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November 30, 2021

From: Jeremy M. Kronick and Alexandre Laurin

To: Finance Minister Chrystia Freeland

Date: November 30, 2021

Re: Taxing Big Banks and Insurers – Unlikely to Go the Way Planned

Most people understand and agree with the notion that taxation should be progressive – people who earn more should bear a greater burden of funding the services provided by government

At the same time, however, taxes affect the relative prices of labour, capital, goods and services, and thus carry an economic cost.

Business taxes in particular affect real activity, and their burden can be passed on to consumers, employees, and investors. As a result, whenever we discuss a new or altered tax, the likely consequences on all economic actors need examination.

Enter the bank tax and the Canada Recovery Dividend.

The federal government plans on increasing the corporate tax rate on banks and insurance companies from 15 percent to 18 percent.

The Canada Recovery Dividend is less well-defined. Consultations with the Office of the Superintendent of Financial Institutions (OSFI) are underway but the expectation is that it will have a similar feel to the tax itself.

The motivation behind both is simple: banks were the beneficiaries of government support during the pandemic, to help encourage them to support households and businesses during both the crisis period as well as the recovery. Banks have recently reported strong profitability, and the time has come to pay back the support, thereby helping the government continue to fund the recovery. The insurance industry, which did not receive any support beyond that given to other industries in general, appears to have been caught in the crossfire.

Most of the arguments against the tax and dividend are standard fare for economists. Banks and insurance companies will pass down the cost to consumers, employees, and investors in the form of higher fees, higher insurance premiums, lower deposit rates, higher interest rates on loans, and lower pay. These cost increases will likely hurt lower-income folks disproportionately.

Moreover, lower dividends to investors may push stock prices down, hurting Canadians with investments in mutual funds and pension funds. As a result, any increased government revenue will be paid for by Canadians generally.

The financial services sector is tightly regulated. Barriers of entry are high. In an unregulated market, competitors would step in and offer a better deal when a business passed its costs down to households and businesses.

Not in Canada, where despite alternatives to the big banks and insurers – smaller banks/insurers, credit unions – the market dominance of the big players makes it very likely that they will be able to pass down the cost of the tax and dividend.

Promoting competition in the sector will help. In the medium-term, moving on open banking is an imperative. The Advisory Committee on Open Banking set a go-live date for January 2023 with a series of intermediate steps, including addressing legislative and regulatory impediments, and determining accreditation standards for new fintech players.

We have heard very little from the federal government on pushing this forward; a lost opportunity. 

However, should the government push ahead with taxing the financial sector, it should put in place a better, less distortive long-term solution instead of focusing on a, hopefully temporary, bandage – one that, like its capital tax for financial institutions predecessor, will hurt the competitiveness of Canadian providers of financial services.

When we think of optimal taxes in terms of fairness, minimizing distortions, and bringing the government the tax revenue we expect, we typically think in terms of broad-based value-added taxes such as the GST. Banking services are for the most part exempt from the GST, largely because of difficult-to-overcome implementation challenges: for example, how do you charge GST on net interest costs? Following the 2008 financial crisis, the IMF suggested another way to implement value-added consumption taxes on financial services. Branded the Financial Activities Tax, it involves taxing the sum of the financial sector’s profits and wages, which also corresponds to business value add – the GST tax base.

One major obstacle, however, at least as it relates to the insurance industry, is that insurance premiums are already taxed provincially. The sum of provincial insurance premium taxes and retail sales tax effectively amount to a much higher proportion of business value added than any HST rate. So, implementing an across-the-board value-added tax for the financial services sector as a whole would entail a difficult recalibration in which the tax burden of the insurance services sector must fall, and the tax burden of the banking sector must increase.

A better solution in confederated Canada would be to improve financial sector competitiveness, which, over the medium-run, will reduce the oligopolistic alleged excess profits Ottawa is targeting, and lead to better economic outcomes for all.

If, however, the tax route is the government’s path, a broad-based, less distortionary solution would be preferable but it will take time and patience to get right.

Jeremy M. Kronick is Associate Director, Research, and Alexandre Laurin is Director, Research, at the C.D. Howe Institute. 

To send a comment or leave feedback, email us at blog@cdhowe.org.

The views expressed here are those of the authors. The C.D. Howe Institute does not take corporate positions on policy matters.