Corporate Tax Revenue: A Closer Look

The fiscal implications of corporate income tax (CIT) cuts are a key issue in the current debate. Federal cabinet ministers and Neil Reynolds have boldly asserted that lower CIT rates will increase CIT revenues. As Andrew and I have pointed out, this claim is implausible and not supported by the government’s own Department of Finance.

The following table provides a closer look at CIT revenues. It covers the past decade, from the last year before CIT cuts started to the most recent year for which annual data is available. The “Finance Revenue” column is in fiscal years (i.e. 2000 = 2000-01). The rest are in calendar years.

Federal Corporate Taxes and Corporate Profits ($ billions)

Looking at CIT revenues reported by Finance Canada, one might observe that they have fallen only in years when the general rate was cut. The largest revenue increase occurred between 2004 and 2007, when the general rate was stable.

Conservative Spin

Here is how conservatives interpret the same figures:

“Corporate income tax revenues – they have gone up during the time that we have been reducing the tax burden.” – Jim Flaherty

“Prime Minister Stephen Harper made the correct observation that Canada collects as much corporate income tax revenue today as it did earlier when rates were much higher.” – Jack Mintz

“Corporate tax receipts are actually going up.” – L. Ian MacDonald

I assume they mean that CIT revenues edged up between 2008-09 and 2009-10 even as the general CIT rate edged down. Revenues were greater in 2009-10 than in years prior to 2005-06, when the general rate had been higher.

Finance Canada’s Numbers

However, that argument looks accurate only in nominal dollars. Adjusting for inflation reveals that CIT revenues were actually higher in 2000-01, 2003-04 and 2004-05 than in 2009-10.

Furthermore, revenues include CIT paid at rates other than the general rate. The “small business” rate was cut from 13.1% to 11%. The manufacturing and processing rate was 22.1% from 1994 through 2007. The fact that CIT rates for small-business and manufacturing profits did not change much over the past decade partly explains why overall CIT revenues held up fairly well.

Other variables – like tax deductions – significantly affect CIT revenues from one year to the next. Indeed, Finance Canada has stated, “Most of the higher-than-expected corporate income tax revenues [in 2009-10] were due to exceptional one-time factors.” It projects that CIT revenues will drop to $28.1 billion in 2010-11. So, pointing to the revenue bump in 2009-10 as validation of ongoing CIT cuts is misleading.

Statistics Canada’s Numbers

Finance Canada reports revenue for fiscal years: the last three quarters of a calendar year plus the first quarter of the next one. Statistics Canada’s figures on federal CIT suggest that revenues may have been so strong in 2009-10 because of unusually large collections in the first quarter of 2010.

Calendar-year data from Statistics Canada avoid this possible anomaly, facilitate comparisons with pre-tax profits, and allow the calculation of effective tax rates (i.e. revenue/profit). Also, federal CIT rate reductions occur on a calendar-year basis (i.e. on January 1).

CIT revenues were buoyant through 2008, despite rate reductions, because corporate profits surged. But CIT cuts would have paid for themselves only if they caused this surge. 

Did lower rates prompt multinationals to report more of their profits in Canada? If so, the largest inflows would have occurred when rates changed. In reality, profits increased as much during the three-year period when the general rate was stable (+32.7 billion between 2004 and 2007) as during the four-year period when it fell (+32.2 billion between 2000 and 2004).

Low Rate, Broad Base?

Because of deductions, CIT does not apply to all profits. Even if rate reductions do not increase profits, they could be revenue neutral if combined with measures to broaden the corporate tax base. As proposed by President Obama, a lower CIT rate applied to a larger proportion of profits could collect the same share of total profits.

Although Mintz used the “low rate, broad base” rhetoric to sell CIT cuts, Canada has not broadened its corporate tax base. Flaherty proposed to eliminate foreign-affiliate interest deductibility in 2007, but backed off when Bay Street (and Mintz) objected. Budget 2010 did lower the interest rate refunded on CIT overpayments, a welcome reform that happened after the period for which we have annual statistics and is projected to save only $0.2 billion.

The share of profits collected by the federal government has decreased over the past decade.  Although the effective tax rate varies, it has tended to fall along with statutory rates.

Conclusion

CIT cuts did not cause much, if any, of the increase in pre-tax profits before the economic crisis. But they have significantly reduced the share of profits collected as public revenue. Therefore, the fiscal cost of CIT cuts is substantial.