing sector significantly less competitive. The $6.8 billion of investment that our members have made over the last couple of years was virtually all in manufacturing equipment and tooling. Our companies are significant exporters with internationally mobile capital that must compete not only internationally, but also internally within our companies in terms of where production is going to be placed and where new product mandates will be sourced.

The recommendations of the committee in this regard would reduce the after tax return on investment of our member companies and impact the location of production within the global economy.

Another recommendation that we have difficulty with would be the recommendations with respect to the manufacturing and processing credit. Our view is that, when viewed in conjunction with the provincial credits, it is essential to provide Canada with tax rates that are at least somewhat competitive with other jurisdictions, especially in the case of auto manufacturing, with other NAFTA countries that compete for investment.

With respect to capital taxes, we again would share the concerns of the previous presenter that the committee seemed to do quite a reasonable job of outlining why capital taxes were not a good idea, but then came to the conclusion that they were a necessity for revenue purposes.

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The committee has recommended the maintenance of the current capital taxes, albeit with the view that federal and provincial capital tax bases should be harmonized to simplify the administration and reduce compliance cost.

The committee has also recommended that provincial capital taxes not be deductible from federal income tax, which we would certainly disagree with.

The other item that was recommended was the permanency of the large corporations tax.

The capital distributions tax would seem to ensure that a minimum level of tax has been paid on distributed corporate profits where the corporate income tax has otherwise been reduced by the availability of corporate tax preferences. The committee notes that while distribution of all existing surpluses, free of the capital distributions tax, is more fair, it suggests allowing a carry-forward for the purpose of offsetting corporate taxes paid in the five years prior to the implementation of the CDT. It would be our view, again, that implementing a CDT is inappropriate given that the government currently uses corporate tax preferences to stimulate certain sectors of the economy and certain economic activity. Presumably those are activities in which Canada enjoys a comparative advantage or where there are other sound reasons for supporting such activities.

The committee has recommended that the existing thin capitalization ratio of 3:1 be reduced to 2:1 as a proxy for financing that would generally be available in an arm's-length context. It is our view that the current ratio of 3:1 is probably appropriate.

We are very concerned about the reduction of tax incentives with respect to research and development from 20% to 15%. The committee would appear to have recognized the value of encouraging research and development. However, it seems to suggest that Canada has an overly generous system that isn't being particularly utilized, and this would seem to be one issue within the context of revenue neutrality that is being sacrificed with respect to bringing about a lower corporate tax rate overall.

Certainly it would have a very negative effect on the automotive industry, as we have noted in our report. The manufacturing sector, according to the committee's own report, is responsible for 48% of the value of all claims for scientific research and experimental development.

Finally, the other issue that we have commented on and don't disagree with is with respect to the fuel tax. There seemed to be a suggestion made by the committee that the tax should be reduced and taxes be imposed on other fuels that are equally if not more environmentally damaging. It would be our view that any tax measure that would be more broadly based, aimed at ensuring that businesses pay more of the social cost imposed by their actions, full cost accounting, if you will, for environmental mechanisms, must be viewed in the light that such measures would have a direct impact on Canada's international competitiveness.

The committee also recognized, and I think quite rightly, that some environmental issues are dealt with through international cooperative efforts, particularly where there are significant environmental slip-overs between countries. Clearly this would be the case with a carbon tax, which, if you really wanted to address where the committee was going with respect to environmental taxation, would probably be the fairest and most equitable means of taxing the fuels that are indicated.

The other thing that has to be recognized with respect to reducing fuel taxes in particular is that one of the things we have noticed in the industry we represent is that any time there is either an increase in fuel efficiency of a particular vehicle or a decrease in the cost of ownership, which reducing the tax on fuel would effectively do, it ends up having a take-back effect, which is to suggest that to the extent that your costs of ownership of driving are reduced, you tend to drive your vehicle more. So we are not sure that the environmental benefits that the committee suggests could be obtained by reducing the tax on fuel, especially motor fuel.

We certainly appreciate the opportunity to appear before the committee today and thank you for your attention.

The Chairman: Thank you very much, Mr. Adams.

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We will now hear from the Alliance of Manufacturers and Exporters Canada, Mr. Jayson Myers.

Mr. Jayson Myers (Senior Vice-President and Chief Economist, Alliance of Manufacturers and Exporters Canada): Thank you very much, Mr. Chairman. First of all, thank you for allowing us to participate in this important discussion on the recommendations of the Mintz committee and its proposals for restructuring business taxation in Canada.

Let me introduce myself and the other members of our delegation. I am Jay Myers, the senior vice-president and chief economist of the alliance. With me today is John Allinotte, director of corporate taxation at Dofasco. John is the co-chair of our national taxation committee. Brian Collinson is also with us. He is the director of national taxation and commercial policy of the alliance.

As you know, the alliance has 3,500 members and 4,000 affiliate members, representing approximately 80% of Canada's industrial production and 95% of its exports. Our members come from all sectors of Canadian business, from financial services, across manufacturing and high-tech industries, and from all provinces in the country.

The members of the committee have received our submission, and you will be glad to know I am not going to go through it point by point, but I want to make some very general comments.

First of all, there is an urgent need to reform Canada's system of business taxation. Seventy-six percent of our members in our latest management issues survey said that high taxes are an impediment to their business expansion plans and to economic growth in the country as a whole, and 84% said that corporate tax reform and tax reduction should be a priority for the federal government as well as for provincial governments.

The fact alone that the government is reviewing the business taxation system and considering changes to it is extremely important. Reforms are necessary and they should proceed along with reforms in personal taxation. But we should not proceed with reforms simply for the sake of reform.

It is really essential that changes in Canada's system of business taxation respond to the real needs of business and to the real needs of the economy and not to any academic theory or any set of bureaucratic priorities that seem to be appearing from time to time in some of the proposals for overall business tax reform that come before this committee and are in this report.

There are some real and very urgent concerns across Canada's manufacturing and exporting community, not only about the level of taxation in this country but also about the recommendations in this report. This is the sector, by the way, that has driven economic growth over the 1990s. It has accounted for 40% of the total employment gains in this country since 1992 and it is the sector that accounts for over 90% of all research and development performed in this country. This is the sector at the forefront of competition, not only in markets for goods and services but at the forefront of competition for investment. Without that investment we wouldn't have jobs and we wouldn't have customers for the services.

We are at the forefront of investment in terms of global companies, even small Canadian companies that are operating on a global stage today that have to be making favourable returns on their investment if they are going to maintain or establish their businesses in Canada.

With respect to the tax system, the overriding concerns in our community are, first of all, that Canada's tax system is simply not competitive when it comes to attracting new direct investment into this country or, for that matter, retaining investment in this country. We have to keep in mind that we are not just simply competing with the United States today when it comes to establishing a favourable tax environment. We are up against such low tax jurisdictions as France, Ireland, and Singapore.

I would refer you to page 17 of our submission, where there is a list of statutory tax rates applied to manufacturing industries around the world. Singapore, Malaysia, Israel, and China have effective tax rates of zero. Brazil is at 8%, Ireland is at 10%, Hong Kong is at 16.5%, and the United Kingdom is at 30%. When you look at the combined rate of federal and Ontario tax in Canada, a 35.6% tax rate does not compete even with the United States when the effect of the fisc is taken into account.

These are the tax jurisdictions that we are competing with in Canada for green field investment, and frankly, Canada's tax rates simply don't stack up. It is not only a matter of perception, it is also reality. The World Economic Forum rates Canada as being 43rd in the world in terms of tax competitiveness. The Conference Board of Canada says that uncompetitive taxation is a major reason we are losing our share of direct investment in this country. Our own members report that Canada frequently doesn't even make it on the short list in terms of their expansion plans and investment plans, simply because of high statutory tax rates.

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Our corporate tax rates are simply too high. From the point of view of manufacturers and exporters, while the corporate income tax reduction that is recommended by the Mintz report goes some way to rectify that situation, it isn't nearly enough when we are competing with low or no-tax jurisdictions in the United States and in other jurisdictions around the world.

Another concern is that Canada is being left behind other nations. France, the U.K., the U.S., and many other countries are already well advanced in tax reform initiatives. They are changing their business tax systems in order to compete effectively in the world. We have to make sure our tax reforms are carried out not so much because we are focused on the Canadian economy, but with the broader global picture in mind. We have to make sure our treatment of transfer pricing or our treatment of withholding taxes and the treatment of income derived from foreign sources is harmonized as much as possible with changes going on at the international level, not just changes in the U.S. tax regime.

Finally, we are concerned that changes should be made to business taxation that will encourage innovation and growth in the most productive sectors of the Canadian economy. The objective of this government has been to build a competitive, innovative economy as the basis for high-value economic growth. We agree, and those are the standards that we set when we assessed the recommendations of the Mintz committee report. The recommendations not only, in our opinion, fall short, but I think they set Canada back in terms of its ability to compete in the global world economy.

We have some very serious concerns about the Mintz report and some very basic concerns about the premises upon which the recommendations are built.

First of all, you really have to question the analysis that goes behind looking at the relative tax burdens. Not all taxes are taken into account here, and certainly not all taxes in other jurisdictions are taken into account.

I refer you to the last page of our submission, which is a simple chart showing the proportion of federal taxes collected by various sectors of the economy in relation to the contribution to private sector GDP made by various sectors of the economy. While it is true that financial services, deposit-taking institutions especially, pay far more in terms of federal taxes than their individual contribution to the Canadian economy—they are direct value-added to the Canadian economy—it is also true of primary industries of manufacturing as well. If you look at other types of industries, the contribution to federal income and capital taxes is far less than the contribution to the private domestic economy as a whole.

We question the basic assumption that underlies many of the recommendations in the Mintz report. As I said, the analysis doesn't cover the full range of taxes that businesses face. It doesn't recognize that various sectors of the economy are facing different markets, different degrees of competition in terms of tax rates, different expenditures and investments in capital equipment and technology, in research and development and in labour. Not all sectors of the economy are the same and not all sectors of the economy should be treated the same in terms of tax policy.

We question, as well, the underlying assumption that the provinces will simply adjust their tax systems in line with steps taken by the federal government. I think a lot rides on this basic assumption. This certainly hasn't been the case historically. I think it is very doubtful and certainly unrealistic that this will take place, although it would be nice if it did.

But given the nature of the committee's proposals, if the provinces refuse or if they come in to occupy the tax base vacated by the federal government, then nothing is gained here. In fact, I think it sets the whole system of business taxation back. Certainly it would impose considerable costs to business. After all, there is only one single taxpayer.

Furthermore, it doesn't seem to me that there is any analysis of what the economic impact of these reforms in the report would be. I would like to see this before any progress is made or any consideration is given.

There is no consideration as to the net revenue effects, the revenue that would be raised by measures to encourage productive economic growth. I would like to see that as well. Tax neutrality is not simply switching revenues around. Surely we have to be looking at the revenues created by further economic growth.

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I agree that the assumption or the premise that the Mintz committee worked on that we had to have some degree of revenue neutrality here certainly imposes severe costs on Canadian industry. Professor Mintz recognizes this himself in a footnote well hidden in the report at page 23, section 4, where he says “As discussed, there may be”, and I tell you that there is “considerable concern regarding the international competitiveness of new investment in manufacturing under our proposal. Any incentives should be provided by way of an investment tax credit.” It would be nice if that recommendation were actually carried into the recommendations in the report and not hidden in a footnote, well buried in section 4 of the recommendations.

Let's be very frank. The recommendations are certainly not tax neutral from the point of view of manufacturers or exporters who would have to pay for a lower general tax rate for other sectors of the economy at the expense of the sector itself. In particular, we strongly oppose the recommendations of the report with respect to changes in the capital cost allowance and changes in the R and D tax credit system. I have to tell you that tabling recommendations to change the R and D tax credit at this time increases the uncertainty that is already there surrounding the viability and the future of this program.

I think quite a bit of damage has been done, simply by taking a look at some of the recommendations tabled in this report, that would decrease the effectiveness of this program.

We also strongly oppose the recommendations with regard to interest expense related to foreign investment, Canadian investors, the corporate distribution tax, the dividend tax credit, and the restructuring of resource allowances. We don't want to see, in the end, tax reforms that are going to make the tax system on manufacturers even less competitive and more costly than it already is.

The alliance has been working with Industry Canada and we have commissioned our own analysis of the impact of corporate tax reforms in the manufacturing sector. This study was carried out by Professor Jeffrey Bernstein of Carleton University. His econometric work is going to be published by Industry Canada in the near future. It is now being translated and prepared for publication. The policy implications of his work are now available from the alliance and we would be glad to share them with the committee. We will be using that work if we make our own recommendations for tax reform to this committee and to the ministry of finance in the forthcoming budget consultations.

Let me summarize some of the findings in terms of the cost. If you refer to page 7 of our submission you will see a very quick analysis of some of the costs and the benefits of three parts of Professor Mintz's recommendations. This is our own analysis, running the numbers through the work that Professor Bernstein did.

The proposal to decrease the corporate income tax rate from 22.12% to 20% at the federal level would save manufacturers about $456 million, it would create jobs, and it would lead to further investment. But if you take only two other recommendations, the changes to the capital cost allowance and the reduction of R and D tax credits, the combined cost effect of that would offset the cost savings of the tax rate reduction and we would certainly see a loss in terms of both capital expenditure and research and development expenditure under both of those recommendations, which would again far exceed the gains that would be realized as a result of lowering the overall tax rate.

The alliance proposes four criteria for business tax reform that should be applied to this technical committee's report and further action by the government. First, the reforms should address real problems, not academic ones. Second, the reforms should not place any sector in a worse position than when it started out. Third, the reforms should reflect what is happening around the world and what is needed for Canada to be tax competitive as other jurisdictions move to a low-tax or a no-tax regime, which simply we are not right now, and the changes that have to occur are far in excess of what Professor Mintz recommended. Finally, the federal government must take the lead in tax reform but not assume that the provinces are going to follow in step.

Again I want to underline the urgency and the priority of corporate tax reform. We are already losing investment and high value-added jobs in this country. That is the key problem and I wish it were addressed in this report. Thank you very much.

The Chairman: Thank you very much, Mr. Myers.

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Before we proceed to the question and answer session, I would like to take this opportunity to welcome a group of tax officials from the Russian finance department who are observing this meeting. They are interested in the public consultation process as it relates to the drafting of the federal budget.

On behalf of the committee, welcome. It is a pleasure to have you here.

We will now proceed to the question and answer session with Mr. Solberg.

Mr. Monte Solberg (Medicine Hat, Ref.): Thank you very much, Mr. Chairman, and welcome to our witnesses. There are many familiar faces here.

I want to start out by sympathizing somewhat with your point of view on revenue neutrality. I think it is a bit of a red herring. I think the hue and cry across the country is for lower taxes, not different taxes. I accept what you are saying. I think it is an excellent point.

However, I would also say that Professor Mintz's focus on this is the result of the mandate he was given by the federal government. I was happy to see his little footnote. We found it in there. We saw it. I think he was simply responding to the marching orders he was given.

The point I want to start off with is that if we all agree that taxes are too high, and I want to expand the debate beyond the mandate, what should we be shooting for in terms of the overall corporate tax levels in this country? What can we do about the problem of the provinces moving in to assume tax room that the federal government has abandoned? Can we set up some federal-provincial agreements?

I guess the final question is, how should corporations be taxed? I realize it is a huge, sweeping question, but if we are to get away from insensitive taxes, profit-insensitive taxes, how do we do it?

Mr. Jayson Myers: Let me take a crack at some of those questions. Maybe I will comment on the last question first.

I don't think it is necessary for Canada to go to a zero tax rate. There are reasons that other jurisdictions have zero tax rates. There are a lot of costs they have to offset, and that is to some extent why they are doing this. Certainly we have to do something, not just to make us as competitive as manufacturers see the situation in the United States, but if we are really serious about attracting investment, we should lower corporate statutory tax rates to a more competitive position.

The second thing, though, is that we want to ensure that the money that is freed up as a result of that is invested as much as possible within the Canadian economy. I think there should be some complementarity with an investment tax credit that would encourage companies to invest in R and D, in innovation, and in equipment here in Canada. That is one set of recommendations.

I think we have to take a broader view of the corporate tax system. I know these recommendations are not necessarily accepted uniformly across all sectors of our constituency either, so I say that with a grain of salt.

There are combinations of tax changes that would enhance our competitive position and would do a lot to encourage investment in innovative assets, including the highly skilled people who I know this committee is also interested in retaining here in Canada.

It is a problem, looking at the whole scope of tax reform measures, in that there will be an initial cost of doing this. I think the question is, how serious is the government in making an initial investment and in ensuring that we retain, let alone attract, the investment that is going to keep industry in this country? The pay-off in doing that, eventually, will be in terms of job creation. That is where the revenue growth will come in the future. The cost, though, is already evident in the investment we are losing. That is what we are going to continue to bear under the current tax regime.

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The Chairman: Thank you, Mr. Myers.

Mr. Brison.

Mr. Scott Brison (Kings—Hants, PC): It is becoming increasingly difficult, even from a

[Editor's Note: Inaudible]...with the mobility of capital, to tax corporations. It is like squeezing a bar of soap. You can't really get money from corporations in the way you used to be able to, due to the mobility of capital.

Your recommendation is to reduce corporate taxes, and I agree with you. In terms of the higher burden of taxes, recognizing that government needs revenue to operate, where would it get the extra taxes? Would you recommend more consumption taxes or would your preference be personal income taxes?

Where would we attain that, from your perspective? Do you have a preference?

Mr. John Allinotte (Director, Corporate Taxation, Dofasco Inc.; Alliance of Manufacturers and Exporters Canada): Where would the tax revenue loss come from?

Mr. Scott Brison:

[Editor's Note: Inaudible]

Mr. John Allinotte: That is generally the intent of tax reductions. The economic growth that is stimulated from both tax reductions in the statutory rate and tax preference items has caused economic growth.

We have seen that. Unfortunately, history doesn't repeat itself all the time in the same way, but if we look back to the early 1970s and the incentives that were provided to manufacturers in the accelerated capital cost realm, we had two-year write-offs in our tax system. That produced billions of dollars of capital investment in this country. Unfortunately, in the early and mid-1980s someone forgot about that and started taking those preference items away.

I would suggest that a reduction in tax rates or an increase in preference items would be made up in an increase in economic activity and higher taxes being paid in general.

Mr. Mark Weseluck: I would agree with that. I think your point about electronic commerce certainly highlights the fact that you can't buck the trend by trying to capture a base that can move offshore or elsewhere. The idea is to be hospitable to that investment, to attract those investments that will be made in the future, and thereby have a sound and broader base against which tax is generated. I think that is the essence of where government should target its policy.

Mr. Scott Brison: To what extent are other tax jurisdictions exploring neutrality alternatives similar to what the Mintz report has posited?

Mr. Jayson Myers: There certainly has been action taken by a number of jurisdictions, but it has mainly been to decrease the tax burden, not necessarily a discussion on neutrality.

Certainly there is going to be an impact on the overall fiscal balance. But I think other jurisdictions have taken a bit broader view into account, that we are not just dealing with the tax system but with the entire fiscal system. It is not simply a matter of the growth that could be expected through tax reduction, it is also a matter of lower expenditures. If you have more people working, then social expenditures go down. Unemployment support goes down. So there are a lot of cost savings as well as more revenue that is generated.

There are other analyses, especially those from Ireland. I am not sure how many jurisdictions are stepping back and trying to come up with a perfect revenue-neutral scheme before they proceed. It seems to me that a lot of them are looking at the success of low tax jurisdictions, like Ireland, which have been very successful in attracting new high-tech investment in services as well as in manufacturing.

It seems to me that is the standard that is being set. You can spend a lot of time trying to come up with the perfect answer, but I can tell you, as an economist, that you never will. Don't wait until you have that perfect answer before proceeding.

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The Chairman: Thank you, Mr. Brison.

Mrs. Redman.

Mrs. Karen Redman (Kitchener Centre, Lib.): Thank you, Mr. Chairman.

To follow along on Mr. Brison's last question, what is the impact of a non-neutral tax structure on other tax revenues? Isn't there a potential to erode Canada's tax base as the corporations rearrange their affairs and their tax structures? Is that not going to force government to rely more heavily on other taxes, such as profit-insensitive taxes, payroll tax royalties, and excise taxes?

Mr. John Allinotte: If I understand your question, it is, what would a tax reduction do to the other revenue-raising activities?

Mrs. Karen Redman: If it is a non-neutral shift.

Mr. John Allinotte: I think one of the aims of the tax structure, particularly from Canada's point of view, is to encourage investment, and that investment would encourage economic growth. As we have seen over the last couple of years, the demand on our unemployment insurance funds has decreased. The government has a nice surplus for the next turnaround in the economy.

A tax system that allows cashflow by offering tax preference items or by offering lower tax rates will encourage economic growth. I would not see any effect on other taxes. The expenditure side would certainly go down—your social services expenditures. Consequently, the loss of revenue as a result of the reduction in taxes wouldn't be affected.

Mr. Jayson Myers: This is an area where there is a lot of discussion at the level of perception and a lot of hearsay about what the impact actually would be.

To tell you the truth, there is not a lot of good analyses about what the impact of tax reduction has been in other jurisdictions where tax reforms have taken place, and it is certainly not on the table right now.

I would suggest, if we are looking at tax changes, that this analysis be provided. We should take a good look at jurisdictions like Ireland and several of the European countries, as well as the United States, to see the actual impact of what has happened when taxes have been reduced.

The current tax system for consumers and for industry distorts the way we spend our money and distorts the decisions, not only about investment but about the levels of production and the cost of doing business in this country. As a matter of fact, the findings of our analysis show that the distortion levels add about half a percent to inflation every year, simply because companies are not making the decisions they would if the cost of labour and the cost of investment capital were not distorted by the tax system.

It is that type of problem that we really have to get at, as well, in corporate tax reform. If there were a tax system that taxed pure profits, that certainly would not distort investment decisions or production decisions. If we had a tax on consumer expenditures that was uniform across all expenditures, that wouldn't be distorting either. But the fact is that we don't have that, and to talk about a pure profit tax or a pure expenditure tax again comes down to a lot of economic theory, but politically and realistically we are not going to have that system in this country.

Let's deal with improving the situation that we have and try to reduce those distortions...but not necessarily one in which we think they will disappear.

Mr. Brian W. Collinson (Director, Commercial Policy, Alliance of Manufacturers and Exporters Canada): I would like to comment on that.

I am certainly in absolute agreement with what Jay was saying with regard to the need for further empirical analysis. However, in terms of those jurisdictions that have reduced their corporate tax rate in recent history, the underlying policy rationale for that is that ultimately, over a longer timeframe, the changes in taxation will be revenue neutral or better. But there is a question about the timeframe over which that revenue neutrality will occur. There seems to be some difference in that respect between the kind of timeframe Professor Mintz is talking about in terms of revenue neutrality, which is very short, and a longer view of the taxation process and of the revenue generation and investment process that perhaps other jurisdictions are taking.

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The Chairman: Mr. Iftody.

Mr. David Iftody (Provencher, Lib.): Thank you, Mr. Chairman.

Thank you for your presentations. This is the second or third round for some of you making presentations to this committee in the last six or seven months.

I have a general comment about taxation policy. We heard a couple of days ago, for example, from the Canadian Medical Association. It asked for a number of things, almost with a scolding finger. It wants personal income tax cuts. It definitely wants more federal expenditures in education, particularly higher research. We just heard that again from the group that appeared before you. It wants general taxes to be reduced at the same time on the other side of the ledger, and compared to the U.S. example, we need to double the salaries of doctors. That is what we are hearing from one side.

I will start by asking if the bankers' association could comment on this and then maybe Jay Myers.

John McCallum recently said that the federal government should have a surplus of around $11 billion two or three years from now. But in his view we don't have any room for tax cuts of any sort. Personal, corporate, tax deferral, any way you want to wrap it, his view is, bottom line, we just don't have the money to do it and we should forestall any tax cuts for some time to come, certainly not within the mandate of this government.

There are a couple of very contrasting views. We are talking about the Mintz report and some of its observations. I guess his theory behind this is looking at the potential for another economic downturn. Governor Thiessen and others have appeared before this committee in the last while and have said that we have perhaps a 24-month to 30-month window before we will start to see a bit of a pullback, when our capacity will be full and perhaps we will see some inflationary pressures. There are some economists out there who are worried that if we really delve into the tax cut area too deeply we might get trapped if we get into a recessionary period four or five years from now.

Given those two contrasting views and the kinds of presentations that have been made to this committee and to the government, I would like to ask the bankers' association, first, for your observations about federal expenditures in the areas of research and development, health care, education, and doctors' salaries.

Secondly, I would like your comments on those made by the very esteemed Mr. McCallum, who says that chattering away at length about spending the dividends is really quite foolish and nonsense and that we should stop it immediately.

Mr. Mark Weseluck: I will comment in general, and then Ron might give his economist's views on what can be expected.

A common view is that our debt level needs to be attended to forthwith. I think that is what John McCallum was targeting, as well as a lot of other commentators.

It is a question of whether it is solely on that basis or do you allocate some for some of the other spending or tax reduction? I think you also have to look at Canada's competitiveness, our position in the global economy in terms of where investment may be placed and where our tax levels are.

Secondly, there is a significant brain drain in that our top talent is migrating to the U.S. So even if you are investing on the spending side in education, you may end up losing it if people leave the country. You want to make sure you are able to retain your talent and also retain the businesses that create jobs and thereby create economic growth.

• 1225

From our perspective, there has been the general view that you need to look, sooner rather than later, at the tax structure, within the context of the fiscal room to move as well as attending to the debt. Whether that is 2001 or 2002, each of the economists from each of the banks has their perspective. We have not, as an association, projected a particular year.

With respect to the competitiveness issue, that is what generates economic growth, so you have to have a long-term perspective of where that growth is going to come from, and particularly as we move to more technology where a lot of it can be placed offshore and sold into Canada. You are not creating investment in bricks and mortar, infrastructure employment; you are simply selling goods and services into a country, and that is leaving the country.

Mr. David Iftody: When Mr. Myers was with us in Toronto—and I remember making notes on this because I was quite intrigued by it—the suggestion at the time, in terms of our competitiveness and ability to attract foreign investment, was our very low interest rates in terms of capital borrowing for investment. It was suggested that that was really the target on which we should all be focused.

In other words, if we get our debt levels down to ratios reasonably comparable with the U.S., then our competitive capacity will increase. More investment will come into Canada. We will pay less for the money we have to borrow. There will be more money freed up for investment.

The level of interest rates is probably one of the key factors in this whole equation. If your interest rates are at 20% and you still have a 40% debt-to-GDP ratio, that is a problem. If you have 60% but your interest rates are at 4% or 5%, at the prime rate, the burden is obviously less.

I was quite intrigued with that analysis. I thought it was very interesting.

How do you contrast that, in terms of an independent variable, in terms of its weight and effect on a five-year or ten-year window? Would there be a marginal moving down? How much would it be on the corporate or personal rate? Or would all of us, as a country, do much better if we reduced the deficit, brought those levels down, and kept our interest rates lower over the next 10 years? Which one of those is more important to the people of Canada?

Mr. Mark Weseluck: The question is, need it be exclusionary or can you endeavour to keep those interests rates down while—and Jack Mintz has mentioned this in the past—the corporate tax base, even small movements initially, can generate some significant benefits? I think even sending the signal out that one is moving to attend to these issues is an important signal to the international community. Whether that is attended to fully, as he might have advocated with some of these changes, in the near term versus moving in that direction, I think you really need to send out the signal that Canada is attending to these issues. Interest rates are a key factor, but what you retain is also important, in terms of what is after tax.

We definitely agree that has to be attended to. I want to send that message.

Mr. Jayson Myers: I think it is a matter of balance. The level of interest rates is important, and certainly reducing the deficit has significantly lowered Canadian interest rates. Again, the perception that the government was going to and has achieved that has helped as well.

The level of debt to GDP, when I talk to investors outside Canada, is a major concern, and so is the level of taxation. It would be nice if we could do everything at once, but the reality of the fiscal situation, of course, is that we can't.

The key question is how we can keep interest rates low, keep the fiscal situation in order, but at the same time begin to lower tax rates in those areas that have the greatest impact on growth. I believe that is our key concern.

• 1230

The history of the last recession shows that we shouldn't be introducing new taxes at a time when we are in the midst of a recession. I think that was a pretty low blow to the Canadian economy at the time.

Ever since 1990 we have seen, on a personal level alone, personal after tax income on a per capita basis decline, from 1989 to the end of last year, by about 12%. Canadians say “I don't feel better off” and they are absolutely right. On an individual level they are 12% poorer.

How can you offset that at the same time as responding to some of these tax competitiveness issues and bringing in investment? We have a lot of problems in that area that have to be dealt with. We don't have a lot of money in surplus, but we have to do something on all of these fronts.

The Chairman: Thank you, Mr. Myers.

We have a final question from Mr. Solberg.

Mr. Monte Solberg: Thank you, Mr. Chairman.

My question has to do with the situation of financial services to some degree, but it probably applies to other sectors as well. On the one hand, the Mintz report pointed out that you are very heavily taxed relative to other industries, but on the other hand, and I think the facts bear this out, you would argue that your industry is producing a lot of the high-paying jobs in the high-tech field. This morning we had a session on brain drain and we were complaining about the fact that we are not keeping a lot of these people in the country. But in fact the banks are contributing to keeping those people in the country to some degree.

When you sit down with the people at the Department of Finance to talk about these issues, how do they explain this sort of incongruity, where, on the one hand, the official pronounced policy is to encourage the development of those jobs, but on the other hand you face, I would argue, abnormally high taxes that discourage the creation of those types of jobs? How do they justify that? I am sure Mr. Myers, on his side too, would run into that in his industry where they also pay high taxes, but those are the jobs we want to keep.

Mr. Mark Weseluck: We have been subject to specific targeted surtaxes, and there is one we currently face that we would look to the Department of Finance to remove in the next budget. It was intended to reduce the deficit. We feel the deficit has been beaten back and we are more than paying the surtax. As a first step, that would be helpful in moving us toward other industries.

We did try to make this argument, and it would be appreciated if it was conveyed through the committee in its report, and we have discussed it with the officials. The types of jobs we are creating and the growth we are initiating and supporting is in the services sector, and yet it is at the higher end of the taxes. So is government policy to target those industries that are growing? I think that needs to be re-assessed and re-balanced. These are exactly the types of jobs we felt were being encouraged.

The information highway is an area that we are key developers and providers of, as well as electronic commerce and all of those issues. We will continue to make the argument that we feel they should be brought down.

I appreciate the Alliance of Manufacturers noting that we are, among the resource manufacturing industry, paying a disproportionate amount of taxes relative to our contribution. At least in our area we would like to see similar tax rates. We are not sure why there should be that difference.

Ms. Karen Redman: I have a supplementary question. At page 3 of your presentation you talk about 221,000 people spending over a quarter of a billion dollars annually on training. How does that number compare with the number of employees you would have had, say, three years ago?

Mr. Mark Weseluck: I think we were focusing on employment in the skill-based area versus the transactions area. I know that since 1994 there has been about a 17% increase in that middle management type of skilled area. I could come back to you with the growth overall. However, I know that particular shift, on which I was focusing in that first paragraph, is happening at that level.

Ms. Karen Redman: I am interested in knowing that. Thank you.

Mr. Mark Weseluck: All right. I will do that.

The Chairman: On behalf of the committee I would like to thank you very much for your presentations. They are quite helpful to us as we try to deal with the many challenges we face in making recommendations to the Minister of Finance, and indeed to the government, for the upcoming budget. As always, your input is extremely valuable and we thank you.

The meeting is adjourned.