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The Progressive Economics Forum

Saunders and The Value of CIT Cuts, Part I

Doug Saunders, of the Globe and Mail, has gamely launched a real and meaningful discussion about corporate tax cuts on these pages. See the comments section of this post.

Since that forum was getting unwieldly, I’m starting a new post.

Doug’s stated pursuit (and mine, and I wager most readers’) – how to harness growth to maximize social welfare – does require of us all to prove our point, with theory and evidence.

Here I try to address his request for evidence to support the position I took on the Legend of Zero post, and make a brief comment about the relationship between growth and the distribution of the gains from growth.

Doug’s comment about retained earnings, and why they should not be taxed, will have to wait for another post.

THE EVIDENCE

Stephen Gordon has prepared a great quick guide to the literature about corporate income taxes, providing themes such as efficiency, incidence and Canadian content.

As per all things economics, much evidence abounds on both sides of the debate, and Stephen has graciously noted he would be happy to add to his list of articles, which mostly support the idea of cutting corporate taxes. My colleagues and I should perhaps collate some articles to add to his list. Here’s my fly-by contribution.

The most hotly debated topics are the effects of corporate tax cuts on investments and jobs. Those two elements do not exhaust the term “social welfare”, but I’ll treat them first.

On investment

Here’s two readings that suggest the impact of reducing corporate income taxes, while it may effect behavior at the margins, does not have a positive effect at the macro level of the economy on the stock of capital or the investment rate.

One is a 2002 working paper from the Bank of Canada, “Entrepreneurial Risk, Credit Constraints and the Corporate Income Tax: A Quantitative Exploration”. It shows “the removal of the corporate income tax decreases capital formation”.

One, an econometric examination prepared for Congress in 2007, states “ …many of the concerns expressed about the corporate tax are not supported by empirical data. Claims that behavioral responses could cause revenues to rise if rates were cut do not hold up on either a theoretical basis or an empirical basis.”
(Stephen Gordon’s list has an earlier paper by Jane Gravelle, a co-author of this excellent piece)

On jobs

The claim is that reducing corporate taxes, or any tax if you are a Harper Conservative, creates jobs.

A huge number of jobs were indeed created while taxes were most actively cut: between 1997 and 2007 Canada created more jobs than any nation in the G7 and cut taxes most aggressively of any nation in the G7. Were tax cuts the reason for the job creation? Other things were going on at the time too. Things like, say, the ascendance of emerging economies and the global supply chain, and Canada’s place in it.

Jim Stanford has recently written a sharp analysis showing the negligible jobs effect of lower corporate income tax. Jack Mintz — the most frequently cited economist on the pro-cuts side — disagrees, and suggests 100,000 jobs and $30 billion in capital stock could be created “in the long run” by lowering the CIT rate.

Fred Lazar — prof at the Schulich School of Business, who says flat out he does not think corporate income taxes serve any economic purpose — thinks Jim has delivered the knockout punch in the Stanford vs. Mintz championship match about the effect of reductions on jobs and investment.

Today’s Globe and Mail tackles the subject with a piece entitled “Cut taxes, create jobs? Not quite” (which, en passant, references a Department of Finance study that ranks the importance of corporate tax cuts in a list of stimulative measures at dead last).

Again, tax rates matter, at the margin. But the margin is, um, marginal. Many other decisions influence business investments, foremost whether there is growing or declining demand for their product or service.


What’s Missing From The Jobs/Investment Analysis: Social Welfare Writ Large

Social welfare doesn’t just get maximized through investments and jobs. Social welfare is also shaped by the social and public side of the economy, not just the business side.

The proponents of corporate tax cuts regularly commit the fallacy of decomposition: they don’t talk about what taxes buy.

One of the most evocative recent studies is Hugh Mackenzie and Richard Shillington’s Canada’s Quiet Bargain. They found 80 percent of Canadians get more value in public services than they pay in taxes. At the halfway mark of the income distribution, the value of public services adds another 50% to a household’s disposable income. That means public services stretch our paycheques, offsetting market prices for healthcare, education, transit, water, electricity….the list goes on. For the majority of Canadians, public services put more money into our pockets than tax cuts. (And they make us healthier, smarter, and more connected.)

That’s at the household level. There is also the business case for what taxes buy. The platform for growth requires a strong public infrastructure in which to do business; stable societies; the rule of law; a ready workforce; etc. The twin engines of the economy are public and private enterprise. Growth is powered by both.

Keep chipping away at sources of public revenue and you erode your capacity to maintain built infrastructure or attend to emerging needs, for businesses and households alike. The result? Growth slows.

THE GROWTH QUESTION

The stated goal of tax cuts is to boost economic growth. The implication is that social welfare is improved by growth, presumably through broad-based distribution of prosperity.

In Canada, U.S., and the U.K., that has not been the case in the decade or two preceding the global economic crisis. While inequality has not galloped ahead everywhere, it certainly has in these nations.

Thomas Picketty and Emmanuel Saez were the first to flag who benefits most from growth, turning the Kuznets’ theory – that growth reduces inequality – on its head. Saez and Michael Veall (from McMaster University) compared the U.S. and Canada and showed similar results.

The top 1% of Canadian taxfilers received a third of the total growth in income in the period 1997 to 2007. In the 1960s, a similar period of sustained and robust growth, they took only 8%. In the U.S., recent gains from growth are even more maldistributed.

If, say, only one in ten people get most of the income gains from growth, what’s in the bargain for the nine others? Particularly if they get less service out of the deal too.

My parents’ generation built the platform for growth in Canada half a century ago. Our economy is five to six times bigger today and we can’t find the money for repairing what our parents built. What’s up with that?

Simply put, the tax cut agenda. It strips public resources and erodes our capacity to meet today’s needs or prepare for the future.

Growth may be good. (Actually, that’s another topic for debate; but its absence certainly makes things difficult.) But growth is not enough.

How is growth shared? How is it used to seed future growth and prosperity? That’s the challenge for my generation of adults. We’ll need to come up with something better than just tax cuts.

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Comments

Comment from Brian Dell
Time: April 19, 2011, 12:39 pm

There needs to be more focus to this debate. At issue is whether a combined federal-provincial corporate rate of 25% would be too costly to govt treasuries, not whether a 0% rate would be. An argument for more progressive personal tax rates also does not necessarily constitute an argument for higher corporate rates.

Comment from Purple Library Guy
Time: April 19, 2011, 1:08 pm

I note that Lazar is a fan of the idea that corporations simply pass on the cost of taxes to (whoever–customers, other stakeholders of one sort or another) and so taxes on corporations are completely irrelevant. I’m not sure why this would only apply to firms; presumably it would also apply to people, i.e. participants in the labour market, and any other market actors. The equilibrium of who gets what is, in this formulation, effectively undisturbable; a tax on anybody is a tax on everybody, because markets will automatically adjust to give them the same real compensation as before for the goods and services they offer the market. CEO pay increases are as irreversible as gravity and came into existence by natural law, presumably caused by the massive increase in the utility of CEOs’ services to the firms they boss. All’s for the best in this best of all possible worlds–or at least, all’s for the necessary in this only possible world.

That would seem to be untrue in practice. But imagining for a moment that it is true, and that therefore both the net size of revenues and corporations’ ability to hog more of society’s wealth and create inequality will be completely unaffected by corporate tax increases . . . fine. Let’s increase the corporate taxes just in case. If the “it doesn’t matter” thinkers are correct, it will make no difference but at least look fairer. On the other hand, if they are wrong, we reduce inequality and gain revenue. It may not be win/win, but it’s at any rate win/not lose.

Or just maybe the reason corporate representatives spend so much time, effort, thought and money on coming up with reasons why corporations shouldn’t be taxed is that taxes do, in fact, cost them money and give it to the government (and by extension to the citizens in the form of government programs).

Comment from jdean
Time: April 19, 2011, 1:15 pm

If corporate tax cuts have not lead to increased investment or jobs, what is the theoretical explanation for this? It’s possible to use standard economic analysis to give an answer: much of corporate profits are economic rent, also known as monopoly profits. Taxing them or untaxing them has very little effect on the behaviour of corporations – on their decisions about whether to invest in productivity or hire new workers.

Mainstream (aka neoclassical) economists de-emphasize the concept of monopoly power and economic rent simply by assuming that markets tend towards perfect competition and in the long run, surplus profits get competed away. But what if this isn’t the case? What if companies are able to consistently earn economic rents through their sheer market power or through controlling the laws of the land? In short, through rent seeking.

The economist.com says this about economic rent: “Reducing rent does not change production decisions, so economic rent can be taxed without any adverse impact on the real economy, assuming that it really is rent.”

http://www.economist.com/research/Economics/alphabetic.cfm?letter=R#rent

Comment from Paul Tulloch
Time: April 19, 2011, 2:22 pm

The more I read about this tax cut issue, the more I realize this is nothing to do with investment, jobs or th like.

A large component is about the neocon assault on public and collective power essentially the last 30 year transfer of power from the public to private- yet we have not discussed this aspect at all.

There are broader forces at play here, and potentially even progressive economists are getting too caught up in the technical debates that the neocons want to frame this cit debate.

Armine, you do have both sides of the fence painted well, the welfare side and the investment side, but you are forgetting about the property of where this fence is being moved to- the incessant attack on government by the neo cons. Harper joined politics for a reason other than his ego- his citizen coalition days paint a picture of a man bent ideologically to take huge swaths of power away from the state.

The census destruction was for me personally the act that finally made the reality od his ideology as real and dangerous a it has ever been. Now the un up of the deficit and further cuts to the taxation base in these times of austerity are just so bold, yet nobody seems to be getting it.

Not even here on the one blog I thought might get it. It is so obvious yet here we sit debating jobs and investment. Given the deficit it is just arrogance that blatant arrogance orpotentially ego that Harper pushes through these tax cuts at a time that we know we will see cuts to the public welfare.

Sadly I do think the left is getting pulled into the ditch here.

Comment from rcp
Time: April 19, 2011, 2:26 pm

Paul, I do think that there are real issues to be discussed here. As I mentioned in a previous thread, most economists will tell you that consumption taxes are most efficient. See for example:

(http://www.cga-canada.org/en-ca/ResearchReports/ca_rep_2008-03_gst.pdf)

Look particularly at Figure 1.

The only good argument in favour of a progressive individual income tax is that it reduces after-tax inequality.

The question of how the tax system should be reformed depends on the relative weights that you apply to efficiency (growing the economy) and equality (getting the after-tax income distribution that you’ve decided, on other grounds, is best).

Comment from Paul Tulloch
Time: April 19, 2011, 2:39 pm

Yes rcp the issues need to b debated, but the fact that the space has been constrained to investment and jobs is problematic.

As Armine pointed out, not a word is mentioned in the media about the social welfare side, which most folk might not realize. throw on the power relations and the scope of my previous post, and the small potatoes of investment and jobs levers that both sides seem to agree, cit have very little impact in the causal chain of investment for brown or greenfield investment and the question then gets back to- WTF are we really talking about here!

We are talking about harpers long run plan to minimize govt and collective power versus that of private property.

Comment from Purple Library Guy
Time: April 19, 2011, 3:25 pm

What exactly do they mean when they say consumption taxes are “efficient”, anyway? Efficient at doing what, and how much difference is it hypothesized to make?

Comment from rcp
Time: April 19, 2011, 5:39 pm

@PLG: on efficiency: I tried to cut and paste Figure 1 from the reference that I cited but apparently we can only post text here. Please look at the figure and tell me what you think.

Comment from Purple Library Guy
Time: April 20, 2011, 12:56 am

Well, I looked at it. It makes claims but presents no actual evidence; Fig.1 is a rather dramatic presentation of a claim made in another study, it isn’t data of any sort. Later it mentions that use of other models returned similar results, which implies that even the study referred to isn’t a study of real-world events but a matter of plugging numbers into economic models and seeing what happens after the model crunches the numbers. All that tells me is that in some manner the assumption that some taxes are more efficient is built into the models. It doesn’t tell me jack about what the impacts of different taxation are like in the real world.

I’m actually finding myself more skeptical rather than less. Maybe I got my back up at the beginning when the piece referred to the efficiency gig as being about the “level of distortion” of people and businesses’ decisions. The subtext of talking about “levels of distortion” is that there is assumed to be some state of nature which would be perfect free markets, and taxes create deviations from that perfect state, which are bad. This is bollocks on many levels, so I lose confidence rather in reasoning that starts from such a base.

Comment from rcp
Time: April 20, 2011, 3:26 am

@PLG: You are free to be as skeptical of the piece I cited as you want. They give references so it’s possible to dig in further if you’re so inclined. However, when, during the 2005-2006 election campaign, many economists said that the GST was “the wrong tax to cut”, this was the kind of thing they had in mind, so I thought it was relevant to your question.

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