Increasing Business Taxes

Would endanger Canada's economic recovery

In recent years many countries have overhauled their business tax systems to improve their global competitiveness. They recognize that in a highly integrated global economy, the tax base is constantly on the move. Businesses and capital easily traverse national borders, seeking the best economic opportunities. They are drawn to low-cost, low-tax jurisdictions.

Daniel Mitchell of the Washington-based Cato Institute wrote: “In the past, governments saw corporations as cash cows that could be milked for money anytime politicians wanted to buy votes. But because of capital mobility, lawmakers are being forced to curtail their greed lest the geese that lay the golden eggs fly across the border.”

In the last two years, 37 countries reduced corporate income tax rates despite facing significant budget deficits (see PricewaterhouseCoopers/World Bank report “Paying Taxes 2011”). Several more have announced plans to do so. The U.K., for example, is cutting business taxes at the very same time as it has to make very painful cuts to public spending, demonstrating the priority the U.K. gives to boosting its competitiveness. Japan, Australia and New Zealand are also reducing their business taxes to attract the investment and jobs that follow. In his annual State of the Union address, President Barack Obama highlighted the need to revamp the U.S. corporate tax structure. 

Canada witnesses a remarkable transformation in the business tax landscape

At the federal level, the corporate surtax for all corporations and the capital tax have been eliminated; the small business tax rate has been reduced to 11 per cent and the income eligible for the lower rate raised to $500,000; and capital cost allowance rates for a number of assets have been aligned to better reflect their useful life.

Liberal Prime Minister Jean Chrétien gradually reduced the federal general tax rate on corporate income earned by large firms from 28 per cent in 2000 to 21 per cent in 2004. Prime Minister Stephen Harper’s conservative government further reduced the rate from 21 per cent in 2007 to 16.5 per cent  in 2011 with a further 1.5 percentage point reduction legislated for 2012, bringing the rate to 15 per cent.

The federal government also sought the collaboration of the provinces and territories to reach a 25 per cent combined federal-provincial-territorial statutory corporate income tax rate by 2013 to make Canada a country of choice for investment. Canada is well on its way to achieving this target.

We cannot turn back now

But today, some are proposing to increase business taxes. Opposition parties are vowing to try to defeat the government on the budget confidence vote—triggering an election—if it does not roll back the legislated business tax relief to 2010 levels which would see corporate earnings taxed at a federal rate of 18 per cent as opposed to 15 per cent. Some have proposed to use the savings to fund a range of government programs.

Tax and spend policies are not the basis for sustainable economic growth and will do nothing to reduce the deficit. In fact the opposite is the case—vigorous economic growth stimulated by lower business taxes brings far more revenue of all types in the long-run as employment grows, consumer demand rises and investment increases. Smart tax policy is a means to achieving fiscal balance. 

Although Canada dodged the worst of the global recession, it faces some significant hurdles to securing the economic recovery, including a relatively strong Canadian dollar and a U.S. economy slowly nursing its way back to health. Commenting on proposals to increase business tax cuts, Canadian Chamber of Commerce President and CEO Perrin Beatty recently told members that, “All Canadians lose when the political parties squabble over this issue. Our job is to help secure sustainable economic growth. We have a weak recovery underway, and we need the help the business tax strategy provides. The issue is too serious to be left to political game players.”

The timing of the legislated tax cuts could not be better. They represent a significant fiscal injection into the Canadian economy just as fiscal stimulus winds down and the focus turns to the private sector to drive growth.

The Bank of Canada reported in its winter Business Outlook Survey that 44 per cent of Canadian firms plan to invest more in productivity-enhancing machinery and equipment in the year ahead than they did over the past twelve months. Almost the worst thing government could do now is to reverse the commitment to lower taxes. Realizing a lower rate of return on capital, businesses may simply change their minds and invest less.

Businesses do not pay taxes; people do

In Ottawa, politicians are making the usual attacks on “big, rich corporations.” Their method of ideological waging of war is to divide and conquer. They want to convince Canadians that big business is getting a break, not them.  Nothing can be further from the truth. Business taxes fall directly on Canadian families—workers through lower wages, consumers in the form of higher prices for goods and services, and shareholders (including pensioners who own equity through RPPs, RRSPs and mutual funds) through lower returns. 

According to an Oxford University study, a $1 increase in corporate taxes tends to reduce real median wages by 92 cents. The American Enterprise Institute for Public Policy Research found a one percent increase in corporate tax rates is associated with nearly a 0.8 percent decrease in wage rates.  The latter study is particularly notable because it analyzed data from 72 countries spanning 22 years.

To put it bluntly, business taxes are the most economically damaging mechanism for raising revenue. As extensive research by the Organization for Economic Co-operation and Development (OECD) shows, corporate income taxes deter capital investment, hinder productivity growth and have the most negative effect on living standards. The American Enterprise Institute for Public Policy Research found that an increase in the business statutory tax rate reduces both inbound foreign direct investment and entrepreneurial activity and, therefore, stifles innovation and productivity.

A vibrant large business sector is also the foundation for a strong and prosperous small business sector. When large businesses are more competitive, they produce more goods for domestic and foreign consumption. They purchase more inputs from small businesses (i.e. their suppliers). For many small businesses—whether in retail, wholesale, manufacturing or service sectors—large businesses are significant or primary customers. Additionally, large businesses employ thousands of people who shop at small businesses in communities across the country. Raising taxes on large businesses dries up opportunities for small businesses.

Tina Kremmidas is Chief Economist at The Canadian Chamber of Commerce