It’s time for the federal government to rethink Canada’s corporate tax regime, the International Monetary Fund (IMF) says in its review of Canada published on Monday.
Although the domestic economy continues to perform well, it’s facing challenges, the review says, including concerns about the outcome of NAFTA negotiations, and the impact of the recent U.S tax reforms.
“Near-term growth will be supported by higher oil prices and strong U.S. growth, but weak productivity continues to weigh on longer-term prospects,” the review states. “The current favorable economic environment presents an opportunity to rebuild policy buffers, and forge ahead with structural reforms to boost Canada’s global competitiveness.”
Canada’s real gross domestic product grew by 3% in 2017, but that is projected to slow to 2.1% in 2018 and to 2.0% in 2019. In the longer term, Canada’s growth potential is expected to decline to 1.75%, well below its historical average, the IMF review says, citing weak competitiveness, sluggish labour productivity growth, and population aging as the limiting factors.
To address these concerns, “It is time for a careful rethink of corporate taxation to improve efficiency and preserve Canada’s position in a rapidly changing international tax environment,” the review states.
The IMF recommends that the federal government should consider whether to adopt incremental changes, such as introducing a more generous capital cost allowance, or to embrace more radical options, such as moving to some form of rent tax at the corporate level.
“Any changes should be implemented in a fiscally responsible way, including appropriate revenue-raising measures, and bearing in mind that corporate taxation is only one of several important determinants of business investment,” the review states.
In the meantime, the priority for fiscal policy should be rebuilding buffers while the economy remains relatively robust.
States the IMF review: “Provinces, especially those that are running high deficits or debt, should restore fiscal discipline and take the lead in implementing more ambitious fiscal adjustments. At the federal level, the overall size of the planned adjustment is appropriate, but it could be frontloaded to build buffers faster.”
Monetary policy should also be tightened gradually, the IMF says. It recommends that federal policymakers remain vigilant when it comes to housing market-related financial sector risk.
The banking system “is heavily exposed to household and corporate debt,” and “risks to financial stability and growth could emerge, if the house price correction is accompanied by a rise in unemployment and sharp contraction in private consumption,” the review warns.
“If housing vulnerabilities continue to rise, new lending by banks should be subject to loan-to-income limits,” the IMF review states.
“At the same time, co-ordinated monitoring between federal and provincial regulators are required to mitigate other potential and emerging risks to financial stability, including the increasing use of home-equity lines of credit, the rise of less regulated mortgage lending, and the rapid growth in exchange-traded funds.”