"Women are persons in matters of pains and penalties, but are not persons in matters of rights and privileges."
Traditional British common law held that women and men were inherently unequal. Today, the equality of men and women is enshrined in the Canadian constitution, and we face a different legal challenge:
Corporations are persons in matters of rights and privileges, but are not persons in matters of pains and penalties.
Corporations can own property and sign contracts. True, corporations cannot vote (yet), but in the US the idea of corporate personhood has been used to extend other constitutional privileges to corporations – most recently corporations' first amendment freedom of speech rights.
Yet the pains and penalties of corporations are restricted by the doctrine of limited liability.
Advocates of the elimination or reduction of corporate taxes argue that corporations don't pay taxes, people do. There is no need to tax corporations, since all corporate income is eventually paid out to shareholders, employees, or other stake-holders, at which time it can be taxed.
Yes, all income that a corporation earns is passed onto shareholders or employees.
But all liabilities that a corporation incurs are not. A corporation has limited liability. Its shareholders have limited liability. This is a problem when high costs come at the end of a production process in the form, of, say, a few tailings, the odd landslide, an oil spill, gas leak or perhaps a tailing pond or two. If the resources have already been extracted and profits paid out to shareholders, a company has every incentive to declare bankruptcy and walk away from the problems. Private profits; public costs. In the end, you and I pay.
One good reason to have corporate income taxes is to make those who benefit from corporate activity pay for the externality it creates: the collective risks society faces as a result of limited corporate liability.
This is especially true if the owners of the corporation are not resident in Canada for tax purposes, and do not contribute to the cost of such goods through their own taxes.
Another argument that is made against corporate taxes is that these taxes are passed onto the consumer in the form of higher prices. But so what?
Corporations benefit from public infrastructure and public services. For example, this weekend many Canadians will be heading towards their local ski hill – and driving on roads financed out of tax revenue. Without roads (and snow plows), the ski hills would have few customers. It is reasonable to ask the companies that run the ski hills to contribute to the cost of building roads. Yes, they may pass those costs onto their consumers – but that's fair too. Those consumers are the ones who are benefitting from the road being in place, not the folks relaxing at home by the fire.
Moreover, businesses in general, and corporations in particular, enjoy so many tax advantages that I find it hard to see why anyone would advocate making incorporation even sweeter.
Employees have few opportunities to deduct every day expenses from their taxable income. But become self-employed, or incorporate…
That new ipod touch? The personal organizer and calendar functions mean that it is clearly a business expense. A new car – necessary for travel to and from work. Expensive veterinary surgery? The dog is a guard dog, used for home security. The self-employed have more opportunities for understating their income, either through not reporting receipts or by overstating expenses. Herb Schuetze estimated a little while ago that, in Canada, the self-employed understate their income by 11 to 23 percent.
There is a large literature on the interaction between tax evasion, tax rates and self-employment, and people have different views on the topic. My gut feeling is that – as one recent paper put it – "small business owners have greater means to shift income between different income sources in order to avoid taxation."
Incorporation provides even greater tax benefits than self-employment. Basically, a a corporation works a lot like one big unlimited registered retirement savings plan. If a comfortably off Canadian earns $1 of employment income, she will typically have to pay taxes of 40 to 50 cents on the dollar. That gives her only 50 or 60 cents left over to invest – and less invested means smaller returns. If she earns $1 of business income, however, that is taxed at the much lower small business tax rate. If she wants to save the income, she just keeps it in her company. With that lower tax rate, she has much more to invest than a person with employment income, hence can generate higher returns.
In the Canadian context, incorporation has another benefit: it permits income splitting. Just make ones spouse a shareholder in ones company, and pay him/her dividends. The income is then taxed at the spouse's marginal tax rate, which again generates significant tax savings.
The evidence suggests that people respond to the tax advantages offered by self-employment. Every reduction in corporate tax rates increases people's incentives to structure work in the form of self-employment rather than employment. The income tax base is eroded on two fronts: (a) less revenue is raised through taxes on existing corporations and (b) firms and workers structure contracts to generate as much self-employment and as little employment income as possible, opening up further opportunities for tax avoidance.
Taking a long cold hard look at corporate income taxes, there is only one sensible response – to say:
"I'm a corporation, and so's my wife."
Worthwhile Canadian Initiative 
Reason – just saw your p.s. after posting the above. Fair enough on dropping it as off-topic. Thanks for your replies on the issue.
Best,
Ryan
Determinant: “Since when is a tax a user fee? I just read Skidelsky’s book on Kenyes for today’s world and my inner social-democrat is screaming to get out….”
Taxes are mandatory levies that are not related to any specific benefit or government services whereas user fees are payments levied to recover the cost of a particular good and service. Case law (see Eurig Estate (Re), [1998] 2 S.C.R. 565) provides additional assistance in clarify the difference between a tax and a user fee. First, tax revenues are used to offset general expenditures where as revenue from a user fee must be used to defray or recover the costs of providing a service from those who benefit. That is, revenues from user fees must be earmarked and spent purposefully. Second, for a user fee the fee charged cannot exceed the cost to government of providing the service. As interpreted by the courts this mean that there must be a reasonable connection between the service provided and the amount charged. No such criteria is applied to taxes.
Congestion charges and road tolls as referenced by Frances can indeed be user fees if properly designed and implemented to meet the criteria that distinguish a tax from a user fee. In fact, many cities in Canada should be pursuing congestion charges far more rigorously.
Frances, the regressive impacts of a congestion charges are very dependent on the socioeconomic and geographical considerations of the city where the user fee is under consideration as well as the current funding of, fees for, and taxation to support transportation infrastructure. The status quo has transportation infrastructure funded through property taxes, the level of which has no link to the consumption of the funded services. Property taxes are certainly not the most progressive tax out there. Much like with consumption taxes, any regressive effect of a congestion charge/road toll can be minimized or even reversed with careful design, revenue uses, and compensation mechanisms.
From a non-economic viewpoint, the personhood of corporations and CIT=0 is best defended as follows:
“Corporations are conduits for the collective action of individual persons. Why, went acting in concert using this particular form of organization, would those persons be denied rights that they have as individuals acting alone, and why would they be taxed an additional amount?”
Bear in mind that corporations are not actually zero-liability – the liability for acts of the corporation is just borne by the directorship rather than the shareholders.
Also, most of Frances points re: write-offs of personal expenses for small corporations apply in the case of non-incorporated sole proprietorships. In fact, they apply more in some cases – as a sole proprietor I can carry business expenses against my non-business income. Corporations need a revenue stream to write off expenses; sole proprietorships do not. Does this mean we should apply an additional tax on entrepreneurs with registered sole proprietorships?
Geoff NoNick: “Bear in mind that corporations are not actually zero-liability – the liability for acts of the corporation is just borne by the directorship rather than the shareholders.”
That isn’t generally true. In some circumstances, directors can be held liable for certain obligations of the corporation (failure to collect and remit certain withholding taxes, and sales taxes, and limited liability for up to 6 months of unpaid salary and wages), but those are statutory exemptions from the general rule that liability is limited to the assets of the corporation.
Bob – True, insofar as we’re talking about financial liability rather than criminal liability. But in the case of financial liability, the corporation is lent money in exactly the same way that individuals are – by having its overall credit-worthiness assessed. If the lenders miscalculate the credit-worthiness of the corporation, or if the risk of their loan is crystallized, I don’t see that being an problem inherent in the organizing structure. Certainly, the very real persons who took out home loans far beyond their means in the U.S. have cost that society quite a bit of money; bad risks are bad risks.
And in the case of small corporations, of course the matter is moot – no one will lend to a mom-and-pop corporation without the co-signature of mom or pop themselves, so the liability in those cases is, for all practical purposes, borne by the shareholder/directors.
Geoff,
Just to be clear, I don’t have any objection with limited liability for corporations either, but the point is that liability is, with a few exceptions, limited. The fact that, as a commercial matter, shareholders may have to guarantee loans merely emphasizes that point. In any event, I don’t think Frances concern is with respect to intentional creditors of the corporation (lenders, customers, employees) who, after all, choose to contract with a corporation. I think the concern is more with unintentional creditors (think fisherman in the gulf of mexico).
With respect to criminal liability, directors aren’t criminally liable for the misdeeds of the corporation. They can, however, be held criminally liable for their own misdeeds in respect of the misdeeds of the corporation.
Bob – Agreed with respect to the fact that it’s “negative externalities” that Frances is after. I just wanted to rule out some common misconceptions about the extent to which corporate liability is truly limited.
Regarding the Gulf of Mexico argument, I think the counter-argument is that the spill was not the work of a single corporation, but of (many) millions of shareholders acting in concert, each of whom pays for their own personal potential negative externalities in the form of personal income taxes. Does it make sense to levy a risk premium on mom and pop corporations for what large, publicly-held corporations may do?
If your goal is to apply a risk premium above and beyond that of the collective risk of all of the individual shareholders, surely there’s a better way to structure that kind of thing. Like, for instance, obliging anyone (real person or legal fiction) running a drilling operation in U.S. waters to take out liability insurance against such a potential catastrophe. If what we’re talking about is insurance, then let’s just buy some insurance instead of levying a CIT that goes into general government revenues and gets spent on bread and circuses.
Frances’ point about the externality associated with limited liability is a good one, but really has nothing to do with the CIT.
That’s sort of where I am here.
Anyone remember the Monty Python sketch about the Argument Clinic?? When the blogosphere feels too much like that, I hide…hence the lack of reaction to all of the comments.
For those who are interested in facts and figures:
In 2009/10, corporate income taxes were 13.9% of federal revenues, or $30.7 billion. Can it be argued that this is largely a withholding tax, as corporate tax revenues are eventually refunded? To figure that out, one has to comb through the tax expenditure accounts and peruse the various memorandum items. The dividend tax credit is about $3.8 billion, the partial inclusion of capital gains costs about $2.8 billion, but there’s a load of other provisions designed to integrate personal and corporate income taxes.
A few responses:
Patrick – men claiming child care triggers an audit? Plausible – fascinating.
Various clarifications on small business taxation, sole proprietorships, etc – thanks, WCIers, for sharing your collective wisdom…
Nick, Mike, Geoff, others – on how to estimate/design a Pigouvian tax on corporations. I don’t know. It’s hard. Moreover, one has to take into account the fact that the current corporate income tax is largely a withholding tax that gets refunded to taxpayers in the form of a dividend tax credit –
Duncan Cameron and others: Stephen Gordon has written a series of posts on Economic Policy Advice for the NDP.
Here’s mine: get some really smart people together who actually understand corporate taxation, corporate liability, and so on, and take up this issue. What are the responsibilities and duties that are associated with the privileges of incorporation? Are there ways of improving corporate governance in Canada?
It’s difficult because the best intentioned policies can so easily go badly wrong – e.g. legislation that required companies to disclose executive compensation – information which executives then used to lobby for higher salaries (“I would like to be paid 10% more than the average salary of executives of firms in my industry” – do the math on that one).
Stephen: “Frances’ point about the externality associated with limited liability is a good one, but really has nothing to do with the CIT. That’s sort of where I am here.”
Economists generally agree that externalities should be internalized. A Pigouvian tax is one way of internalizing them. True, CIT isn’t perfect as a Pigouvian tax – it’s like a tire tax or vehicle registration fees that imposes a tax on all car owners regardless of how much they use the roads.
I’m open to other ideas.
But I’m wondering how many people writing here have been up north and seen the destruction – understand the scale of harm – have stood on top of the Midnight Dome in Dawson City and looked down at the placer mining scars – every river valley for miles turned upside down, the topsoil stripped off and left to float downriver – nothing left but piles of rocks where nothing will grow. I went there as a kid. I went back again just a few years ago. Nothing had changed. Once an environment has been destroyed like that it takes a long time to heal.
For what it’s worth, I grew up about 200 feet away from Pottersburg Creek (which is well known in London for all the wrong reasons):
http://www.londontopic.ca/article.php?artid=8591
Okay, but not all corporations are engaged in strip mining.
And almost everyone and every organization has the potential to wreak enormous havoc for private benefit and at others’ expense. For example, the professors’ union at Laval could go on strike and wipe out a year of the lives of tens of thousands of students at a crucial point in their careers.
I don’t see why the CIT is the remedy for these problems. Things like carbon taxes or stronger regulations requiring firms to clean up their messes seem to be far more appropriate.
“But I’m wondering how many people writing here have been up north and seen the destruction – understand the scale of harm – have stood on top of the Midnight Dome in Dawson City and looked down at the placer mining scars – every river valley for miles turned upside down, the topsoil stripped off and left to float downriver – nothing left but piles of rocks where nothing will grow. I went there as a kid. I went back again just a few years ago. Nothing had changed. Once an environment has been destroyed like that it takes a long time to heal.”
To which the owner of a web design company might ask: “Whats’ that got to do with my company’s income?” Certainly, in the mining context, that’s an argument for higher royalties or, at least, royalties linked to environmental harm. And its an argument which really doesn’t depend on whether the miner is a corporation or not.
Idea: Employers in Ontario pay WSIB premiums to cover workplace safety issues:
http://www.wsib.on.ca/en/community/WSIB/230/ArticleDetail/24338?vgnextoid=c6aae35c819d7210VgnVCM100000449c710aRCRD
“Your premium payments will depend on the health and safety risk of your type of business, the size of your payroll, and on your company’s health and safety record.”
Why not have the same type of system for environmental risks? (Except base the system off of revenues, not size of payroll).
FWIW, the Green Party has naturally spent a lot of time considering these issues (corporations and the environment) and has a comprehensive plan in their Vision Green document:
http://greenparty.ca/issues/vision-green
Note: This should not be seen as an endorsement of any particular policy in their platform (or their platform as a whole).
“Why not have the same type of system for environmental risks? (Except base the system off of revenues, not size of payroll).”
That’s exactly what we should do, in theory, but in practice, indemnifying against open-ended and ill-defined tail risks such as this is going to be very expensive. Think lead paint remediation, asbestos, nuclear waste disposal, DDT, etc. I live in a Victorian with lead paint, built in the 1890s. I just don’t see a painter in the 1890s being able to engage in Coasian bargaining to ensure that he paid the social costs of using of lead paint. It’s not realistic.
The government will end up providing this insurance anyways, and will need to absorb the occasional huge event. This is similar to deposit insurance, IMO, and like deposit insurance, it is much cheaper to regulate behavior than to rely on the tort system to punish ex-post. This is also exactly why we need both LLC as well as regulations.
In terms of externalities as a justification for CIT — I just don’t see this as relevant. I think retained earnings need to be taxed, but it’s inconsistent to have interest payments be deductible while dividends are not. Either they are both taxed equally, with the amount taxed rebated to creditor households, or they are not taxed at all, with creditor households paying the same taxes on capital income as they pay on wage income.
For me, the default assumption should be that all income is taxed equally by the households that receive it, whether that is capital income, wage income, inheritances, etc. I don’t like taxes on expenditures of any kind — once you receive income, from whatever source, you should pay taxes on it and then be able to employ it for any use without the government putting its thumb on the scale, encouraging households to remodel their kitchens rather than buy back-scratches. Just my 2 cents 🙂
Frances,
I must confess that after reading the several excellent primary posts by Stephen, Mike and you concerning CIT, and the ensuing excellent responses concerning appropriate CIT levels, I am confused concerning the “confusion” or substantial disagreement concerning level, incidence and utility of CIT, in light of the comprehensive research undertaken by the OECD Tax Policy Studies branch that culminated in the 157 page summary report published by the OECD, “Tax Policy Reform and Economic Growth” 2010.
The Forward to this Report states:
“This report discusses how tax structures can best be designed to support GDP per capita growth. The analysis suggests a tax and economic growth ranking order, according to which CORPORATE TAXES ARE THE MOST HARMFUL TYPE OF TAX FOR ECONOMIC GROWTH [Ian’s caps],followed by personal income taxes and then consumption taxes, with recurrent taxes on immovable property being the least harmful tax. A revenue neutral tax reform that shifts the balance of taxation more toward consumption and recurrent residential property taxes, could thus strengthen the growth of output in the medium term”.
By my count, the phrase, “corporate taxes are the most harmful type of tax for economic growth” is repeated at least 20 times throughout the 157 page report and certainly in every chapter (and thus does not appear to be a mistake) – and is repeated in some of the other OECD publications in this OECD Tax Policy series.
IF I understand the OECD Tax researchers correctly, they seem to suggest that this is an issue that has been settled by the extant research.
Can you clarify or illuminate?
Ian
So, if the OECD repeats something enough times, it’s settled?
Remember when the OECD complained about Canada’s “years of expenditure increases above trend economic growth” even though its own data showed Canadian public spending decreasing as a share of GDP?
What about when the OECD recommended privatizing Canada Post and then admitted, “we haven’t done a study of the postal sector or Canada Post”?
I just don’t see any reason why Jane Q. Citizen is going to impose ‘less stuff’ constraint on herself for the sake of abstract health risks or distant threats to plants and animals she will never see.
Cleaning-up messes is expensive. By leaving the mess we all get cheaper stuff as a result. And it seems that we like cheap stuff more than we like pristine wilderness or cancer free organs.
I suspect it’s going to take a global disaster on a human time scale for something to change. The only candidate I see is perhaps if global warming causes rapid sea level rise. If Florida disappears within 30-50 years, that might do the trick. Short of that, I have little hope that the destruction will stop.
If we privatize Canada Post, there is a legitimate question of who would want to buy it. Postal volumes and revenues are steadily declining. The Internet has cut into much of Canada Post’s business and the profitable parcel and courier service has direct competition in the form of Fedex and UPS.
No need to hide Frances. Your post has sparked a very good discussion. I will try to post something inflammatory later this evening. Maybe something about the improvident poor, and MMT?
I’m looking forward to Nick’s piece: “Should the poor be allowed to use public parks?”
“If we privatize Canada Post, there is a legitimate question of who would want to buy it.”
That’s more than a legitimate question. Wonder if the CUPW would take it for $1?
I’ve worked in Fort Mac, simply awesome. I like the post, cit as an insurance buffer that regulations aren’t fully covering. unknown/unknowns.
There’s crazy political pressure, Stelmach a couple years ago tried to raise revenue from Oil, Gas with the NRF, then the wild rose stepped up. Also at last years conservative convention, there was another motion put forward, on measures to increase the incentive for capital development in the oil/gas sector, simply unreal.
MMT and the “improvident poor”? Suddenly I’m getting an urge to hurl the Communist Manifesto at Nick.
“Suddenly I’m getting an urge to hurl the Communist Manifesto at Nick.”
Now I know the CUPW would buy that for $1.
I don’t want my comment to sound anti-oilsands, one of my favorite lines from a chem prof, is that we are cleaning up the world’s largest oil-spill. If you want to help the tailing’s ponds, try and develop a flocculant, and you could get pretty rich. Get rid of the clay colloidal suspension. Allow water to evaporate, save the birds, which are more of a signal to labour relations than of environmental negligence. That said building the ponds right beside the river, esp the case for Suncor, doesn’t look like the smartest move.
Frances in the early 1990s a group of highly experienced people got together in Ontario under the banner of the Fair Tax Commission and produced a good report, and some very interesting studies.
With Jack Mintz, and some business Executive Vice-President taxation, Andrew Jackson, a brilliant woman accountant, and others, our group on a corporate minimum tax had trouble reaching a conclusion. The NDP did bring in such a tax. It was not hard to do; the U.S. had one, and Ontario followed the precedent. In all modesty, I had written as such in my regular column in the Financial Post before the Commission was created. I had also published the list of corporations that were paying no tax at all at that time. This did become an election issue and helped Bob Rae get out the union vote for the first time provincially or federally in Ontario. It probably contributed to my losing my regular FP gig as well.
Unhappily Premier Rae, chose not to use his report to prepare his re-election campaign, he was defeated by “the tax fighter” Mike Harris who came from third to win.
In general I follow Aristotle on issues of justice, and taxes can be conceived as justice issues. Do the corporations get what they deserve? I think they deserve to pay more taxes, and your reasons are very compelling as to why that should be the case. The balance sheets of companies, profit and loss statements, etc. do not begin to account for the social and environmental costs of corporate organization of production and exploitation of resources. This is not an argument against corporations NIck, it is argument about how we account for their real costs to Canada and the world.
Arguments against CIT rely on utilitarian theories about the greatest good for the greatest number, or more often Kantian arguments about the absolute rights of property owners. Aristotle makes more sense to me because he starts from the idea that we are citizens (political animals). Other prefer to see us primarily as consumers, or bearers of rights in the Kantian sense. Hayek would be in the latter group for instance. Among economists Sen stands out for his sympathy for Aristotle.
Most economists live and breath utilitarian air, and of course there is much to be said for JS Mill. However, I find that dumbing down utility to preference as often happens, and substituting taxpayer or consumer for citizen, limits the scope of what we should be discussed.
Erin,
The academy, NGOs, unions and some public servants, have recently strongly criticized the Conservative Govt “for not being evidence or research based” – while presumably we are.
However, if we are to be credible in making such a claim, we cannot cherry pick the research simply on the basis that we like the outcomes or dislike previous findings. Credible researchers must investigate the research in question to determine if for example, it is robust, legitimate, credible, rigorous, logical, empirical.
Thus, your comment, “must we accept the OECD research because they repeat it” and then to invoke a non sequitor i.e. the Post Office, is to engage in the same conduct that we criticize in political parties. You are attempting to trivialize the research – and not challenge or interrogate the research. Researchers must investigate to determine if the research was e.g. peer reviewed e.g. was the lit review comprehensive, e.g. methodologically sound? E.g. biased? E.g. tainted etc. etc?
To dismiss it out of hand, without serious consideration, is no different than political parties that dismiss or refuse to review the research evidence they do not like.
On issues dealing with business or economics and public policy, we should try to be evidence based by reviewing what the OECD, UNCTAD, WTO, WB, IMF – and YES – the ILO – to determine what these international, non-profit institutions are discovering in their research.
However, this is merely the starting point of our own discovery – not the end point as you suggested.
Erin,
Apologies. I forgot to mention that these international organizations e.g. OECD, UNCTAD, are international government institutions, funded by governments. Indeed, some are sub units of the United Nations.
And these international bodies obtain much of their empirical data from the national government statistical agencies of countries around the world e.g. Stats Canada, and they work closely with academic scholars, union researchers such as yourself, and NGOs from these countries.
All in all, the rigor and quality of these researchers, national statistical agencies and international research organizations e.g. OECD, is very distinguished.
By the bye, this was why I was so deeply dismayed by Canada’s recent CPP pension debate. I was unable to locate a single reference to the OECD 2009 Pensions at a glance +500 page report that emprically demonstrated that Canada’s elders were 4th or 5th wealthiest in the OECD i.e. thus the world and that Canada experiences one of the lowest elder poverty rates in the world. Yet, I could not find any reference at all to this salient empirical information in any of the Op Eds published on the CPP debate. Nor was there any mention of the $6.2 trillion in net household worth including $2 trillion in net residential real estate.
A genuine transparent policy debate must acknowledge and incorporate all relevant legitimate empirical information that illuminates the issue. Omission of critical empirical data from legitimate international research organizations does not meet this standard.
@ Marc
Yah the Manifesto what a rag it demanded utopian things like the vote for people without property. That Marx and Engles, what a bunch of dumb asses. Meanwhile the apologist school was running around saying the sky would fall if that happened. Oh and Capital has been outselling the Road for a while now: markets never lie. Yada Yada Yada fish paste.
What is this sophomore hour?
Ian,
If the OECD’s research is so rigorous and comprehensive, why not draw upon that research to provide specific responses to the points which Frances (and others) have raised? Just repeating the OECD’s conclusion that corporate taxes are bad does not advance the debate.
I am happy to admit that my ad hominem attacks on the OECD did not advance this debate either. But that was my point: if you are going to make an argument from authority, then the natural retort is to question that authority’s credibility.
Let’s discuss the substance of the analysis rather than its provenance from the OECD.
Or you could read what the OECD report said and explain to us why it’s wrong.
Frances’ point doesn’t invalidate it; the link between “corporate externalities exist” to “therefore we should raise/not cut the CIT” doesn’t seem to be there. Why would a higher CIT reduce those externalities?
And why is the burden of proof never on you? Why aren’t you citing – or even writing – empirical studies documenting how higher CIT rates reduce the costs associated with negative externalities of corporations?
As usual, Stephen is far more trenchant.
However, Erin, I will provide what I think are the core arguments provided in the foundational article by Johansson, Å. et al. (2008), “Taxation and Economic Growth”, OECD Economics Department Working Papers, No. 620, OECD Publishing.
This article is cited often in the 2010 OECD Report, whicxh I cigted previously.
Below, I have copied key findings quotes from the Johansson article.
1. Corporate taxation affects capital formation
Empirical evidence obtained from both firm-level data covering a sample of 14 European OECD
countries and industry-level data covering 21 industries in 16 OECD countries suggest that investment is adversely affected by corporate taxation through the user cost of capital (see Box 7, p. 33).
The investment-to-capital ratio is negatively affected by increases in corporate taxation. The long-run user cost elasticity is estimated to vary between -0.4 and -1, depending on the empirical specification, p. 34
2. Corporate taxation affects productivity in several ways
First, as with labour taxes, corporate taxes can distort relative factor prices resulting in a re-allocation of resources towards possibly less productive sectors (e.g. non-corporate sector) which may lower total factor productivity
Second, complex corporate tax codes can cause high tax compliance costs for firms
and high administrative burdens for governments, which absorb resources that could be used for productive activities, causing productivity and efficiency losses.
Third, high corporate taxes may reduce incentives to invest in innovative activities by reducing their after-tax return.
Fourth, to the extent that corporate taxes reduce FDI and the presence of foreign multinational enterprises they can hinder technology transfers and knowledge spill-overs to domestic firms (see below).
Also, corporate taxes distort corporate financing decisions, favouring debt over equity because of the deductibility of interest from taxable profits. This can affect TFP by distorting the allocation of investment between industries, favouring those that find it easy to raise debt finance and disadvantaging those that have to rely more on equity, such as knowledge-based industries that invest heavily in intangible property.
The main empirical results concerning the influence of corporate taxes on TFP at the firm-level are (see Schwellnus, 2008 for details):
Lowering corporate taxes is estimated to boost firm-level TFP in profitable industries (Table 9, Column 1). A simulation experiment indicates that the effect of a reduction of the corporate tax rate from 35% to 30% on the average yearly TFP growth rate (over 10 years) would be 0.4 percentage points higher for firms in industries with median profitability than for firms in industries with the lowest level of profitability. Under the assumption that the effects of corporate taxation are close to zero for firms with the lowest tax base, this may be interpreted as a median effect. Given that trend TFP growth of OECD countries averaged around 1.1% over the period 2000-2005 (OECD, 2007e) the simulated increase in TFP growth due to a tax reduction would seem to be an upper bound estimate. The effect of this tax cut on TFP depends on the industry structure and this reduction would increase the average annual productivity growth rate by 0.4 percentage points more in an industry at the 75th percentile of profitability than in an industry at the 25th percentile of profitability.
The negative effect of corporate taxes is uniform across firms of different size and age classes, except for firms that are both small and young. This may either be due to some countries’ exemptions or reduced rates targeted at start-up firms or to their low average profitability, which both reduces the amount of their effectively paid corporate (Table 9, Column 2).
The main empirical results obtained at the industry-level are (see Vartia, 2008 for details):
Lowering corporate taxes is estimated to boost TFP in profitable industries (Table 10, Column 1). A simulation experiment indicates that the average effect (over 10 years) of a reduction of the corporate tax rate from 35% to 30% on the yearly TFP growth rate would be 0.08 percentage points higher for industries with the median profitability than for an industry with the lowest level of profitability. As mentioned above, this may be interpreted as a median effect. The effect of this tax cut on TFP depends on the industry structure and this reduction would increase the average annual productivity growth rate by 0.08 percentage points more in an industry at the 75th percentile of profitability than in an industry at the 25th percentile of profitability.
The empirical results using industry-level data on a panel of 12 OECD countries covering 21 industries over the 1981-2001 period suggest that the average effective corporate tax (AETR) has a negative effect on TFP. As pointed out in Box 4 and Box 9, the estimated effects are significant and give qualitative information about the sign of the effect of effective taxes on TFP, but the size of the effects is somewhat larger than expected. A simulation experiment indicates that the effect of a reduction of the effective tax rate from 35% to 30% on the average yearly TFP growth rate (over 10 years) would be 0.1 percentage points larger for an industry with the median profitability than for an industry with the lowest level of profitability. As discussed in Box 9, this may be interpreted as a median effect. The effect of this tax cut on TFP depends on the industry structure and this reduction would increase the average annual productivity growth rate by 0.1 percentage points more in an industry at the 75th percentile of profitability than in an industry at the 25th percentile of the distribution of profitability (see Vartia, 2008 for details).
Hope this provides some of what you are seeking.
Ian
As ever, you Canadians are behind the times. When it comes to constitutional rights for corporations, you ain’t seen nothing yet.
Scalia and Thomas are soon to be put in a bind. On the one hand, they strenuously disagree that the US Constitution guarantees a right to privacy. On the other, corporations are now claiming just that right. I think the likely third hand these two will choose is that the constitution guarantees a right to privacy for corporations but not for natural humans, probably on the grounds that corporations cannot engage in sex or any of the other messy, sinful, activity related to that.
Ian Lee,
I presume you are the Assistant Prtofessor at Carlton’s Sprott School of Business. And if so, I note you have prepared papers on competitiveness.
Given the amount of criticism from a number of individuals concerning the lack of competitiveness of Canadian managers, and lack of innovation and lagging productivity, where do you place CIT cuts of 1.5%-3% on the priority list for gov’t actions to address these concerns? Top priority?
Georgian,
Some years ago in the 1990s, I used the word “competitiveness”. However, per Krugman’s frequent hectoring (?) and the sage writings of learned economists such as Nick Rowe and Stephen Gordon, I learned the error of my ways and now stand corrected. I now use the word that is commonly used – productivity – necessary to support a high and real increase in the standard of living.
As Gov Carney noted recently, Canada dropped from 3 to 15 in the OECD in terms of our productivity.
Carney, as have many others, identified several explanations:
– under investment in ICT
– under investment in M & E
– ineffective exploitation of capital investment
However, these failures are due, to a failure to compete aggressively. Canadian firms are not generally as aggressive as American firms.
This is largely because we have protected our markets for over 100 years. While the FTA and NAFTA have gone a long way to correct these policy failures, there is still substantial protectionism in our laws. Think of the just awful agricultural marketing boards or laws targeting foreigners for discrimination in telecom or banking or airlines.
The dark and dirty secret is that firms i.e. managers, do not like to compete. As Adam Smith noted 300 years ago, when business people get together, in short order the discussion turns to a conspiracy against the public good. Potash is an excellent recent example.
Firms will only compete when they are FORCED to compete. By removing protectionist policies that protect telecom, banking, agriculture – see the excellent final 2008 report: Compete to Win – we FORCE firms to become more innovative, invest in more ICT and M&E and use capital more strategically – and those firms that do not will die in the face of new competitors.
Thus, I rank the removal of protectionist policies at the top of the list, followed by a much stronger AIT removing most/all interprovincial barriers, followed by reduction or elimination of corporate taxation (for the reasons provided by the OECD and related research).
Thanks,
You made my point. Your third priority is by far the easiest to accomplish, and arguably the least effective. How Canadian.