Economic Survey of Canada 2006: Improving the business environment


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The following OECD assessment and recommendations summarise Chapter 2 of the Economic Survey of Canada 2006 published on 26 June 2006.


Boosting productivity growth depends on improving
the overall business environment

Establishing a more positive overall business environment is an essential requirement for both encouraging and enabling firms to make productivity-enhancing decisions. Indeed, if basic conditions do not allow businesses to flourish, then special programmes, policies and strategies directed at helping businesses may not do much good in many cases and considerable harm in others. The federal government and the provinces and territories between them have an extensive array of such measures. At the same time, some key dimensions of the underlying economic framework remain inefficient and need to be improved.

Business taxation discourages investment, especially in some provinces

Firms in Canada faced one of the highest average marginal effective tax rates (METRs) on investment in the OECD in 2005. This means a worthwhile investment project before tax is less likely to be profitable after tax in Canada than elsewhere, slowing the rate of capital-deepening that is one source of productivity growth. Both federal and provincial/territorial governments tax businesses in a range of ways, and firms face considerable variations in the METRs. Two elements of provincial taxation have an especially pernicious effect. First, provincial capital taxes are levied on debt and shareholders' equity beyond a threshold in six provinces, including Ontario and Quebec. These taxes directly raise the cost of financing business investment for larger firms. Abolishing capital taxes as rapidly as possible would significantly improve the business environment in those provinces. Second, provincial sales taxes are not generally refunded on capital goods purchased by firms. This directly raises the cost of purchased machinery and equipment, discouraging investment. Existing Canadian value added taxes, such as the federal Goods and Services Tax (GST), the joint federal provincial Harmonized Sales Tax in place in three Atlantic provinces and the Quebec Sales Tax, ensure that sales taxes are not imposed on investment purchases or intermediate goods used in production. Therefore, a shift by the five provinces (including Ontario) that still have retail sales tax regimes to provincial value added taxes would create a more favourable investment climate. 

Marginal effective tax rates on capital in OECD countries
Medium and large companies, percentages, 2005

Source: Mintz, J., et al. (2005), "The 2005 Tax Competitiveness Report: Unleashing the Canadian Tiger", Commentary, No. 216, C. D. Howe Institute, Toronto.

Corporate tax should aim for a more level playing field, a broader base and lower rate

Corporate tax rules are complex at both the federal and provincial/territorial levels, and tax expenditures are significant. Both levels provide a significantly lower corporate tax rate for small businesses than for large ones. There are special federal tax breaks ranging from the Atlantic Investment Tax Credit through to sectoral tax credits, while provinces offer additional targeted measures. In addition, some provinces apply higher corporate tax rates to some sectors than others. All these factors combine to distort business decision-making by favouring manufacturing and primary production at the expense of services and penalising firms when, according to the tax rules, they grow from “small” to “large”. They may also lead managers to modify their business strategies to optimise tax rules and steer the economy away from the most efficient use of resources. Against this backdrop, the government’s announcement of further cuts in the federal corporate income tax rate is welcome, but it would be better still for all governments to undertake more comprehensive reform that broadened the corporate tax base and treated all businesses equally, regardless of size or sector. This would make room for a larger reduction in the standard corporate rate itself.

And value added taxes could contribute a greater share of tax revenues 

Canadian governments raise a higher share of government revenues by taxing businesses than do most countries and a lower share than most through value added taxes, such as the GST. However, value added taxation raises revenue more efficiently than either personal or corporate income tax, because it generally has a broader base and does less to discourage work, saving and investment. Nonetheless, the federal government has opted to reduce the federal GST rate from 7 to 6% and intends to cut it to 5% at some point. Provinces should take this chance to move closer to an optimal tax mix by lowering taxes on business and raising value added taxes. This would include replacing provincial retail sales taxes with value added tax structures harmonised with the GST. Doing so would provide a more productivity-friendly environment for business, without necessarily increasing the overall tax burden on consumers. If provinces do not take up this opportunity, then the efficiency of the overall tax structure in Canada will be reduced. 

More efficient product markets would also encourage higher productivity growth 

Vigorous product market competition on a level playing field leads both to a more efficient allocation of resources and to higher productivity growth. Although many product markets function well, there are some glaring exceptions where policy reforms are needed, including:

  • Liberalising highly regulated provincial electricity markets to obtain more efficient generation and use of such energy as well as to provide clear price signals for investment.
  • Lifting restrictions on foreign direct investment in airlines, telecommunications and broadcasting to boost competition by making the threat of entry more credible and to allow for infusion of new technology and management into those sectors.
  •  Dismantling the remaining obstacles to inter-provincial trade in services and promoting more vigorous competition in services by reducing the number of so-called “regulated occupations” to those where significant irreversible harm is likely and the benefits of restrictions clearly outweigh the costs.
  • Winding up agricultural supply management schemes and instead allowing prices in open markets to balance supply and demand. This would not only give all farmers more opportunities, it would also lead to significantly lower prices for Canadian consumers, especially for dairy products where large scarcity rents have been artificially created.
  • Minimise subsidies that distort competition, which include both some large one-off packages to specific companies and a plethora of programmes providing grants, soft loans and advice. This would reverse the rising trend in government transfers to business.
  • Introducing employer experience rating for unemployment insurance to remove the significant and persistent cross-subsidy to firms that repeatedly use that system to cover their seasonal and temporary workers. Alternatively, this subsidy element could be reduced by tightening the relevant eligibility criteria to limit access for seasonal and temporary workers.  

Financial market efficiency could be improved

Efficient financial markets contribute to the rate of growth. Overall, Canada’s financial sector is well developed and diversified and has performed reasonably well. However, some policies, such as bank ownership restrictions and political approvals for bank mergers, may impede gains in efficiency. Further streamlining entry requirements in banking would make it easier for new players, foreign or domestic, to enter the market, thereby adding to competitive forces in the sector. Provinces currently exercise responsibility for regulating securities markets. Substantial gains could be achieved by establishing efficient and effective Canada-wide securities regulation, but governments to date have not agreed on the appropriate model to adopt. Every effort should be made to reach a decision as quickly as possible.

How to obtain this publication                                                                                      

The Policy Brief (pdf format) can be downloaded. It contains the OECD assesment and recommendations but not all of the charts included on the above pages.

The complete edition of the Economic Survey of Canada 2006 is available from:


Additional Information                                                                                                  

For further information please contat the Canada Desk at the OECD Economics Department at The OECD Secretariat's report was prepared by Deborah Roseveare and Annabelle Mourougane under the supervision of Peter Jarrett.





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