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The Progressive Economics Forum

Dion’s Voodoo Economics

The Liberals claim, “Corporate tax cuts implemented by the previous Liberal government actually raised government revenues and helped balance our country’s budget after years of Conservative economic mismanagement.”

The federal budget was balanced in 1997, but the Liberals did not cut corporate taxes until 2001. Chronology does not support the notion that corporate tax cuts helped to balance the budget.

The notion that lower corporate tax rates increased corporate tax revenue is reminiscent of Ronald Reagan. Again, the Liberals have a chronological problem: corporate tax revenues fell as they cut corporate tax rates. Budget 2008 projects that revenues will again fall as the Conservatives cut corporate tax rates. Most of the rise in revenues occurred when the corporate tax rate was stable at 22.12% (incidentally, the rate that the NDP would maintain.)

 Year

 CIT Rate

 CIT Revenue

 Investment/GDP

 2000

 29.12%

 $28,293

 11.6 %

 2001

 28.12%

 $24,242

  9.9 %

 2002

 26.12%

 $22,222

  9.3 %

 2003

 24.12%

 $27,431

  9.4 %

 2004

 22.12%

 $29,956

  9.9 %

 2005

 22.12%

 $31,724

 10.8 %

 2006

 22.12%

 $37,745

 11.3 %

 2007

 22.12%

 $42,405

 11.1 %

 2008

 19.50%

 $36,830

  9.6 % (Q2)

 2009

 19.00%

 $36,570

 NA

 

Of course, the key driver is corporate profits, which sagged for a couple of years after 2000 but then skyrocketed to record heights. Overall, pre-tax profits surged from $86 billion in 1998 to $227 billion in the second quarter of 2008 (annualized). Therefore, it’s hardly surprising that corporate tax revenues increased over the past decade.

Profits rose for many reasons, including higher commodity prices and the failure of wages to keep pace with productivity. The Liberal argument appears to be that pre-tax profits rose mainly because of lower tax rates. There are two possible theories.

First, lower corporate tax rates could have induced businesses to make new investments, generating more profit in subsequent years. However, corporate investment has not increased. Indeed, investment declined as corporate tax rates fell and partially bounced back when rates stabilized.

As Statistics Canada observes, “Over much of the last decade, corporations as a whole have been posting record profits. Meanwhile, business fixed capital investment has been relatively sluggish in recent years.”

Second, lower corporate tax rates could have induced multinational corporations to report more of their taxable profits in Canada. But had that been a major factor, corporate tax revenue would presumably have increased most in years when rates fell. On the contrary, as noted above, most of the revenue increase occurred when rates did not change.

Therefore, corporate tax cuts have not achieved their stated goals of attracting more investment or reported profits to Canada. Certainly, they have not increased corporate tax revenues.

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Comments

Comment from Travis Fast
Time: October 4, 2008, 10:29 am

There was no shortage of silly economic promises during the debates. In French it seemed all 5 parties agreed to never run deficits. In the English debate May was the only one to sound close to reasonable “no deficits in good times perhaps in bad”. Jack evaded the question in the english debate, Dion said absolutely not and then Harper topped Dion with the unequivocal promise to stay in surplus. Talk about pro-cyclical.

Comment from Econometron
Time: October 4, 2008, 7:24 pm

Mr. Weir, some advice: before you comment on issues related to business taxation and investment, please consult the relevant literature as many of your assertions are simply incorrect and inconsistent with basic public finance economics. This is notwithstanding your fundamental disregard for basic econometrics.

A high CIT rate in 2000 did not produce high CIT revenue and investment. An important driver pushing up revenue and investment at this time was the ICT boom. Perhaps unsurprisingly, revenue and investment declined after the dot-com bubble burst in 2001. Have a look at investment data in this time period and you will notice that all types experienced a similar boom and bust. Again, the CIT rate likely had a minimal impact.

More concerning is your disregard for the most important and relevant type of tax: the marginal effective tax rate. As you’re probably aware, it is the METR that mostly influences business decisions, not the statutory CIT rate. But there is no mention of the METR in your analysis. That’s troubling and leads an objective person to think that your analysis is less about economics and more about ideology.

The bottom line is that simplistic “cause and effect” analysis is misleading, and just down right wrong. Where are your control variables? Where are the (academic) references for the claims you make?

Also note that recent declines in CIT revenue and investment are probably due to what’s transpiring in the US and much of the world (re: a bursting housing bubble and global financial market uncertainty). Obviously these events are completely unrelated to the statutory CIT rate…

Comment from Erin Weir
Time: October 5, 2008, 12:31 pm

Please note that my post agrees that changes in corporate profits (as opposed to changes in the CIT rate) have been “the key driver” of CIT revenues. However, for any given level of corporate profits, a lower CIT rate collects less CIT revenue.

I also agree that “the CIT rate likely had a minimal impact” on investment. Based on these facts, you must agree that the Liberals are incorrect in claiming that lower CIT rates caused higher CIT revenues?

There is no consensus that METRs are the most important measure. To quote Canada’s leading public finance economist, Robin Boadway, “mobile factors should respond to average tax rates rather than marginal ones.”

However, if you are interested in METRs, check out my previous post on corporate taxes.

Comment from Travis Fast
Time: October 5, 2008, 1:19 pm

Erin’s post was about the notion that cuts in CIT pay for themselves. They don’t. Nobody believes this anymore (if they ever really did) except for red in the tooth and claw ideologues. The only way you can get cuts in CIT to pay for themselves is if there is a huge multiplier. There isn’t.

As for tax metrics the accountants at KPMG (you know the people who actually advice multinationals on where to locate (invest) they use the following approach to give investment advice.

“Our goal in preparing this supplement is to offer a broad ranging methodology to assess the numerous and complex factors affecting a company’s tax burden, in order to provide a simple and effective approach for cross-location comparisons based on the tax results of different business scenarios.

To this end, this report compares the total tax burden faced by companies in each country and city, including:
• corporate income taxes
• capital taxes
• sales taxes
• property taxes
• miscellaneous local business taxes
• statutory labor costs (i.e., statutory plan costs and other wage-based taxes).

This total tax cost is compared between countries and cities using a Total Tax Index (TTI) for each location. The TTI is a measure of the total taxes paid by corporations in a particular location and industry, expressed as a percentage of total taxes paid by similar corporations in the U.S. Thus the United States has a Total Tax Index of 100.0, which represents the benchmark against which the other countries and cities are scored. (for details of the calculation, see Appendix B).”

Nowhere in the study will you find METRs. You will find however the following:

“•The Total Effective Tax Rate (TETR), which expresses total tax costs as an effective rate, rather than as an index of taxes actually paid, in order to explore the specific tax components that drive these results.

Total Effective Tax Rate is the sum of the effective corporate income tax rate (net of incentives), the effective rate of other corporate taxes, and the effective rate of other statutory labor costs.

The TETR expresses total tax costs as a percentage of standardized net income before income taxes, which is a fixed dollar amount in all locations. The use of a fixed dollar (US) amount of net income before income taxes in all locations allows income taxes paid to be compared in dollar terms and also allows other corporate taxes and statutory labor costs (which are not calculated based on income) to be compared in percentage terms. Rankings obtained using TETR are the same as those obtained using the Total Tax Index.”

Now why would corporate accountants not use METRs if they are what really affects investment decisions?

Link to study.

Comment from Econometron
Time: October 5, 2008, 2:57 pm

Mr. Weir, the issue is not whether “for any given level of corporate profits, a lower CIT rate collects less CIT revenue.” Neither I nor anyone can dispute this mathematical identity. Rather, the issue is, as Mr. Fast notes, the impact of a given CIT rate on CIT revenue. And in this case, Dion’s claim that tax cuts are to some extent self-financing is not necessarily “voodoo economics.” It is quite possible and indeed likely, in theory and reality, that a lower CIT rate could raise more CIT revenue through the impact on economic growth (see Mankiw and Weinzierl, 2006, Journal of Public Economics). This conclusion sounds counter-intuitive, but it isn’t when one realizes the dynamic effect of a reduced tax burden on incentives for work, savings, and entrepreneurship.

Please note that the reason the METR is more important than the statutory rate is not only because it is a marginal rate, but because it measures the “effective” rate businesses pay on investment. An effective rate is more comprehensive in nature because it includes nearly all components of the business tax regime (i.e. credits, allowances, taxes on business inputs, etc). In turns out that these components are very critical for investment decisions as they provide an indication of the “true” cost of doing business. I’m not surprised KPMG doesn’t include the METR – after all, KMPG is an accounting not an economics firm, with the key difference being that the latter discipline focuses on “marginal” decision-making. My sense is that KPMG could bolster the report by including the overall METR as well as the METR on specific sectors and industries. This would certainly benefit their clients.

Comment from Travis Fast
Time: October 5, 2008, 3:23 pm

Ecometron,

Look the only way you can get CIT reductions to pay for themselves is if you assume a huge multiplier. The best you can say is that the actual size of revenue shortfall will not be equal to the size of the CIT cut. But the tax multiplier is something like 1.7. Do the math. It is not a pretty picture. And Dion basically insinuated that CIT cuts paid for themselves which is voodoo economics.

I will assume accountants know well how it is their clients make decisions. If I assume they don’t but yet still get paid by their clients, when a better metric is out there, then I have to assume that corporations are not make rational choices because they are not using all available information.

Comment from Erin Weir
Time: October 5, 2008, 4:31 pm

Thanks for the Mankiw/Weinzierl reference.

They conclude that “tax cuts are at least partly self-financing.” In particular, they estimate that reductions in capital taxes recoup 50% of their cost through higher economic growth. In other words, cutting the CIT rate would reduce CIT revenues by half the amount implied by static calculations.

The Liberals claim that cutting the CIT rate increased CIT revenues. For that to happen, more than 100% of the cost would have to be recouped through higher economic growth, a far cry from the Mankiw/Weinzierl estimate.

This article provides further support for characterizing Dion’s position as “Voodoo economics.”

On measures, if the main advantage of METRs is that they are “effective”, then we should be willing to consider average effective tax rates (such as those computed by KPMG).

Comment from Travis Fast
Time: October 5, 2008, 5:02 pm

And that is if we think the basic neoclassical model is a useful guide to how the economy works. Basically what their study did was show that in a purely neoclassical universe with all the relations tweaked to get the best outcome (and maintain a straight face) the best they could get to was 50% on capital gains.

As the NBER concluded:

“These results depend on a number of key assumptions, which are open to debate. Mankiw and Weinzierl acknowledge that current studies do not afford clear guidance about how best to apply the neoclassical growth model to the actual economy. Economists will need to focus next on evaluating which generalizations of the basic model are the most salient and then on estimating the key parameters.”

Comment from Paul Tulloch
Time: October 6, 2008, 8:43 am

Just a quick comment.

I don’t care what kind of politics the NDP pr the Liberals say they have a difference on. At least they believe their is a role for government intervention.

Watching Mr. Harper during the last debate with his gleeful look that nothing is wrong with the economy and watching the market meltdown is quite surreal.

I think this lack of planning for the coming storm is starting to finally get some traction with the voters.

How can HArper sit there and have the access to information he has and then with a straight face tell the people of Canada that the international economy is going to hell in a hand basket, but somehow our fundamentals are just fine.

The opposition would be best to just keep hammering away at this fact and forget about each other.

Peeling off votes from the tories should get a little easier as I am sitting here the TSX is just about to drop below 10,000.

We need plans and action for the economy, not wishful thinking and invisible hands. Mr. Harper is an idealogue and even faced with the truths about the failur of markets, like at this historical point in history, he still maintains that non-regulation and interventyion is still the approach.

At least some ideologues do blink once in awhile.

This guy is a fantatic. The last peopel we need in power with the current crisis grwoing in strength is a bunch of libertarian, Mike HArris, reform party ideolgues.

We need leaders not ideologues.

Mr. Harper, as you live through this historic time, how can you still maintain that markets oriented solutions are the remedy needed.

He sounds an awful lot like Hoover during the early stages of the Great Depression.

I was reading some material on the economic policy proposed by Hoover,, Balanced budgets and reduced govenremnet was what he was preaching,

What we need is potentially something similar to the first 100 days of the new under Roosevelt. And alot of the new policy for the economy will be linked to innovation and the greening of the economy. Simple to say but it is what the future economic path out of this will be.

Spend spend spend will become the new mantra across the world.

Funny how focused the culture is so quickly turned when the super rich lose theor money and how quickly the governemnet reacts. When we have coordination at that level, amazing the kind of relief programs that one can put togetehr. Staggering the amounts of dollars thrown around for the rich.

I am just amazed at how easily they turn the rational on its head and justify it. Yet for years we have been seeking solutions for poverty and imbalances in income distribution, yet it is so easily rationalized as being irrational. Suddenly corporate socialism for the rich is all the rage.

Pathetic! We need to get some artists to capture that powerfully unjust emotion and enshrine it on every street corner.

Okay my rant for the day.

Paul

Comment from Paul Tulloch
Time: October 6, 2008, 11:55 am

sorry for the typos but i was driving on a bumpy road.

the tsx i snow down 900 points

Comment from Michael Mendelson
Time: October 7, 2008, 10:08 am

A good discussion.

Having been involved in budgets in Ontario and Manitoba from 1986 through 1995, I can predict with certainty that, whatever the CIT rate, corporate taxes are going to fall through the floor over the next few years. Corporate taxes are the most volatile of the major tax sources, not least because corporations are able to defer or advance tax payments depending upon their cash needs.

Ontario’s corporate tax will likely fall by some huge percentage – I would not be surprised to see a 50% decline – next fiscal year. The statutory rate is a very minor factor in predicting what actual corporate tax revenue will be in any given year. The trouble with the economists’ proviso ‘everything else being equal’ is that everything else is never, ever equal.

On the discussion at hand, I find Econometron’s faith in METR’s very touching. How about some careful empiricism? No doubt METRs on new investment capital do have some effect om some decisions some time, but the question is: how much? The how much question can only be answered empirically.

If you do have an empirically derived quanta the next question is: how do you design an instrument that is as efficient as possible in off-setting the negative effects, if any? The costs of the program need to be less than the benefits. Cutting corporate taxes by $1B to ‘stimulate’ $10M in new investment hardly makes sense. If you were really concerned about the METR the last thing you would do is cut the statutory corporate rate. Cutting the CIT provides tax cuts to every single firm that is making a profit (or reporting one), so you have humongous deadweight costs. Assuming your goal is to encourage new investment you should instead develop carefully targetted tax credits and grants aimed only at new investment.

By the way, while I am posting I cannot help but point to an article I wrote for the Caledon Institute a few years (note:years) ago called ‘Anyone Got a Plan?’ It makes interesting reading in light of today’s circumstances. I have attached the link.

Comment from Dave Thompson
Time: November 17, 2008, 9:17 pm

The notion that tax rate cuts will stimulate growth to the point they will pay for themselves (the “Laffer curve” idea) has been thoroughly de-bunked.

See, for example: Richard Kogan and Aviva Aron-Dine, “Claim That Tax Cuts ‘Pay For Themselves’ Is Too Good To Be True” (Center on Budget and Policy Priorities, July 27, 2006) http://www.cbpp.org/3-8-06tax.htm; Mark Thoma, “Do Tax Cuts Ever Raise Revenues” (Dept of Economics, University of Oregon, Dec 10, 2007) http://economistsview.typepad.com/economistsview/2007/12/do-tax-cuts-eve.html and sources cited therein.

While some politicians (a shrinking number) still make this claim, professional economists do not, and a 2006 study by the Congressional Budget Office of the United States confirmed that tax cuts do not result in revenue increases. The CBO study estimates a recovery of 1% – 32%, at most. Congressional Budget Office, “Economic and Budget Issue Brief: Analyzing the Economic and Budgetary Effects of a 10 Percent Cut in Income Tax Rates” (December 1, 2005) http://www.cbo.gov/ftpdocs/69xx/doc6908/12-01-10PercentTaxCut.pdf

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