The federal government’s admission that last year’s surplus was $9.1-billion rather than the expected $1.9-billion has led to calls for increased spending, tax relief and debt reduction. Obviously some prioritization will have to occur. Recent comments by Finance Minister Ralph Goodale, indicating the federal government is open to tax relief, have ignited a flurry of tax-cutting proposals. Unfortunately, too many of the proposals respond to political practicality rather than to what is best for Canada.

One of the pressing issues facing the country is our inability to close the productivity and prosperity gaps with the United States. Our income levels are still well below those enjoyed south of the border, our unemployment rate remains high despite a vibrant labour market and our labour productivity is slipping further behind. The apparent willingness of the government to consider tax relief presents the country with an opportunity to not only shift resources to individuals but also to improve the functioning of our economy.

Tax relief must focus on improving the incentives to work, save, invest and undertake risk if they are to increase the efficiency of the Canadian economy and provide for more prosperity: increasing incomes, more jobs, less unemployment and greater opportunities. Applying the standard of improving incentives leads to two tax relief measures.

One, reduce business taxes. Specifically, the federal government should expedite the elimination of the corporate capital tax and further reduce corporate income tax rates. Two, statutory personal income tax rates for middle- and upper-income earners should be reduced while simultaneously increasing the thresholds at which the rates apply. Both measures would improve economic incentives and ultimately yield a more productive society that would benefit all Canadians.

The politics of business tax relief are difficult as many Canadians incorrectly believe businesses actually pay business taxes. However, research on taxes overwhelmingly indicates such taxes are passed on to workers in the form of less investment and lower wages, owners in the form of reduced rates of return on investment, and/or customers in the form of higher prices, less quality and/or less selection. In other words, it is average Canadians who ultimately pay the price of business taxes.

There is also a growing consensus among economists that capital-based taxes such as corporate income taxes impose much heavier costs on society than do more efficient taxes, such as sales taxes. One estimate by the Organization for Economic Cooperation and Development concluded that one dollar raised in corporate income taxes costs the Canadian economy an additional $1.55 while the same dollar raised through sales taxes imposed only $0.17 in additional costs.

In addition to these negative effects and high costs, there is also a competitive rationale for reducing business taxes. Despite the small but nonetheless important business tax relief enacted in 2000, Canada still maintains a much heavier aggregate tax burden on capital (31.7%) than our U.S. counterparts (25.8%).

In terms of personal income tax relief, the modest reductions enacted in 2000 have provided some improved incentives for individuals and families to work harder, save more and invest. However, more is needed to bring our rates and thresholds in line with our southern neighbours. For example, the top personal income tax rate in the United States begins at US$319,100. The same rate for Canada begins at $113,704. Put differently, high-income earners begin to pay the top rate much sooner in Canada than they do in the United States. Similar problems exist for middle-income earners.

The two-pronged approach to tax relief -- broad-based business tax cuts and personal income tax relief -- will significantly improve incentives in the Canadian economy. They would also begin a virtuous circle in which more people work, more savings and investment are undertaken and more business developments are completed, ultimately increasing tax revenues. In fact, the current riches enjoyed by Ottawa are at least partially due to the important business and personal income tax relief implemented in 2000.

Unfortunately, many groups that are normally sound on their prescriptions for what ails the Canadian economy are either silent (e.g. many business groups) or propose tax relief that would provide very little lasting improvement in the Canadian economy. The litmus test for tax relief should be improving the performance of the Canadian economy, not just returning resources to taxpayers. By that test, the government has to focus on reducing the burden of taxation on capital and decreasing personal income taxes, particularly for middle- and upper-income earners.