A sea change is coming to the politics of corporate tax rates

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The biggest change in Canada's tax policy over the last generation was the steep reduction in corporate income taxes (CIT) engineered since 2000 at both the federal and provincial levels. Advocates of CIT cuts promised they would stimulate more business investment and thus generate trickle-down benefits for all Canadians. Free-market economists built theoretical models to show that lower corporate taxes would boost investment, productivity and even wages.

Their argument was always dubious. Actual historical statistics (as opposed to theoretical economic models) indicate that investment responds predictably to growth and interest rates, but not to statutory tax rates. In Canada's case, CIT cuts are especially ineffective because of our reliance on foreign subsidiaries -- many of which (including U.S. multinationals) must pay tax at home on global earnings, and hence don't even benefit from our reductions. (As economist Erin Weir has pointed out, CIT savings are effectively transferred into the coffers of foreign governments!)

But in the context of the generally favourable fiscal conditions prevailing in the early 2000s, the CIT cuts were politically saleable. After all, governments at the time had fiscal space to do many things: lowering other taxes (though none as deeply as CIT rates), and providing bits of new program spending. Few Canadians seemed to mind that corporations were getting a disproportionate share of the largesse.

The federal rate was cut virtually in half after 2000 (to just 15 per cent today). Several provincial governments followed suit. Alberta was most aggressive, slashing its rate by over one-third (to just 10 per cent) by 2006. This sparked a destructive race to the bottom among Canadian provinces -- aided by explicit threats from companies to move head offices to Alberta, if other provinces didn't follow suit. Combined, Canada's average federal-provincial rate is now the second lowest in the G7 (according to OECD data).

But despite this dramatic change, the promised pay-off in business investment is impossible to find. Capital spending has consistently disappointed -- and it's getting worse. Last year, business non-residential investment declined in real terms. Innovation investment has been shrinking for a decade. In fact, non-residential business capital spending has grown more slowly since the election of the Harper government in 2006 (and its CIT cuts, which now cost Ottawa at least $15 billion per year) than under any other government in Canada's postwar history.

In today's constrained fiscal environment, however, the political calculus of CIT has changed dramatically. Now most Canadians are getting less from government, but being asked to pay more for it. Their willingness to watch corporations receive favourable treatment, even while delivering less economic effort, has evaporated.

Several provinces have already begun dialling back their CIT favours. B.C. abandoned its attempt to match Alberta's threshold, boosting its CIT rate by one point in 2013. New Brunswick lifted its rate by 2 points. Ontario cancelled a plan to ratchet its rate down to Alberta's, freezing the CIT at 11.5 per cent.

Nowhere has the sea change in the politics of CIT rates been more dramatic, however, than in Alberta. Jim Prentice's austerity budget featured tax hikes on virtually anything that moves in that province -- except for corporations. That did even more political damage than his infamous "look in the mirror" quip. Polls showed a huge majority of Albertans -- even Conservatives -- supported higher CIT rates. Despite desperate efforts by corporate backers to "prove" that CIT cuts work, Albertans elected a government promising to boost the rate by 2 points.

Alberta's new 12-per-cent rate may become a new effective minimum for provincial CIT rates. Indeed, formally agreeing on a new interprovincial CIT floor would prevent the destructive competition that undercut provincial coffers so badly in recent years. In any event, we can expect more provincial CIT hikes in the coming years.

Meanwhile, at the federal level, Canadians will have another chance to debate CIT rates this fall. The NDP will propose a modest hike, and even the Liberals might consider revenue-boosting CIT reforms (if not raising the rate, at least restricting some loopholes). That would leave Stephen Harper as the lone champion of this failed trickle-down theory. Jim Prentice's experience is surely causing him considerable trepidation.

Jim Stanford is an economist with Unifor. A version of this commentary was originally published in the Globe and Mail.

Photo: Cheryl DeWolfe/flickr

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