Canada is taxing the life out of its own economy

Investors follow returns. When productivity lags and taxes bite, money finds a better home

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Canada is sliding into economic decline, and the warning signs are no longer subtle.

Productivity growth lags other G7 countries. Business investment and research spending trail other major economies. Entrepreneurs and startups are increasingly looking to jurisdictions outside of Canada for growth. The effects are visible in weaker income gains, widening investment gaps and mounting deficits.

When countries fall behind in productivity, they lose economic strength, fiscal flexibility and national influence. Productivity does not weaken by accident. It is reflected in the incentives governments create, particularly around work, investment and reinvestment.

The tax system is not the only cause of the decline in productivity, but how Canada taxes income and investment is central to it because it shapes incentives across every sector of the economy.

According to Statistics Canada, Canada’s labour productivity growth has trailed the United States and many other advanced economies for much of the past decade. That gap shows up in weaker income gains over time. For Canadian families, that means slower wage growth, fewer high-paying job opportunities and less room for governments to improve the services people rely on. It also reduces the government’s ability to fund services such as health care, defence and infrastructure.

Research from the OECD and other international bodies consistently finds that corporate income taxes and high marginal personal income taxes are among the most economically distortive forms of taxation because they directly affect decisions to invest, hire and expand. When after-tax returns fall, fewer projects meet the threshold for investment. Companies delay upgrading equipment, technology and facilities. When businesses invest less in better tools and automation, workers produce less over time.

Our system no longer rewards expansion, reinvestment and risk the way it once did. Countries with fewer structural advantages are growing faster because they have made deliberate choices to encourage growth. Canada has not.

Investors have noticed the shift. Canada’s large pension funds now allocate a majority of their assets outside the country, and foreign direct investment into Canada has weakened relative to other economies in recent years. While global diversification is prudent, sustained net capital outflows combined with weak domestic business investment signal that returns are more attractive elsewhere.

At the core of it is a tax system that has become overly complex and less competitive.

Canada’s income tax framework was last comprehensively reviewed in the 1960s. Since then, successive governments have layered credits, carve-outs and exemptions on top of one another. The result is a system that absorbs time and capital in preparing and filing taxes rather than building businesses. Compliance costs are not trivial. Small and medium-sized firms devote significant managerial time and professional fees to navigating the system, resources that could otherwise be directed toward expansion and innovation.

High marginal tax rates reinforce the message that additional effort isn’t worth it because it is heavily taxed. In most provinces, combined federal and provincial top personal rates exceed 50 per cent. Empirical studies show that high marginal rates influence labour supply decisions among high-skilled workers and affect where mobile professionals choose to live and work. Over time, that shapes behaviour. Skilled professionals compare jurisdictions. Entrepreneurs weigh where to scale. Ambition cools when the reward for additional effort narrows.

Corporate taxation compounds the problem. While Canada’s statutory corporate tax rate appears competitive on paper, the effective tax burden on new investment depends on depreciation rules, treatment of retained earnings and integration with personal taxation. Companies that reinvest profits often face tax treatment that reduces the benefit of expansion, while distributed profits face further layers of taxation. When capital is taxed at multiple stages, fewer expansion projects clear the required rate of return.

Other countries have moved in a different direction. Estonia, for example, taxes corporate profits only when they are paid out not when they are reinvested, creating a clear incentive to grow. In 2025, the U.S. restored full expensing for qualifying capital investments placed in service after Jan. 19, 2025, allowing immediate deduction of eligible equipment. That lowers the after-tax cost of expansion and strengthens cash flow. These policy changes send clear signals about where investment is welcome.

Canada has responded largely with temporary measures such as GST credit top-ups and targeted deductions aimed at specific sectors. Those may ease short-term pressure, but they do not alter the long-term incentive structure that drives productivity.

Fiscal policy adds another constraint. The 2025 federal budget reported a deficit of roughly $78 billion before adjustments for capital accounting, continuing a pattern of significant federal deficits in recent years. Borrowing can be justified when it finances productive capacity. Borrowing to fund consumption without improving growth prospects increases future obligations while leaving the core economic problem unresolved.

Taken together, slower productivity growth, weaker business investment, sustained capital outflows and structural deficits point toward reduced competitiveness.

Middle powers either adapt or accept diminished influence. A country that tolerates persistent productivity gaps and capital outflows will find its options narrowing over time.

A major tax reset is necessary if Canada intends to compete in a harder, more disciplined global economy.

That means simplifying personal tax brackets and reducing punitive marginal rates so additional effort is rewarded. It means reworking corporate taxation to favour reinvestment and expansion by lowering the effective tax burden on new capital formation. It means reducing administrative friction through automation for straightforward filings and removing carve-outs that distort behaviour.

The objective is simple: make it easier to work, invest and build in Canada.

None of this guarantees success. Productivity depends on multiple factors, including skills, regulation, infrastructure and global conditions. But tax policy is one of the few structural levers governments directly control across the entire economy. Continuing on the present path risks entrenching stagnation.

Canada cannot tax its way to prosperity, regulate its way to innovation or subsidize its way to competitiveness. Prosperity grows when people are encouraged to work, invest and build here rather than elsewhere.

If Canada intends to remain a serious economic actor rather than a reactive one, it must fix the economic incentives embedded in its tax system.

David Leis is President and CEO of the Frontier Centre for Public Policy and host of the Leaders on the Frontier podcast.