In many cities and towns across Canada, residential properties are increasing in value, while some local businesses are struggling to survive. There are different reasons for this development including factors well beyond our borders, but in most of those cities and towns, business property tax rates are higher than residential rates—often two, three or four times higher.

For example, a new Fraser Institute study, which compares commercial-to-residential property tax ratios in Canada’s largest metropolitan areas, shows that business rates were 3.81 times higher in Toronto, 3.56 times higher in Vancouver and between 3.98 to 4.39 times higher in Montreal (depending on the borough) than the residential rate in the latest years of available data.

In some municipalities the ratio falls to roughly 2-to-1, while in others it skyrockets into the double-digits, notably for industrial properties. What’s common across virtually all municipalities, however, is that rates are higher for businesses.

And yet, governments across Canada—both municipal and provincial—seldom justify the disproportionate tax burden on businesses. According to the literature on the subject, governments at all levels are likely responding to political incentives to overtax non-voting property classes such as businesses (and to a lesser extent, tenants) while subsidizing services enjoyed by residential property owners who are more likely to be voters.

This implicit income redistribution is not without consequences. For one, it erodes political accountability, as the property tax no longer follows a clear principle such as “user-pay” or payments for benefits received from the municipality or province. It can also threaten the survival of many small businesses. Although business property taxes are deductible expenses from corporate income taxes, they still represent approximately half of the tax burden faced by businesses. This burden may prevent businesses from starting up, expanding, hiring more workers and remaining open for business. It will also have a disproportionate effect on small businesses that can’t absorb costs like their larger competitors.

Moreover, the tax burden imbalance, alongside the raft of other advantages the federal (and to a lesser extent, provincial) governments offer homebuyers and homeowners, encourages investors (other things equal) to favour residential real estate over other forms of capital investment such as software, machinery and equipment. Homeowners are exempt from paying capital gains on the sale of their primary residence, while businesses must pay capital gains tax on land and (indirectly) on other assets (including machinery, equipment and intellectual property) that increase the value of a business when it’s sold. Mortgage stress test or not, federal incentives clearly favour investment in residential real estate.

And we may already be witnessing the consequences. The growth of capital investment in Canada slowed substantially from 2005 to 2018 compared to earlier periods. Crucially, during this same period business investment’s share of total capital investment declined markedly while residential real estate’s share of total investment increased. Again, there are many possible reasons for this, including increased uncertainty about Canada’s trade environment and the effects of government regulation and carbon taxes. But the relatively heavy local tax burden on businesses likely plays a meaningful role in the decline of business investment, the lifeblood of local economies.

Given Canada’s population growth, increased housing investment serves a valuable economic purpose. However, to the extent that property tax distortions steer capital investment away from other productive assets, especially research and development and new business equipment, the commercial-residential property tax imbalance could come with a significant overall cost to Canada’s productivity performance and local businesses across the country.