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The Progressive Economics Forum

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 Canada’s conservative pundits (although corporate-tax cutters also resemble the Ferengi).

Yesterday’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 Wednesday’s front-page report that corporate tax cuts are filling company coffers rather than funding investment:

. . . businesses’ 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 Canada’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 Pineault’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.

Yesterday’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 – specifically, that a “10 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.”

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 Canada’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. Mintz’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 paper’s main methodological problems when it was released three years ago. To recap, it examines 2001 through 2004, when Ottawa’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 “treatment group” (that got corporate tax cuts) and manufacturing as the “control group” (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 that’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): Jim’s latest paper hammers home the flawed methodology of the 2008 Finance paper, on which Mintz’s projections are based.

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Comment from duncan cameron
Time: April 9, 2011, 6:13 am

This letter is from the Globe of April 9th.

How to tax

Re Making Companies Pay More Is Not Smart Policy (April 8): The argument for lower corporate taxes, or even zero taxes, on corporate profits is always that corporations use their profits to invest in research and technology to grow businesses and create jobs. Okay, let’s take the argument at its face value. Tax corporate profits at the same tax rate individuals pay. Then allow corporations and small businesses to deduct from their taxable income 100 per cent of the money they can show they have invested in research, development and job creation in Canada.

Tax to the hilt those corporations that downsize jobs in Canada to exploit cheap labour abroad, that hoard money, and that engage in casino-capitalist practices like speculative betting on stock markets, buying up other companies only to strip their assets, slash jobs, and dump them back on the market. Tax corporate profits before they pay out bonuses to CEOs. Then we can all applaud those corporations that pay zero taxes because they really will have invested their profits in Canada’s future.

Dr. Sylvia Hale, St. Thomas University, Fredericton

Comment from Marc Lee
Time: April 9, 2011, 9:17 am

I saw a lot of Jason Clemons when he was with the Fraser Insitute. Fairly consistently, I caught him misrepresenting studies in order to bolster his argument. And a few times, it was more than cherry picking the studies that supported his view — when I went and checked, the study actually found the exact opposite as what he claimed.

Comment from Erin Weir
Time: April 9, 2011, 9:25 am

It’s good to see that Dr. Hale was on the ball. I did not even notice the Borg’s op-ed until today.

Comment from Donald Hughes
Time: April 9, 2011, 1:46 pm

I was just thinking that Bush’s strategy was expanding corporate tax expenditures while keeping the general rate steady at 35%. Possible angle for the NDP for winning over the business class? “We support the Bush approach to corporate taxes.” 😉

Comment from Erin Weir
Time: April 9, 2011, 4:07 pm

I more or less said that in the comments on this post: “While many American tax loopholes are indefensible, I think Canada should emulate the American model of greater depreciation, etc. for actual investments instead of across-the-board rate reductions.”

Comment from Donald Hughes
Time: April 9, 2011, 6:42 pm

It seems like the US will go in the opposite direction in a few years – eliminating some of the expenditures to reduce the rate to something like 25% or 28%.

Comment from Erin Weir
Time: April 10, 2011, 12:15 am

Even if the US were to cut its federal rate to those levels, there would still also be state corporate taxes. The combined federal-state rate would be at least 30%.

Comment from Donald Hughes
Time: April 10, 2011, 12:37 am

Yes. I don’t really understand how corporate tax rates need to be “competitive” in the first place. That seems like the sort of error Krugman talked about with “a country is not a company.” That is, taxes affect (primarily) the composition and (secondarily) level of income, but they don’t normally profoundly affect levels of employment. Employment levels being set by (primarily) macroeconomic policy and (secondarily) micro issues that affect tolerance of unemployment and job search. As in, Canada could raise corporate taxes to well above American levels and the number of jobs in the economy wouldn’t be dramatically reduced.

Comment from duncan cameron
Time: April 10, 2011, 12:57 am

The idea that taxes should be neutral (i.e. one rate for the GST instead of multiple rates to achieve environmental protection roles with the consumption tax) I think comes from a Walrasian General Equilibrium world in which everything (labour, capital, goods, services) can be made commensurable that is to say be reduced to money values that create equivalences. But pricing water, or clean air is not obviously going to become optimal as a result of market interactions. Some planning assumptions are required. How much water do we have, how can it best be conserved?
This a long way to say that I agree with Erin. By all means think about integrating economic goals in setting tax rates. This lower taxes is better for all is a bit much. If the public knew what had happened with corporate taxes since the war there would be another fury

Comment from Paul Tulloch
Time: April 10, 2011, 2:30 am

This across the board capitulation to corporate tax cuts that seems to be gathering steam across several countries, is mind boggling.

Is it a concerted ideological outcome of those in political office, I.e. Overabundance of right wingers and hence just greedy corps looking to fatten margins or is it what corporations perceive they need to survive under post great
recession adjustments.

If it is the first then it is merely a political battle and not an economic.

If it is the second, then one must get further down the road to concldinf that capitalism is now more dysfunctional than
ever. This by the logic that if anything the world requires more public good and hence revenue and not less. Given the social and ecological balances, I truly do not see how having less public good will get us to these goals. Taxing individuals under such asymmetry of current tax laws will never get the job done as a tax revolt is a possibility. So unless we have a dramatic shift in personal taxation, then Corp taxes must be increased. Otherwise it is a failing capitalism, as the social gains made under actually existing capitalism if 30 years ago will continue to be cut back. And we all know what happens went public good becomes imbalances to a point that macro and micro social forces destruct, no matter how many jails or wars are built.

Truly I do think the answer is, we are witnessing a bit of both and ultimately we are witnessing potentially the last phase of capitalism before it truly tears itself apart. If anything is left in 50 some years, then we will have an answer to what replaces it. Barbarism is my bet.


Comment from Elizabeth
Time: April 10, 2011, 8:51 pm

I am the public. Tell me what has happened to corporate taxes since the war.

Comment from PDA
Time: April 10, 2011, 10:36 pm

I find the “transfer pricing” argument that you mentioned very interesting. Thanks for the points about the 2007 budget, etc…I never knew about this. Would not allowing Canadian tax deductions for the financing of foreign affiliates really put a dent into transfer pricing? If yes, then it seems like this should be I huge scandal for the government that they didn’t put in this legislation. I suppose they made the case that, if such legislation were put in, then firms would indeed move their operations elsewhere…is that how they justified it?

So, if it’s true that corporations will devote more resources to tax avoidance when you raise CITs at the margin, then presumably by lowering CITs they will devote fewer resources to this and maybe tax revenues will remain fairly neutral. Seing as how CITs have been falling recently, taking a look at how these things have changed might be informative as to the seriousness of these concerns.

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