navigating disruption: the politics of business tax reform ... 2019/issue 3/667_2019… · * of the...

canadian tax journal / revue fiscale canadienne (2019) 67:3, 667 - 92https://doi.org/10.32721/ctj.2019.67.3.sym.hale

667

Navigating Disruption: The Politics of Business Tax Reform as Two-Level Game

Geoffrey Hale*

P R É C I S

L’auteur aborde la politique de l’imposition des sociétés et de la concurrence fiscale internationale comme une série de jeux à deux (et parfois à multiples) niveaux qui s’enchâsse dans les débats plus vastes sur la concurrence internationale pour les investissements et la distribution des coûts et des avantages fiscaux au Canada. Se fondant sur plusieurs théories des relations internationales (néo-institutionnaliste, choix publics, et réaliste), l’auteur explore l’évolution du régime d’imposition des sociétés au Canada et la compare avec celle d’autres grands concurrents pour les investissements internationaux, en particulier les États-Unis — changements qui s’inscrivent dans un effort plus vaste pour équilibrer et intégrer les objectifs contradictoires et les objectifs qui se chevauchent des politiques économiques nationales et internationales. L’auteur résume le contexte historique et contemporain de la concurrence fiscale internationale, en particulier en ce qui concerne le fractionnement du revenu, les défis macroéconomiques et microéconomiques de l’arbitrage fiscal, et les compromis qu’implique la gestion de la politique fiscale nationale. L’auteur conclut en présentant les options possibles pour maintenir la souplesse fiscale et politique tout en réagissant efficacement à la concurrence fiscale croissante, comme l’incarne la réforme fiscale américaine de 2017 et d’autres changements politiques semblant indiquer une baisse de l’engagement politique à assurer un paradigme de l’économie ouverte chez les principaux partenaires commerciaux du Canada.

A B S T R A C T

The author addresses the politics of business taxation and international tax competition as an interactive series of two- (and sometimes multi-) level games embedded in broader debates over international competition for investment and the distribution of fiscal costs and benefits within Canada. Drawing on several international relations theories (neo-institutionalist, public choice, and realist), the author explores the evolution of Canada’s business tax system in relation to the evolving systems of other major competitors for international investment, especially the United States—changes that are occurring as part of a wider effort to balance and integrate competing and overlapping objectives of domestic and international economic policies. The author summarizes the historical and contemporary context for international tax competition, particularly with respect to

* OftheDepartmentofPoliticalScience,UniversityofLethbridge(e-mail:[email protected]).

668 n canadian tax journal / revue fiscale canadienne (2019) 67:3

income shifting, macro- and micro-challenges of tax arbitrage, and the tradeoffs involved in managing the domestic politics of taxation. The author concludes by identifying the options available for maintaining domestic fiscal and policy flexibility while responding effectively to growing tax competition, as embodied in the US tax reform of 2017 and other shifts in policy that point to declining political commitment to an open economy paradigm among Canada’s major trading partners.

KEYWORDS: CANADA-US n CORPORATE INCOME TAXES n FOREIGN INVESTMENT n INTERNATIONAL

TAXATION n TAX COMPETITIVENESS n TAX NEUTRALITY

C O N T E N T S

Introduction 668Tax Policies as Two- (or Multi-) Level Games 670Foreign Investment and International Tax Competition 676

The Evolving Context for International Tax Competition 679US Tax Reforms of 2017: Consequences for Cross-Border Tax Competition 686

Conclusion: Evolving Canadian Tax Policies for an Uncertain World 690

INTRO DUC TIO N

A central challenge in the structuring of Canada’s taxation system has been toattractandretaininternationalcorporateinvestment,includingthepromotionofregionallyandgloballycompetitiveCanadianbusinesses,whilereducingincentivesandopportunitiesfortaxarbitrage(includingbothadverseincomeandcostshift-ing)bybothCanadian-andforeign-basedcorporations.1Duringhiscareer,TimEdgaraddressedtheseissuesinconnectionwithbothincomingandoutgoinginvest-mentinthecontextofwiderinternationalanddomesticpolicies.2

International fiscal competition occurswhen governments deliberately struc-tureordesigntaxsystems,indetailorasawhole,inordertoenhanceorpreservetheirjurisdiction’srelativeattractivenessasadestinationforcapitalinvestmentandothermobilefactorsofproduction,includinghighlyskilledindividuals.Theydosoin response to similar actions by other governments or to the organizational and operationaldecisionsofcompaniesseekingtominimizetheirtaxliabilitieswithin

1 Arguably,federaltaxpoliciesinthe2006-2017periodweredesignedtopromoteincomeshifting toCanada,includingthelocationofheadofficesandotheroperationsinCanada,ratherthanpromotingcapitalimportneutrality.

2 Forexample,TimEdgar,“CorporateIncomeTaxCoordinationasaResponsetoInternationalTaxCompetitionandInternationalTaxArbitrage”(2003)51:3Canadian Tax Journal1079-1158;TimEdgar,Interest Deductibility Restrictions and Inbound Foreign Investment, research report preparedfortheAdvisoryPanelonCanada’sSystemofInternationalTaxation(Ottawa:DepartmentofFinance,October2008);andTimEdgar,“OutboundDirectInvestmentandtheSourcingofInterestExpenseforDeductibilityPurposes,”inArthur J.Cockfield,ed.,Globalization and Its Tax Discontents: Tax Policy and International Investments(Toronto:UniversityofTorontoPress,2010),60-83.

navigating disruption: business tax reform as two-level game n 669

thelaw.Accordingly,suchcompetitiveactionmaybeproactive,defensive,oracom-binationofboth.

Sincethe1990s,successivefederalgovernments inCanadahaveembracedan“openeconomyparadigm”3aimedatthenavigationofcross-cuttingpoliticalandeconomicinterests,domesticandinternational,inordertoenhanceCanadians’eco-nomicopportunities.Amajorobjectiveofthisparadigmhasbeentopromotethecompetitiveness of Canadian businesses in the context of North American andbroaderinternationalmarketintegration,notwithstandingthegrowingconstraintsonthiselementofglobalizationinrecentyears.Theconceptofcompetitivenessmayreflect(1) aggregatemeasurementsoftaxationanditsimpactonafter-taxreturnsoninvestment,or(2) keysector-specificmetricsofdisproportionaterelevancetoparticularindustries.

Ofcourse,governmentspursuethisobjectivealongsideotherkeypoliticalandeconomic goals, particularly the goal of domestic fiscal sustainability—that is,keepingoveralllevelsoftaxationandspendinginapproximatebalanceinordertofinancetheprovisionofessentialpublicservicesatlevelsconsistentwithmaintain-ing economic growth and improved living standards, and with constraining orreducingpublicdebtrelativetogrossdomesticproduct(GDP).Moreexplicitlypol-itical goals of the open economy paradigm include facilitating Canadians’adaptation to changing social and economic realities, promoting national resilience inthefaceofperiodicpoliticalandeconomicshocks,and(notthe leastof thesegoals)sustainingabroadenoughdistributionofthebenefitsofeconomicgrowthtosecureagovernment’speriodicre-election.Asaresult,althoughtheprevailing(ifnotalwaysobserved)normsoftaxpoliciesdiffer intheirformsofneutralityandothermeasurescalculated toenhanceeconomicefficiency, the tax system itselfexiststoservebroaderclustersofpublicpolicyobjectivesthatareoftendeeplyem-beddedinpublicexpectationsandpatternsofeconomicactivity.4

In this paper, I address the challenges of business taxation as an interactiveseriesoftwo-(andsometimesmulti-) levelgames,embeddedinbroaderdebatesover internationalcompetitionfor investmentandthedistributionoffiscalcostsandbenefitswithinCanada.Idrawonamixtureofinternationalrelationstheories(neo-institutionalist,publicchoice,andrealist)oftwo-levelgamesininternationaleconomicrelationstoexplaintheevolutionofCanada’sbusinesstaxsysteminrela-tion to the systemsofothermajor competitors for international investment—inparticular,theUnitedStates.Isummarizethehistoricalandcontemporarycontextof international tax competition, particularly as it relates to (1) income shifting,

3 DavidA.Lake,“OpenEconomyPolitics:ACriticalReview”(2009)4:3Review of International Organizations219-44,at224-31(https://doi.org/10.1007/s11558-009-9060-y);andRichardM.BirdandJ. ScottWilkie,“TaxPolicyObjectives,”inHeatherKerr,KenMcKenzie,andJackMintz,eds.,Tax Policy in Canada(Toronto:CanadianTaxFoundation,2012),2:1-39,at2:24-25.

4 Foradiscussionofmajorstructuralelementsofthetaxsystemastantamounttoconventionalelementsofaneconomicconstitution,seeGeoffreyHale,The Politics of Taxation in Canada (Peterborough,ON:BroadviewPress,2001),at64-87.


(2) the evolution of Canadian business tax policies in response to macro- andmicro-challengesoftaxarbitrage,and(3) thechallengesofmanagingthepoliticsoftaxationduringaperiodofpoliticalandeconomicuncertaintypossiblyunrivalledsincethe1970s.Thesethreeissueshavebecomeparticularlypressingwiththelong-deferredreactiontointernationaltaxcompetitionthattheUnitedStateshastakenintheTaxCutsandJobsAct(TCJA)of2017,andwithotherpolicyshiftsthatpointtoadecliningpoliticalcommitmentamongCanada’smajortradingpartnerstoanopeneconomyparadigm.

TA X P O LICIE S A S T WO - (O R MULTI -) LE V EL G A ME S

TheextentofNorthAmericanandwiderinternationaleconomicinterdependencereinforcestheintermesticdimensionofCanada’staxsystem—thatis,theblurringof traditionaldistinctionsbetweenprimarilydomesticand internationalpolicies5 (includingbutnotlimitedtobusinesstaxationpolicy)thatreflects“interlinkagesbetweenallpartsofthetaxsystem.”6 Scholars of international political economy note certain parallels between the efforts of different governments—particularlythegovernmentsofdemocraticcountries—tomanageinternationaleconomicandsecurityrelationships.Politicalleadersandtheirseniorofficialsenjoyadegreeofautonomyininternationalrelations.However,theyalsofacesignificantdomesticinstitutional and political constraints7—not the least ofwhich is the reality thatmajorfirmsandotherinvestorsareindependentactorswhoseinterestsmayoverlapwith,butremaindistinctfrom,thoseoftheircountriesofformalresidence.Therel-ativesuccessofanationalgovernment’sinternationaleconomicpolicies—whetherthesepoliciesare(1) unilateral,(2) theproductoftacitpolicyconvergencethroughvariousformsofparallelism,or(3) theproductofexplicitnegotiations—dependssignificantlyon thatgovernment’s capacity toachieve somedegreeof alignmentbetweentheinterestsofmajoreconomicactors,thenationalinterests,andthatgov-ernment’songoingrelationshipswithothergovernments.However,thedefinitionof“nationalinterests”isheavilyconditionedbythestructureofnationalpolitical

5 BaylessManning,“TheCongress,theExecutiveandIntermesticAffairs:ThreeProposals”(1976)55:2Foreign Affairs306-24(https://doi.org/10.2307/20039647).

6 MichaelKeen,LiLiu,andPeterHarris,“TaxingBusinessinaChangingWorld,”inCanada: Selected Issues,IMFCountryReport18/222(Washington,DC:InternationalMonetaryFund,June28,2018),4-31,at 18.

7 RobertD.Putnam,“DiplomacyandDomesticPolitics:TheLogicofTwo-LevelGames”(1988)42:3International Organization427-60;HelenV.Milner,Interests, Institutions, and Information: Domestic Politics and International Relations(Princeton,NJ:PrincetonUniversityPress,1997);andEugéniadaConceição-HeldtandPatrickA.Mello,“Two-LevelGamesinForeignPolicyAnalysis,”inOxford Research Encyclopedia of Politics(Oxford:OxfordUniversityPress,2017)(https://doi.org/10.1093/acrefore/9780190228637.013.496).


institutions, including the capacityof agiven structure to secure the consentoracquiescenceofformalandinformalvetoholdersorblockingcoalitions.8

Inthiscontext,effortstomanagefiscalandtraderelationsandtheinteractionsofnationalregulatorysystems(amongothersystems)helptocreateaseriesoftwo-and multi-level games embedded within broader governance processes thatcombine relations among governments, transnational actors, and varied domestic interestsinsideandoutsidegovernments.9Therestructuringofbusinesstaxsystems,whetherundertakeninconjunctionwithbroadertaxreforms,asduringthe1980s,orinresponsetochanginginternationalanddomesticbusinesspractices,asduringthe2000s,typicallyrequiresabalancingofcompetinggoalsinvolvingbothexternalanddomesticfactors.10

At its simplest, the concept of international economic relations as two-levelgames is rooted in the interdependence of international and domestic political and policy processes in participating countries—interdependence with one anotherand with largely market-driven economic processes and relationships.11 At one level,governmentsseektomanagetheirongoinginteractionswithothernationalorcentralgovernments—andwithotherinternationaleconomicactors—tomutualadvantagewithinrelativelystablelegalandeconomicarrangements.Theseprocessesarepunctuatedbytheperiodicnegotiationorrevisionofbilateralormultilateralagreements.Atasecondlevel,however,taxpolicyandothermajornationalregula-tory processes remain primarily national because of asymmetries of power,institutionalarrangements,therelativeinterdependenceorvulnerabilitybetweenandamongcountries,theprimacyofdomesticlegislativeauthority,andseniorpol-icymakers’desiretomaintaincontroloftheirrespectivepolicyagendas.

Thegreaterthepoliticalvisibilityorprospectiveeconomicimpactofsignificantchangestotaxpolicies(whetherthesechangesarisefromdomesticorinternationalconsiderationsorfromamixtureofboth),thegreatertherelativeimportanceofthesecondlevelofthegame—thatis,thelevelatwhichgovernmentsseektocreate,withrespecttoproposedchanges,asupportiveconsensuswithpublicopinionandkeydomesticstakeholders(or,atleast,seektocreatetheconditionsnecessaryto

8 EdwardD.MansfieldandHelenV.Milner,Votes, Vetoes, and the Political Economy of International Trade Agreements(Princeton,NJ:PrincetonUniversityPress,2012);andGeoffreyHale,“RegulatoryCooperationinNorthAmerica:DiplomacyNavigatingAsymmetries”(2019)49:1American Review of Canadian Studies123-49(https://doi.org/10.1080/02722011.2019.1570956).

9 Putnam,supranote7;Milner,supranote7;andGeoffreyHale,“Transnationalism,TransgovernmentalismandCanada-USRelationsintheTwenty-FirstCentury”(2013)43:4American Review of Canadian Studies494-511(https://doi.org/10.1080/02722011.2013.858757).

10 Hale,supranote4,at38et seq. 11 Thedegreeofpoliticizationoftheserelationshipsdependsontheextenttowhichthey

areintertwinedwithnationalsecurityconsiderations(aswithnuclearmaterialsandexportcontrolsoverdefence-relatedtechnologies)orwiththerelativepower(andrelatedelectoralcalculations)ofcentralandsubnationalgovernmentsoverparticulareconomicsectorsasinstrumentsofeconomicdevelopment,distributivepolitics,orboth.


diffuseprospectiveoractualopposition).Writingalmost40yearsago,DavidGoodobservedthatinsidersresponsibleforfederaltaxpolicy“maketaxpolicybyantici-patingtheoutsideworldand,totheextentdesirableandfeasible,byaccommodatingtaxpoliciestotheiranticipations.”12Thegreaterthetechnicalcomplexity(orrela-tiveobscurity)ofactualorproposedmeasures,thegreatertherelativeautonomyofbureaucraticpolicymakers,13aslongasthesepolicymakersenjoytheconfidenceandsupportof theirpolitical“masters.”FederalDepartmentofFinanceofficialshavesubstantiallyincreasedtheirengagementwithmajorstakeholdersandotherattentive actors, institutionalizing their consultationprocesses since thepoliticalfiascoof the 1981 tax reformbudget.14 Since that time, theseofficials have alsoconvenedperiodicadvisorypanels,whichusuallyinvolvebothprivateand(former)publicsectorexpertsonparticularlytechnicalorcontroversial issues,aswiththeAdvisoryPanelonCanada’sInternationalSystemofTaxation(2007-8).15

However,thesedebatesaretypicallyconfinedtoataxpolicycommunitycom-posedof(1) economistsandotherpolicyprofessionalswithintheDepartmentofFinance,(2) theselectgroupoftaxlawyers,accountants,andacademiceconomistswithwhomthepolicyprofessionalsinteract,and(3) other“attentiveactors”gener-ally interestedinparticularsegmentsoftaxpolicyratherthaninthesystemasawhole.Good’sobservationthat“[a]ttentiveactors. . .areseparateandisolatedcom-ponents . . .distinguished fromeachotherbyahighlyparticularized interest intaxation”16 appears to be as true as it everwas, particularly in highly technical,specializedfieldssuchasinternationaltaxation.Broaderpublicengagementgener-allyoccursonlywhenthedebatebecomespoliticizedasaresultofdivisionswithinthetaxpolicycommunityorasaresultofpolicymakers’failuretoanticipatead-equatelythedisruptiveeffectsofproposedpolicychangesonentrenchedinterestsorordinarycitizens.17Two-levelgamesfocusedonparticularpolicyinitiativesmayturnintomulti-levelgameswhentheyaffectcompetingsetsofinstitutionalinter-estsandobjectiveswithingovernmentsthatareinteractingwithcompetingsetsofcorrespondingeconomicand/orsocietalinterests.

Policymakersanddisciplinaryexpertswithinthetaxpolicycommunityseektobalance(1) theinstitutionalobjectivesofmaximizingoverallrevenues(asopposedtomaximizingrevenuesfromparticularsources)inwaysthatareleastdisruptivetoeco-nomicactivitywith(2) competinggovernmentalandsocietalinterestsandobjectives

12 DavidA.Good,The Politics of Anticipation: Making Canadian Federal Tax Policy(Ottawa:CarletonUniversity,SchoolofPublicAdministration,1980),at xi.

13 EricA.Nordlinger,On the Autonomy of the Democratic State(Cambridge,MA:HarvardUniversityPress,1981).

14 Hale,supranote4,at162-74.

15 AdvisoryPanelonCanada’sInternationalSystemofTaxation,Final Report: Enhancing Canada’s International Tax Advantage(Ottawa:DepartmentofFinance,December2008).

16 Good,supranote12,atxii-xiii.

17 Good,ibid.;andHale,supranote4.


(includingthegovernment’sprospectsofperiodicre-election).18 Good has described thesebalancingprocessesas“thepoliticsofanticipation.”19 Savoie and others have characterizedthemastheinstitutionalizedcompetitionof“guardiansandspend-ers.”20Withinthisframework,the“guardian”roleoftheDepartmentofFinance,particularlyitstaxpolicybranch,islargelydefensive—whetherinanticipatingandlimitingrisksof taxarbitrageandotherunintendedconsequencesofprospectivetax policydecisions,orinreactingtoaggressivetaxarbitrageandavoidancestrat-egiesusedtoexploitpastpolicydecisionsortoleveragemodestpolicyanomaliesintomuchbroaderfiscalcrevasses.21 Other governments face similar challenges, includingtherelativecentralizationordiffusionofresponsibilityforoversightofcomparable policies across governments, differences in the legal or institutionalprocessestobenavigated,andthepresenceofprospectivevetoplayerswhosecon-sentmust be negotiated either by governments or through cross-national policycoalitions.22

However, international tax policies of particular governments are typicallyembeddedwithinandlargelydependentonthestructuresofnationaltaxpolicies,asnotedabove.Themajorfeaturesofagovernment’sinternationaltaxpolicyarerelativelydurable, and they are shapedbydomestic institutions, slowly evolvingbalancesofeconomicandsocialinterests,andpoliticalandbureaucraticperceptions

18 Threeelementsofthisinternaldebate—inwhichadvocatesofthe“openeconomy”paradigmwithintheCanadiantaxpolicyhavecometoconclusionsthatdifferfromprevailingoutlooksintheUnitedStates—arethefollowing:(1) theroleofcorporateincometaxation(“withholdingtax”and“backstop”asopposedtoprimaryinstrumentofredistribution),(2) theultimateincidenceofcapitaltaxation(itseventualdistributionamongworkers,consumers,andshareholders),and(3) theefficiencyeffectsor“deadweightloss”ofdifferentformsoftaxationindifferenteconomicsettings.Richard M.BirdandThomas A.Wilson,“TheCorporateIncomeTaxinCanada:DoesItsPastForetellItsFuture?”(2016)9:38SPP Research Papers [UniversityofCalgary,SchoolofPublicPolicy]1-32;GeoffreyHale,“Cross-BorderFiscalCompetitionandTaxReform,”paperpresentedtotheAssociationofCanadianStudiesintheUnitedStates,”LasVegas,October 20,2017;andGeoffreyHale,“InstitutionsMatter:FiscalCompetitionandTaxReformintheUnitedStatesandCanada,”paperpresentedtotheWesternSocialSciencesAssociation,Houston,April 7,2018.

19 Good,supranote12. 20 Donald J.Savoie,The Politics of Public Spending in Canada(Toronto:UniversityofToronto

Press,1990);andDavid A.Good,The Politics of Public Money,2d ed.(Toronto:InstituteofPublicAdministrationofCanadaandUniversityofTorontoPress,2014).

21 Thetwomostnotoriousexamplesofsuchexploitationinrecentmemoryareprobablythescientificandresearchtaxcredit(SRTC)fiascoofthemid-1980sandthespectaculargrowthofincometrustsbetween1999andOctober 31,2006(thedateofFinanceMinisterJimFlaherty’spre-emptionofthistechniqueoutsidetherealestatesector).CurrentFinanceofficialspointtotherapidgrowthofself-incorporationbymembersofprofessionalfirms,whichpromptedthefederalgovernment’scontroversialeffortstocontainaccesstosmallbusinesstaxpreferencesin2016asagrowingformoftaxarbitrage.AlexandraPosadski,EricAtkins,andDavidParkinson,“SmallBusiness,BigTrouble,”Globe and Mail,September16,2017;andKeenet al.,supranote 6,at 5-6.

22 Hale,supranote8;andMansfieldandMilner,supranote8.


ofnational,institutional,andpolitical(self-)interest.23 Pantaleo and Smart observe that“Canadausesallthreepatterns[ofinternationaltaxation]:worldwide,territorial,andremittancebasis(ordeferral). . .depend(ing)onthenatureofboththetax-payerandtheincome.”24Notwithstandingsignificantstructuralreformsinthe1980s,thecentralelementsofCanada’sexistingtaxsystemweredesignedduringaperiodofrelatively limitedinternational interdependence,althoughtheformallyworld-widecharacterofitsbusinesstaxsystemhasevolvedintoa“de facto territorial form ofinternationaltaxationforactive(business)income.”25

ThegrowthofCanada’sinterdependencewiththeNorthAmericanandglobaleconomiessincethe1980shasreinforcedcross-cuttingformsoffiscalandtaxcom-petition at several levels in allocating the costs and benefits of governmentactivities—competitionbetweencitizens(or“residents”)andgovernments,betweenindividualsandcorporations(aswellaslargeandsmallfirms),betweennationalandforeign governments, and among their citizens, who benefit to varying degreesfromdifferentkindsofinternationalinvestment.Insomecases,asdiscussedinthenextsectionofthispaper,majortaxpolicychangeshaveaccompaniedorfollowedfundamental changes in Canada’s international relationships—most notably, thenegotiationoftheCanada-USFreeTradeAgreementin1986-87andthesubsequentrapidgrowth inboth inboundandoutboundstocksof foreigndirect investmentrelative to GDP. Inothercases, these taxpolicychangeshavebeenresponses toincrementalchangesintheinternationalpolicyenvironment—forexample,changesinmarginaltaxrates,thincapitalizationrules,andthedebatesoverwhether(andhow) torestrict thedeductibilityofarm’s-length interestpaymentsonthe inter-nationaltransactionsthatweretheobjectofmuchofTimEdgar’sresearch.26

ChangestodomestictaxpoliciesinCanadaandinitsmajortradingpartners,especiallytheUnitedStates,createpolicyexternalities,bothforothergovernmentsand(particularly)forbusinessesthatoftenincorporatetaxconsiderationsintotheirallocationofinvestments,organizationofsupplychains,andchoiceoftransactionalformsacrossjurisdictionalboundaries27—a“bottom-up”formoftaxcompetition.Cockfieldhasobservedthatgrowinginternationaleconomicintegration,combinedwithdifferencesinnationaltaxrules,hasincreasedcompetitionbetweennational

23 Hale,supranote4,at63-87.SeeDouglasG.Hartle,The Revenue Budget Process of the Government of Canada: Description, Appraisal, and Proposals,CanadianTaxPaperno. 67(Toronto:CanadianTaxFoundation,1982);Savoie,supranote 20;andGood,supranote 20.

24 NickPantaleoandMichaelSmart,“InternationalConsiderations,”inTax Policy in Canada, supranote 3,12:1-48,at 12:4.

25 Keenet al.,supranote6,at7;compareSimonRichardsandDylanGowans,“CorporateIncomeTaxesinCanada:Revenue,RatesandRationale,”HillNotes,March 21,2017(https://hillnotes.ca/2017/03/21/corporate-income-taxes-in-canada-revenue-rates-and-rationale/).

26 Edgar,Interest Deductibility Restrictions,supranote 2;andEdgar,“OutboundDirectInvestment,”supranote 2.

27 Edgar,“CorporateIncomeTaxCoordination,”supranote 2,at1081.


governmentsandmultinationalfirmsbyencouragingthelatterto“shiftthelocationoftheirinvestmentsandoperationstocountriesthatimposerelativelylower. . .taxburdens,”28andtoengageintaxarbitragebetweenandamongcountriesthroughsophisticatedtax-planning,financial,andtransfer-pricingstrategies.29

Asaresult,governmentshavebecomeincreasinglysensitivetotheuseofincomeshiftingandotherformsoftaxarbitragetoreducetheirtaxbases—amajorconcernraisedbythe1997reportoftheTechnicalCommitteeonBusinessTaxation(“theTechnicalCommittee”).Federaltaxpoliciessince2000havebeenaimedatreduc-ing Canada’s vulnerability to such activities, creating a relatively favourableenvironmentforinternationallycompetitiveCanadiancompanies,andwelcominginwardforeigninvestment(outsideahandfulofprotectedsectors).30

Themulti-levelgameoftaxcompetitionfunctionswithinadynamicenviron-ment characterizedby amixtureof intergovernmental competition, cooperationinnavigatingdifferencesbetweennationaltaxsystems,andevolvingstrategiesofadaptationtochangingfiscalandothercompetitiveconditionsbyCanadian-andforeign-based multinational corporations (MNCs), with implications for invest-mentflows, employment, andgovernment revenues.Nationalgovernmentsmaycooperateselectivelytolimitbothdoubletaxationandthearbitragethatresultsintaxbaseerosion,bothofwhichresultfromtaxcompetitionanddifferencesamongnationaltaxsystems.Suchcooperativearrangementsmaytaketheformof“hardlaw,”asinbilateraltaxtreaties,orof“softlaw”thatisdependentonintegrationwithnationallegalsystems,suchastherecentOrganisationforEconomicCo-operationand Development (OECD)multilateralconvention31 and its International VAT/GST [value-added tax/goods and services tax]Guidelines of 2017.32 Even so, Arnold notesthatsuchmeasuresare“essentiallyproductsofdomesticlaw. . .thataffectcross-bordertransactions,”33aswithmanyotherformsofinternationalregulatorycooperation.34

28 ArthurJ.Cockfield,“Introduction:TheLastBattlegroundofGlobalization,”inGlobalization and Its Tax Discontents,supranote 2,3-17,at 5.

29 Ibid.,at6;andEdgar,“CorporateIncomeTaxCoordination,”supranote2. 30 GeoffreyHale,Uneasy Partnership: The Politics of Business and Government in Canada,2ded.

(Toronto:UniversityofTorontoPress,2018),at291-315. 31 OrganisationforEconomicCo-operationandDevelopment,MultilateralConventionTo

ImplementtheTaxTreatyMeasuresToPreventBaseErosionandProfitShifting,releasedNovember 24,2016.

32 OrganisationforEconomicCo-operationandDevelopment,International VAT/GST Guidelines (Paris:OECD,April12,2017).

33 BrianJ.Arnold,“Canada’sInternationalTaxSystem:HistoricalReview,ProblemsandOutlookfortheFuture,”inCanada’s International Law at 150 and Beyond,Paperno. 8(Waterloo,ON:CentreforInternationalGovernanceInnovation,February2018),1-12,at 1-2.

34 Anne-MarieSlaughter,A New World Order(Princeton,NJ:PrincetonUniversityPress,2004).


Asaresult,Canadiansgovernmentshavetendedtowardtheincrementaladapta-tion of domestic tax policies to changing international conditions.High-profilemeasures, such as the elimination of capital taxes on non-financial corporations(2002-2008)andphasedreductionsincorporatetaxrates(2006-2012),havebeencombinedwithbroaderreductionsinpersonalincomeorconsumptiontaxratesthatareintendedtomaintainaroughbalancebetweenlevelsofpersonalandbusinesstaxation,andwithothermeasuresintendedtomeetbroaderfiscaltargets,suchasbalancedbudgetsorthegradualreductioninfederal-net-debt-to-GDPratios.

FO REIGN IN V E S TMENT A ND INTERN ATIO N A L TA X COMPE TITIO N

[T]he main policy challenge [in tax reform] is to develop effective international tax rules and processes within what is essentially a non-cooperative government setting.35

International tax competition takesplace indifferentdimensionsbecauseofdif-ferences in the structures of national tax systems (and relateddomestic politicalexpectations) anddifferences in thenational rates of taxation for different typesof economic activity.Governmentsmay engage in tax competition innumerousways:bysettingmarginaltaxratesbelowthoseofmajorcompetitors,byprivilegingvariousformsofeconomicactivity,orbyalteringtaxstructures—forexample,bycreatingterritorialtaxstructuresthattaxdomesticbutnotactiveoffshorebusinessincome.

Policymakersmustdecidehowtointegrateorprioritizedifferentformsoftaxneutrality—thatis,theapplicationofequalorsimilartaxratestobusinesses(andothertaxpayers)thatareinsimilarcircumstances.Inprinciple,governmentsmayseektopursuecapitalimportneutrality(CIN),inwhichforeign-basedanddomes-tically based firms are taxed at similar rates on business operations in the samejurisdiction;orcapitalexportneutrality(CEN),inwhichtheforeign-sourceincomeof domestically based MNCsistaxedatratescomparablewiththeratesappliedtoincome from theirdomesticbusiness activities.36 CIN is typically associatedwithsource-basedorterritorialtaxsystems,aswellaswitha“level-playingfield”betweendomesticbusinessesandaffiliatesofforeign-basedfirms.37 CENisassociatedwithresidence-based or worldwide tax systems and, in principle, with the pursuit ofglobalproductionefficiencyintheinternationalallocationofcapital.38

35 Cockfield,supranote28,at8. 36 Canada,Report of the Technical Committee on Business Taxation(Ottawa:DepartmentofFinance,

April1998),at6:3-4;AdvisoryPanelonCanada’sSystemofInternationalTaxation,supranote 15,at 12-13;andJaneG.Gravelle,Reform of U.S. International Taxation: Alternatives,CRSReportRL34115(Washington,DC:CongressionalResearchService,August1,2017),at 3-7.

37 MichaelP.Devereux,Taxation of Outbound Direct Investment: Economic Principles and Tax Policy Considerations,researchreportpreparedforAdvisoryPanelonCanada’sInternationalSystemofTaxation(Ottawa:DepartmentofFinance,July2008),at 4-5and9-10.

38 Ibid.,at6.


Inpractice,manycountries,includingCanada,havehybridsystemsthatrecog-nizethedifficulty,ifnottheimpossibility,ofachievingcapitalimportandexportneutralitysimultaneously.39Thegrowthininternationaleconomicintegrationandthe expansion ofMNCs based inmultiple countries, includingCanada, have ledto thespreadofathirdconceptofneutralitythatsupportssource-based(territorial)taxationofactivebusinessincome.Theobjectiveofthisformofneutrality—namely,capitalownershipneutrality(CON),sometimescalled“marketneutrality”—isthat“[t]axes shouldnotdistortcompetition . . .betweenanycompaniesoperating inthe same market.”40 Canadian governments seeking to promote internationallycompetitive, Canadian-based MNCs in the absence of effective coordination ofinternationaltaxationregimeshaveembracedCONforactivebusiness income, ifnotwithoutcontroversyamongchampionsofothernormativetaxprincipleswithinthetaxpolicycommunity.41Atthesametime,thesegovernmentshaveusedevolv-ingforeignaccrualpropertyincome(FAPI)rulestopreservetheircapacitytotaxpassive international income by limiting the conversion of active to passive income ofCanadian-basedfirms’foreignaffiliates.

However,asnotedabove,Canadiangovernments facecross-cuttingpressuresinmanaging international taxcompetition,pressures that impose limitson theireffectiveautonomy.Atthelevelofdomesticpolitics,thesegovernmentsarecon-strained by public expectations (expectations rooted in normative principles ofverticalequity)thatcorporateincometaxationshouldcontributetopublicservices,incometransfers,andotherredistributivefunctions.Threemajorpolicyconsider-ationshavedisciplinedpolicymakers’responsestothesepressures.First,thereisstrongeconomicevidencethatinrelativelysmall,openeconomies,highertaxesoncapitalhaverelativelyhighadverseeffectsoneconomicgrowth.42 Second, there is widespread recognition amongCanadian tax economists (unlikeUS economists)thatasizeableshareofcapitaltaxationisultimatelybornenotprimarilybyshare-holders but byworkers (in the form of lowerwages) and by consumers (in the

39 PantaleoandSmart,supranote24,at12:4;andDavidA.Weisbach,The Use of Neutralities in International Tax Policy,Coase-SandorInstituteforLaw&EconomicsWorkingPaperno. 697(Chicago:UniversityofChicagoLawSchool,Coase-SandorInstituteforLawandEconomics,August2014).

40 Devereux,supranote37,at11.

41 Forexample,Arnold,supranote33,at11,criticizesthedeductibilityofinterestonfundsloanedtoforeignaffiliatesofCanadian-basedfirmstogenerateactivebusinessincomethatiseffectivelytax-exemptinCanadaasa“dubiouspolicyofsubsidizingoffshoreinvestmentbyCanadianmultinationals.”

42 MaximilianBaylorandLouisBeauséjour,Taxation and Economic Efficiency: Results from a Canadian CGE Model,WorkingPaper2004-10(Ottawa:DepartmentofFinance,November2004);andKevinMilligan,Tax Policy for a New Era: Promoting Growth and Fairness,Benefactor’sLecture2014(Toronto:C.D.HoweInstitute,November2014).


formofhigherprices).43Third,although the statisticsvaryacross typesofbusi-nesses,availabledataindicatethatmorethanhalfofbusinesstaxcostsareincurredthroughprofit-insensitivetaxes.44TheTechnicalCommitteesuggestedthatthesetensionsshouldbemanagedbymorecloselyaligningprofit-insensitivetaxeswiththebenefitsreceivedbythebusinessesthatpaythem.45However,theenthusiasmwithwhichfederalofficialsresortedtouserfeesduringOttawa’sfiscalrestructuringofthe1990sledFinanceMinisterJohnManleyin2002,followingstrongpressurefrombusinessgroups,toimposestrongparliamentarychecksontheintroductionofnewuserfees.Theserestrictionswererelaxedonlywiththe2017federalbudget.46

Second,Canada’srelativelyopen,trade-dependenteconomyhaslongconstrainedgovernments’taxingofmobilefactorsofproductionbyenforcingeffectivecorpor-ateincometax(CIT)ratesthatarerelativelycompetitive,particularlyincomparisonwiththeUSrates.47TheseconstraintsweredecisiveinCanada’sshifttovalue-added

43 Report of the Technical Committee on Business Taxation,supranote 36,at1:3;Jonathan R.KesselmanandRonCheung,“TaxIncidence,ProgressivityandInequalityinCanada”(2004)52:3Canadian Tax Journal709-89;BirdandWilkie,supranote 3;Robin W.BoadwayandJean-FrançoisTremblay,Modernizing Business Taxation,C.D.HoweInstituteCommentaryno. 452(Toronto:C.D.HoweInstitute,May2016);andKenneth J.McKenzieandErgeteFerede,“WhoPaystheCorporateTax?InsightsfromtheLiteratureandEvidenceforCanadianProvinces”(2017)10:6SPP Research Papers[UniversityofCalgary,SchoolofPublicPolicy]1-26.

44 TheCIT’sshareoftotalbusinesstaxationvarieswidelywithcyclicallevelsofcorporateprofitabilityandshiftsintheoverallfederal-provincialtaxmix.TheCIT’sshareoftotalbusinesstaxationincreasedfrom22 percentin1995toabout37 percentin2015,andto43 percentin2016.Report of the Technical Committee on Business Taxation,supranote36,at2:19;andPeterVanDyckandAndrewPackman,Total Tax Contribution and the Wider Economic Impact: Surveying Canada’s Leading Enterprises(Toronto:PricewaterhouseCoopersandtheBusinessCouncilofCanada,2018)(https://thebusinesscouncil.ca/publications/2018ttc/).

45 Report of the Technical Committee on Business Taxation,supranote36,at1:7and1:10-11.

46 FordiscussionoftheUserFeesAct,SC2004,c. 6,andtheeffectiveconstraintsthatitimposedontheexpansionofuserfeesbythefederalpublicservicebeforeitsreplacementbytheServiceFeesAct,SC2017,c. 20,section 451,seeConnieHache,“FinancingPublicGoodsandServicesthroughTaxationorUserFees:AMatterofPublicChoice?”(PhDdissertation,UniversityofOttawa,SchoolofPoliticalStudies,2015)(http://citeseerx.ist.psu.edu/viewdoc/download?doi=10.1.1.1032.3659&rep=rep1&type=pdf ).A2017SenatereportcriticizedtheServiceFeesActfor“removingallmeaningfultransparencyandconsultations”fromproposedincreasesinuserfees.AndrewGriffith,“BillC-44Division 21:RisksandImplicationsoftheServiceFeesAct,”brieftoSenateCommitteeonNationalFinance,at2(https://sencanada.ca/content/sen/committee/421/NFFN/Briefs/C-44__Brief_e.pdf ).

47 Canada.DepartmentofFinance,The Tax Systems of Canada and the United States: A Study Comparing the Levels of Taxation on Individuals and Businesses in the Two Countries(Ottawa:DepartmentofFinance,November1978)(releasedwiththeNovember 16,1978federalbudget);andCanada,“RoleofMarginalEffectiveTaxRatesinCanadianTaxPolicy,”presentationtoMENA-OECDInvestmentProgram,Paris,January2009(www.oecd.org/mena/competitiveness/42031384.pdf );andHale,supranote 30,at302-11.


taxationsincetheearly1990s,graduallyfollowedbytheshifttosalestaxharmon-izationinthesixprovinceseastofManitoba,whichcontributedtosharplylowermarginaleffectivetaxrates(METRs)inparticipatingprovinces.48However,atrans-ideological taxpayers’ revolt,49which resulted in the reversalof aharmonizationagreementinBritishColumbiain2010,alongwiththecontinuingpublicresistancetohigherconsumptiontaxesreflectedbywidespreadpoliticaloppositiontorisingcarbontaxes,demonstratethepracticalpoliticallimitsofsuchastrategy,especiallyifitisintroducedwithoutequivalentfiscalcompensationtotaxpayers.50

Third,effortstoreducecorporatetaxesinresponsetowideinternationaltrends(andinresponsetotheefficiencyargumentsnotedabove)areconstraineddomes-ticallybypublicexpectationsthatsuchtaxreductionswillbematchedorexceededbycomparabletaxreductionsforindividualsandhouseholds,withdueattentivenesstodistributiveconsiderations.SincethepoliticalfiascoofAllanMacEachen’staxreformbudgetof1981,Canadianpoliticalleadershavetypicallybeenunwillingtopursue substantive tax reform initiatives unless they canbepackaged as broadlybasedtaxreductionformostCanadiantaxpayers.51Moreover,inCanada,unliketheUnitedStates, substantial changes to federal taxpolicies involving tax reductionhavetypicallybeenconditionalonfiscalsustainability,whethersuchsustainabilityisbasedoncontinuedeconomicgrowthorstrictspendingdiscipline.Theseconstraintshelptoexplaintherelativelytargetedcharacterof initial federalresponsestoUS businesstaxreformsof2017inCanada’seconomicstatementofNovember2018.52

The Evolving Context for International Tax Competition

Whether in settingmarginal tax rates ormaking adjustments tomajor businesstax incentives,Canadiangovernmentshavealwaysbeensensitivetointernationaltax

48 Hale,supranote30,at302-5. 49 GeorgeMalcolmAbbott,“ThePrecariousPoliticsofShiftingDirection:TheIntroductionof

aHarmonizedSalesTaxinBritishColumbiaandOntario”[2015]no. 186BC Studies: The British Columbia Quarterly125-48(https://doi.org/10.14288/bcs.v0i186.185567).

50 TheTrudeaugovernmenthastacitlyrecognizedthisreality,respondingtogrowingpoliticalresistancetotheintroductionofcarbontaxesinseveralpartsofCanada,bycraftingitscarbontax“backstop”forprovincesthatwithdrawfromorrefusetoparticipateinthefederalschemetorecyclemostrevenuestoresidentsofprovincestowhichtheschemewillapply.See“FortheLiberals,aSpoonfulofSugarHelpstheCarbonTaxGoDown,”Globe and Mail,October 24,2018.Federalsupportfor“emissions-intensivetrade-exposed”(EITE)industriesreflectssimilareffortstomitigatethecompetitiveeffectsofintroducingcarbontaxesintheabsenceofcomparableactionsbyCanada’smajortradingpartners.SarahDobsonandJenniferWinter,“AssessingPolicySupportforEmissions-IntensiveandTrade-ExposedIndustries”(2018)11:28SPP Research Papers[UniversityofCalgary,SchoolofPublicPolicy]1-44.

51 TheintroductionofthefederalGSTin1990wastheexceptionthathasprovedtherule.FinanceMinisterMichaelWilsonmadethetaxvisibleatpointofsaleinordertodiscouragehissuccessorsfromraisingitinfuture(conversationwithauthor,1994),whateveritseffectsontheMulroneygovernment’sprospectsforre-election.

52 Canada,DepartmentofFinance,Investing in Middle Class Jobs: Fall Economic Statement 2018 (Ottawa:DepartmentofFinance,November2018).


competition,particularlyasitaffectsinvestmentandemploymentinmajorCanad-ianindustries.53 At the same time, these governments have acted repeatedly, albeit oftenwithlimitedsuccess,tolimittheerosionofCanada’sincomeandconsumptiontaxbasesbyvariousformsoftaxarbitrage.Thesefactorsreflectmajorelementsofthe“macro,”sectoral,and“micro”dimensionsoftaxcompetition.

AlthoughthescaleofCanada’srelativeinternationalinterdependencehasfluctu-ated,themaintainingofcompetitiveeffectivetaxratesfortradedsectorshasbeenamajorobjectiveofCanadianpoliciesformanyyears.Ottawa’sapproachtoCIT rate-setting strategies and to restrictions on income-shifting practices has generally been defensive—a response to incremental trends (or periodic tax reforms) in othercountries.Since1989,Ottawahasbeenmoreinnovativeinaddressingcompetitiveissuesrelatedtoconsumptiontaxes—inlargemeasurebecauseofcompetitivepres-suresandopportunitiescreatedbytheabsenceofanationalsalestaxintheUnitedStates.

Federalandprovincialgovernmentshavealsosoughttoaddresscompetitivenessissuesinmanagingtheevolutionofenvironmentaltaxation,whetherinparallelingUSfederaland/orstatepolicyinitiativesbefore201054ortheformer’ssubsequentfederalinactiononcarbon-pricingmeasures.TheTrudeaugovernment’sdecisiontoimplement(withoutcorrespondingUSaction)anationalcarbon-pricingstrategyinresponsetoCanada’s2017ParisAccordcommitmentsillustratesthenumerouschallengesofbalancingenvironmentalobjectives,competitivenessissues,andtrade-offs imposedbyCanada’s decentralized federal system and regionally diversifiedenergyendowments.

Canada has tracked effectiveUS tax rates, particularly for manufacturing, tovaryingdegreessincethe1970s,althoughthiswasdonemoreasaninformalthana formal policy goal until theHarper government committed itself in 2006 toachieving“thelowesttaxrateonnewbusinessinvestmentinthe[GroupofSeven]G7.”55 Successive efforts to reform the antiquated federal sales tax, culminatingin its replacement by the federal GST in 1990, sought to limit progressive baseerosionwhileachievingneutralityinthetaxtreatmentofdomesticandimportedgoodsandservicesinaneconomycharacterizedbythegrowingdisaggregationofbusinessactivity.56MajortaxreformsintheUnitedStatesandGreatBritain,whichsignificantlyreducedmarginalincometaxratesforindividualsandbusinessesinthe

53 The Tax Systems of Canada and the United States,supranote47;Report of the Technical Committee on Business Taxation,supranote 36;and“RoleofMarginalEffectiveTaxRatesinCanadianTaxPolicy,”supranote 47.

54 GeoffreyE.Hale,“Canada-USRelationsintheObamaEra:WarmingorGreening?”inG. BruceDoernandChristopherStoney,eds.,How Ottawa Spends, 2010-2011: Recession, Realignment, and the New Deficit Era(MontrealandKingston,ON:McGill-Queen’sUniversityPress,2010),48-67.

55 Canada,DepartmentofFinance,Advantage Canada: Building a Strong Economy for Canadians (Ottawa:DepartmentofFinance,October2006),at14and73-78.

56 Hale,supranote4,at207-23.


mid-1980s,createdbothdemonstrationeffectsandpoliticalimperativesforotherindustrialcountries,includingCanada.57Morerecently,therapidgrowthofdigitalcommerce has created challenges in the enforcement of VATs on cross-border com-merce,andithasintensifieddebatesoverregistrationrequirementsforlarge-scaleoffshorevendors.58

Canadacontinuestohaveoneoftheworld’smostopeneconomies,asillustratedby the relative importance of international trade and investment as a share of the country’sGDP,andthisincreasestherelativeimportanceofCanada’staxcompeti-tiveness and fiscal sustainability. Two-way trade accounted for 64 percent ofCanada’sGDPin2017,thefourth-highest percentageintheGroupofTwenty(G20)afterGermany,Korea,andMexico.59At90.1 percentofGDP,Canada’stotalstockofoutwardforeigndirectinvestment(FDI)isthelargestamongG20nations,asisthetotalvalueofCanada’sinwardFDI, based on the OECDdefinitionof“equity”plusnetloanstoenterprisesinforeigneconomiesthatresultinatleast10 percentownershipof foreignaffiliates.Keenetal.estimate thatUS-basedmultinationalshavegeneratedabout15 percentofCITrevenuesinrecentyears60—afigurethatissubject tosignificanterosiondependingontheeffectivenessofCanadianfederalresponses to recent UStaxreforms.

Table1outlinesoutwardandinwardstocksassharesofGDPforCanadaandtheworld’slargesteconomiesbetween2005and2017.Table 2pointstolonger-termtrendsininwardandoutwardFDI,usingStatisticsCanada’sequity-basedmeasure-ment.Differencesbetweenthetwobenchmarksillustratetherelativeimportanceofrelated-partydebtinthestructuringofforeignaffiliates.

Canada’saverageoutwardandinwardflowsofFDIinthe2008-2017periodhavealso been among the largest of G7andG20countries,averaging3.7and2.6 percentof GDP,respectively,between2008and2017(substantiallyabovetheG7averagesof1.9and1.2 percent,respectively).61However,non-taxconsiderations—notleasttheglobaltakeoverboomof2005-2007andtheebbandflowofinternationalenergyinvestments(ordisinvestmentsin2016-17)—havetypicallyplayedlargerrolesin

57 Ibid.,at192-98;andUnitedStates,CongressionalBudgetOffice,Corporate Tax Rates: International Comparisons(Washington,DC:CongressionalBudgetOffice,November2005).

58 BrunoBasalisco,JimmyGårdebrink,MartinaFacino,andHenrikOkholm,E-commerce Imports into Canada: Sales Tax and Customs Treatment(Copenhagen:CopenhagenEconomics,March2017);PricewaterhouseCoopers,Rise in Canada’s De Minimis Threshold: Economic Impact Assessment(Toronto:RetailCouncilofCanada,December2017);RosalieWyonch,“CompetitiveDigitalTaxationforFederalBudget2019,”C.D.HoweInstituteIntelligence Memo,December 12,2018;andJackMintz,“WhoDaresToTaxtheFlix?”Financial Post, January 22,2019.

59 WorldBank,“Trade(%ofGDP),”2018(https://data.worldbank.org/indicator/ NE.TRD.GNFS.ZS).

60 Keenetal.,supranote6,at28,note7.

61 OrganisationforEconomicCo-operationandDevelopment,“FDIFlows,”2019(https://doi.org/ 10.1787/99f6e393-en).


thesedevelopmentsthantaxconsiderations,withtwomajorexceptionsdiscussedlaterinthissection.

AlthoughboththeUnitedStatesandCanadaraisedtaxesduringthe1990saspartofbroadbudget-balancingstrategies, the1997TechnicalCommitteereportnotedthatCanada’sMETRsweresubstantiallyaboveinternationalnorms,creatingbothopportunities and incentives for income shifting through theaccumulationofdebtfinancinginCanadianoperationsofmultinationalfirms.AkeystructuralchallengeinlimitingincomeshiftingisthatCanada’sincometaxsystem(likethatoftheUnitedStatesbefore2018)makesfinancingexpansionthroughdebt“inherentlytax-preferredtoequity.”62

TABLE 1 Outward and Inward Direct Investment: Canada in International Context

Outward Inward

2005 2011 2017 2005 2011 2017

percentage of GDP

Canada . . . . . . . . . . . . . . . 59.2 49.9 90.1 54.6 48.2 65.2UnitedKingdom . . . . . . . 49.1 65.6 61.7 31.2 43.9 61.2EuropeanUnion. . . . . . . 34.6 48.0 66.5 29.9 38.4 57.4Germany . . . . . . . . . . . . . 29.1 38.1 43.5 22.6 26.3 25.8United States . . . . . . . . . . 27.8 29.1 40.4 21.5 22.6 40.5Japan . . . . . . . . . . . . . . . . 8.3 15.2 30.7 2.1 3.7 4.1China................ 2.8 5.6 12.3 20.6 25.2 24.3

Note:Boldfaceindicatesthehighestpercentageinayear.

Source:OrganisationforEconomicCo-operationandDevelopment,“FDIFlows,”2019(https://doi.org/10.1787/99f6e393-en).

TABLE 2 Canada’s Outward and Inward Foreign Direct Investment

1990 2000 2005 2011 2013 2017

percentage of GDP

Canadiandirectinvestment abroad.....................

14.2 32.3 31.9 38.3 41.0 52.4

Foreign direct investment . . . . . . . 18.9 28.9 28.1 35.6 36.3 38.6

Sources:StatisticsCanada,table36-10-0008-01(formerlyCANSIMtable376-0051),“InternationalInvestmentPosition,CanadianDirectInvestmentAbroadandForeignDirectInvestmentinCanada,byCountry,Annual,”andtable36-10-0222-01(formerlyCANSIMtable384-0038),“GrossDomesticProduct,Expenditure-Based,ProvincialandTerritorial,Annual”;andauthor’scalculations.

62 Keenetal.,supranote6,at10.Atthesametime,thecapacitytoshelterretainedearningsin(small)Canadian-controlledprivatecorporationscreatesaninherentbiastowardretainedearningsfinancing.Thisbiasisreinforcedbythetypicallymoregenerousspreadbetweengeneralcorporateandsmallbusinesstaxratesinmostprovinces(exceptQuebec)


ThecommitteeidentifiedseveralareasinwhichOttawacouldengageinbasebroadeningandlimitopportunitiesfortaxarbitrage(forexample,bythetighten-ingof thincapitalization ratios)while functioningwithin“internationalnorms.”However,thecommitteealsorecommendedcontinuingtheeffectiveexemptionofactivebusinessincomefromforeignaffiliatetaxation,butwithtighterrestrictionsonthedeductibilityofinterestinCanadausedtofinanceinternationalinteraffiliatetransactions.63

TheTechnicalCommittee’smostsignificantlong-termimpactwastodrawatten-tion to the importance of aggregatebusiness taxation, in the formofMETRs, on internationalcapitalflows.AlthoughtheChrétienandMartingovernmentsbegantoreduceCanadianMETRlevelstothelevelsofothermajorindustrialcountries,withphasedCITandcapitaltaxreductionsafter2000,theHarpergovernmentfor-malizedthisprocessbetween2007and2012by introducingmajorreductionstomarginal CITratesandprovidingprovinceswithincentivestoharmonizetheirsalestaxeswiththeGST.Asaresult,Canada’saveragecorporateMETRfellfrom43 per-centin2000to26.5 percentin2013.64

Canadiangovernmentshavegradually,ifperhapsbelatedly,tightenedthincap-italizationrulessincethe1980s:theyreducedpermitteddebt-to-equityratiosfrom3:1(in1987)to2:1(in2000),followingtheTechnicalCommitteereport;andto1.5:1in2012,followingtheAdvisoryPanelreport.65Inaddition,disallowedinterestpaidbynon-residentinvestorsistaxableasdividendsunderthetermsofrelevanttaxtreaties.66However, successive governments have preferred incremental changesandtheexpansionofanti-avoidancemeasurestomajorstructuralchangessuchasthosesuggestedbyTimEdgar—forexample,suggestionsthatCanadafollowtheexampleofAustralia,NewZealand,andtheUnitedKingdominapplyingthincap-italization rules to arms-length borrowing, or that Canada significantly limitrestrictionsondeductibilityofinterestborrowedbyCanadian-basedmultinationalstolendtoforeignaffiliates.67

andinthefederaltaxsystem.AverageprovincialsmallbusinessratesoutsideQuebecwere10.3 percentagepointsbelowcomparablegeneralcorporateratesin2018,comparedwith 4 percentagepointsinQuebecin2018(4.9 percentin2019),and,forthefederalspread, 5 percentagepointsin2018(6 percentin2019).

63 Report of the Technical Committee on Business Taxation,supranote36,at1:4,3:26,and6:11-30. 64 ChenandMintzdefineMETRsas“theportionofcapital-relatedtaxespaidasashareofthe

pre-taxrateofreturnoncapitalformarginalinvestments”:DuanjieChenandJackM.Mintz,“The2014GlobalTaxCompetitivenessReport:AProposedBusinessTaxReformAgenda”(2015)8:4SPP Research Papers[UniversityofCalgary,SchoolofPublicPolicy]1-19.

65 Supranote15. 66 EvelynMoskowitz,Financing Issues: The Thin Capitalization Rules(Ottawa:CanadianBar

Association,May29,2010),at3-4,note7(www.cba.org/cba/cle/PDF/Tax10_Moskowitz_FinanciingIssues_ThinCapitalizationRules_paper.pdf );andJohn M.Campbell,“ThinCapitalizationRegime,”International Tax Newsletter,November2012(www.millerthomson.com/ en/publications/communiques-and-updates/international-tax-newsletter/november-2012/thin-capitalization-regime/).

67 Edgar,“OutboundDirectInvestment,”supranote2.


Theissuesofinteraffiliatefinancingandthedeductibility,inCanada,offundsborrowedforinvestmentabroadhasbeenreinforcedbythescaleofoutboundFDI ininternationalfinancialcentresandotherlow-taxjurisdictions,particularlybecausedividends from such affiliates are often tax-exempt in Canada.68 For example,BermudaandfourotherCaribbeantaxhavenshaveaccountedforanaverageof16.5 percentofoutwardCanadianFDIandfor2.3 percentofinwardFDIsince2013,reflectingthefrequentuseofthesecountriesasvenuesforinternationalfinancialtransactions.69The2007federalbudgetannouncedplans(hereinafterreferredtoas“section18.2”)70torestrict,by2011,so-calleddouble-diptransactionsinvolvingtheuseoffundsborrowedinCanadato“obtainatleasttwointerestdeductionsontheamountofmoneyborrowed”throughforeignaffiliateslocatedinlow-taxjurisdic-tions.71 Strong corporate resistance to this measure—given the persistence ofmeasuresfavourableto“tax-efficient”interaffiliatefinancingbyforeignaffiliatesofUS, British, and Dutch-based MNCs (among others),72 the onset of the global financialcrisis,and(possibly)therecordnumberofforeigntakeoversofmajorCan-adian firms in 2007-8—convinced theAdvisory Panel onCanada’s InternationalSystemofTaxationtorecommendthewithdrawalofthemeasureinitsfinalreport.73 Inresponse,FinanceMinisterJimFlahertyrescindedsection 18.2inhisFebruary2009budget.ThisincidentsuggeststhatthenatureofinternationaltaxcompetitioneffectivelylimitsthecapacityofrelativelysmallcountriessuchasCanadatointro-ducemajorstructuralchangestotheirinternationaltaxationsystemswithoutsomedegreeofcoordinationwith(orcleardemonstrationeffectsofpolicychangesmadeby)majoreconomicpowerswithouttheriskofincreasingrelativefinancingcostsforthesecountries’residentMNCs.

Asecondcross-cuttingchallengetotheachievementofinternationaltaxequityisaby-productofdomestictaxchangeswithinCanada.TheChrétienandMartin

68 FrançoisLavoie,Canadian Direct Investment in “Offshore Financial Centers”StatisticsCanadacatalogueno.11-621-MIE(Ottawa:StatisticsCanada,March2005);andBrianMustard,“Canada’sSystemofInternationalTaxation:ALookBack,aLookForward”(2013)61,specialsupp.Canadian Tax Journal257-70.

69 StatisticsCanada,table36-10-0008-01(formerlyCANSIMtable376-0051),“InternationalInvestmentPosition,CanadianDirectInvestmentAbroadandForeignDirectInvestmentinCanada,byCountry,Annual.”

70 IncomeTaxAct,RSC1985,c.1(5thSupp.),asamended.

71 OfficeoftheAuditorGeneralofCanada,Report of the Auditor General of Canada to the House of Commons(Ottawa:OfficeoftheAuditorGeneralofCanada,December2002),chapter11,atexhibit11.3.SeealsoCanada.DepartmentofFinance,Explanatory Notes relating to the Income Tax Act, the Excise Act, 2001, and the Excise Tax Act(Ottawa:DepartmentofFinance,February2009),atclause 7(www.fin.gc.ca/drleg-apl/biafeb09n-eng.asp);andEdgar,“OutboundDirectInvestment,”supranote2.

72 TheNetherlandsaccountedfor11.2 percentofoutwardCanadianFDIstocksin2017,andLuxembourgforanother6 percent—percentagesthataredisproportionatelyhighinrelationtothestatusofthesecountriesasEuropeantradingpartners.StatisticsCanada,supranote69.

73 Supranote15,at50-53;andMustard,supranote68,at259.


governments’ gradual phaseout of IncomeTax Act restrictions on internationalinvestmentsbypension funds andother retirement savings vehicles in the early2000s(combinedwithprudentialpressuresfordiversificationoftheirinvestments)contributedtotherapidgrowthofoffshoreinvestmentsbymajorpublicsector(andother)pensionfunds.ForeignholdingsofCanada’s10 largestpensioninvestmentmanagers were estimated at 55.4 percent of their $1.2 trillion of assets undermanagement in 2014.74The economic interactions of pension fund investmentswithtaxpolicies(particularlyforoffshoreinvestments),andthevarietyinowner-shipstructures,aresufficientlycomplextodeterbroadgeneralizationsabouttheireconomiceffects.75Thesizableroleplayedbytax-exemptinvestorsinbothdomes-tic and international capital markets76 significantly constrains the expandedtaxationofactivebusinessincomebyforeignaffiliatesofCanadianMNCswithoutriskingsignificantissuesofhorizontalequity.Atthesametime,theCanada-UStaxconventionallowsforreciprocalexemptionsfromwithholdingtaxesoncross-borderinvestmentincomepaidtonon-residentpensionfunds.77

However, concerns over the sheltering of investment income in foreign taxhavensinrecentyearshavegivengovernmentsinmanymajorindustrialcountriesa shared interest in limiting the erosion of their personal and CIT bases and increas-ingtheireffectivenessincombattingoutrighttaxevasion.TheOECD base erosion andprofit shifting (BEPS)project, inaugurated in2013,hasbenefited fromthreemajorfactorscriticaltoovercomingpreviouspoliticalandbureaucraticobstaclestointergovernmentalcooperation.First,theunilateralactionoftheUSCongressinpassingtheForeignAccountTaxComplianceAct(FATCA)of2010requiredforeign

74 BostonConsultingGroup,Measuring Impact of Canadian Pension Funds(Toronto:BCG,October2015),at 11(http://image-src.bcg.com/Images/Measuring-Impact-of-Canadian -Pension-Funds-Oct-2015_tcm79-39773.pdf ).By2018,theproportionofoffshoreinvestmentswassubstantiallylarger(85 percent)fortheCanadaPensionPlanInvestmentBoard(CPPIB)andforQuebec’sCaissedeDépôt(64 percent).SeeEstebanDuarte,“OverseasShoppingProtectsAAARating,”Financial Post,April 23,2019.

75 VijayJogandJackMintz,“The30PercentLimitationforPensionOwnershipinCompanies:PolicyOptions”(2012)60:3Canadian Tax Journal567-608,at581-86.

76 JogandMintz,ibid.,at584,notethatin2004“[t]ax-exemptinvestors[held]40 percentoftotal[Canadian]corporateassets,Canadiantaxableinvestors[held]20 percent,andtheremainder[were]heldbynon-residents.”Conversely,the“top10”Canadianpensioninvestmentfundsaccountedforalmost60 percentofthestockofCanadiandirectinvestmentabroadin2014:BostonConsultingGroup,supranote74.RosenthalandAustinestimatethatretirementaccountsandplansheld37 percentoftaxableholdingsinUS“C” corporationsin2015,foreignresidentsabout26 percent,UShouseholdinvestors(includingpartnerships)24.2 percent,andnon-profitorganizationsabout4.9 percent.However,passthroughvehiclesnowaccountformorethanhalfoftaxableUSbusinessincome.Steven M.RosenthalandLydia M.Austin,“TheDwindlingTaxableShareofU.S.CorporateStock”(2016)151:7Tax Notes923-34.

77 JackM.MintzandStephenR.Richardson,“NotJustforAmericans:TheCaseforExpandingReciprocalTaxExemptionsforForeignInvestmentsbyPensionFunds”(2014)7:34SPP Research Papers[UniversityofCalgary,SchoolofPublicPolicy]1-25.


financialinstitutionstoprovidetheInternalRevenueServicewithinformationonaccountsheldbyUSclients.Theseprovisions—effectivelyapolicyreversalintendedto preserve USpolicydiscretion(alsoknownas“sovereignty”)outsideconstraintsimposed by previous multilateral processes—provided a model for the OECD’sGlobalForumonTransparencyandExchangeofInformationforTaxPurposesinitsframingofmodeltaxinformationexchangeagreements(TIEAs)and,ultimately,amodelforthe2017multilateralconvention,inordertoenableparticipatingcoun-triestocombataggressivetaxplanningwithouttriggeringdomesticUS concerns overtheerosionofdomesticsovereignty.78

TheBEPS project and TIEAsrelyonamendmentstoexistingtaxtreatiesandtheimplementationofvariednationallaws,areliancethatisconsistentwithtraditionalconventions of horizontal (“soft law”) international cooperation.79 Accordingly, the BEPS project and TIEAs limit the political challenges of harmonizing diverse nationallegalinstitutions—atraditionalbarriertointernationaltaxpolicycoopera-tion—whileenablingexpandedcooperationthroughtransgovernmentalnetworkstoenhancetheenforcementofdomestictaxlaws.TheBEPS process has also enabled theCanadaRevenueAgencytofacilitateitsinternationalenforcementbyrequiringcountry-by-countrydisclosureofCanadians’ internationalcorporate incomeandtransactions, including thedisclosureof investment funds anddataon transferpricing, along with the exchange of information among national tax collectionauthoritiessince2016.80

US Tax Reforms of 2017: Consequences for Cross-Border Tax Competition

MajorstructuralchangestotheUStaxsystem,whichwereapprovedbyCongressin2017,haveresultedinbothsignificantCITratereductionsandmanytechnicaltaxpolicy innovations that have changed the competitive environments for investment and taxplanning inCanadaandothercountries.Passageof the2017TCJA on a party-line vote followed several yearsof debatesoverwhetherUS CIT rates had becomeuncompetitiverelativetothoseofmajortradingpartnersandinvestmentdestinations.81 Many observers expressed concerns that the US residence-based (worldwide)CIT system had provided US-based MNCswithsignificantincentivesforincomeshifting—particularlythroughtheuseofcorporateinversionstoshift

78 Arnold,supranote33,at9.

79 Slaughter,supranote34.

80 OrganisationforEconomicCo-operationandDevelopment,Action 13: Country-by-Country Reporting Implementation Package(Paris:OECD,2015);andCanadaRevenueAgency,“GuidanceonCountry-by-CountryReportinginCanada,”November23,2018(www.canada.ca/en/revenue-agency/services/forms-publications/publications/rc4651/guidance-on-country -country-reporting-canada.html).

81 Hale,“Cross-BorderFiscalCompetitionandTaxReform,”supranote18.


their head offices to other countries (see figure 1), including Canada—notwith-standing periodic efforts to tighten anti-avoidance rules.82Table 3 contrasts thecompositionoffinancialsourcesofUSoutboundFDIwiththecompositionoffinan-cialsourcesofUS inboundFDI in2016,showingthemuchhigherproportionofintracompanydebtinthelatter.

TheTCJAreducedtopUS federal marginal CITratesfrom35.3 percent(39 per-cent,whenaveragestatetaxratesareincluded)to21 percent,anditreducedaveragecombined METRs fromanaverage35.3 percent to18.9 percent,withsignificantsectoralvariations,eliminatingapreviousaverageCanadianadvantageestimatedat14.2 percentagepointsacrosssectorsandprovinces.83 It converted the UStaxsystemfromitspreviouslyworldwide(residence-based)structure,withcreditsforforeigntaxespaidanddeferraloftaxesonnon-repatriatedprofits,toabroadlyterritorialsystem,withone-timetransitionaltaxesthatarebasedondeemedrepatriationofliquidandilliquidassetsearningsandarepayableovereightyears.84

Moresignificantlyforongoingtaxcompetition,theUStaxreformcreatessub-stantial incentives for the repatriation and attraction of capital to the United States and formovingthecostsof incomeshiftingandother tax-planningmeasures toothercountries,thussuggestingthetacticsusedinstrategictradepoliciesratherthanthemerepursuitofCIN.85 Indeed, the TCJAmaybethemostaggressiveexerciseinmanyyears intaxcompetitionandengineeringdesignedto increasedomesticinvestmentandinternationalincomeshifting,althoughsomeofitssharpedgesmaybebluntedbyphaseoutperiodsonparticularmeasures,growingfiscalexigencies,andpartisanshiftsincomingyears.MacroeconomicincentivesforthereallocationofinternationalinvestmentarereinforcedbyCongress’sdecisiontofund“permanent”business tax rate reductions by increasing deficits (and, implicitly, by increasing

82 MichelleClarkNeelyandLarryD.Sherrer,“ALookatCorporateInversions,InsideandOut”(2017)25:1Regional Economist[FederalReserveBankofSt.Louis]andDonaldJ.MarplesandJaneG.Gravelle,Corporate Expatriation, Inversions, and Mergers: Tax Issues,CRSReportno. R43568(Washington,DC:CongressionalResearchService,September25,2014).The2016anti-avoidanceregulationsdesignatedany“foreignacquiringcompany”asadomesticentityif80 percentormoreofitsequityisheldbyformerUSownersofthebusiness(orofmultiplefirmsacquiredin“serial”transactions),withotherpenaltiesapplyingtofirmswith60 percentormoreUSownership.PaulSeraganian,JenniferLee,WilliamCorcoran,andRaminWright,“MajorU.S.Anti-InversionRegulationsImpactCanadianCompaniesBothinandoutoftheInversionSandbox,”April 11,2016(www.osler.com/en/resources/cross-border/ 2016/major-u-s-anti-inversion-regulations-impact-canad).

83 JackMintzandDuanjieChen,The U.S. Corporate Effective Tax Rate: Myth and the Fact,TaxFoundationSpecialReportno. 214(Washington,DC:TaxFoundation,February2014);andP. BazelandJ. Mintz,“CanadianPolicyMakersConsiderResponsetoU.S.TaxOverhaul,”Tax Policy Trends,October2018[UniversityofCalgary,SchoolofPublicPolicy],1-2.

84 EricaYork,Evaluating the Changed Incentives for Repatriating Foreign Earnings,TaxFoundationFiscalFactno. 615(Washington,DC:TaxFoundation,September27,2018).

85 JackMintz,Global Implications of U.S. Tax Reform,EconPolWorkingPaper08/2018(Munich:IfoInstitute,March2018);andKeenetal.,supranote6.


internationalborrowinggivenrelativelylowUSsavingsrates),ratherthanbyoff-settingratecutswithmoreextensivebasebroadeningorbysubstantiallyincreasingUS federal spending in separatebudgetaryactions.Mintzandothershavenotedseveral elements in the TCJAthatareofcriticalimportancetoCanadianbusinessesinbothCanadaandtheUnitedStates:

1. theexpensing,through2022,ofinvestmentinassetswithexpectedlifespansoflessthan20 years,withplansforphasingoutthesemeasuresby2027;

2. the accelerated (five-year) amortization of research and developmentexpenditure;

3. an exemption for dividends received from foreign affiliates with at least10 percent ownership by theUS parent (ameasure that parallels existingCanadianpolicies);

TABLE 3 Composition of Financial Sources of US Direct Investment Abroad and Foreign Direct Investment in the United States, 2016

US direct investment abroad

Foreign direct investment in US

percent

Equitycapital. . . . . . . . . . . . . . . . . . . . . . . . . . 10.0 53.0Reinvestedearnings. . . . . . . . . . . . . . . . . . . . . 95.8 20.4Intracompany debt . . . . . . . . . . . . . . . . . . . . . −5.8 26.6

Source:JamesK.Jackson,U.S. Foreign Direct Investment Abroad: Trends and Current Issues,CRSReportno. R21118(Washington,DC:CongressionalResearchService,June29,2017),at4.

FIGURE 1 Completed US Corporation Tax Inversions, 1982-2017

Number

Source: Zachary Mider, “Tracking Tax Runaways,” Bloomberg.com, March 1, 2017 (www.bloomberg.com/graphics/tax-inversion-tracker).

0 5 10 15 20 25Singapore

PanamaJerseyIsrael

DenmarkBritish Virgin Islands

AustraliaSwitzerland

LuxembourgCayman Islands

NetherlandsCanada

EnglandBermuda

Ireland


4. anewbaseerosionanti-avoidancetax(BEAT)ontheadjustedtaxableincomeofforeignaffiliatesoperatingintheUnitedStates,withsignificantrestric-tionsonrelated-partytransfers;and

5. newglobal intangible low-taxed income(GILTI) taxrulesonboth foreignand domestic income of US-basedmultinationals.86

Thesemeasuresarepartlyoffsetbylimitsonthedeductibilityofinterestexpensestoamaximumof30 percent,excludingrealestateinvestments—withtheadditionaleffectofdiscouragingincomeshiftingthroughincreaseddebtfinancingoftheUS affiliates of foreign-basedmultinationals.Taken together at amacro level, thesemeasureshaveeliminatedtheCanadianMETRadvantageovermostsectors.Theyhavecreatedsignificantincentivestoshiftinvestments,particularlyinintellectualproperty,totheUnitedStates,andtoreallocatedebtfinancingtoothercountries,includingCanada.

TheGILTI ruleshavebeendescribedas a “foreignminimumtax”on“super-normal”(over10 percent)investmentreturns—sometimeslabelled“excessprofits.”87 Theyaredesignedtolimittheshelteringinlow-taxjurisdictionsofprofitsgener-ated by UStechnologyindustries,inparticular,whichaccountforadisproportionateshare of USexportsandservicestrade.TheserulesalsocomplementUS strategic trade policies, including tighter intellectual property rules negotiated under theUS-Mexico-Canada Agreement (USMCA) of October 2018.88 Some observers suggestthatthesemeasuresarealsointendedtopre-emptor“guide”prospectiveoutcomes of OECD discussions of digital taxation, including but not limited tothe outcomesrelatedtointernationalapportionmentoftaxesonmajorglobaltech-nologyfirms,manyofwhichoriginateintheUnitedStates.89

Ideological and partisan polarization inWashingtonmakes the durability ofthesemeasuresafter2020anopenquestion.However,thecumulativeeffectofwhatcertainobservershavedescribedasthe“weaponizationofuncertainty”90 in inter-nationaltradeandeconomicrelationscreatesanongoingthreattoCanada’sinvest-mentclimateandcompetitiveness.FiscalcountermeasuresannouncedbyFinanceMinisterBillMorneau inNovember2018matched theTCJA’s provision for theexpensing of capital investment in assets with expected lifespans of less than20 years,andthesubsequentphasingoutofthesemeasuresby2027.Morneaualso

86 Mintz,supranote85,at3-4. 87 BazelandMintz,supranote83. 88 JunyiChen,“USMCA(NAFTA 2.0):What’sNewforIntellectualPropertyinCanada,”

October 12,2018(www.blaney.com/articles/usmca-nafta-20-whats-new-for-intellectual -property-in-canada).

89 G.CharlesBeller,“GILTI:‘MadeinAmerica’forEuropeanTax—UnilateralMeasuresandCooperativeSurplusintheInternationalTaxCompetitionGame”(2019)38Virginia Law Review271-313.

90 Forexample,seeMeredithCrowleyandDanCiuriak,Weaponizing Uncertainty(Toronto:C.D. HoweInstitute,June19,2018),at7.


announcedthe triplingof initialdepreciationrates forarangeofotherassets inorder to address assorted issues of supply chain competitivenesswithinCanada.Takentogether,thesemeasuresareexpectedtoreduceaveragefederalMETRs from 17.0to13.8 percent(seefigure 2).

Ottawa’sNovember 2017measures are a stopgap, comparable with, if moreextensivethan,provisions foraccelerateddepreciation introducedbytheHarpergovernment following similarUSmeasures approvedbyCongress aspartof theObama administration’s 2009 stimulus bill. However, because the likelihood ofpartisangridlockinCongressfollowingthe2018midtermelectionslimitsthepros-pectsformuchUSpolicyinnovationbeforethe2020presidentialelections,Canadahastimetoconsideroptionsforabroaderrangeofpolicymeasurestosustainitscompetitivenessinanevolvingglobalenvironment.

CO NCLUSIO N: E VO LV ING C A N A DI A N TA X P O LICIE S FO R A N UNCERTA IN WO RLD

Thebroaderfederalstrategyforinternationaltaxcompetitiveness,astrategythatcrystallizedoverthedecadefollowingtheTechnicalCommitteereportof1997andwassubsequentlyimplementedundertheHarpergovernment,wascontingentonabroaderdomesticstrategy—aimedatfiscalsustainability,debtreduction,andwide-spreadimprovementsindomesticlivingstandards—thatpaidcarefulattentiontodistributiveconsiderations.Variousscholarshavesuggestedbroaderblueprintsforcomprehensiveorstructuralcorporatetaxreforms.91However,historicalexperiencesuggeststhatanysuchundertakingislikelytobetooeconomicallyandpoliticallydisruptivetorewardanygovernmentthathasthetemeritytoinitiateitwithintheextendedtimeframerequiredforeffectivepolicydesignandimplementation,unlessfiscalconditionspermitbroadlybasedtaxreductionsformostindividualsandbusi-nesses.Proposalsformajorchangesinoveralllevelsanddistributionoftaxesmustbeginwiththetaxsystemasitis,notaswemightwishittobeinthebestofallpossibleworlds.92

TheexistingtaxsystemisembeddedwithintheeconomiclivesandexpectationsofCanadians—oftenincontradictoryways,asdemonstratedbytherecentpoliticalfiascoovertheTrudeaugovernment’sproposedrestrictionsof2016-17onaccessto the small business deduction.93 Levels of public trust in political, economic,andacademicelitesaresufficientlytenuousthatpoliticallysustainabletaxreformdepends, as it always has, notmerely on revenue neutrality but on achieving aconsensusofaffectedsocietalinterestswhoseconsentiscontingentontherebeing

91 Forexample,seeMilligan,supranote42;ChenandMintz,supranote64;BoadwayandTremblay,supranote 43;andKennethMcKenzieandMichaelSmart,Tax Policy Next to the Elephant: Business Tax Reform in the Wake of the US Tax Cuts and Jobs Act,C.D.HoweInstituteCommentaryno.537(Toronto:C.D.HoweInstitute,March2019).

92 Hale,supranote4,at27.

93 Posadskietal.,supranote21.


broadlydistributedreductionsinoveralllevelsoftaxationwithoutthedisruptionofvaluedpublicservices.94However,taxandspendingmeasuresmustbekeptinaroughbalancetoensurefiscalsustainabilityinthefaceofongoingdemographictrendsinaging.

ToachievepublicconsenttosignificanttaxpolicychangeswhilemaintainingtheoverallcompetitivenessofCanada’staxsystem(thetwo-levelgamethathasbeenthefocusofthisarticle),thegovernmentthatemergesfromtheupcomingfederalelectionshouldsetbroadpolicygoalsthatrecognizetheinteractionofvariousele-mentsofthetaxsystem,including,butnotlimitedto,corporateandinternationaltaxlevels.

There are two keys tomaintaining the balance between competitiveness andpublic consent. First, governments should use the personal tax system as theirprincipaltoolforaddressingissuesofdistributiveequity,whilemakingincrementalchangestothecorporatetaxsystemthatcontributetogreaterefficiency,growth,andbusiness competitiveness.Second, in theCanadiancontext, thegovernment

FIGURE 2 Corporate METRs Across G7 Countries: Impact of US Tax Reforms (2017) and Canadian Responses (2018)

Perc

ent

Source: Canada, Department of Finance, Investing in Middle Class Jobs: Fall Economic Statement 2018 (Ottawa: Department of Finance, November 2018), at 59.

0

5

10

15

20

25

30

35

JapanFranceUnited Kingdom

GermanyUnited States

OECD average

ItalyCanada

13.8

16.718.4

25.126.6

27.7

31.4

18.717.0

29.8

94 EdelmanCanada,“2018EdelmanTrustBarometer:Canada,”February2018(www.edelman.ca/ sites/default/files/2018-02/2018-Edelman-Trust-Barometer-Canada_ENGLISH.PDF);ProofInc.,“CanTrustIndex2019:CanadaIsSeeingCracksintheFoundationofTrust,”April2019(www.getproof.com/thinking/the-proof-cantrust-index/);andHale,supranote 4,at26-27.


should continue the recent years’ trend of maintaining competitive METRs for Canadianbusinessesrelativetomajorglobalcompetitorswhile(1) redressingmajorsectoralanomaliesthatunderminecompetitivenessand(2) incrementallyextendingmeasurestolimitbaseerosioninawaythatisconsistentwithbroaderinternationalnorms.

Toachievetheseobjectives,theDepartmentofFinanceshould

n maintainlevelsofaccelerateddepreciationthatarebroadlycompetitivewithUS levels, while attempting to limit distortions in their application acrossindustrysectors;

n align profit-insensitive taxes on businessesmore closely with the costs ofprovidingrelatedpublicservices,subjecttotransparentjustificationofdirectcostsandservices;

n reviewpatentboxmodelsthatcouldencourageinnovationinCanada,review-ing them on the bases of expert analyses of evolving models in otherindustrialcountries;95

n consider expansion of the thin capitalization rules to include arm’s-lengthdebt transactions in the financing of foreign affiliates of Canadian-basedfirms,subjecttocarefulexaminationoftheeffectsofsuchmeasuresinothercountries;

n limitcompetitivepressuresfrom“carbonleakage”bymonitoringtheimpactsofcarbontaxationinordertobalanceongoingprogresstowardoverallreduc-tions in carbon emissions with the mitigation of impacts on particularly“trade-exposed”industries;

n limit base erosion and address the growing challenge of offshore internetcommerce by tightening GST/HST(harmonizedsalestax)requirementsforoffshorevendors,withareasonabledeminimisthreshold,followingQuebec,Saskatchewan,andtherecentWayfair96decisionintheUnitedStates.

Purposefulincrementalismofthissort,whichaddressesaggregatelevelsoftax-ationwhileidentifyingsectoralopportunitiesforandvulnerabilitiestointernationaltax competition, is likely to bemore practically achievable and sustainable thantheoreticallyambitiousapproachesthathavethepotentialtodisruptexistingeco-nomicrelationshipsandtriggersubstantialpoliticalconflict.

95 Forexample,seeJohnLesterandJacekWarda,“AnInternationalComparisonofTaxAssistanceforR&D:2017UpdateandExtensiontoPatentBoxes”(2018)11:13SPP Research Papers[UniversityofCalgary,SchoolofPublicPolicy]1-33.

96 South Dakota v. Wayfair, Inc.,585US(2018).

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