Why Tax Competitiveness Matters

February 25, 2013
Jock Finlayson

British Columbia is a small, open trading jurisdiction that relies heavily on natural resource exports to fuel the economy. While our economy continues to diversify (and that is a good thing) into more service oriented sectors, the core driver of the economy remains our exports, and natural-resource based products represent 70-75% of the province’s international merchandise export shipments. These exports, together with our strategic location and high quality of human capital, have combined to create a high standard of living.

In order to realize the theoretical benefits of these resources, there is also a need for sound public policies that enable development through effective planning, infrastructure development and tax/regulatory structures that attracts private sector investment. On this latter point, British Columbia’s historical track record is mixed, with significant improvements occurring in recent years that have helped to stimulate a lot of activity on the land base.

At present, BC’s Major Projects Inventory is sitting at over $130 billion in proposed projects valued at $15 million or more ($20 million or more in the case of the lower mainland region). This is on top of $80 billion in projects that are already approved or under development/construction. Just five years ago the inventory stood at $75 billion of proposed and $57 billion of active projects. The increase in the inventory, particularly during the turbulent period since the 2008-09 global downturn and financial crisis, is remarkable and speaks to the economic opportunities available in BC.

However, investments by the private sector are deployed not on the basis of vague notions of potential, but according to risk adjusted rates of return as estimated by company managers, entrepreneurs and their financial advisers. It’s important to note that a very large portion of the current Major Project Inventory in BC has not received final investment approval from the proponents. A fundamental determinant of final investment decisions is the cost of capital – both equity and debt capital – after taking account of expected payments to governments via various taxies, royalties, and fees. Many investors active in BC have highlighted how the province’s location, skilled workforce and infrastructure assets have combined with a fiscally responsible government and broadly competitive taxation to drive investment decisions.

Unfortunately, the return of the PST on April 1, 2013 promises to alter the tax landscape in a way that will make it considerably harder for many companies to get to “yes” when they ponder whether to put more capital into British Columbia. This is because once the PST is re-instituted, the tax-inclusive cost of producing goods and services in BC will rise by a whopping by $1.5 billion per year; there will also be additional compliance costs of $150 million or so stemming from the need for businesses to deal with two separate sales tax systems (the PST and the federal GST). The extra costs for business from the looming return of the PST will vary across industry sectors; among the industries hit hardest will be manufacturing, transportation, construction, telecommunications, and film production – along with all parts of the broad natural resources sector. Looking across all industry sectors, the average marginal effective tax rate on new capital will jump by about 70% following the return of the PST and the elimination of the more efficient HST. This will leave BC with the highest tax burden on investment in the country, as noted by the Expert Panel on BC’s Business Tax Competitiveness (page 21 of its August 2012 final report).

Unfortunately, last week’s 2013 BC Budget will compound the problem, with an ill-timed corporate tax increase. While some may find higher business taxes an attractive option, it is noteworthy that a 1% increase in nominal GDP yields roughly the same extra provincial government revenues as a 1% corporate tax increase - and that’s just in the short-run, before considering the longer-term implications of tax policy changes on business growth, investment, or jobs.

Regardless of the outcome of the May election, the next government will face a substantial and growing challenge around BC’s business tax competitiveness. Our province boasts a tremendous set of opportunities yet to be realized. But much more attention will need to be given to how this investment potential is converted to investment reality – and the additional jobs, business activity and government revenues that flow from it.

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