May 2001

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Chilly Business Climate in BC

by Jock Finlayson

For much of the past decade, it has been common wisdom among private sector leaders and economic commentators that British Columbia has a "business climate" problem. By this it is usually meant that, compared to other, similar jurisdictions both in Canada and the United States, BC has become a less appealing place to invest and do business. Although this view is widely held, those who espouse it do not always offer evidence to back the claim. What data can be adduced to support the proposition that BC has developed an increasingly uncompetitive business climate?

To begin with, as documented in The Fraser Institute’s recent study Returning British Columbia to Prosperity, BC has fared abysmally by Canadian standards on a number of key economic performance measures—notably the growth of both real GDP per capita and real after-tax incomes.¹ If British Columbia truly had an excellent business climate, presumably it would not have experienced such feeble gains in per capita output and incomes.

Beyond such aggregate measures, it is instructive to consider evidence that bears more directly on the health of the business environment.

Business investment

"Business fixed capital formation" refers to private-sector expenditures to acquire machinery, equipment and technology; to build plants, factories and commercial structures; and to expand the housing stock. It excludes investment in inventories or repairs. According to the most recent edition of Statistics Canada’s annual Provincial Economic Accounts, BC ranked last in the country in the growth of total real business investment over the period 1992-1999 (see table 1). Excluding the housing sector, BC did somewhat better, but was still second last among the provinces in the growth of non-residential business investment.²

The Fraser Institute’s recent study of economic trends and public policy in British Columbia examined a different measure of investment: changes in real net business investment, i.e., real investment after accounting for the replacement of existing fixed assets such as plant and equipment. It turns out that over the past decade, the level of investment in BC has not kept pace with depreciation of the capital stock. On average, real net business investment declined by 0.4 percent between 1990 and 1994, and then decreased by a further 4.2 percent between 1995 and 1999 (Clemens and Emes, p. 24). On this measure, BC actually performed slightly better than Canada and Ontario over 1990-94, although it did much worse than Alberta. Between 1995 and 1999, however, BC fell badly behind Canada, Ontario, and Alberta, all of which recorded substantial gains in real net business investment.

Most of the post-1992 period saw a business investment boom across North America. That British Columbia has been near the bottom in Canada on several measures of private sector capital spending since the early 1990s certainly does not speak favourably of its business climate.

Table 1: Change in Aggregate Real Business Fixed
Investment, 1992-1999 ($1992 dollars; total percentage increase over the period)

Head offices

The presence of corporate head offices can also provide useful information on a jurisdiction’s ability to attract high-value business activity and nurture the growth of existing businesses. On this score, British Columbia is at best a middling performer. Moreover, its importance as a business centre within Canada has diminished over time.

Of Canada’s 500 biggest corporations, British Columbia is the home base for 55 (11%) (National Post).³ Not surprisingly, Ontario and Quebec, which together represent more than 60 percent of the nation’s population, continue to account for the largest number of major companies (see table 2). On the basis of population, one might expect British Columbia to rank third in the number of head offices, as indeed it did two decades ago. Instead, BC now trails Alberta by a sizable margin, even though it has 1.1 million more people and enjoys several locational advantages over Alberta, including better access to the US and Asia, an excellent port and airport, and a more temperate climate. In 1999, 70 of the 500 largest Canadian firms had their headquarters in Alberta (most in Calgary). Looking beyond the top 500 to the largest 800 Canadian businesses, BC is home to 84 of these companies while 110 have their head offices in Alberta.

Investment Managers Survey

The Fraser Institute periodically conducts a survey of senior pension fund and investment managers. Among other things, respondents are asked to assess the investment climate for all 10 provinces. In the most recent survey, BC was judged to have the worst investment climate in Canada (Clemens). Both Ontario and Alberta received ratings 2.5 times higher than British Columbia. Even Quebec and Newfoundland were judged to offer better investment climates than BC.

Business migration

Stories about companies moving to Alberta and the United States have frequently appeared in the BC media during the past several years. Unfortunately, there is little reliable data on outflows and inflows of businesses or investment dollars. Contrary to what some may believe, BC has not experienced an exodus of major corporate head offices, although it has been notably unsuccessful in luring new ones to the province. A small number of companies of significant size have shifted their head offices outside of BC in recent years; examples include Finning Canada,⁴ Trans Mountain Pipe Line Company, Wajax Inc., and the Jim Pattison Group’s automobile leasing business. However, such evidence as exists—and it is almost wholly anecdotal—suggests that the vast majority of businesses that have left the province are small, private concerns.

Based on newspaper reports, it appears that at least a dozen early-stage, high-technology companies have moved to the United States since 1995 in order to escape BC’s high personal income taxes, get closer to their customers, and/or improve their odds of raising venture capital. The downturn in BC’s residential construction industry since 1998 has prompted some contractors to re-locate to the more robust economy of Alberta. The Western Canadian food and beverage manufacturing industry has seen a consolidation of corporate decision-making functions in Alberta in the 1990s, a trend that has worked to the disadvantage of both BC and Saskatchewan (Finlayson). Apart from this, a significant number of large corporations with their head offices or other major operations in BC have transferred jobs outside of the province and decided to focus on growing their businesses elsewhere. This pattern is readily apparent in the forest and mining industries.

All of that said, the data on business migration are mainly anecdotal and of poor quality. One exception is a recent report produced by BC Stats. According to this study, net transfers of corporate charters from BC to the rest of the Canada have clearly accelerated since the early 1990s. In 1990, 35 more corporate charters were transferred into BC from other provinces than were transferred out. By 1994, the trend had turned, with net outflows rising steadily to a record of 169 in 1999. From 1994 to 1999, BC saw a cumulative net loss of almost 500 corporate charters to other provinces, with Alberta being the principal beneficiary. The statistics on corporate charter movements do not specify the size or nature of the businesses involved, although it is likely that almost all of them are small.⁵

Table 2: Top 500 Corporate Head Offices
by Province, 2000 (ranked by 1999 revenues)

Tax policy and the business climate

Tax policy is not the only factor affecting the business climate, but it is taken into account when investors and business managers ponder where to establish operations or allocate capital. Although BC has relatively low provincial taxes in a few areas (such as payroll), its taxes are high by Canadian (and US) standards in several important areas that bear on business location decisions, entrepreneurship, and wealth creation. In particular, compared to many other North American jurisdictions, BC imposes high taxes on skilled labour; on investors; and on many types of business enterprises (especially large firms in capital-intensive industries).

Most of the public debate over taxes in British Columbia is directed at personal taxes. Yet taxes imposed on business arguably have a greater impact on investment location decisions, at least in most industries.⁶ This is because capital remains more mobile than labour, notwithstanding the rising number of highly skilled workers who are willing to move to other jurisdictions in pursuit of economic opportunity.

On the business tax side, British Columbia is quite competitive in a few areas but operates at a marked and increasing disadvantage in others. Two features of the business tax structure make British Columbia an attractive location for companies and entrepreneurs:

• Payroll taxes are low compared to the United States and to several other Canadian provinces. To begin with, the burden of federal payroll taxes in Canada is significantly less than that in the US. And unlike Ontario, Quebec, Manitoba and Newfoundland, BC does not levy a general-purpose provincial payroll tax.
• The income tax rate imposed on small business (4.75 percent on net income up to $200,000 in 2001) is also relatively low in British Columbia, although most provinces are trimming their small business tax rates so any advantage enjoyed by BC is likely to prove both minor and fleeting.

On the other hand, at least four aspects of the business tax environment in BC act to discourage new "greenfield" investments as well as the expansion of existing businesses:

• BC’s provincial corporate income tax rate (16.5 percent in 2001) is higher than comparable rates in other major provinces: Quebec (9.0%), Ontario (14.0%) and Alberta (13.5%). Moreover, both Ontario and Alberta are in the midst of reducing their statutory corporate tax rates to 8 percent by 2005 and 2006, respectively. To date, the BC government has given no indication that it plans to follow suit. This means that provincial corporate tax rates in BC will be more than double those in the other two "have" provinces, a prospect that can only hasten the outflow of capital and business activity from BC to other parts of the country.
• Approximately two-fifths of the $3.5 billion in revenues that the BC government collects from its 7 percent provincial sales tax is derived from the taxation of business inputs, from equipment, vehicles and computers, to energy, legal and consulting services. The BC sales tax base is broader than all other provincial bases for business purchases. The only exemption available for BC businesses is a partial refund in respect of provincial sales tax paid on purchases of machinery and equipment for use in manufacturing. Overall, the design of BC’s sales tax regime serves to put all exporters and many categories of industry in the province at a competitive disadvantage within Canada. Alberta, of course, does not levy a sales tax, so its businesses face a significantly lower tax burden than their counterparts in British Columbia. Quebec and the Atlantic provinces have harmonized their sales taxes with the federal GST. This means that businesses in those provinces get back all of the sales tax paid on business inputs. Manitoba, Ontario and Saskatchewan, like BC, impose sales tax on many business inputs, but they have established more generous exemptions or tax credits for businesses than BC. Eventually, the only sensible course for BC is to harmonize its sales tax with the GST. In the meantime, the government needs to expand the number of business inputs eligible for full or partial exemption from the retail sales tax.
• The Corporation Capital Tax (CCT) applies to about 20,000 large- and medium-sized businesses in BC. It is levied at a rate of 0.3 percent on paid-up capital in excess of a $5 million threshold. Large financial institutions pay a higher rate—up to 3 percent. Under the CCT, the tax base for non-financial businesses is basically the liability side of the balance sheet and includes share capital, retained earnings, surpluses, and deferred credits. Foreign investors in particular have loudly objected to the capital tax, arguing that it makes little economic sense to impose an up-front tax on business investment. While the point is well taken, six other provinces also maintain some form of general corporate capital tax, and the federal government levies its own capital tax on large enterprises. The problem for BC is twofold: 1) neither Alberta nor nearby American states have a capital tax; and 2) capital taxes are also unknown in Asian countries like Hong Kong and Taiwan, which are important trading partners and long-standing sources of investment for BC.
• Finally, compared to other provinces, BC also levies high fixed taxes, including direct royalties, fees, and property taxes, on most of the resource-based industries that still provide three-quarters of its exports and close to 70 percent of its manufacturing shipments. The fact that forestry and mining in BC operate at a relative tax disadvantage no doubt helps to explain the sluggish pace of capital spending by these industries since the mid-1990s.⁷



Conclusion

British Columbia’s lacklustre reputation as a place to invest has undermined the province’s prosperity and dampened its growth prospects. Within Canada, BC has been attracting a diminishing share of both foreign and domestic direct investment; it has also lost ground, notably to Alberta, as a location for corporate head office functions and the high-paying managerial, professional, and technical jobs that go with them.

Improving the business climate will take time. The probable election of a new provincial government in 2001 will be welcomed by local private sector leaders, investment fund managers, and businesses based elsewhere that have an interest in the BC market. At this stage it is impossible to say whether the policy agenda the next government follows on taxes, labour relations, regulation, resource industries, and other key areas will lead to a meaningful improvement in the province’s business climate and economy. But it is hard to imagine BC performing as poorly in the coming 5 to 10 years as it did during the past decade.




Notes

1 BC has a considerably better record in the area of job creation. To some extent, this reflects rapid growth in the province’s population. A rising population increases the demand for consumer goods and services, which in turn leads to higher levels of employment in the domestic industries that supply these goods and services.

2 Calculated from Provincial Economic Accounts, Table 3. Data on investment growth by province is available upon request from the Business Council of British Columbia.

3 The National Post’s ranking of the top 500 Canadian companies excludes Crown enterprises and subsidiaries.

4 The parent company, Finning International, is still headquartered in BC.

5 Because interprovincial movements of corporate charters are minuscule in relation to the numbers of both existing and newly incorporated businesses, caution is called for in using these data as a basis for drawing conclusions about the business environment.

6 Some advanced technology industries may be an exception, given intense North American and global competition for skilled information technology workers and managers and professionals experienced in building successful technology enterprises.

7 The situation is different in the upstream oil and gas industry, where the BC government has reduced royalties and taken other steps to encourage new exploration and development activity. These policy initiatives are now beginning to pay dividends, as both capital spending and production in the upstream oil and gas sector have increased appreciably since 1998.




References

BC Stats (2000). "Transfers of Corporate Charters to Other Provinces Suggest Business Migration from British Columbia," Infoline. October 13.

Clemens, Jason (2000). Summer 2000 Survey of Investment Managers. Vancouver: Fraser Institute.

Clemens, Jason and Joel Emes (2001). Returning British Columbia to Prosperity. Public Policy Sources, no. 47. Vancouver: Fraser Institute (March).

Finlayson, Jock (2000) "Decline of BC’s Food and Beverage Industry is Further Proof of Dwindling Opportunities," Business in Vancouver, January 4-10.

National Post. Business 500: Canada’s Largest Corporations. 2000 edition.

Statistics Canada (2000). Provincial Economic Accounts.

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Jock Finlayson is Vice-President of Policy at the Business Council of British Columbia. He holds a Master’s degree in Management from Yale University and undergraduate and MA degrees from UBC.

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