Thursday, April 07, 2011

Taxes in Canada:: Where the Nation Really Stands (And the Truth About Those Tax-Cutting Liberals!)

click for larger image

I've blogged about the political rhetoric of taxes that enters into the collective consciousness. I'm sure we'll hear more about Conservative tax policy in the forthcoming weeks, which will emphasize how low taxes are the only path to economic recovery. The above graph uses OECD data to compare countries with respect to their tax revenues as a percentage of GDP. The global trends have been a rise in taxes as a percentage of national income until about 2000 and subsequently flattened out. Canada is in the middle of the pack and is below the OECD total. Well, look at the OECD countries with taxes below Canada. Countries like Ireland, Australia, Japan, US, Korea, Turkey, Chile, and México. I've seen many studies and graphs that point to low taxes as a pathway to growth, but there's the problem of spurious correlation—the relationship isn't causal but driven by other factors. Does it make sense for Canadian tax revenues to engage a race to the bottom? Should Canadian taxes mirror those of Chile or México, the low tax leaders? More specifically, does Canada resemble either in terms of economic or social structure?

Corporate Income Taxes
There's a lot of talk that taxes should shift from income to consumption, along with a rebate to address the regressive nature of taxing the latter. I'm not sure I'm buying those arguments 100%, but I'll blog about that in the future. The OECD has examined this issue of an optimal tax mix, i.e., the rates and levels of taxation on personal and corporate income, capital gains, consumption, etc., and considers corporate taxes to be the most detrimental, as they harm firm productivity [pdf]. The OECD notes a downward trend in corporate taxes [pdf]::

Average Corporate Tax Rates-OECD

How does Canada fare with corporate income taxes, as a percentage of GDP? Pretty much on par, as of 2005::

Corporate Taxes as a Percentage of GDP, OECD

What about the corporate income tax rate? While Canada's 2007 corporate income rate is higher than the average::

Corporate Income Tax Rates in 1982, 1994, & 2007, OECD

bear in mind that total taxes as a percentage of GDP are on par. The Conservatives latest budget aimed at lowering federal corporate taxes to 15% and managed the deficit through unspecified spending cuts, while the Liberals and the NDP want to see corporate taxes raised to 18% and 19.5%, respectively. The Conservative rate would bring Canada's total {federal plus provincial} corporate taxes to 26.52%, around the 2007 OECD average. Now, it's worth noting how the corporate income taxes went from over 40% to the current level of 29.65%...much of it was done under the Liberals!

Corporate Income Tax Rates in Canada, Department of Finance
“As a result of the actions of the government, our corporate taxes, in a couple of years, will be lower than the United States’...Those are the kinds of policies that will lead to increased productivity.”
The effects of this decade long lowering of corporate taxes that both the Liberals and NDP want to reverse? Lower paid taxes, higher profits, and lacklustre employment, according to the Canadian Centre for Policy Alternatives [pdf]. According to the study that examined Canada's top companies {198 publicly-traded firms}, the firms didn't invest, as the theory goes, but pocketed the cash. Ostensibly, the same strategy taken by many a financial bailout bank in the US. Why might this be?

Well, while the theory of lower corporate taxes is that it spurs investment and employment, this may not always be the case. Risk and uncertainty can affect this, stemming from global, macroeconomic, and industry effects. Over the past decade in Canada, the evidence may appear to be mixed. The Globe & Mail shows both sides of the argument. This graph shows an investment decline, despite falling corporate taxes::

while Stephen Gordon argues his counterfactual analyses show the opposite and supposedly real story::

Stephen Gordon, "corporate tax cuts: a look under the hood", Globe & Mail

The problem with this is one of relevant range and comparative data. In other words, what about before 2000 and what about other countries? Above we saw that the US and Germany have had higher corporate taxes compared to Canada and France had slightly lower taxes. A curious pattern emerges. There's a lot of similarity over time. Let's start with Canada::

The relatively high tax 80s saw a rise in investment as a percent of GDP, as did the tech boom years of the late 90s. Investment persisted despite relatively high taxes. 

What about the rise in investment that Gordon found above in the mid '00s? Well, it looks like other nations with higher or similar experiences {US, Germany, & France}::

While Canadian investment was higher in the 2004-2008 era, compared to the other economies, there appears to be a global pattern showing that there's something else going on than a pure tax effect. Now, attributing Canada's higher investment rate to taxes would require more deconstruction, but it should be clear from the 80s data that the relationship between corporate taxes and investment is spurious, i.e., there is another factor driving the relationship. I feel it is disingenuous for the Conservatives to point their fingers at the Liberals as the tax and spend party, given they were responsible for cutting them in the first place. Additionally, while there appears to be a taxwise race to the bottom, there are arguments in favour of a positive corporate Canadian income tax. Earlier eras of relatively high Canadian corporate taxes (pre 2000) have enjoyed strong GDP growth, in fact, higher than in the past decade.

The economy is complex and Canada is no longer a small open economy, so the effects of tax hikes and cuts aren't likely to be that pronounced and quite difficult to isolate.

In a future blog, I'll be examining the NDP platform that embraces small business development and differential tax rates for small and medium-sized enterprises, while raising corporate tax rate to 19.5%. I feel this can serve as an incentive that can increase entrepreneurship, competition, and employment. While some academics argue that this may be a costly way to increase employment, due to supposed relatively low productivity of small and mid-sized businesses, and may push companies offshore, I think one should be cautious before making such blanket statements. Another thorny issue I'll be exploring is how R&D expenditures in Canada are lower, despite the low corporate taxes.

Twitterversion:: [blog] Data on the truth about Canadian taxes. #CPC forgets history & relationship b/t taxes & economy is murky. #canpoli  @Prof_K

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