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Value Added? The Dubious Impact of Corporate Tax Cuts

Corporate tax cuts have become a defining feature of the election campaign thus far.

The Globe and Mail covered the topic today with an article entitled “Corporate tax cuts don’t spur growth“.

Stephen Gordon fired off a critique of the piece in his latest blog at the Globe and Mail’s Economy Lab, to which I am also a regular contributor.

Here’s two responses to his two main points – that there has been more investment in real terms, notwithstanding Stat Can figures showing a decline; and that CIT cuts “are associated with” higher investments than would otherwise have been the case.

First: The big story behind corporate investments is what types of things that are being invested in. The fastest growing category of business investment is computers, growing from 9.2% of all business investment in machinery and equipment in 2000, when the big tax cuts started, to 20.7% in 2010. That’s up from only 4.5% in 1997, when the most sustained period of economic growth since the 1960s began.

Some of that investment replaces obsolete technology and introduces important efficiencies. Some of that is simply keeping up with the latest gadgets and software. It is an open question how much productivity improvement results from these investments.

But there is little question that some business investments actual lead to a decline in value-added production. For over a decade, foreign corporations have been buying up our resources and shipping value-added production elsewhere …. Along with middle class jobs. The Vale Inco story is a striking example, no pun intended.

As to the second point, that corporate tax cuts are associated with economic growth: a correlation does not a cause make.

A period of aggressive reduction to corporate income taxes is indeed associated with a period of rapid economic growth in Canada.

But that same period saw the emergence of the BRIC – Brazil, Russia, India and China – as the major new forces propelling the global supply chain.

These nations have been the true engines of global economic growth for the better part of a decade. These days they’ve been pulling the advanced industrial nations out of the slump, through rising aggregate demand.

The first beneficiaries of the recovery are the nations that have the raw materials essential to the production process.

Canada is one such nation, along with an constellation of emerging economies in Africa and South East Asia, rich in natural resources or cheap labour.

At this point in the business cycle investors are coming here for two reasons: natural resources, and a safe place to park their money in an unstable world. The fastest growing category of incoming foreign direct investment is bonds.

Investors are not primarily coming here because of our tax regime.

There is no dispute that corporate income taxes are important to decision-makers. But they are only one item towards the end of a long list of why companies invest or disinvest in a particular place.

First in that list is growing demand for their product or service. Second is the rate of return.

Taxes are an important consideration, but only at the margin, when everything else is equal, for companies choosing to invest or divest in a particular place.

Let’s look at the big picture. Canada has been hemorrhaging value-added production and jobs with decent wages, benefits and pensions.

If you are committed to using billions of dollars to incent behavior, target it to getting what you want: value-added investments and good jobs.

Corporate investment and corporate income taxes are important. But business interests are not synonymous with the public interest. And the bottom line for most Canadians is their own well-being.

The litmus test for any public policy is not just the costs and benefits, but the distribution of the costs and benefits.

It is surprising how corporate tax cuts and income splitting became two hot button topics in this federal election campaign.

The first leg of the election campaign has quickly turned into a conversation about income inequality and who benefits from this or that policy. Nothing could be more appropriate in the wake of the worst global economic meltdowns in two generations.

“Who benefits” is the central question that should be asked when a policy proposal is advanced. It is even more pertinent in the middle of an election campaign.

Enjoy and share:

Comments

Comment from Avon Barksdale
Time: April 6, 2011, 8:53 pm

I have one question for you. How can a corporation pay tax?

Think about the question carefully. It can’t. Now, the shareholders, they can pay taxes. The employees, well, they can pay taxes, too. And the customers, yup, they can pay taxes. See the common thread here – only PEOPLE can pay taxes. Corporations can’t pay taxes.

When you tax a corporation you tax people, but who are they? Is it the shareholder, the employee, the customer or some mixture of all three? It’s hard to tell who is paying the tax. Good tax policy is about knowing exactly who is paying the tax so that you can understand as best as possible the distortions and the dead-weight loss that the tax imposes on society. When you tax in such a fashion that you really have no idea who ultimately bears the cost, well that is just poor policy. It might be expedient at election time, but it is very poor economics. Now, if what you want to say is, “tax rich people”, then say that. If you want to say is, “nationalize part of the production of the corporation”, then say that. People can debate the merits of those policies. But don’t pretend that anything but human beings can pay taxes.

Comment from Michael Smith
Time: April 10, 2011, 9:21 pm

Avon – one of us in an idiot. I believe it’s you. When I first got started in the political arena, the corporate tax rate and the personal tax rate were just about even. Corporations now shoulder less than 10% of the burden. Any by the way, why would you make such an arguement when your friends are suggesting that corporations should be treated the same as people under the constitution?

Comment from Avon Barksdale
Time: April 11, 2011, 7:56 pm

Mr. Smith,

No, I am not an idiot. I have a real PhD in a real, mathematical discipline. I just can’t help be logical.

Corporations do not pay taxes. People do. When you tax a corporation you are taxing the productive capacity of the corporation. That cost will be shared between the consumers, the employees, and the owners (shareholders). It will mean that those funds cannot be given to the shareholders as a larger dividend, to the employee as a larger wage, or to the consumer in terms of lower prices or superior products. Now, you might argue that only the rich shareholders will benefit from zero corporate taxes. Maybe, that might happen – but the correct way to address that is to set the tax policy to address the perceived social harm that is caused by the uneven distribution of wealth. If what you want to do is tax rich people, then do that. People can debate the merits of that policy. When you tax a corporation, you do not know who you are taxing. It is just as likely that the dividend yield does not go down, but the cost burden of the corporate tax is passed on to the employees in the form of lower wages and less job opportunities (and therefore less output). Remember, people do not know what job they would have gotten if the corporate taxes were zero and so they do not form a lobby to try to change the government’s mind – they just remain unemployed. Unless you can trace the effect of the corporate tax through the economy (which is just monstrously hard) you can easily create wicked market distortions that harm the poor and help the rich. This is the point about effective tax policy – and corporate tax is generally not it.

-Avon

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