The Borg and Corporate Taxes
Perhaps the most compelling villain on Star Trek: The Next Generation was the Borg, which seeks to assimilate other groups into its hive. The Macdonald-Laurier Institute seems to be performing this function for Canadaâ€™s conservative pundits (although corporate-tax cutters also resemble the Ferengi).
Yesterdayâ€™s Globe featured an op-ed by Brian Lee Crowley, former President of the Atlantic Institute for Market Studies, and Jason Clemens, formerly of the Fraser Institute. Apparently, both have been absorbed into the Macdonald-Laurier Borg.
They attempt to refute Wednesdayâ€™s front-page report that corporate tax cuts are filling company coffers rather than funding investment:
. . . businessesâ€™ accumulation of cash reserves has been misinterpreted. Like people, businesses respond to credit crunches by holding as much cash as they can to meet their financial obligations. And it makes sense for firms to plan future business expansion out of such retained earnings, rather than, say, by borrowing.
The credit crunch and deleveraging are intuitively appealing explanations for corporate Canadaâ€™s drive to build up cash reserves. However, a credit crunch two years ago hardly explains cash hoarding in recent quarters. The conservative C. D. Howe Institute believes that credit is now too loose and that the Bank of Canada should raise interest rates.
In any case, as this Statistics Canada paper and Eric Pineaultâ€™s excellent post show, the great cash stash has been underway for years (especially since corporate tax cuts started in 2000). This trend substantially predates the credit crunch.
Even if you accept the Crowley-Clemens theory of capitalism that firms ought to accumulate cash before investing it, the accumulation should actually translate into more investment at some point. After a decade of ever lower corporate tax rates and ever higher piles of cash, Canadians are still waiting.
Yesterdayâ€™s op-ed also made the killer point that, since corporations will try to avoid paying tax, we should not bother trying to collect much:
Businesses react to increased CIT [corporate income tax] rates by using mechanisms such as transfer pricing and by shifting profits into lower-tax jurisdictions. For example, a multinational firm could borrow in Canada, thus increasing its financing costs here, and use the money to finance expansion elsewhere.
In fact, this problem has a simple solution. The 1997 Mintz report and 2007 federal budget sensibly proposed to not allow Canadian tax deductions for the financing of foreign affiliates. Ottawa backed down when Bay Street pushed back, but it is a question of political will rather than technical feasibility.
Crowley and Clemens opened with some seemingly credible evidence:
. . . a 2008 Department of Finance paper examined industry-level investment in 43 manufacturing and services industries from 2001 to 2004, a period in which the general CIT rate was reduced from 28 per cent to 21 per cent. The study concluded that lower CIT rates led to higher investment â€“ specifically, that a â€œ10 per cent reduction in the tax component of the user cost of capital is associated with an increase in the capital stock in the 3 to 7 per cent range.â€
As well, Canadian economist Jack Mintz, the architect of the Liberal business tax reforms, estimates that reductions in CIT rates this year and next will increase Canadaâ€™s stock of capital (investment) by more than $50-billion and employment by roughly 200,000.
In Borg-like fashion, multiple beings share a common hive mind. Mintzâ€™s investment and employment estimates, which take at least seven more years to materialize in his model, are based on the 7% figure from that same Department of Finance paper (see footnote 31).
I outlined this paperâ€™s main methodological problems when it was released three years ago. To recap, it examines 2001 through 2004, when Ottawaâ€™s general corporate tax rate fell from 28% to 21% (29.1% to 22.1% including the surtax). But the manufacturing and processing rate was already 21%.
Resource companies continued to face higher corporate tax rates during this period. Their rate did not reach 21% until 2007.
Between 2001 and 2004, commodity prices rose and the loonie started to appreciate. Those price signals pushed investment out of Canadian manufacturing and into resource extraction.
The Finance paper explicitly excludes resource industries. It classifies service industries as the â€œtreatment groupâ€ (that got corporate tax cuts) and manufacturing as the â€œcontrol groupâ€ (without corporate tax cuts).
Not surprisingly, regression analysis of those variables suggests that corporate tax cuts increased investment (which was stronger in services than manufacturing). Of course, using resource industries as the control group would produce the opposite result. The honest conclusion is that the largest investment increases and decreases were driven by factors other than taxes and occurred in industries where tax rates changed the least.
If thatâ€™s the best the Borg can do, Canadians may yet be able to resist assimilation like Jean-Luc Picard. Make it so!
UPDATE (April 13): Jimâ€™s latest paper hammers home the flawed methodology of the 2008 Finance paper, on which Mintzâ€™s projections are based.