Wednesday, August 30, 2006
Capital Integration In North America: A Real Estate Perspective
Should the United States and Canada go the way of the European Union? And how would this affect real estate investing in both countries? Find out...
_______________________________________
For more than 70 years now, the Couchiching Institute on Public Affairs (http://www.couch.ca) has been asking some thought-provoking questions and encouraging lively, stimulating debates and action on a variety of key public policy issues. For example, it was at Couchiching, 56 years ago, that the idea of creating a North Atlantic Treaty Organization (NATO) was first floated publicly by Escott Reid, a senior official with the Canadian Department of External Affairs. NATO was established a year and a half later, reflecting almost exactly the vision that Reid outlined in his speech at Couchiching.
One such lively debate that is presently going on not only at the Institute but, indeed, in many political and economic circles all over Canada, is the effects that an integrated ‘Continentalism’ would have on different facets of the economies of both Canada and the United States. Here is a topic that is thought-provoking and, some might say, provocative!
Economic integration refers specifically to the free movement of goods and services, capital, and labour and the harmonization of the rules governing the operations of these three key economic elements. Both countries stand to reap the rewards and the benefits of opening up to the fullest their respective markets to cross-border competition and, above all, to the free flow of capital. Real estate investing would possibly become the forefront recipient of such benefits.
To be sure, capital integration is very much a political decision for Americans, Canadians and their elected governments. It is a big decision that all of us, on both sides of the border, would have to determine as democratic societies. Specifically as it relates to capital flows in North America, both countries eliminated wartime foreign exchange controls in the early 1950s. Thus, for most of the post-war period, the United States and Canada have benefited greatly from the free movement of capital and from competition in financial markets. Consequently, capital flows have played a very important role in North America’s development as a modern economic powerhouse.
Indeed, particularly through the 1950s, 1960s, and early 1970s, foreign savings helped finance the large investment projects that were necessary to develop industrial infrastructure and increase production potential, especially in the resource and manufacturing sectors. At the same time, both American and Canadian firms, corporations and consortiums were able to set up businesses and pursue investment opportunities abroad. Through two-way direct investments, they also had access to, and mutually benefited from, technological innovations and processes developed both in North America and elsewhere.
In the North American context, freeing up capital flows has not been part of formal negotiations between Canada and the United States. In both countries, this has largely been a domestic endeavour. This means that the integration of Canada-U.S. capital markets has proceeded as fast as the Americans and the Canadians have been able to reduce domestic impediments to movements of capitals across the border.
One such and still existing impediment – perhaps the biggest – is the different sets of rules and regulations in the matter of capital gains taxation. In general lines, both the United States and Canada make use of a ‘Withholding Tax’ applicable to non-resident investors. But what differs greatly is the percent rate. If the Seller is a non-resident of Canada, he must apply for and obtain a Clearance Certificate from the Canadian Customs and Revenue Agency (CCRA) and provide the Buyer with this Certificate. The Certificate exempts the non-resident Seller from the withholding tax if the Buyer is a Canadian resident. It normally takes four to six weeks for the CCRA to issue a Clearance Certificate. If a Clearance Certificate is not provided to the Buyer, then the Buyer must hold back one-third of the sale price until the Certificate is provided. Conversely, the withholding tax applied in the United States in similar circumstances, i.e. of a non-resident Seller transferring an interest in land to a non-resident Buyer is only ten percent of the sale price.
Another great impediment to a freer flow of investment capitals has been the gap created by the conversion rate between the two currencies, which gap, however, has been steadily diminishing these past few years.
And last, but not least, there is the fact that the economies of the two countries are significantly different. Not only is the American GDP (US$13.049 trillion) approximately 15 times larger than the Canadian (US$880 billion) – the very economic philosophies of the two countries are diametrically opposed. America’s capitalism is based on consumption and gives priority to consumerism, that is spending as opposed to saving. Canada, on the other hand, does exactly the opposite by giving, in fact, priority to saving.
It follows, therefore, that a prerequisite towards capital integration would be the ‘harmonization’ of a number of federal, provincial and state regulations. Any such ‘harmonization’ would not have to make the regulations identical, but only compatible – pretty much following the footprints of the 25-member states of the European Union. There are efficiency gains to be made on both sides by moving to common regulatory standards in North America. Not only would common standards reduce the costs of compliance, they would also allow investors to actively participate on a more level playing field.
Fundamentally, the decision to deepen economic integration in North America is a political one that the United States and Canada would have to make. From a purely economic perspective I have, as an economist, a strong predilection for continuing to tear down barriers — preferably multilaterally but, realistically, first within North America. Over the long haul, this is going to encourage a more efficient, productive and integrated economy, greater opportunities for investors and, most importantly, higher living standards. And economic theory and the experiences of other countries support the view that, on balance, the benefits of opening up outweigh the costs.
Luigi Frascati
Real Estate Chronicle
