Nothing Mega About the “Mega Productivity Deduction”
At this week’s investment summit, Prime Minister Mark Carney announced a “mega-productivity” deduction that will enable companies to “expense” — that is, write them off immediately — about two-thirds of their capital assets on a permanent basis. Business groups were as thrilled as kids in an ice cream shop — on the grounds any improvement in incentives is better than none.
From society’s perspective, however, there is nothing mega about the new policy, which fails three criteria for a good tax structure: efficiency, fairness and simplicity. A far better choice would be to reduce corporate income tax rates so as to spur investment in all business activities, not just those chosen by the government. Most major tax reforms around the world, including Canada’s past efforts, follow two principles: low rates and neutrality across business activities. The mega productivity deduction goes in the opposite direction.
Expensing capital expenditures, as the proposed rules allow, results in a double deduction for capital expenditures: a company can write off both the investment cost itself as well as related interest expenses from their taxable profits. This produces a negative tax rate that effectively subsidizes capital, giving businesses a preference for investing in capital-intensive processes like AI rather than hiring workers. Even the Department of Finance points out in its backgrounder that negative effective tax rates will cause some industries to over-invest in capacity — notably agriculture and fishing, manufacturing and processing, and transportation and storage.
Over the past decade Ottawa has brought in, not just the mega deduction, but also investment tax credits and other preferences that favour manufacturing and clean energy over other investments. Short-lived assets that are repeatedly replaced get the tax benefits over and over again, which favours investment in machinery rather than structures, which are longer-lived.
Combining expensing with investment tax credits will enable many companies not to pay any income taxes at all, blunting these policies’ effectiveness. As their tax losses and credits accumulate, companies use complex manoeuvres to shift them to taxpaying entities like banks. It’s all perfectly legal but angers the public even so.
Countries have used accelerated depreciation for decades, though often with limited impact on investment. Why has expensing failed? Companies only get a timing benefit from writing capital costs off right away rather than doing so over time. From a cash-flow perspective, expensing has only a marginal impact in improving profitability. The Department of Finance estimates that the mega deduction will have an incremental fiscal cost of $36 billion over five years — equivalent to a minor federal corporate tax rate reduction of just 0.9 percentage points.
We should keep to the tried-and-true recipe we have followed in tax reforms over the past half century: lower the tax rate and broaden the tax base.
A version of this article also appears in the Financial Post.
