Corporate Taxes and Investment

It looks like Jim has hit the pig again. The “Research Report” in the Tax Expenditures and Evaluations released by Finance Canada today cites one of his excellent pieces on corporate tax cuts.

Finance Canada overtly takes on the critique of corporate tax cuts put forward by this blog, the labour movement, and the NDP. Its news release promises “clear evidence that investment was strongly and positively influenced by the 2001–2004 tax reductions.” The Research Report delivers rather opaque econometrics that cannot be scrutinized until the corresponding Working Paper is released.

However, the methodologies outlined in the Report are clearly open to question. The first method compares investment before and after the corporate tax cuts. It does so in constant 1997 dollars, which seems to involve deflating GDP back several years based on one price index and deflating investment back several years based on a different price index. Much of the apparent increase in investment during the tax-cut years may simply reflect the vagaries of the capital-goods price index.

The second method, which generates results twice as optimistic, compares non-manufacturing industries that benefited from the 28%-to-21% tax cut with manufacturing, which already had a 21% tax rate. Not surprisingly, investment growth was much stronger in non-manufacturing industries. The problem with using Canadian manufacturing as the “control group” is that it has been hammered by various other factors: a rising dollar, expanding imports from Asia, increasing energy costs, etc.

Finance Canada’s equation makes some effort to account for variables other than tax changes. However, if the regression attributes even a fraction of the difference between manufacturing and other industries to corporate tax cuts, then it is bound to show that these cuts have had a hugely positive effect on investment. Comparing manufacturing to the rest of the economy is not a good way of measuring the effects of corporate tax cuts.