Canadian banks warn about negative fallout from U.S. tax reforms

Two of Canada's big banks are sounding the alarm over the negative impact that Canada's economy will see as a result of new tax reform measures in the U.S. under the Trump administration.

Analysts from both Toronto-Dominion Bank (TD) and the Canadian Imperial Bank of Commerce (CIBC) put out reports this week highlighting how Canadian businesses havelost their competitive advantage to their U.S. peers and how this could impact economic activity.

"Canada's formerly favourable position in corporate taxation has eroded considerably, with the U.S. now holding the edge," said economists at TD.

"[Tax reforms]along with growing NAFTA uncertainties, increases the likelihood of a slow bleed of investment from Canada to south of the border," they said.

Strategists at CIBC, meanwhile, pointed out that a lower tax rate in the U.S. makes Canada a less attractive destination to locate headquarters, manufacturing in the country has become less competitive, and Canadian firms will see their U.S. peers more competitive on mergers and acquisitions now.

"With a revitalized tax code, CEOs have another reason to locate in, or worse yet, relocate tothe US," said Ian de Verteuil of CIBC.

Tax cuts

In December, U.S. lawmakerspassed the$1.5-trillion US tax reform bill, known as the tax cuts and jobs act (TCJA)making the biggestchange to the U.S.tax code in over 30 years.

The complex legislation cuts the U.S. corporate income tax rate to 21 per cent from 35 per cent, and gives other business owners a 20 per cent deduction on business income, among other changes.

Prior to this law, the U.S. hadone of the highest business tax rates among G7 countries, with no decline over the past 20 years. Canada, meanwhile, had one of the lowest corporate tax rates in the group and rates had been in consistent decline for several years.

"For Canadian companies, the focus has so far been on companies that win from the lower overall level because they have large U.S. operations and were accruing taxes at a higher rate," said Verteuil, listing companies like New Flyer Industries which gets over 90 per cent of itsrevenue from the U.S.

But he also highlightedthat there wasa "far more insidious" aspect of the tax reform for Canadian firms, as businessesbecome"tentative on betting too heavily"that Canadian exports will have long-term "unfettered" access to the U.S.

New complaints

Meanwhile, the reports come as U.S. President Donald Trump made headlines on Monday aftercomplaining about Canadian trade practices.

He threatened implementing a new international tax that has revived fears of new American import duties.

Derek Burleton, economist at TD said the risk to Canada from U.S. tax reductions does put the heat on the Canadian government to take action in the upcoming budget.

"We do not believe that a tit-for-tat reduction in tax rates is necessary to guard against these risks, since taxes form only one part of the competitiveness equation," he said.

"Maintaining longer term fiscal sustainability, increasing the efficiency of tax systems through revenue-neutral tax reforms and well-thought-out investment in human capital and skills training can achieve the similar aim of improving competitiveness," he added.

Finance Minister Bill Morneau is scheduled to sit down with leading economists in Toronto on Friday for a pre-budget meeting.