Canada’s macroeconomy continues to be lethargic at best, and there is growing recognition that the continuing sluggishness of business capital spending since the 2008-09 crisis is a big part of the reason why. Governments are in austerity mode; consumers are maxxed out and cautious about new spending; our exports are restrained by an overvalued dollar and uncertain demand in our key markets. The traditional engine of growth in a capitalist economy is supposed to be business investment — and vibrant capital spending by companies could help to jump-start all of those other categories of spending (by creating jobs, stimulating more innovative exports, and boosting tax revenues). Business profits and cash flow are healthy — yet businesses are spending far less on capital, than they take in in cash flow. The corporate reinvestment rate (the share of after-tax cash flow reinvested in new projects) has languished at around 70 cents to the dollar in recent years. The resulting net corporate saving (of some 30 cents out of each dollar of cash flow) imparts a significant deflationary bias to the economy. I think it’s an important reason why growth is so underwhelming across most of the OECD. In places where capitalists still demonstrate “animal spirits” and a drive to accumulate (like China), growth is much faster.
Because corporations are taking in so much more than they are spending, liquid cash assets in the non-financial corporate sector continue to swell, and now total almost $600 billion. Many blue-chip companies, literally holding more money than they know what to do with, are finding ways to distribute excess cash to their owners — either through share buy-backs (like the Royal Bank and CN Rail) or boosting dividends (like Enbridge, Brookfield, and Fortis). While this may reduce the amount of cash sitting idly in corporate coffers, it will have no direct impact on real business investment, which is what the economy really needs.
The stagnation of business capital spending is a huge disappointment to the advocates of the dramatic reduction in corporate income taxes which has been a central feature of Canada’s fiscal policy in recent years. Since 2007 the Harper government has cut the federal CIT rate from 22.1% (including a former surtax) to 15% today: that’s a decline of 7.1 points, or about one-third. Many provinces also cut their rates, bringing the combined federal-provincial average rate down to around 26% today — among the lower rates of industrialized countries, and far lower than America’s 35% federal statutory rate (closer to 40% when we include state CITs). The federal CIT cut has reduced federal revenues by about $13 billion per year.
The argument has been that tax cuts would elicit more business investment spending. In 2006, the year before the Harper CIT tax cuts were announced, non-residential business investment equaled 10.5% of GDP. In the first half of 2013, with corporate taxes reduced by one-third, non-residential business investment has equaled 10.7% of GDP. That apparent increment of 0.2% of GDP represents $4.6 billion in “extra” capital spending. Motivated from a $13 billion tax cut. In other words, the government had to spend almost $3, for each $1 in new business spending. (Of course, there are many other factors influencing investment that vary from one year to another, so it’s hard to isolate the impact of the tax cut.) So far in 2013, business investment has actually declined, making a bad situation worse.
Three times as much investment would have been motivated if the government simply spent the $13 billion directly on new public infrastructure (something we badly need, and that would boost private sector productivity. And here’s the biggest irony of all: econometric evidence suggests that the biggest influence on business investment is the pace of economic growth (since businesses won’t invest, if they are worried final demand for their products will be unable to ratify the capacity added through their investment). Growth generates investment (and hence more growth) via multiplier and accelerator effects that are stronger, based on econometric evidence, than any positive effect of lower taxes on business investment. My own regressions (reported in my CCPA study on corporate taxes and business investment, “Having Their Cake and Eating It Too“) suggests that government would elicit almost as much private business investment (via indirect multiplier and accelerator effects) by spending the $13 billion directly on new public capital, as it would by siphoning off the same amount to corporations in tax cuts.
In contrast, back in the bad old 1960s and 1970s, when the combined federal-provincial statutory CIT rate was about 50%, Canada routinely allocated 13% of GDP to business non-residential capital spending. Business investment has trended steadily down since the first big corporate tax reforms under the Mulroney government in the late 1980s (followed by the Paul Martin cuts of the early 2000s, and then the expensive reductions under Harper).
The pitiful economic payoff from these expensive corporate tax cuts, combined with the potent politics of growing inequality in Canada, has created the conditions for a reversal of the corporate tax cut agenda. This year alone, two provinces (British Columbia and New Brunswick) have increased their CIT rates (by one and two points, respectively). Ontario cancelled its planned reductions (freezing the rate at 11.5%, instead of cutting it to 10% as previously planned).
Facing these challenging politics, the defenders of CIT cuts are mobilizing their arguments once again. Jack Mintz recently castigated Ontario’s government in the National Post for not cutting the rate to 10%, despite the absence of any visible payoff from previous rate reductions already in place. And Chris Ragan tilted at the NDP’s windmills in the Globe and Mail, predicting that they will campaign in 2015 on corporate tax hikes, and criticizing them for it. Mintz and Ragan both cited the beneficial impact of CIT cuts on business investment, despite the lack of real-world evidence supporting that view.
Ragan also argued that since corporations are owned by individuals (true), there is no point taxing them (false). The problem with this argument is that the ownership of corporations is incredibly unequal. So claiming that “corporations r us,” hence why would we punish them, doesn’t wash. About one-third of all business wealth is owned by the richest 1% of society, and two-thirds by the richest 5%. So CIT taxes are highly progressive in their incidence — which explains why they (along with higher personal income taxes on the top echelons) are politically popular right now. On top of that, another rationale for collecting taxes directly from corporations (rather than the individuals who own them) is because corporations, as institutions, benefit heavily from many of the public services (infrastructure, education, utilities) that are funded by the state — hence it is entirely legitimate to charge them directly for a share of those costs.
I have argued for years that instead of across-the-board CIT cuts (which reward all profitable companies, whether they are investing in Canada or not), government could do more to elicit business capital spending with fiscal incentives tied directly to incremental investment (like accelerated depreciation allowances, investment tax credits, or focused co-investments wielded as part of pro-active industrial policy initiatives). Ontario’s Finance Minister hinted at this direction recently, in his fiscal update — indicating a greater role in the future for targeted incentives, rather than across-the-board tax cuts (eliciting a slap on the wrist from Mintz). However, if we do that while still locking in recent CIT cuts, then corporations really will get to have their cake and eat it, too. Better to undo the CIT reductions and channel some of the resulting revenues into more focused pro-investment incentives — using the rest of the new revenue to fund badly needed public investment. Alternatively, we could accomplish the same thing by clawing back CIT savings from those companies which are sitting on their cash, instead of investing it (through a clawback of CIT savings from companies which, over a reasonable period of time, do not meet specified capital spending thresholds).
- Corporate Olympics: Profit Sprint vs. Investment Crawl (February 26th, 2014)
- PEF Session at the House of Commons Finance Committee (December 2nd, 2013)
- A Nuclear Error: Uranium Royalty Cuts (December 1st, 2013)
- Canada’s (not so incredible) shrinking federal government (November 20th, 2013)
- Do C. D. Howe’s Numbers Support its Policies? (November 6th, 2013)