Trade, Tariffs, and Competitiveness – An Interview with Trevor Tombe

February 24, 2025

As the threat of U.S. tariffs looms over the Canadian economy, it is crucial for CPAs to have access to insightful economic analysis and public policy foresight. Enter Trevor Tombe, one of Canada's foremost experts on international trade and economic policy. A Professor of Economics at the University of Calgary and Director of Fiscal and Economic Policy at The School of Public Policy, Tombe's research not only analyzes potential tariff impacts but also provides concrete, evidence-based recommendations for strengthening Canada’s economic resilience.

In this exclusive interview for CPA Ontario, Tombe delves into the complexities of the current Canada-U.S. trade landscape, offering CPAs the insights they need to understand the economic environment, make informed decisions, and help their organizations adapt, innovate, and thrive as Canada reimagines its economic future.

This wide-ranging interview covers the scale of the Canada-U.S. trade relationship, the multifaceted impacts of tariffs, and Canada's existing productivity challenges. Importantly, Tombe outlines what Canada should do next to bolster its economic resilience. For CPAs advising businesses or planning for the future, understanding these dynamics and potential responses is essential for navigating the economic landscape ahead.

Setting the Stage: The Canada-U.S. Trade Relationship

The stakes are clear in the numbers: while trade with the U.S. represents about one-third of Canada’s gross domestic product (GDP), American trade with Canada accounts for just 3% of U.S. GDP. This disparity is further highlighted by the fact that approximately 40% of Ontario’s economy is linked to U.S. trade.

Beyond those numbers, the nature of the trade relationship adds another layer of complexity. “About four of every five dollars that is traded between our two countries is an intermediate input,” Tombe explains. Unlike final consumer products, intermediate inputs are materials and components that businesses use to create other goods. Tariffs on these inputs are more economically damaging than those on final goods because their effects multiply; when input costs rise, it triggers price increases throughout the supply chain, creating cascading economic harm.

The Hidden Cost of Uncertainty

The mere threat of tariffs is already inflicting economic damage on Canada. “Canada has reached a level of uncertainty that we have never seen before,” Tombe points out, noting that current policy uncertainty is double what Canada faced when renegotiating NAFTA (now CUSMA) in Trump’s first term

Even if tariffs are ultimately avoided, this uncertainty will have both immediate and potentially long-lasting effects. Businesses are pausing investments, reconsidering their supply chains, and shifting towards more predictable—though often more expensive and less efficient—providers. “The mere threat of tariffs coming at a time when the Canadian policy landscape is highly uncertain, especially federally, makes it challenging for firms to plan significant, long-lived investments” notes Tombe. Spikes in uncertainty are connected not just to drops in investment, but also to drops in employment and economic activity in general.

The Harsh Reality of Tariff Implementation

Tombe broke down the mechanics and potential magnitude of these tariffs. As he explains, tariffs are a tax on Americans who purchase goods from targeted countries—in this example, American businesses and consumers pay an additional 25% cost on Canadian goods. The immediate effect of this is a change in behaviour—U.S. buyers may look for alternative suppliers, or they may simply reduce their purchases of Canadian goods altogether.

The scale of disruption is unprecedented; Tombe highlighted that we haven’t experienced a trade shock at this scale since the 1930s. While the exact impact is difficult to predict, Tombe has modeled out what he calls a “conservative assumption” surrounding tariff impacts.

If the demand for Canadian goods falls in proportion to the tariffs, Canadians could see a 25% decrease in demand from the United States. While this could impact different sectors differently—for instance, the auto sector could see an estimated drop in demand of 15%—in aggregate, there could be a 3% overall reduction in demand. The result: $150-160 billion per year in foregone sales and roughly 600,000 jobs lost—bringing the unemployment rate up to 10%. According to Tombe’s estimates, a 25% tariff could reduce Canada’s GDP by 2.6% or about $2,000 per person, causing a recession.

Tombe’s calculations come with caveats; they are built on the assumption that tariffs would be permanent, which may not be the case. There are many things that we don’t know, including the length of the tariffs, if and how the federal and provincial governments will intervene, and how Canadian policy adapts to this new reality. Answers to these questions would significantly shift the impact of tariffs.

The Economic Situation: Canada’s Pre-Existing Weak Productivity

Canada’s vulnerability to U.S. tariff threats is further magnified by a concerning trend in economic performance over the last decade. Put simply, Canada is in the midst of a productivity crisis. Over the past 10 years, Canadian productivity has essentially flatlined. “We’re only barely above where we were ten years ago,” Tombe points out.

The gap between Canadian and U.S. productivity tells a sobering story. According to Tombe’s analysis, if Canada had kept pace with U.S. economic growth, the Canadian economy would be roughly $640 billion larger today, translating to $15,000 per person. Tombe explains: “If you look over the 20 years prior to 2015, our two economies grew together on a per person basis. Ups and downs, through energy booms and busts, through September 11th, the financial crisis, and so on. So, we’ve been experiencing an unusual decoupling or divergence.” The historical pattern makes this divergence even more concerning. “It’s really hard to overstate how significant an economic challenge Canada faces right now.”

Should Canada Retaliate?

We talked to Tombe about retaliatory tariffs, but he sees it ultimately as a losing battle. "Our ability to economically pressure the United States is just really, really small, and we ought to be realistic about that.” For example, if our demand for U.S. output fell by 25%, the state of Wisconsin, which is the most heavily exposed state to Canadian retaliatory tariffs, would experience a drop equivalent to 0.15% of GDP. It's a small impact, but not nothing. A 25% tariff levied by the U.S. would have 40 times the impact on Canada vs the same tariff level levied by Canada on the U.S. On retaliatory tariffs, Tombe concludes: “I don't tend to think it's a cost worth paying because it's hard to see any material pressure actually being exerted on the United States.”

Retaliation in some way is unavoidable for government due to public pressure. Symbolic retaliation, like pulling American alcohol from shelves, would cause minimal economic damage for Canada. While retaliation may make sense as an emotional reaction to tariffs, Tombe says that instead strengthening the Canadian economy will have a more meaningful effect.

The Recommended Path Forward: Strengthen Canada’s Economy

Given the dual challenges of potential U.S. tariffs and Canada’s pre-existing productivity gap, we asked Tombe if he could enact any key policy changes to strengthen Canada’s economy, what would they be. His recommendations focus on three key areas that could help Canada both weather the storm and address long-term competitiveness.

Reform Corporate and Personal Income Taxes

Tombe’s recommendations begin with tax reform as the crucial first step in attracting investment and boosting productivity. Since 2000, 90% of Canada’s labour productivity growth has come from business investment, including investments in machinery and equipment and new technology. So, as Tombe emphasizes, “…anything that can improve investment incentives is needed now in order to move the needle.”

On the corporate side, Tombe recommends adjusting the tax code to enable Canadian companies to write off fully and immediately 100% of all capital investment. He contrasted this more ambitious idea to the federal government’s welcome, but more timid proposal in its 2024 Fall Economic Statement to reinstate the Accelerated Investment Incentive, which was set to be fully eliminated after 2027.

In this economic environment, he also thinks that federal and provincial corporate income tax rate reductions should be considered, with a target to move the combined total rate to around 20%. Currently, in Ontario, the statutory combined rate is 26.5% – 15% federal and 11.5% provincial. With capital being mobile, cutting corporate tax rates would help make Canada more attractive to investment and increase our competitiveness vis-à-vis the U.S., especially as the Trump administration contemplates their own tax cuts.

Beyond corporate taxation, Tombe makes a case that that personal tax reform is equally crucial for Canada’s competitiveness. Here, the gap between Canadian and U.S. rates presents an even more pressing challenge. For example, in Ontario, the top combined marginal personal income tax rate is 53.5%, while in neighbouring Michigan, it’s only 41%, and in Pennsylvania it’s 40%. These large tax rate differences make it harder to attract and retain skilled labour. This challenge is compounded by the fact that Canadian personal tax rates kick in at much lower levels of income.

To pay for these tax changes, Tombe put some controversial but important ideas on the table like raising the GST/HST (a relatively less economically damaging type of tax), increasing the age of eligibility for Old Age Security, cutting corporate subsidies, and doing away with special tax credit carve-outs that are embedded in both the personal and corporate tax systems.

Remove Interprovincial Trade Barriers

With the constant barrage of tariff threats, it's more crucial than ever to remove trade barriers within Canada. Tombe is clear on this point: removing interprovincial trade barriers is "a complete no-brainer" that would immediately strengthen Canada’s domestic market.

Easing these interprovincial trade barriers would not only align with global trade practices but also significantly boost Canada's economic performance. Tombe maintains that "those barriers hurt Canadian consumers" and keeping them serves "no clear public policy objective." By making trade between provinces smoother, Canada can create a stronger, more integrated market that benefits all regions, reduces costs, and improves economic efficiency.

Interprovincial trade is an area where reducing the burden of regulation should be easier to achieve than anything else. It's not about less regulation; it’s about ensuring that regulations approved in one part of Canada are recognized and accepted in all provinces and territories. This is something where it's hard for the federal government to make progress, but provinces have every tool they need. In Tombe’s opinion, the only thing lacking is the political will.

Diversify Trade Through Infrastructure Development

Tombe emphasizes trade diversification as a key strategy to reduce Canada’s economic risk. While there is a clear growing appetite for diversification of trade, Tombe points out a critical issue: "If we want to increase our capacity to trade beyond the United States, we need more rail, more ports, more pipelines; more infrastructure… There’s no mechanism to trade more if we don’t have the physical capability to do it."

Canada’s trade infrastructure faces significant bottlenecks. With rail networks and ports operating at maximum capacity, increasing exports of one product could mean reducing exporting of another. Tombe emphasizes that improving trade capacity isn’t just about securing funding, it requires streamlining regulations for infrastructure development and balancing local concerns with national priorities.

Conclusion

As Canada navigates an increasingly complex web of tariffs, and braces for potential economic impact, Trevor Tombe paints a sobering but actionable picture. The threat of tariffs demands attention but also presents an opportunity to address long standing challenges in tax policy, interprovincial trade barriers, and infrastructure development. For Ontario CPAs, success will depend on understanding both the immediate risks and strategic opportunities to strengthen Canada’s economic resilience. While the path ahead is challenging, with clear analysis and decisive action, Canada can adapt and potentially emerge stronger from this period of uncertainty.