Estonia, a small nation with an economy one-50th the size of Canada’s, has consistently topped the Organization for Economic Co-operation and Development’s tax competitiveness rankings for 13 years. The secret to its success lies in a radical shift in corporate taxation introduced in 2000, which taxes companies only on distributed profits, not retained earnings. This approach allows firms to reinvest profits without immediate tax burdens, fostering economic growth.
The policy has significantly boosted Estonia’s economic performance. In 1990, its GDP per capita was just 30% of Canada’s, but by 2021, it had risen to 48%. The distributed-profits tax has also improved productivity, investment, and firm liquidity, particularly for smaller companies. A 2011 study from the University of Tartu found that the policy strengthened balance sheets, helping firms weather the 2008-09 financial crisis.
Despite its success, Estonia still lags behind the OECD average in GDP per capita, partly due to recent economic disruptions from the Russia-Ukraine war. However, the C.D. Howe Institute has highlighted Estonia’s model as a potential solution for Canada’s economic challenges, including low productivity growth and difficulties in small business financing. The institute suggests adopting a similar system could reduce corporate tax paperwork and eliminate distorting tax breaks.
The C.D. Howe paper argues for a ‘Big Bang’ approach to tax reform, including scrapping the small business tax rate and sector-specific breaks. While the policy is not a panacea, Estonia’s experience demonstrates that bold tax reform can alter a country’s economic trajectory. For Canada, embracing such changes could mean moving away from a model that overtaxes and over-subsidizes, potentially unlocking greater economic potential.