The chances that U.S. President Donald Trump will be able to keep one of his key campaign promises – deep tax cuts – appeared considerably higher after the U.S. Senate managed to pass its own version of a tax reform bill on Saturday morning.
Although the two chambers of Congress still have to reconcile their different versions of the legislation, the “odds of passage – likely early next year though possibly sooner –are now clearly better than even,” BMO senior economist Sal Guatieri wrote in a research note on Monday morning.
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And despite significant discrepancies between the two draft bills, both would lower the U.S. federal corporate tax rate from 35 per cent to 20 per cent.
The prospect of a sizable U.S. corporate tax cut has prompted much hand-wringing north of the border about Canada losing much of its competitiveness.
But will investment dollars and jobs really start flowing south if the Trump tax bill becomes a reality?
We don’t know yet how Canadian and U.S. corporate taxes will compare
At 20 per cent, the new U.S. tax rate would still be higher than Canada’s federal corporate tax rate of 15 per cent. But that doesn’t mean U.S. corporations would necessarily pay higher taxes.
What companies really care about is the overall tax they have to pay on their profits, also known as “effective tax rate” said Guatieri. That includes federal as well as state and provincial taxes and a depends on a host of tax provisions.
For now, it’s hard to tell whether the reform equalizes the corporate tax burden on the two sides of the border, he noted.
All that’s safe to say is that the bill would at least erode the competitive advantage Canada now enjoys, he added.
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One provision of the new tax bill might matter more than the corporate rate, anyways
There’s a bigger issue than the corporate tax rate, anyways, according to Avery Shenfeld, chief economist at CIBC Capital Markets.
And that’s a provision that would allow companies to fully expense their business investments until 2022. Both the House and the Senate versions of the bill currently contain that measure.
This would allow companies to deduct from their tax bill the capital cost of, say, building a new plant all at once during the year in which they incur the expense. In Canada, on the other hand, they would have to write off that cost gradually, spreading the tax deduction over the life of the plant.
The ability to expense the cost of a big investment all at once would be a “new incentive for companies that are currently thinking of expanding to do it in the U.S.,” said Shenfeld.
Still, one of the things Canadians will have to watch is whether that provision will be made permanent in the final version of the bill, said Kevin Milligan, professor of economics at the University of British Columbia.
If it does expire in five years, it might simply have the effect of prompting companies in the U.S. to anticipate business investments that had originally been planned for after 2022. This might cause an investment spike in the short-term but starve the economy of investment dollars later on, said Milligan.
Overall, the impact on Canada would be more muted if the measure were only temporary.
The U.S. tax changes may be unsustainable
Business investment isn’t the only way in which the proposed tax reform could have an energy-drink type impact on the U.S. economy, causing a short-term boost followed by the economic equivalent of a caffeine and sugar hangover.
In its current form the tax reform is “potentially not sustainable,” said Milligan.
All things equal, the cuts would add $1 trillion to the U.S. deficit, according to official projections. And although some Republicans argue that the resulting boost in economic activity would absorb most or all of that, many others remain skeptical.
At some point, it’s likely that the U.S. government would have to either trim spending or raise taxes back up in order to contain the fiscal bleeding, said Milligan. And that would put the brakes on economic growth.
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It’s also possible that the economic acceleration induced by the tax cuts could force the U.S. Federal Reserve to hike interest rates, which would also slow things down again, said Shenfeld. That’s because the U.S. economy is already expanding at a healthy pace and might have little room to speed up further. When the economy overheats, it tends to generate inflation, which the Fed would try to fight with higher interest rates.
This means the Canadian economy might see little benefit from the tax reform.
While a boom south of the border generally lifts economic activity here too, “it’s unlikely that Canada will benefit from a U.S. economy growing any faster than it already is,” Shenfeld said.