Dangerous delusions about corporate income tax cuts
For years we have been asking Stephen Gordon to provide the evidence for lower corporate taxes. Like Stephen I like the Nordic model and take away from it that tax mix matters, so funding a large public sector may require more than taxes on â€œpeople we do not knowâ€ (ie corporations and the rich), so consumption taxes need to part of the mix, offset by transfers to the poor; and that corporate taxes should not be too high to avoid capital flight. This is an important lesson if Canada wants to go from taxes of about one-third of GDP to Nordic levels of more than 40%.
That said, Stephen has turned this into an ideology where corporate tax cuts are always and everywhere a good thing, and it is cause for celebration if Canada cuts corporate taxes because this will presumably lead to higher long term rates of economic growth. Because the empirical literature says so.
This is a dangerous delusion. The problems with it are several:
It fails to explain Canadaâ€™s economy, where corporate taxes have been cut but investment as a share of GDP and as a share of profits have both fallen, even as corporate profits have grown as a share of GDP. Stephen prefers to use a sleight-of-hand which uses a different deflator for investment than GDP so that in adjusted terms this situation looks better but in the real world of dollars as we know them, it just ainâ€™t so.
It fails to capture Canadaâ€™s unique circumstances, in particular its relationship with the US, where corporate rates are now higher than Canada. This does not reduce the total taxes paid of US corporations but leads to a treasury transfer effect from the Canadian to US treasuries because US corporations are taxed on their worldwide income.
It fails to capture the nuances of why corporations invest. Investment decisions in the real world are lumpy and uncertain in terms of rates of return. Small changes in the after tax rate of return pale beside the other major considerations for investment such as access to resources, access to skilled labour, electricity and other utility costs, and markets for products. A recent KPMG study found that only 14% of location specific costs are due to taxes. My quick look at the OECD sources cited finds that these factors are never adjusted for in regression analyses.
I could go on and on about methodological problems with the empirical studies (which independent variables, which industries, which countries, what functional forms are used), but that just gets into he said she said discussions that are over the top of the heads of most readers. I think most empirical researchers on the topic find evidence that justifies their previous beliefs. One study I found persuasive was a survey for the IMF by Gerson, who found that the only consistent outcome was that corporate investment was strongly related to strong demand conditions not the supply side factors that most economics are overly obsessed with.
In any event, Canadian taxes were among the lowest in the world according to the KPMG study, second after Mexico among the countries studied. In fact, Vancouver was the lowest tax city studied, and Montreal and Toronto were number 4 and 5 respectively. The knee jerk demand for more corporate tax cuts is nonsensical and counter to the evidence of KPMGâ€™s corporate bean counters anyway.
But even if there are no diminishing returns to corporate tax cuts, ie strong growth benefits to even lower taxes, we should not unequivically cheer. A huge amount of investment in Canada in recent years has been in the tar sands. This is bad economic growth that is contributing to a planet that will be largely unhabitable by humans within 100-200 years. We need to think carefully about in what sectors economic growth is happening.
The ideological approach to corporate tax cuts means that they should simply be zero. But it is not desirable to cut corporate taxes below a certain amount, or the wealthy will use corporations to accumulate wealth and dodge their personal taxes. Minimally, when corporate taxes are reduced we must acknowledge that this is a windfall to the owners, who tend to be in the top 5% of income earners, so there should be some compensating increase in top MTRs for personal income tax.
Going back to our agreement about the Nordics, my interpretation of this literature is less fundamentalist. I do not oppose a freeze on further tax cuts as I am doubtful of the benefits of doing so. Indeed, Canada could harmonize rates upward to US rates, and generally aspire to be in the middle of the pack without fear of economic harm. Based on Stephenâ€™s related post, there is no obvious reason why Canada needs to go further than that.