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Value Added? The Dubious Impact of Corporate Income Taxes

April 6, 2011

2-minute read

Corporate tax cuts have become a defining feature of the election campaign thus far.

The Globe and Mail covered the topic today with an article entitled "Corporate tax cuts don't spur growth".

Stephen Gordon fired off a critique of the piece in his latest blog at the Globe and Mail's Economy Lab, to which I am also a regular contributor.

Here’s two responses to his two main points – that there has been more investment in real terms, notwithstanding Stat Can figures showing a decline; and that CIT cuts “are associated with” higher investments than would otherwise have been the case.

First: The big story behind corporate investments is what types of things that are being invested in. The fastest growing category of business investment is computers, growing from 9.2% of all business investment in machinery and equipment in 2000, when the big tax cuts started, to 20.7% in 2010. That's up from only 4.5% in 1997, when the most sustained period of economic growth since the 1960s began.

Some of that investment replaces obsolete technology and introduces important efficiencies. Some of that is simply keeping up with the latest gadgets and software. It is an open question how much productivity improvement results from these investments.

But there is little question that some business investments actual lead to a decline in value-added production. For over a decade, foreign corporations have been buying up our resources and shipping value-added production elsewhere …. Along with middle class jobs. The Vale Inco story is a striking example, no pun intended.

As to the second point, that corporate tax cuts are associated with economic growth: a correlation does not a cause make.

A period of aggressive reduction to corporate income taxes is indeed associated with a period of rapid economic growth in Canada.

But that same period saw the emergence of the BRIC – Brazil, Russia, India and China – as the major new forces propelling the global supply chain.

These nations have been the true engines of global economic growth for the better part of a decade. These days they’ve been pulling the advanced industrial nations out of the slump, through rising aggregate demand.

The first beneficiaries of the recovery are the nations that have the raw materials essential to the production process.

Canada is one such nation, along with an constellation of emerging economies in Africa and South East Asia, rich in natural resources or cheap labour.

At this point in the business cycle investors are coming here for two reasons: natural resources, and a safe place to park their money in an unstable world. The fastest growing category of incoming foreign direct investment is bonds.

Investors are not primarily coming here because of our tax regime.

There is no dispute that corporate income taxes are important to decision-makers. But they are only one item towards the end of a long list of why companies invest or disinvest in a particular place.

First in that list is growing demand for their product or service. Second is the rate of return.

Taxes are an important consideration, but only at the margin, when everything else is equal, for companies choosing to invest or divest in a particular place.

Let’s look at the big picture. Canada has been hemorrhaging value-added production and jobs with decent wages, benefits and pensions.

If you are committed to using billions of dollars to incent behavior, target it to getting what you want: value-added investments and good jobs.

Corporate investment and corporate income taxes are important. But business interests are not synonymous with the public interest. And the bottom line for most Canadians is their own well-being.

The litmus test for any public policy is not just the costs and benefits, but the distribution of the costs and benefits.

It is surprising how corporate tax cuts and income splitting became two hot button topics in this federal election campaign.

The first leg of the election campaign has quickly turned into a conversation about income inequality and who benefits from this or that policy. Nothing could be more appropriate in the wake of the worst global economic meltdowns in two generations.

“Who benefits” is the central question that should be asked when a policy proposal is advanced. It is even more pertinent in the middle of an election campaign.

Armine Yalnizyan is a Senior Economist with the CCPA.

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