The Treasury Transfer Effect

As noted before on this blog, federal and provincial corporate tax cuts will redirect revenue from Canadian governments to the U.S. treasury.

Today, the Canadian Centre for Policy Alternatives released a short paper (PDF) I wrote on the treasury transfer effect. My executive summary follows:

The U.S. government taxes American corporations on a worldwide basis. Profits repatriated from other countries are subject to the U.S. federal corporate tax rate minus a credit for taxes already paid to foreign governments. Earlier this year, President Obama announced more rigorous enforcement of this policy.

American corporations account for about one-third of the profits subject to Canada’s general corporate tax rate. If Canadian federal plus provincial corporate taxes equal or exceed the U.S. federal rate, these corporations do not owe American tax on their Canadian profits.

However, the federal government and some provincial governments are now cutting Canada’s combined general rate from 36% to 25%, far below the 35% U.S. federal rate. This lower corporate tax rate will not help Canada attract more investment from American corporations, which will have to pay the rate difference back to Washington. Planned federal and provincial corporate tax cuts will transfer between $4 billion and $6 billion of annual revenue from Canadian governments to the U.S. treasury.

Commentators of all stripes once acknowledged this strong rationale for keeping Canada’s corporate tax rate at least equal to the U.S. federal rate. Unfortunately, it has been essentially absent from the public debate about recent corporate tax cuts.

Finance Canada has deflected concerns about the treasury transfer effect by arguing that loopholes allow American corporations to avoid facing U.S. tax on their Canadian profits. But Obama plans to close these loopholes. U.S. Internal Revenue Service statistics appear to contradict Finance Canada’s further claim that American corporations will have enough foreign tax credits to meet their U.S. tax obligations despite much lower Canadian corporate taxes.

Canadian federal and provincial governments should enact a combined corporate tax rate of at least 35% to retain revenue that will otherwise be transferred to the American federal treasury. Canada could meet this threshold while staying below the U.S. combined federal-state corporate tax rate, which averages 40%.

11 comments

  • So basically you’re arguing that our corporate tax policy should be dictated by Americans?

    Why can’t Canada have a lower corporate tax rate? If American companies pay at least the American federal tax rate no matter where they locate, lowering our corporate taxes wouldn’t give any incentives to American firms to relocate here. But it might give incentives for more Canadian firms to stay at home or expand more rapidly, and for other foreign firms to come here.

    I think we should set Canadian tax rates based on what’s right for Canada, rather than simply trying to blindly mimic the U.S.

  • I am not arguing that the U.S. should dictate Canadian corporate tax rates, just that it sets a floor below which we should not cut.

    There is a case to be made for somewhat higher corporate taxes in Canada than in the U.S.

    Japan also taxes its corporations on a worldwide basis and has a higher corporate tax rate than the U.S.

  • I would say that if you’re saying that the Canadian corporate rate should equal the maximum of either the U.S. rate or the optimum Canadian rate, you’re definitely arguing that the U.S. should dictate corporate tax rate.

    Adopt a strategy of taxing our corporations abroad like the U.S. and Japan do sounds like it’s probably a good idea. But I don’t see why a low Canadian corporate tax rate is such a bad thing.

  • Erin, deferring federal corporate tax reductions for a few years makes a lot of sense given projected federal deficits over the next five years. This would reduce the Treasury transfer effect in the short term at least.

    In the long term, though, isn’t the flip side of the Treasury transfer effect a competitive boost to domestic vs. American-owned businesses? If we end up with (say) Metro or Loblaw having a competitive advantage over Wal-Mart, is that all bad?

  • This is a great piece of research. The blather about corporate tax rates needing to be reduced conflicts with the reality that the U.S. government is the winner when Canadian governments set corporate rates below U.S. rates.
    I hope the NDP raise this in the House. And the Globe should be doing an editorial, right?

  • It is always amusing to listen to those who would never encourage beggar thy neighbour types of currency devaluations push for just that in terms of corporate tax rates.

    I suppose if one is working with a purely negative definition of liberty it makes sense.

  • If lower corporate tax rates (on profits) lead to more greenfield investment in plants, offices, machines and jobs, then there is a case to be made. But, if lower tax rates simply lead to more leveraged buyouts (CanWest, anyone?), unfocused acquisitions (Nortel, anyone?) or derivatives trading (hey, let’s have a lot more CDO’s, shall we?), then what’s the point? Taxes are not theft, they are simply back-to-work legislation for capital.

  • The Truth about Canadian subsidiaries of foreign corporations is that unless they are stupid, they don’t pay any Canadian Tax ever. How? Many simple schemes, but here’s just one:
    – the parent company ‘buys’ the land and buildings used by their wholly owned Cdn. subsidiary who is a ‘separate entity’ in law.
    – the Canadian operation then ‘leases’ the assets back from their parent company at many times more than the normal going price for similar assets.
    – on paper the Canadian subsidiary makes no profits, because they are paying such high rent
    – the money is thus funneled to the U.S. or wherever the holding company wants through their labyrinth of related companies: to a location where these enormous profits can be offset by government loopholes;
    – example: donating some of the profits to a University, which is actually doing research that will be co-owned and to the advantage of the parent company.

  • Nice piece Erin. I hope it gets picked up by the mainstream media

  • Note that the just-released 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.

  • Thanks for the link.

    The U.S. and Japan may be outliers, but they are also the largest bases of multinational corporations.

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