The campaign’s top corporate tax myths

Posted on April 26, 2011 in Policy Context

Source: — Authors: – FinancialPost/FPComment
Apr 25, 2011.   Jack M. Mintz

The wealthy would benefit more from the NDP’s small business tax cut than from any corporate tax cuts

After the May 2 federal election, some politicians should sign up to a boot camp on corporate tax policy. Our election banter reminds me of the 1960s, with populist views that corporations only benefit the rich and powerful and should therefore be taxed to the hilt. The many myths about corporate tax policies being propagated are deplorable.

Myth 1 Corporate tax reductions do not spur investment. The Globe and Mail’s analysis of corporate tax rate reductions produced the biggest myth in the election. As Ken McKenzie explained in a recent National Post column, the overwhelming consensus is that a reduction in corporate taxes — whether via rate cuts or richer capital cost deductions — spurs investment. A reduction not only affects large employers but also small businesses selling their services to large companies. With improved data in recent years, it is well established that a 10% reduction in tax-inclusive cost of capital increases capital stock by 5% to 15%. I personally use 7%, which is consistent with a study by Mark Parsons of Liberal corporate tax reductions from 2000-05. It was this number that led me to conclude that increasing the federal corporate income tax rate by three points would reduce capital stock by at least $50-billion in the next seven years.

Myth 2 Corporate taxes on large companies are paid by the rich and powerful. Recent studies come to the opposite conclusion: Corporate taxes are disproportionately paid more by the poor. Capital is highly mobile, so any tax causes investors to shift funds to other jurisdictions. Because international markets determine the after-tax return on investments, any corporate tax must ultimately be borne by domestic consumers or immobile factors of production (labour). Lower corporate taxes on small businesses, on the other hand, favour high-income households, which shift high-tax personal income into the low-tax corporations. Ironically, the NDP proposal to reduce the small business tax rate is a sop to many high-income Canadians without necessarily creating new jobs.

Myth 3 The three-point federal corporate tax increase raises $6-billion in revenue. This 2013-14 revenue estimate used by the Liberals, NDP and Green parties for their platforms is just plain wrong. For this reason alone, the three parties’ fiscal numbers don’t add up. Most estimates ignore the impact of a rate hike on the size of the corporate tax base and therefore over-estimate the revenue gains. Several recently published Canadian and international studies have shown that multinational corporations quickly and easily shift profits from high to low tax-rate jurisdictions. Based on a federal-provincial 26% tax rate, I have estimated that the three-point increase in the federal rate would yield about $1.8-billion in revenue for the federal government. However, the provinces would lose $1.7-billion due to shrinkage of the tax base. This suggests that corporate tax rate reductions give the biggest bang for the buck, a view also taken by Bev Dahlby in a recent C.D. Howe Institute publication.

Myth 4 Cutting the corporate income tax rate leads to a large transfer of revenue from Canadian to U.S. treasuries. Some have argued that the Canadian corporate tax rate should be higher because more revenue would be transferred from foreign governments to the Canadian treasury through international tax-crediting arrangements. While this point is correct, it is of third-order importance. Today, all major capital-exporting countries exempt dividends paid from Canada to the parent, except for the United States, which taxes remitted earnings with a credit given for foreign taxes deemed to be paid on such earnings. While the United States dominates foreign investment in Canada (53.5%), foreign-controlled assets in Canada have shrunk to only 20.3% of business assets (Statistics Canada latest estimate for 2008).

This would suggest that 2013 taxable corporate profits (about $150-billion) accruing to U.S. companies would be $16-billion. A one-point increase in the corporate tax rate would therefore raise $160-million in corporate taxes on U.S. companies, but this amount would not be credited against U.S. tax for two reasons. First, at least 60% of profits are reinvested in Canada and are not subject to U.S. tax. Second, dividends distributed to the U.S. parent are typically untaxed since the global foreign corporate taxes are more than the U.S. tax owing on dividends repatriated to the United States.

Recent IRS data shows that 60% of corporate dividends paid from Canada subsidiaries to the U.S. parent is exempt from U.S. tax since the parent has excess foreign tax credits. As a share of U.S.-owned taxable profits in Canada, the transfer is therefore only $40-million from the United States to Canada with the one-point tax rate increase. Given that a point rate reduction on investment roughly corresponds to $17-billion in additional capital stock, the transfer effect is indeed a small economic cost.

Putting together all the benefits and costs associated with corporate tax rate reductions, there is no question that moving to the 15% federal rate is good public policy. Now we just need to re-educate politicians to understand this good advice.

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