Voodoo Economics at the C. D. Howe Institute

In successfully seeking the 1980 Republican nomination for President, Ronald Reagan embraced the Laffer Curve theory that tax cuts would increase tax revenues. At the time, rival candidate George Bush Sr. derided this notion as “Voodoo economics” and it has been since been discredited many times.

Jack Mintz struggles to revive the theory in today’s 2007 Tax Competitiveness Report, declaring that “Canada’s corporate income tax rate is on the wrong side of the ‘Laffer curve’.” He estimates a “tax-revenue-maximizing rate of 28 percent”, which is well below the current statutory rate of 34 percent.

But Mintz does not seem to believe his own argument. On the next page, he writes, “Federal and provincial surpluses make it possible for further tax reductions.” He also proposes base-broadening reforms and increased consumption taxes to offset “the fiscal costs” of corporate-tax cuts. Of course, neither surpluses nor revenue-raising measures would be necessary if he genuinely thought that lower corporate-tax rates would raise more revenue.

In any case, Mintz’s ultimate goal is to reduce corporate taxes to “roughly 20 percent”, which is far below both the current rate and his own estimate of the revenue-maximizing rate. Why, then, does he trot out the Laffer Curve?

My sense is that the C. D. Howe Institute is grasping at straws because the mainstay of its Tax Competitiveness Program, that the marginal effective tax rate (METR) on capital is relatively high in Canada, is no longer accurate. Although statutory corporate-tax-rates remained essentially unchanged between 2006 and 2007, Canada’s METR dropped from 37% to 31% mainly due to accelerated depreciation for manufacturers and other targeted measures. Not surprisingly, measures tied to new investment have more effect at the margin (at much less overall cost) than across-the-board rate cuts. These facts weaken the Institute’s lobbying for lower corporate-tax rates.

Since the METR is no longer higher in Canada than in other major economies, the Institute immediately followed its 2007 Report with a shorter release entitled, “World’s Major Economies Have High-Tax Handicap”. This release begs a couple of questions. Why, if allegedly high corporate taxes are such a handicap, have the countries with them been so successful? If most major economies have high corporate taxes, how can they constitute a competitive disadvantage for Canada?

To the Institute’s credit, it seems to have (partly) accepted that tax havens should not be included with industrialized countries in unweighted averages. Following my approach, the 2007 Report provides averages weighted by GDP for the OECD and all 80 countries examined. The results follow:

Statutory

METR

Manufacturing

METR

Services

METR

Canada

34%

31%

23%

36%

OECD

36%

32%

31%

32%

All

35%

32%

31%

32%

Considering that international mobility is greater in manufacturing than in services, these figures hardly support the claim on the following page that Canada “still has one of the most uncompetitive business tax regimes in the world.”

Finally, Mintz misleadingly presents the Irish takeoff as a result of corporate-tax cuts. The Canadian Tax Journal published a more balanced assessment of the Irish experience.

Although the case for further corporate-tax cuts is weak, some of Mintz’s base-broadening measures would be welcome. In particular, he proposes a carbon tax, eliminating the lifetime capital gains exemption, and limiting foreign-affiliate interest-deductibility.

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