Seeing the forest through the trees

Why continued corporate tax cuts miss the point.

Much ink has been spilt debating the merits of continued corporate tax cuts in Canada. But it’s fair to say that much of this debate misses the point. For corporate tax cuts are only one element, amongst many, of an economic strategy that will facilitate the development of a highly skilled, flexible workforce that will provide the foundation for a competitive Canadian economy well into the 21st century.

In isolation, corporate tax cuts are proving to have very little impact on either job growth or foreign direct investment. For example, the federal corporate tax rate in 2009 was 18%, down from 29% a decade ago. Similar cuts in Ontario have made this province tax regime one of the most competitive in the developed world, ahead of both the US and EU averages. But instead of leading to more investment in employment-creating or productivity enhancing projects, all they’ve done is pad corporate profits and savings rates – while business investment and private sector R&D development inputs have actually decreased, as shares of GDP, across Canada.

The impact on foreign direct investment was similarly muted. Even the Canadian Association of Manufacturers and Exporters (an invariably staunch supporter of corporate tax cuts), have admitted that “over the past decade, reductions in Canada’s effective and average combined statutory corporate tax rates have had little observable impact on net flows of foreign direct investment into the country.”

So why, in the face of Canada’s so far ambiguous (and perhaps that’s being generous) record with corporate tax cuts, are policy makers and economists still battling over their implementation – and why are we now looking to reduce them further (target of 15% in 2012)?

Jack Mintz from the University of Calgary is often pointed to as a primary source of support for the cuts in corporate taxes. His work, as well as research by the OECD, highlights a large body of empirical evidence that shows that higher corporate taxes have a negative relationship with economic growth, therefore cutting taxes should expand the economy.

That this theory has not played out in the real economy should make us leery. But the bigger issue is that much of the empirical basis of this work is on the effects of cutting corporate tax cuts in high tax economies – not what should be done once corporate tax levels have been made competitive. This is an important distinction, because otherwise the theory would point to 0% tax rates across the board.

So further tax cuts have neither a strong theoretical foundation, nor any recent evidence of real impact on job creation and productivity. Further, they could be counterproductive. As Jim Stanford of the Canadian Auto Workers notes, by choosing to allocate tax revenue back to corporations and consumers rather than to productive investments in infrastructure, we actually cost ourselves the opportunity to create 50,000 new jobs.

Hence the focus on corporate tax cuts fails to address the most important issues related to the future of our Canadian economy. Our key issue is not corporate profitability, or even driving economic growth. Rather, it is productivity. Canadian labour productivity lags behind our American counterparts by 25 per cent, and over the last decade ranks second last amongst G7 countries and far behind most comparable EU countries. A decade of large corporate tax cuts has not improved this; it’s unlikely another decade of them will either.

So perhaps some tweaks to the tax code, such as targeted subsidies and tax incentives for productivity-enhancing investments in new technologies, research and development and job creation activities, and maybe even tax cuts aimed directly at  small and medium sized businesses, could be beneficial. However, implementing blanket tax cuts for large corporations, when we already have a competitive tax regime, is not the answer.

What will attract both domestic and foreign investors in the future is a productive and highly skilled workforce, and further incentives for long-term investments that boost productivity and our ability to compete. This means that ongoing investments into education, retraining and infrastructure (both digital and physical), are the keys to building a Canadian economy able to withstand the pressures and uncertainties of a hyper-competitive global marketplace – rather than continually lowering tax rates to pad corporate profits. If we’re serious about competing with the world then Canadians need to look beyond political and economic rhetoric and focus on the real issues and actions that can help facilitate the ongoing development of a highly-skilled, flexible workforce that positions Canada as a place to invest.

Dan Herman is a PhD student at the Balsillie School of International Affairs and a Senior Associate at the Ottawa-based Institute on Governance. You can follow him on Twitter @danherman


One Comment on “Seeing the forest through the trees”

  1. Dan Herman says:

    Below is a response to the published version of this op-ed (published in the Waterloo Record on March 12th 2011). Evidently the author doesn’t address the bigger question of whether zero is thus the only logical tax rate, nor how to define a competitive tax regime. Nor does he address why tax cuts and increased investment haven’t followed since the cuts began in 2002.

    I take it as a compliment that he bothered to respond.

    Dan Herman is wrong when he states that corporate tax cuts show no clear economic benefit. Over 110,000 companies pay corporate taxes and will therefore benefit from lower corporate tax rates, and 90 per cent of those businesses are small and mid-sized enterprises.

    These are the companies on Main Street, not just Bay Street, in which most Canadian workers are employed. When businesses keep more of their profits, they have more money to expand, hire more people, and invest in new equipment and technologies.

    More jobs and more investment lead, in turn, to the improved productivity that is necessary to sustain strong economic growth, higher personal incomes, more government revenues and reduced demand for employment insurance. This isn’t just theory — the statistics themselves show the positive impacts that stronger profitability and cash flow performance have on investment and job growth.

    My good friend Jim Stanford is correct, as quoted in this article, that more infrastructure spending also support job growth — that’s why it has figured so prominently in government stimulus over the past two years. But with federal and provincial governments now under tight budgetary constraints, we need to focus on how to encourage businesses to invest and grow. The investments in new products, technologies, markets, and skills that Herman says are so necessary to boost productivity and generate high paying jobs have to be paid somehow.

    Our economic recovery is extremely fragile. This is the time we need to rely on businesses to sustain economic growth. The repeal of corporate tax reductions would not only stymie investment, it would raise taxes on job creation at the time it is needed the most.

    Jayson Myers

    President and CEO

    Canadian Manufacturers and Exporters


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