Why the NDP’s exact plan for the corporate tax rate matters

If Mulcair keeps his promises on the budget and the corporate tax rate, it’s unclear how an NDP government could avoid spending cuts


 
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NDP Leader Tom Mulcair speaks to supporters along with candidate Andrew Thomson, left, during a campaign stop in Toronto on Thursday, August 27, 2015. THE CANADIAN PRESS/Frank Gunn

NDP Leader Tom Mulcair speaks to supporters along with candidate Andrew Thomson, left, during a campaign stop in Toronto on Thursday, August 27, 2015. THE CANADIAN PRESS/Frank Gunn

Given the NDP’s current position in the polls and the importance of corporate tax increases in its economic platform, I don’t think this story got as much attention as it should have. (No, not just because it quotes me.)

The NDP leader has not yet spelled out precisely how high he would boost the federal corporate tax rate, which currently stands at 15 per cent.

But Mulcair earlier this month said he would impose “a slight and graduated increase” that would still be “far below the average that the Conservatives had for the 10 years that they’ve been in power.”

The average rate under Stephen Harper’s government is 17.5 per cent. If Mulcair really intends to stay “far below” that, he’s looking at something like a one percentage point increase—maybe two, if one stretches the definition of “far below.” And he’s now saying even that small hike would be phased in over a number of years.

This is a considerable climbdown from what Mulcair was saying two years ago:

“We will get back to something resembling the American combined rate in Canada, which would indeed constitute an increase in corporate taxes.”

To put that in context, the OECD says that the current combined (that is, federal plus state/provincial) corporate income tax rate in the US is 39 per cent. In Canada, it’s 26.3 per cent (the federal rate of 15 per cent plus an average provincial rate of 11.3 per cent.) Getting us up to something resembling the U.S. rate (in the absence of changes in provincial rates) would require increasing the federal rate to around 27 per cent.

The NDP has made use of several different reference points since then. For example, rolling back the cuts made under the Conservative government would bring the rate back up to 22 per cent. Increasing the federal rate to 19 per cent would bring us up to the average of the other G7 countries. The NDP’s target is apparently now down to 17 per cent or so.

As far as the prospects for Canadian economic growth go, this steady reduction is good news: corporate income taxes are the most harmful to economic growth. The growing recognition of the negative effects of corporate tax rates explains why Canada and other OECD countries have made it a point to reduce corporate income taxes over the past few decades:

oecd_cit_rates_panel_2013

Here is how that steady reduction in corporate tax rates in the OECD has affected corporate tax revenues:

scatter_oecd_cit_revs_rates_2013

If you draw a line through those data points, you’d conclude that changes in corporate income tax rates have essentially zero effect on changes in corporate income tax revenues. Canada’s experience looks to be typical of that of other OECD countries; the Canadian data points lie in the middle of that scatter plot.

If you look at just the relationship between federal corporate income tax rates and federal income tax revenues, you get pretty much the same story. Even though federal corporate tax rates have fallen by more than half over the past 30 years, corporate income tax revenues have continued to fluctuate around two per cent of GDP.

fed_cit_rates_cit_revenues

There are at least two reasons why you might think that higher corporate tax rates might not result in higher corporate tax revenues:

  1. Higher corporate tax rates reduce the after-tax rate of return on investment. Everything else being equal, this reduces investment, capital accumulation and profits. Less profits means less corporate income to tax.
  2. Higher corporate taxes produce an incentive for multinational firms to shift taxable activities away from high-tax jurisdictions.

In the short and medium term, the second point is probably more important.

I’ve gone through the exercise of estimating how much tax revenues could be expected to be generated from an increase in corporate income taxes a couple of times (here and here). Here I’m going to update those numbers, and focus attention on the sort of increases the NDP is currently considering.

The base case is built around the numbers in last April’s budget. Corporate tax revenues for 2016-17 were projected to be $39.5 billion. The current federal corporate tax rate is 15 per cent, so that implies a tax base of about $263 billion. The question is what would happen to this tax base if the corporate tax rate went up.

One answer is “nothing”: this is the “static analysis” case. Under this scenario, increasing the rate by one percentage point would increase revenues by one per cent of the original tax base. Here, that works out to $2.6 billion for each percentage point.

But nobody believes that when corporate tax rates increase, corporations will react by gritting their teeth and carrying on as before. The empirical evidence suggests pretty strongly that firms will in fact adjust their behaviour to minimize their tax liabilities.

There are two recent empirical studies that I think are most relevant for the case at hand. One is by Bev Dahlby and Ergete Ferede, published in International Tax and Public Finance, and the other is by Aleksandra Riedl and Silvia Rocha-Akis, published in the Canadian Journal of Economics. The Dalhly-Ferede study uses Canadian data, while Riedl and Rocha-Akis do a cross-country analysis of OECD countries.

Dahlby and Ferede offer two sets of results, and I’ll use both. I’m going to call them the “weak” and “strong” cases, because one set of estimates yields a stronger response.

The weak case is based on a model that looks like this:

[log of tax base] = -0.946*[federal corporate tax rate] + 0.522*[log of previous year’s tax base] + other variables and controls

The strong case has the same form, but with a slightly different set of controls:

[log of tax base] = -1.657*[federal corporate tax rate] + 0.602*[log of previous year’s tax base] + other variables and controls

The inclusion of the previous year’s tax base captures the dynamics of the response to the tax change. Firms will adjust gradually over time, and not all at once.

Riedl and Rocha-Akis’s results have a slightly different form:

[log of tax base] = -0.522*[log of combined corporate tax rate] + 0.395*[log of previous year’s tax base] + other variables and controls

If the original tax base is $263 billion and if nothing else changes—the assumption you have to make in assessing the effects of a policy—then this information is enough to put some numbers on the sort of revenues you can expect to generate by an increase in corporate tax revenues. I’ve worked through four cases: the static (no response) case, both Dahlby-Ferede cases and the Riedl and Rocha-Akis case.

There’s another thing to consider here: the effect of changes in federal corporate tax rates on provincial revenues. Both the federal and provincial governments apply their respective corporate tax rates to a common tax base. If firms act to reduce that tax base in response to an increase in the federal rate, then provincial revenues will fall, even if the provinces haven’t changed their rates.

Here’s what might be expected from increasing corporate taxes by one percentage point:

table1

And here’s the case of a two-percentage-point increase:

table2

These estimates aren’t all that much different than what it looks like the NDP had in mind back in June:

Erin Weir, a labour economist running for the NDP in Saskatchewan, has estimated that each percentage point increase in the corporate tax rate would generate about $1.5 billion in revenue each year.

That $1.5 billion estimate is pretty much in the middle of the range of estimates in that first table.

If the NDP is scaling down its plans to a one- or two-percentage-point increase, then it’s not clear how an NDP government could avoid the spending cuts that are built into the current budget projection, much less finance new spending. Nor is it clear how—or if—a federal NDP government would compensate the provinces for their lost corporate tax revenues.

I’ve made the point before that the projected surpluses in the 2015 budget were based on continued restraint in direct program spending (this excludes transfer payments to individuals and provinces, and includes salaries paid to public sector workers). Even if the next government cancelled all the tax cuts and spending measures in the 2015 budget, it still wouldn’t be enough to obviate the need to make further cuts in the public service.

2015_07_07b

It’s also worth noting that those projected surpluses were also based on revenue forecasts that seem unlikely to be met.

Mulcair has pledged to balance the budget, come what may. In order to do that, it’s unlikely that an NDP government will be able to fulfill many—or even any—of its spending promises.


 

Why the NDP’s exact plan for the corporate tax rate matters

  1. Sorry, but as someone who has spent some time looking at the impact of corporate taxes on the return on investment in a range of mining and energy projects over the years, I am having a hard time buying that a 2 percent increase in the federal corporate tax rate will have any measurable impact on business activity. Commodity prices, capital costs, the exchange rate are going to swamp corporate tax impacts. The easy “all else equal” argument doesn’t really cut it because it ignores the fact that we are dealing here with risk. Put it another way, shifting activities on the basis of corporate tax would not make sense when there are a host of much higher risk factors whose daily fluctuations make a nonsense of a 2 percent change in the tax rate.

    • Corporations pay lots of taxes, city, provincial, federal and employment taxes that are not included as “corporate taxes”. Corporate income taxes only are of value if a company makes money, and many do not. Where as the other taxes are paid even if the business is a loser. And any money sent to owners is taxed again at the stock owner.

      But there is a lot of tax greedy propaganda that ignores the reality.

      • Dave,

        If you really want to see people “ignoring reality” just look at anyone who supports a party that proposes a carbon tax.

        Are people really so stupid as to think that business is simply going to “absorb” the loss?

        Nope…they will just raise prices on everything. Of course, this will hurt the poor more than anyone else…but hey, if it lets a politician claim to have “saved the planet” no price is too high.

        • Go on, tell us how much the carbon tax has increased taxation in BC.

          • You really are an idiot.

            “Tell us how much a carbon tax has increased taxation……”

            You told us yourself.

          • “You told us yourself.”

            Glad you were paying attention!
            So you know it was a bit of a trick question – BC’s carbon tax has slightly reduced taxation in BC. Too bad you forgot that when you posted the nonsense above.

          • You can’t deflect that one Tresus……

            you posted an idiocy even obvious enough for Emily to notice. Glad to see you picked it up when it was brought to your attention.

            As for a carbon tax reducing taxation….it does to a point. When businesses have to close down or fire people….they pay less tax.

            not sure if that is the “win” you are looking for however.

          • Awww. I’m so disappointed.
            For a moment I thought you were actually recalling comments in which I explained that BC’s carbon tax is designed to be revenue neutral, and has actually been revenue negative in practice.
            So yes, taxes have been reduced with the introduction of the carbon tax in BC. I should have known I was overestimating you. I’m always the optimist though!

          • Tresus,

            It is pretty pathetic when you make a post showing that even you don’t understand your own comments.

            I won’t point out your obvious confusion…..I’ll let you stew over it a while to see if you can figure out how once again you have demonstrated your complete lack of intellectual capacity.

          • Okay.
            I’ll just stew away on the fact that the carbon tax has reduced taxation in BC.

  2. Politicians should not be allowed to dictate how much we know about them and their policies. We get more reliable information from a can of soup. We have a right to be informed voters. We want to know who you are, what you stand for and binding commitments on what you’re going to do, before we get to the ballot box.

    • bad politicians operate where the rules are weak
    • there are simple, proven rules to stop them
    • we need to make sure those rules are present as basic standards in all levels of government, all the time

    We’re building the institution to write minimum standards of process. Sign up, participate, nominate the people to run it.
    http://www.GCHRD.ca
    We’re so much more than our government.

    • GCHRD (Paul?)

      I visited the site. I note that the only problem children you show are both Liberal and Conservatives. You could say that this is because the NDP has never formed Government; but they are still MP’s in Parliament. Currently, EVERY SINGLE NDP MP is paying back money they stole to fund party activities. You may want to include that to avoid looking partisan.

      Further, you are obviously opposed to Bill C-51 (as is the NDP) which means you again seem to lean towards the NDP mindset. You have pictures of known terrorists and state that they have all been “caught” by public tips. That may be so, but you fail to note on your website that these terrorists had already committed their terrorist acts BEFORE they were stopped. C-51 is meant to STOP attacks before they occur……not catch the bad guys after they commit their murderous acts.

      the entire site (even the name) sounds like those types of organizations that came into being simply to make the current Government look bad. We can agree that we need higher standards for our politicians, but if you REALLY want to make an impact, tell those who have been nominated to run for office themselves. If you get enough of them, they can replace the “rot” that may be in place already.

      the site looks very “progressive” so you may want to expand your criticisms to all parties, and not just those you disapprove of. Otherwise, someone may think your stated reason for starting the site is just a facade for a different narrative.

  3. Does not mater. I have very little invested in bankrupt Canada. Without oil to prop up the rest of dysfunctional Canada, Canada is in for a rough ride. In the last 2.5 years we have seen money, GDP, pensions, savings, investments devalue 35% with 74 cent loonies.

    Makes Canada not worth saving or investing in. And why people like me sent our pensions, savings to USD and foreign. To avoid mass economic idiocracy by our 5 corrupt layers of idiocracy governance. (city, provincial, federal, FN and mafia)

    We are a nation of consumption waste, corrupt morally, ethically and financially bankrupt. Borrowing our futures with pyramid ponzi debt, thin air money as no one legitimate buys our government debt, we now have a new tax, devaluation tax. As we slid down even further in the OECD indexes. We were a G7, now a G18 and falling.

    35% devaluation of GDP too, when measured in world terms of USD or Yuan. We smile, as 12 cm is longer than 10 inches right? Well, same with GDP, we measure it with 74 cent loonies so it looks better. Fact is Canada is in a very active decline and all media can do is push the propaganda to the people.

    And why I save in US, debt to Canada.

  4. What the NDP continually fail to consider, is that the people who run successful multi-billion dollar companies are MUCH SMARTER than they are. Business will come up with a “work around” to avoid paying unduly high taxes; either through legal manipulation of the regulations, or through simply pulling up stakes and leaving to a more friendly jurisdiction. If they want proof of this, simply look at the big companies to leave Ontario since the high-tax liberals have been in charge. That by the way, is where all the manufacturing jobs have gone. Companies simply left when they realized that the Liberal Government was economically inept. (Wynne and McGinty didn’t / don’t have a clue)

    Frankly, I can’t say I’m surprised that the Canadian media isn’t questioning Mulcair or Trudeau about their policies; as the average “journalist” in Canada doesn’t really have that much financial savvy.

    For example, when Mulcair insists he is going to produce balanced budgets, the only one who is admitting how he is going to do it…..is Stephen harper.

    To the NDP, it is no problem balancing the budget….they just keep raising the taxes until they have enough money to pay for their socialist polices.

    you can do it yourself. Just tell your wife or husband that you have no problem paying off the credit card this month, as you are going to get your neighbours to each kick in $200 bucks per month until it is paid off.

    Of course, your neighbours may complain about it, but if you had the force of law behind you they wouldn’t have much choice in the matter. Except for moving of course.

    And that is what will happen if the NDP gets into office.

    If you work for a large company and the NDP gets elected……be ready to be unemployed in the next year.

    • ” Just tell your wife or husband that you have no problem paying off the credit card this month, as you are going to get your neighbours to each kick in $200 bucks per month until it is paid off. ”

      Hah!
      That analogy is not even wrong.

      • Don’t worry Tresus…..

        I’m sure your Dad will take away the credit card he gave you if you spent too much on your X-box.

        Careful though…he may start charging you rent. It really is a nice basement.

        • Feel free to let your imagination run wild.
          This is a safe space to post all your fantasies, and it obviously provides some consolation to you.

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