There has recently been a bitter exchange between the federal and Ontario governments over Ontario's corporate income tax rate.

The federal government is urging Ontario to take up the federal challenge, put down by Finance Minister Jim Flaherty in last year's fall update, to move its tax rate down to 10 per cent from the current 14 per cent.

Ontario responds by pointing out that it has substantially cut corporate taxation and has faced a need to respond to other pressing priorities.

Both sides make valid points. The exchanges do not strike us as an appropriate manner to debate serious policy matters. They risk damaging confidence in the Ontario economy.

Further, by cornering the Ontario government, the federal tactics may actually make it more difficult politically for Ontario to continue cutting corporate taxation.

The TD Economics position has long been that Ontario will face growing problems of attracting and retaining businesses and have them book their profits in the province if it has more than a two percentage point spread between the Ontario general corporate income tax rate and that prevailing in the other large provinces.

With Alberta at a 10 per cent rate, B.C. heading to 10 per cent and Quebec at 11.4 per cent (but scheduled to rise to 11.9 per cent), that suggests that over the next several years Ontario needs to get its general rate down to around 12 per cent.

Its rate for manufacturers is already there. A 12 per cent rate would of course be a minimal defensive move. It would not provide an Ontario advantage.

We have also argued that a retail sales tax, where a large portion of the revenue comes from capital and business inputs, has no place in a modern economy. Hence, Ontario should reform its retail sales tax to move it to a value-added structure that places the burden on final consumption.

A few points seem to have been lost in this debate.

First, as noted above, against a backdrop of a large deficit when the current Ontario government first took office, Ontario has provided considerable corporate tax relief through the capital tax and the provincial portion of property taxes.

Second, corporate taxation was not the only deficit the Ontario government faced. It also had the need to reinvest in education and in almost all forms of infrastructure. Addressing the desperate need to rebuild electricity generating capacity, as one example, will reap benefits for Ontario businesses.

Third, while we agree that Ontario will need to bring down its general corporate income tax rate over time, we should not pretend this will have an immediate impact of insulating the provincial economy and its manufacturers from the U.S. downturn and the effects of the strong Canadian dollar. Many of the province's manufacturers are not currently in a profit position and hence not paying tax, regardless of the rate.

Finally, TD Economics has pointed out in the past that one of the factors holding up Ontario's tax effort is the net withdrawal of federal funds from the provincial economy. Federal revenues from Ontario exceed federal spending in the province by some $20 billion per year.

Some of this reflects the substantial overall surpluses the federal government has been recording in recent years. Some amounts to Ontario financing a substantial portion of the redistribution role the federal government plays across provinces.

In total, the net federal withdrawal amounts to 4 per cent of Ontario's GDP. That's a lot of income that is not available to meet the pro-vince's needs, including the requirement to provide a competitive corporate tax playing field.

We note, and applaud, the support of the Ontario government and its citizens to finance the federal government's redistribution role. But at the same time Ontario faces a need to be competitive with other provinces and other countries.

It once was shielded in this competition behind high tariff walls and other barriers, but most of those have been dismantled. There is an intriguing question that needs to be addressed in Canada of how much redistribution can be financed in the modern, competitive global economic context.