Dangerous delusions about corporate income tax cuts

For years we have been asking Stephen Gordon to provide the evidence for lower corporate taxes. Like Stephen I like the Nordic model and take away from it that tax mix matters, so funding a large public sector may require more than taxes on “people we do not know” (ie corporations and the rich), so consumption taxes need to part of the mix, offset by transfers to the poor; and that corporate taxes should not be too high to avoid capital flight. This is an important lesson if Canada wants to go from taxes of about one-third of GDP to Nordic levels of more than 40%.

That said, Stephen has turned this into an ideology where corporate tax cuts are always and everywhere a good thing, and it is cause for celebration if Canada cuts corporate taxes because this will presumably lead to higher long term rates of economic growth. Because the empirical literature says so.

This is a dangerous delusion. The problems with it are several:

It fails to explain Canada’s economy, where corporate taxes have been cut but investment as a share of GDP and as a share of profits have both fallen, even as corporate profits have grown as a share of GDP. Stephen prefers to use a sleight-of-hand which uses a different deflator for investment than GDP so that in adjusted terms this situation looks better but in the real world of dollars as we know them, it just ain’t so.

It fails to capture Canada’s unique circumstances, in particular its relationship with the US, where corporate rates are now higher than Canada. This does not reduce the total taxes paid of US corporations but leads to a treasury transfer effect from the Canadian to US treasuries because US corporations are taxed on their worldwide income.

It fails to capture the nuances of why corporations invest. Investment decisions in the real world are lumpy and uncertain in terms of rates of return. Small changes in the after tax rate of return pale beside the other major considerations for investment such as access to resources, access to skilled labour, electricity and other utility costs, and markets for products. A recent KPMG study found that only 14% of location specific costs are due to taxes. My quick look at the OECD sources cited finds that these factors are never adjusted for in regression analyses.

I could go on and on about methodological problems with the empirical studies (which independent variables, which industries, which countries, what functional forms are used), but that just gets into he said she said discussions that are over the top of the heads of most readers. I think most empirical researchers on the topic find evidence that justifies their previous beliefs. One study I found persuasive was a survey for the IMF by Gerson, who found that the only consistent outcome was that corporate investment was strongly related to strong demand conditions not the supply side factors that most economics are overly obsessed with.

In any event, Canadian taxes were among the lowest in the world according to the KPMG study, second after Mexico among the countries studied. In fact, Vancouver was the lowest tax city studied, and Montreal and Toronto were number 4 and 5 respectively. The knee jerk demand for more corporate tax cuts is nonsensical and counter to the evidence of KPMG’s corporate bean counters anyway.

But even if there are no diminishing returns to corporate tax cuts, ie strong growth benefits to even lower taxes, we should not unequivically cheer. A huge amount of investment in Canada in recent years has been in the tar sands. This is bad economic growth that is contributing to a planet that will be largely unhabitable by humans within 100-200 years. We need to think carefully about in what sectors economic growth is happening.

The ideological approach to corporate tax cuts means that they should simply be zero. But it is not desirable to cut corporate taxes below a certain amount, or the wealthy will use corporations to accumulate wealth and dodge their personal taxes. Minimally, when corporate taxes are reduced we must acknowledge that this is a windfall to the owners, who tend to be in the top 5% of income earners, so there should be some compensating increase in top MTRs for personal income tax.

Going back to our agreement about the Nordics, my interpretation of this literature is less fundamentalist. I do not oppose a freeze on further tax cuts as I am doubtful of the benefits of doing so. Indeed, Canada could harmonize rates upward to US rates, and generally aspire to be in the middle of the pack without fear of economic harm. Based on Stephen’s related post, there is no obvious reason why Canada needs to go further than that.

11 comments

  • Possibly you missed linking to this post.

    It’s at least a little relevant to the points that you’re making.

  • Another dangerous delusion is positing that lower corporate taxes will be accompanied by higher consumption taxes. It is one thing to advocate a shift from corporate to consumption taxes, which would at least preserve public fiscal capacity.

    But it is a different matter to cheer for corporate tax cuts where there is no prospect of an offsetting increase in other taxes (e.g. at the federal level in Canada.) While Stephen Gordon purports to favour more public spending, he supports corporate tax cuts that substantially reduce public revenues and hence expenditures.

  • Another dangerous delusion on lower corporate taxes is the somehow thinking and believing we are through this crisis. As the crunch starts to make its way into the specter of deficit cutting, we all know what is happening in Greece and the EU. Austerity is creating social unrest approaching some high water marks. Imagine the specter in Canada, if the pressure is increased more for deficit cutting, Corporations off the hook and workers and public services cut. Who knows how far these Tories will go with the deficit mantra, and the resulting actions on public cutting, especially if they ever get a majority.

  • I really don’t see how you call a plea for evidence-based policy analysis a ‘dangerous delusion’.

    I’ll just deal with two points.

    A recent KPMG study found that only 14% of location specific costs are due to taxes.

    This is presented as a crucial piece of evidence. It’s not. What is important is the effect of taxes on the after-tax rates of return on capital. The KPMG numbers are essentially useless for those purposes, which is why no-one uses them in empirical analyses of tax policy.

    Minimally, when corporate taxes are reduced we must acknowledge that this is a windfall to the owners We must acknowledge no such thing; please read some of that corporate tax incidence literature.

  • So once again your argument, Stephen, is “but the literature says so” even though there are major shortcomings in that literature and nuances and context that you choose to ignore. Are you really an academic?

  • What are these shortcomings? Please don’t tell me you’ve explained what they are, because you haven’t. At best, you’ve shown an inexplicable disinterest in the scholarly literature.

  • Okay, I’m now in a sufficiently snarky mood to ask: are you really a progressive?

    Because a progressive would be preoccupied with distributional issues. She would be keenly interested in the question of “Who bears the burden of corporate taxes?” She would make the effort to do some thinking and reading in order to answer this question.

  • The fact is that pressures for corporate tax cuts always come from the wealthy, pressures for flatter/less progressive income taxes always come from the wealthy, pressures for increasing the proportion of consumption taxes always come from the wealthy, pressures for reducing taxes on capital gains and similar things always come from the wealthy, pressures for increases in levels of tax-free investments like RRSPs always come from the wealthy, pressures for user fees always come from the wealthy, and these pressures are all there for the same reason:
    They allow the wealthy to make more money, largely at the expense of the rest of us.
    This has been readily visible over the last while as their pressures have been successful, they have gotten all these things, and they have in fact made lots more money, largely at the expense of the rest of us. (You yourself apparently have been documenting this shift, and well done. Averting your eyes from reasons why, not so well done)

    Now that’s a distributional issue if you like. And frankly, while economic growth does happen and various notions about its causes are wielded like a club by the corporate-tax-cut set, it’s pretty clear that the people funding the think tanks and other PR outfits popularizing all this stuff, not to mention endowing the university chairs–as I say, it’s clear the people funding these claims don’t actually see things in terms of growth, they see things in basically zero-sum terms, as a game where they need to get more by making sure others get less, and where they need to pay less and arrange for others to pay more.

    It’s berluddy obvious to anyone who’s looking at the flippin’ elephant instead of explaining that the only way to understand it, as the Very Learned Indeed would realize, is to don a blindfold the better to carefully feel a portion of the beast. The corporate tax cut mantra is just one cog in a very successful machine dedicated to sucking money (and power) from the poor and middle class into the pockets of the very wealthy indeed, and I’m in awe at the gall of saying that not buying into the Fraser Institute more-for-the-rich position constitutes a failure to think of distributional issues.

    Who bears the burden of corporate taxes? Well if it weren’t corporations, they wouldn’t be pushing so bloody hard to get rid of them, would they? And I’d be far more willing to believe they really invest so blasted much more when they aren’t taxed if we’d actually seen any bloody investment for the years now that Canada’s been a lower-corporate-tax environment than the US. Not only hasn’t it happened, but the most significant cases of choices to invest in Canada rather than the US that I did hear of in that time was due to our superior health care model and the high cost of US health insurance!

  • Stephen, I wrote this whole post pointing out some of the shortcomings, and the nuances and caveats that seem to float past you every time. Have you ever heard of an omitted variables problem? Does the fact that the studies you cite omit key variables that determine corporate investment other than taxes not give you pause for thought about vocalizing such rigid positions?

    I’ve read the literature on incidence of corporate taxes, heck I did a whole tax incidence study, and we’ve had this debate before. And time and time again you do not get it. I thought you were an academic but your responses consistently suggest an evidence base that you are an ideologue.

  • Stephen, I am sorry to gang up, but will try to be less sassy than Marc.

    The KPMG numbers are essentially useless for those purposes, which is why no-one uses them in empirical analyses of tax policy.

    I do not really know what goes on in corporate boardrooms. But KPMG figures strike me as something that business leaders might actually consider in making investment decisions. Certainly, KPMG is in the business of advising businesses.

    Conversely, “marginal effective tax rates” get a lot of play in the tax policy literature. However, I am not aware of any companies or individual investors making decisions based on them.

    If actual investment is our concern, then it might make sense to pay attention to KPMG’s figures. They indicate that taxes account for only a small fraction of business costs and are already quite low in Canada.

  • I hate to say this but I think you are all partially wrong and partially right.

    The investment decision is filled with a whole lot of variables, whether it be greenfield or brownfield. We all witnessed the corporate divestment that went on during the crisis of 2008. Plants permanently shuttered, idled and cut backs in shifts to meet decreased capacity. Especially the auto sector. Corporate tax rates, as long as they are within some notion of the ballpark, contra competing sites for investment, would received a relatively small weight.

    Investment in developed economies is so much more complicated now that we have exited the mass production era. To me, a bleeding edge workforce is what I would be after, along with targeted help in terms of capital depreciation rates and joint investments from government sources. So it is not taxes per say, but the politics of the situation. How about exchange rate- fluctuations and political stability, long term profits are what successful investors are after. So tax rates are dynamic and a risky factor to takes as some kind of fixed input into the equation.

    Of course most of this has already been said, and like a spoiled child, ideologue, or apologist, or potentially just plain old having too much time on his hands, Stephen continues to argue something and spend hours digging up academic economic fossils that, like many of the debates within the field are loaded up with bias and subjectivity.

    As long as a rate is within some notion of sanity, corporations that promote good jobs, will have taxation rates a lot lower on the list of priorities in the decision equation that what Stephen obsesses on.

    However it is about the only time I have seen people get rowdy on this blog, so if you must Stephan keep bickering away at us on your apparent superior intellect and treasure trove of knowledge regarding corporate taxes.

    It is an important deception, there is no doubt, but please realize we are not the economic idiots that you might think we will ever buy into your notions. Not that it would ever matter anyway.

    pt

Leave a Reply

Your email address will not be published.