The C.D. Howe Institute is calling for a radical transformation of Canada’s tax system, arguing in a report released earlier this month that the current system has become a drag on prosperity because it relies too heavily on income taxation and is too complex. The think tank proposes a wholesale restructuring that would shift away from income taxes in favour of levies that it says are less harmful to economic activity, lower corporate taxes and simplified income tax credits.
“This bold tax reform agenda would stimulate capital investment and economic growth, reduce reliance on costly tax planning and support higher employment and wages across the country,” said Alexandre Laurin, vice-president and director of research, said in a release.
The authors of the report, “Big Bang” Tax Reform: Unleashing Growth in the Canadian Economy, say the reforms would be revenue-neutral in the short term. They argue that the changes are urgent in light of ongoing geopolitical tensions and Canada’s weak per capita growth over the past decade.
Between 2015 and 2023, the report notes that Canada recorded the lowest growth in gross national income per capita among G7 countries, with a cumulative increase of just 2%. By comparison, Ireland posted growth of 39% over the same period and Australia grew 14%. Even Italy, often noted for its economic underperformance, did better at 12%. According to the report’s data, Canadians’ income per capita is 74% of that Americans earn.
C.D. Howe says the four-point plan could lead to $140 billion in additional non-residential capital investment. The reforms could also deliver a 2.5% increase in GDP, adding roughly $79 billion in today’s dollars.
This expansion of the tax base would generate more than $26 billion in additional annual public revenue, the report says.
“By relying less on the most economically damaging taxes, governments can raise real incomes, boost business investment and strengthen the fiscal outlook without increasing the overall tax burden.” said Jack Mintz, senior fellow and former CEO of the C.D. Howe Institute, in a release.
A system that penalizes work and investment
Canada derives about 18% of its GDP from personal and corporate income taxes combined — the highest ratio in the G7 and well above the OECD average of 12%.
By contrast, the country taxes consumption relatively lightly. The GST and excise taxes account for 6.9% of GDP, compared with an OECD average of 10%.
Consumption taxes and payroll contributions — which weigh more heavily on spending than on production or investment — play a smaller role in Canada compared to other advanced economies.
“High marginal tax rates in Canada for middle- and upper-income earners discourage work, risk-taking and talent retention — precisely when stronger growth is needed,” Mintz said.
The issue also affects businesses. As recently as 2012, Canada enjoyed a corporate tax rate well below the OECD average, giving it a genuine competitive advantage. That advantage has since vanished.
In 2018, U.S. tax reform cut the federal corporate tax rate from 35% to 21%, eliminating the gap with Canada. By 2024, the two countries had almost identical combined corporate tax rates, at around 26% when state taxes are included.
Four pillars
The report proposes a package of measures designed to work in tandem, while maintaining short-term budget neutrality.
- Lower federal personal income tax rates and reduce the number of tax brackets. Federal income taxes would be 14% for income up to $60,000; 20.5% for income between $60,000 and $180,000; and 26% for income above $180,000. Provinces could adjust their own rates accordingly, but the combined top marginal rate would settle at roughly 45%, comparable to the level that existed about 15 years ago.
- Introduce a simplified personal income tax credit. The report proposes a voluntary $10,000 simplified tax credit that would replace a wide range of current deductions and credits. This option would simplify tax filing for low- and middle-income taxpayers and would benefit lower-income earners. The authors estimate more than 90% of taxpayers would choose the simplified option rather than itemizing deductions.
- Modernize corporate taxes. The report outlines two possible approaches to corporate taxation. Option one is the “Irish model,” based on reforms adopted by that country. This option would reduce the federal corporate tax rate to 10% from 15%, and eliminate targeted incentives such as accelerated depreciation, investment tax credits and the small-business deduction. Option two is a more innovative model that was introduced in Estonia in 2000. It would exempt undistributed profits that are reinvested in business activities and tax corporate profits, only when distributed to shareholders, at 13%.
- Compensate for lost income-tax revenue.To offset lower income tax revenues, the report proposes one of two measures. The first is to increase the GST by 2.8 percentage points, to 7.8%. Alternately, implement a 3.2% employer payroll contribution dedicated to funding healthcare — a model widely used in Europe and the U.S.
The report notes that Canada scored the lowest in after-tax income inequality among the G7 countries as of 2022.
“Canada cannot tax its way to stronger growth if the system penalizes investment, innovation and effort,” said Nicholas Dahir, research officer with the think tank. “A ‘big bang’ reform would create better jobs, raise living standards and secure the long-term fiscal capacity needed to fund the public services Canadians value.”