Tax Competitiveness 2009: Flogging a Dead Horse
Should we care that the marginal effective tax rate on capital is higher in Prince Edward Island than in Serbia?
Of course, this question is a joke. But the C. D. Howe Institute actually did put out a press release (PDF) last week singling out PEI for its allegedly high business taxes compared to an average of 80 countries, among which Serbia is the star.
This Institute, which is governed and funded by corporate Canada, has been extremely influential in shaping Canadian tax policy. The federal corporate income tax rate is being cut in half between 2000 and 2012. Provincial corporate income taxes are also falling and corporate capital taxes are gone. All but three smaller provinces have removed, or will soon remove, their sales tax from business inputs.
Despite all of these ongoing business tax cuts, Jack Mintz still got back in the saddle to co-author yet another Tax Competitiveness Report (2009 PDF). But the result is tantamount to flogging a dead horse.
The original argument was that Canadaâ€™s corporate taxes needed to be competitive with the US. When the average corporate income tax rate of Canadian federal plus provincial governments was cut well below the average of American federal plus state governments, the C. D. Howe Institute instead emphasized a measure of marginal effective tax rates (METRs) indicating that Canadaâ€™s overall business taxes were still higher (e.g. 2003 PDF).
As the tax cuts continued, Canada was soon competitive with the US by this measure as well. So, the Institute found some new comparators, arguing that Canada had a high METR among 36 countries: the OECD plus â€œleading developing countriesâ€ (e.g. 2005 PDF).
As I pointed out a couple of years ago, such international rankings or averages are skewed by small tax havens. Simply weighting countries by economic size (GDP) revealed that Canadaâ€™s corporate income tax rate was already in line with the OECD average.
The 2007 and 2008 (PDF) Tax Competitiveness Reports estimated METRs for 80 countries. Not surprisingly, Canadaâ€™s rate was in line with the weighted average, but well above the unweighted average. While the C. D. Howe Institute kept up the push for yet more business tax cuts, its own data indicated that Canada was already internationally competitive.
The 2009 report mentions only an unweighted average METR of 17.6% among the 80 countries. The Canadian rate is 28.0% in 2009 and will be 18.9% in 2013. The authors conclude that announced corporate tax cuts and sales-tax harmonization are indeed needed to make Canada competitive in the global economy.
However, their most recent weighted average was 28.7% among the 80 countries. By this more relevant measure, Canada is already competitive in the global economy. There is no need for future corporate tax cuts or sales-tax harmonization.
The 2009 Tax Competitiveness Reportâ€™s other main theme is that â€œdistortingâ€, â€œdistortiveâ€ and â€œdistortionaryâ€ tax incentives for particular activities or sectors are counterproductive. The authors make some valid criticisms, most of which also apply to the across-the-board tax cuts that they favour.
Regarding the accelerated capital cost allowance for manufacturing investment, they note, â€œThe allowance provides much less assistance to companies that are currently not paying taxes.â€ This point is correct, but lower corporate income tax rates are equally unhelpful for enterprises with no taxable profits.
The Report notes that manufacturing contracted while service industries grew even as such targeted measures provided a lower METR for manufacturing than for services. Clearly, tax breaks were not enough to save Canadian manufacturing from a high dollar, Asian competition, the economic crisis, etc. This observation suggests that tax rates, and â€œtax competitiveness,â€ are far less important than the C. D. Howe Institute asserts.
If METRs affect (or distort) investment decisions as the authors assume, then we can only imagine that manufacturing would have garnered even less investment and suffered an even worse decline without the tax incentives. On the other hand, if METRs do not influence investment decisions, then why strive to lower them?
The authors also complain that targeted tax measures â€œare rarely tested as to whether they achieve positive economic results.â€ This complaint is entirely valid: tax measures should be subject to the same scrutiny as expenditure programs.
But it is hardly unique to targeted measures. Across-the-board tax cuts are never tested as to whether they achieve positive economic results. Indeed, I have suggested that conducting such evaluations could be a useful role for the Parliamentary Budget Officer.
The 2009 Tax Competitiveness Reportâ€™s opening paragraphs emphasize the return of budget deficits. After raising this concern, the document provides no figures on the fiscal cost of the corporate tax cuts that it advocates or of the targeted measures that it opposes.
Finance Canada estimates that federal corporate tax cuts enacted since 2006 will cost $14.9 billion annually when fully implemented in 2013-14. About half of this reduction has not yet been implemented. Along with planned provincial corporate tax cuts that will cost billions more, it is not needed to bring Canadaâ€™s METR down to the 80-country weighted average. Cancelling unnecessary business tax cuts would help to minimize future deficits.
If concern about Canadaâ€™s METR is warranted, the most cost-effective means of reducing it are measures focussed on new investment. Whereas across-the-board tax cuts provide a break to the entire existing capital stock, targeted tax incentives usually only apply to new capital added at the margin.
The C. D. Howe Institute calculates that Canadaâ€™s METR fell by 0.9% from 2008 to 2009. Only 0.3% of this reduction reflected decreasing the federal corporate income tax rate from 19.5% to 19.0%. Introducing the accelerated capital cost allowance for computers contributed the remaining 0.6%. (The accelerated capital cost allowance for manufacturing was already in effect in 2008.)
Finance Canada projects that the fast writeoff for computers will cost $350 million annually. Cutting the general corporate tax rate by half a percentage point costs more than twice this amount, but reduced Canadaâ€™s METR by only half as much. In this case, the targeted measure was at least four times more cost-effective than the across-the-board tax cut.
The 2009 Tax Competitiveness Report provides no reason for concern about the international competitiveness of Canadaâ€™s current business taxes. Its concerns about targeted tax measures generally also apply to across-the-board corporate tax cuts. If governments wish to reduce METRs, measures targeted to new investment are the most cost-effective policy.