Business

Canada's corporate income tax fight

Sane economists divide widely about the effectiveness of cutting corporate levies.

Whether or not to cut corporate income taxes — what companies pay into the public coffers — might be the closest thing Canadians will see to a real ideological debate in the 2011 federal election.

All three parties basically seem to get the notion of corporate competitiveness and the link to job creation.

University of Calgary's Jack Mintz has long advocated lower corporate income taxes. ((University of Calgary))

But, the Conservatives, Liberals and the New Democratic Party differ as to where Canadian companies fit in the international landscape and whether chopping what these firms pay to Ottawa is the best way to create jobs.

Of course, some of these variations are the result of political calculations by the federal parties, designed to position themselves to get the most votes.

But, as is true with many questions one thinks have already been answered, sane economists also divide markedly about the effectiveness of cutting corporate levies.

The battle is joined

Some like the notion of chopping what firms pay.

"The recent and planned general corporate rate reductions are good for the economy with a minimal impact on government revenues," Jack Mintz, Palmer Chair of Public Policy, School of Public Policy at the University of Calgary, wrote in a recent opinion piece in the National Post.

Others not so much.

"Corporate tax cuts may not reduce the costs of doing business but may, instead, contribute to rising business costs, falling profits, slower growth and job declines," said Robert Lynch, chairman of the economics department of Maryland-based Washington College and an expert of U.S. corporate taxes.

Waving the low-tax flag

At first blush, the case for knocking down company taxes would appear to be fairly straightforward.

Proponents argue lower company taxes means more investment and more hiring. ((Canadian Press))

"To increase after-tax cash flow — leave more money in the hands of business to invest," noted Jeff Brownlee, vice-president of public affairs and partnerships for the Canadian Manufacturers and Exporters, an Ottawa-based business group.

Simply put, if a company has more cash on hand, it can buy more performance-enhancing machinery or hire new workers.

Conversely, if the government takes away that money, public officials are more likely to waste at least some of those tax dollars on inefficient projects, losing the maximum benefit the money could have on the overall economy.

Hiking profitability

A second — and related — point is that a lower corporate tax rate boosts the after-tax return of money spent on things like capital equipment.

That makes such investments more attractive to firms and keeps company cash out of dormant financial instruments, such as treasury bills and government bonds.

Thus, a lower corporate income tax rate might give firms an incentive to improve their business productivity, an area in which Canada has generally lagged for decades.

Brownlee also points to comparative factors, such as the need for Canada's tax rates to mirror those in other countries. In that way, Ottawa can make sure domestic companies are not lured away to lower tax jurisdictions.

Who really pays?

Finally, proponents of lower levies complain that firms do not pay higher taxes; people do.

"Business taxes are borne directly or indirectly by people — workers through lower wages, consumers in the form of higher prices for goods and services, and shareholders through lower returns," said the Canadian Chamber of Commerce in a February paper.

Indeed, many fans of eliminating corporate taxes argue that employees could be the biggest victims of the type of levy.

"The burden of corporate income tax can fall on labour. When faced with higher production costs due to the corporate income tax, firms can pass the burden along by decreasing their wage payment," wrote Li Lui and Rosanne Altshuler, economics professors at Rutgers University in New Jersey, in a 2009 academic paper.

And, lest the opposing argument gets made that corporate income tax cuts will only benefit, Brownlee said, there are 120,000 Canadian businesses —more than 90 per cent of the small variety — that would see the gain from lower government levies.

Business sitting on its hands...

Needless to say, opponents to slashing business income taxes line up to turn the 'pro' arguments into a public policy pinata.

Jim Stanford (left), seen here in 2004 with CAW head Buzz Hargrove, argues that companies use tax cuts to boost cash in the bank. ((Canadian Press))

Essentially, the gripes of the contrarians are more practical than theoretical in nature, namely that past corporate income tax cuts never generated much extra investment nor did they result in any new burst in hiring.

Jim Stanford, an economist with the Canadian Auto Workers and prominent critic of corporate Canada, argued in a recent report that business investment as a portion of the country's gross domestic product (GDP) and as a percentage of commercial cash flows has fallen steadily over 20 years.

Meanwhile, at the same time, the country's corporate income tax rate has been almost halved, from 50 per cent in the early 1980s to 29.5 per cent in 2010.

Stanford's result is the reverse of what the lower corporate rates should have generated.

"Whatever impact this…reduction in federal corporate income taxes may have had (or not had) on business investment, it was vastly overwhelmed by macroeconomic factors which proved far more important in the determination of business spending," Stanford wrote in a study of the Conservative government's corporate tax cuts for the Canadian Centre for Policy Alternatives.

...Or worse, just hoarding cash

Similarly, opponents of tax cuts argue that many corporations stash away the extra cash from federal income tax cuts to shore up their feeble cash positions, not for any short-term economically useful purpose.

Indeed, Canadian firms accumulated nearly $500 billion in cash, deposits and short-term paper in the third quarter of 2010, according to Statistics Canada.

That is up compared with $413 billion in liquid reserves that companies accumulated in the second quarter of 2008, just prior to the beginning of the international recession.

Of course, such a policy might be prudent in the face of a liquidity crisis that hammered many firms during the period between 2006 and 2010.

And firms usually need to bank some cash before they start spending on equipment and other investments.

Still, Stanford complained, you would expect to see some pick-up in business investment during these years.

"Business capital spending has begun to recover, but by the end of 2010 was well under one-half of the decline experienced during the recession. The business sector is the only sector in Canada's economy still spending less in 2011 than in 2008 before the recession started," he wrote in another study, this one on capital spending trends.

Canada competes on rates

Finally, it is unclear as to whether Canadian corporate tax rates are out of line when compared internationally.

Generally, a country can have a low posted tax rate — essentially the percentage levied against profits that is listed on a tax form — and the "effective" rate — the federal assessment once you take into account taxes from other levels of government and special breaks governments sometimes extend to businesses.

For example, Canada has a statutory rate of 16 per cent in 2011, according to Deloitte Canada, a large financial consultancy and accounting firm.

Once you throw in taxes applied by other levels of government, however, that tax rate jumps to between 26 per cent and 32 per cent of a firm's income.

Corporate tax Statutory rate Effective rate
Canada 16.5% 26.5
U.K. 28  28 
U.S.  35  39.5 
Japan  30  41
Germany  15  30 
Source: Deloitte Canada

By Deloitte's calculations, Canada's lowest effective tax rate — the 26.5 per cent — is better than similar levies applied by the United Kingdom, the United States, India, Mexico, France, Germany and Brazil.

(According to the consultancy, Canada's effective tax rate ranges between 26.5 per cent and 32.5 per cent.)

Thus, Canada's effective tax rate looks more in line with its main competitors than is often assumed.

Political endgame

In the end, however, whether the last tranche of the Stephen Harper government's corporate income tax cuts come to fruition will not come down to a bunch of eggheads arguing the intellectual merits of the policy.

Instead, the struggle will revolve around which leader can sell their vision better, Stanford said.

"Back in 2001, Paul Martin’s corporate tax cuts were not nearly so controversial — but that was when the government had a surplus (and) when taxes were being cut for everyone.  It’s a much harder sell today... while the rest of Canadians are tightening their belts," he said.