Corporate Tax Giveaway to Uncle Sam

A couple of weeks ago, the Canadian Centre for Policy Alternatives released a paper of mine about how Canada’s corporate tax cuts will transfer revenue to the American federal treasury. That day, I debated this issue with Don Drummond on the Business News Network (video clip).

Also that day, Jack Layton raised it in Question Period. Ontario NDP leader Andrea Horwath had raised it at Queen’s Park six months ago.

The Harper Index deserves credit for reporting my argument before I even finished writing it out. Indeed, Ish Theilheimer’s interview questions helped me refine my paper.

Last week, La Presse printed an excellent report on my paper, but got my gender wrong. (I thank David Karp for tracking down the online version, which I could not find.)

Yesterday’s Financial Post featured the following op-ed:

Counterpoint: Corporate tax cuts would hurt Canada

The prospect of ongoing budget deficits should cause governments to re-evaluate planned corporate tax cuts. As corporate profits recover, stronger corporate tax revenues could make a major contribution to balancing public budgets. However, the federal government is in the process of slashing its corporate tax rate from 22% to 15%.

Finance Canada estimates that, when fully implemented, this cut will reduce annual revenues by $14-billion. Simply maintaining today’s rate of 19% would prevent more than half of this revenue loss. But in addition to pushing ahead with federal corporate tax cuts, Ottawa is encouraging provincial corporate tax cuts that will cost billions more.

While these cuts will detract from public finances after an economic recovery, they will contribute very little to bringing about a recovery. Finance Canada itself estimates that each dollar of annual corporate tax cuts adds only 10 cents to Gross Domestic Product (GDP) this year and 20 cents next year. By comparison, it estimates that each dollar of annual infrastructure spending adds a dollar to GDP this year and $1.50 next year.

The case for corporate tax cuts is that they supposedly prompt businesses to invest more in Canada. Critics have countered that an unconditional gift to those corporations which are already profitable will not necessarily increase investment. A third possibility that has received little attention helps explain why corporate tax cuts are so ineffective.

Much of the revenue forgone by Canadian governments will flow not to enterprises operating in Canada but to foreign governments. In particular, the U.S. government taxes its corporations on a worldwide basis and President Obama has proposed tougher enforcement of this policy. American corporations account for nearly one-third of all profits subject to Canada’s general corporate tax rate.

When an American company repatriates profits from Canada to the U.S., it pays the 35% American federal corporate tax rate minus a credit for taxes already paid in Canada. If our federal plus provincial rate is at least 35%, these corporations do not owe American tax on their Canadian profits.

Ongoing federal and provincial corporate tax cuts are reducing our combined rate from 36% in 2007 to 25% by 2013. American companies operating in Canada will have to pay this rate difference back to Washington, shifting between $4-billion and $6-billion annually from Canadian governments to the U.S. treasury.

There will be a further transfer to Tokyo, which taxes Japanese corporations on a worldwide basis. Canadian federal and provincial governments should retain these revenues by enacting a combined corporate tax rate of at least 35%.

Since American corporations must part with 35% of their Canadian profits anyway, setting Canada’s corporate taxes at this threshold would not diminish their incentives to invest here. Indeed, we would still have a relatively lower combined corporate tax rate than the U.S. because all but three American states levy additional corporate taxes over and above the 35% American federal rate.

Several policy changes will probably be needed to balance Canadian budgets. Stopping the giveaway of corporate tax revenue to foreign treasuries would be a great place to start.

Erin Weir is an economist with the United Steelworkers union. His recent paper, The Treasury Transfer Effect: Are Canada’s Corporate Tax Cuts Shifting Billions to the U.S. Treasury?, is available at www.policyalternatives.ca

8 comments

  • Much of the revenue forgone by Canadian governments will flow not to enterprises operating in Canada but to foreign governments.

    Corporate profits in 2008 were $216b. Your number for profits repatriated to the US is $28b.

    You might be overselling your point.

  • You are comparing a pre-tax, Canadian-dollar figure from 2008 with an after-tax, American-dollar figure from 2004. Of course, the latter figure seems relatively small.

    Also, the former figure includes tens of billions of dollars of Canadian “small business” profits, which are not subject to the general corporate tax rate. Did you read the final sentence of the paragraph from which you quote?

    American corporations account for nearly one-third of all profits subject to Canada’s general corporate tax rate.

    Do you disagree with that fraction?

  • No, but it’s still not enough to overturn argument in favour of lower corporate income taxes.

    1) That one-third number is not set in stone. US investors don’t *have* to make use of US corporations in order to invest in Canada. If US laws prevent them from taking advantage of lower Canadian tax rates, they can use Canadian firms to transform current savings into future profits.

    2) The usual story applies to the other two-thirds.

  • There are other important critiques of the usual story, several of which have been discussed elsewhere on this blog.

    If corporations are simply vehicles through which shareholders transform savings into profits, then consider the integration of corporate and personal income tax. Much of “the other two-thirds” is Canadian corporations, largely owned by taxable Canadian shareholders.

    These shareholders receive dividend tax credits equal to the corporate tax rate. Their credits are being reduced in line with the rate. For them, corporate tax cuts are a wash. Therefore, far more than one-third of investment is insensitive to corporate tax rates.

    However, even one-third is pretty significant. Corporate tax cuts should be compared to other potential uses of public funds. If corporate tax cuts are one-third less effective than you had previously believed, you would presumably favour some reallocation of funds away from them toward alternative measures.

  • Hey Gordon I noticed you quit decrying economic illiteracy when it was Carney repeating the same nonsense about technical limitations to devaluation. Do you always go weak in the knee when it comes to your betters?

  • As I pointed out in a previous thread, a recent KPMG survey shows that the U.S. is the outlier on corporate tax rates: Canada’s rates are closer to the OECD and EU averages. So the issue is not that Canada’s corporate taxes are too low, it’s that U.S. taxes are too high. Given the horrible state of U.S. public finances, we shouldn’t expect them to reduce their corporate taxes any time soon.

    Deferring lower Canadian corporate tax rates for a couple of years would presumably help us get out of deficit sooner. In the long run, though, a lower Canadian corporate tax rate ought to provide less of a disincentive to EU investment in Canada.

  • Just wanted to mention a point that is somewhat related to this.

    I was researching a cable plant in Brockville during the mid- 90’s. The plant had been under some stress when apparently some excess capacity in the market opened in up, at least that is what the union told, both in the building wire and specialty cable markets.

    After 3 years of restructuring the shop floor and a whole pile of work re-org experiments that I got involved in as a grad researcher for the union, the company announced it was closing the plant and many of the machines were being moved down to a sister plant in Indiana.

    Okay here is the issue with relation to taxes. Before the company moved the plant, they retrofitted and rebuilt and retooled many of the machines. This was all done at the Canadian plant and charged against the expenses incurred in Canada. Let me say this, this was no small expense, and one of the reasons given by teh American company for shutting down the plant was the machinery was inefficient and old.

    So basically when you think about the write-off to the Canadian revenues and the tax allowances, Canadians ended up footing the bill to rebuild an American plant.

    This in a round about way is part of a larger problem with inter border tax- revenue realization rules are quite lax and therefore a multinational will engage in what is called transfer pricing which allows them to avoid taxes in one country over another. This allows them to partially skirt around the entire issue of tax rates.

    THat is a whole paper in itself, but I will say this Erin, you should have a look into that issue. It is extremely hard for statistical programs to pick on such activities to quantify the relevant levels, but it has been estimated as a quite prevalent practice.

    (my example is a bit of an outlier of transfer pricing and potentially not the norm- it was such a sad day when that plant closed- we moved from work re-org committees to workforce adjustment and resume writing classes oh so fast)

    THe day of the closing a whole pile of

  • I meant to say, Erin you should look into the issue further.

    It is a very important topic. But how can you police transfer pricing, the corps have been a slippery snake on this issue for quite some time.

    Interfirm transaction across borders are fairly difficult to monitor- and intra-firm trade- where transfer pricing occurs is without a doubt hardly measured at all, accept of course by the multinational who knows precisely how much is going on.

    THe US SEC does require reporting of revenues to be registered in various reports but I am not sure how much oversight this actually provides.

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