The investment summit made the pitch, but the sale isn’t closed

By: William Robson and Mawakina Bafale

A big question going into the first-ever Canada Investment Summit held in Toronto this week was whether Prime Minister Mark Carney could bolster his pitch for fund managers to invest more in Canada with a major policy change? He did. The exclamation point in his speech to the summit was a “productivity mega deduction” (PMD) that will allow business to write off new investments in most capital assets immediately. The Department of Finance calculates that the PMD will cut the economy-wide marginal effective tax rate on new capital investments in half – to 6.4 per cent, compared with 16.9 per cent in the United States and an average of 19 per cent in other OECD countries. Its estimated fiscal cost is also impressive, at $36-billion over the next five years. This is a major policy initiative.

The Prime Minister needed something big. After a decade of indifference, a federal government putting capital formation at the centre of its economic strategy was a welcome change. Business investment in non-residential capital has been so weak since 2015 that the average Canadian worker today has roughly 9 per cent less capital to work with than a decade ago. That fact, and the stagnation of productivity and incomes that went with it, have made Canada a less inviting place to invest.

Canadian investment per worker has always been somewhat lower than in the United States and other OECD members. From the mid-1990s to the mid 2010s, however, the gaps were narrowing. By 2014, the average Canadian worker was backed by about 98 cents of new capital for every dollar received by the average worker across the OECD, and about 89 cents for every dollar the average American worker had. Projections from the OECD this spring implied that the average Canadian worker would see only 64 cents of new capital for every dollar per OECD worker in 2026, and only 50 cents per American worker.

These numbers matter not only as indicators of declining attractiveness but because they affect prospects for the future. Investment and productivity move together. In the 1990s, Canadian workers produced less than their U.S. counterparts and slightly more than their peers in other advanced economies. Today, the gap with the United States has widened, and Canada has slipped down the international rankings. For Canadians, that means disappointing growth in earnings and living standards; for international investors, it means a less dynamic and inviting economy.

The PMD is big enough to make a difference. Forecasters will be raising their estimates of investment and growth in Canada, and businesses considering responding to U.S. President Donald Trump’s trade aggression by serving more of the North American market from production in the United States now have better reason to produce in Canada. Importantly, the PMD applies to most capital assets; unlike the more targeted accelerated depreciation it will replace, it looks less like industrial policy favouring particular activities and more like a boost to investment across the board.

Now that the Prime Minister has put the PMD exclamation point on the investment summit and the attendees are dispersing, questions will arise. Immediate expensing of capital favours capital-intensive industries over others. Calculations from the Department of Finance show that the economy-wide marginal effective tax rate of 6.4 per cent is an average of dramatically different rates: close to 20 per cent in retail and wholesale trade, and rates that are actually negative in agriculture and fishing, manufacturing and processing, and transportation and storage.

Immediate expensing does nothing about the widening gap between small- and large-business rates that locks capital into smaller, less productive companies. High general corporate income-tax rates discourage reporting income in Canada and encourage leverage – too many new PMD-inspired investments may be financed by debt. And it does nothing to address Canada’s high personal income tax rates, which encourage talent – and the investment that follows it – to locate in the United States or more welcoming jurisdictions overseas. The Prime Minister needs answers for those as well.

The next challenge is to reintroduce Canada to domestic and foreign investors as a place where economically motivated projects generate solid returns over the long haul – past the horizon affected by fast write-offs. Lower, simpler taxes on businesses and people would show that Canada is not just a good host for a summit, but a good destination for their next investment in capital that will produce competitive products – and raise Canadians’ productivity and living standards – for many years to come.