Corporate Taxes and Investment in Ontario

Last week, Ontario’s Ministry of Finance released the Ontario Economic Accounts for the third quarter of 2011. As The Globe reported, business investment was less than impressive:

. . . investment in machinery and equipment fell slightly by 0.2 per cent between June and September, 2011, prompting Ontario Finance Minister Dwight Duncan to fire a shot across the bow of corporations.

Mr. Duncan said Ontario has the most competitive tax system in North America thanks to reforms introduced by the governing Liberals that have eliminated capital taxes and reduced the corporate rate to 11.5 per cent from 14 per cent in 2010. The rate is set to decline further, to 11 per cent this June and 10 per cent in June, 2013.

“I expect businesses to invest and create jobs,” Mr. Duncan said. “They’ve got to step up to the table and invest here in Ontario.”

As Duncan waits impatiently for a deluge of investment following his recent corporate tax cuts, he should consider that corporate tax rates have been falling for more than a decade. The Ontario Economic Accounts show that we are still waiting for the promised pickup in business investment.

Last week, I presented the following table to the Commission on Quality Public Services and Tax Fairness. It displays Ontario’s provincial corporate income tax rate, the combined federal-Ontario corporate income tax rate, and business investment in machinery and equipment as a share of provincial Gross Domestic Product at market prices. The 2011 figure covers the first three quarters.

The Harris government enacted a schedule of deep corporate tax cuts in 2000, but the Eves government delayed further cuts in 2002. In 2003, the McGuinty government legislated a partial reversal of these cuts as of 2004. In budget 2009, it announced a new schedule of corporate tax cuts, starting in 2010.

Despite the McGuinty government’s inconsistent policy, the overall corporate tax rate for Ontario business declined steadily because of federal cuts. The combined rate has fallen by well over a third since 1999.

Meanwhile, business investment in machinery and equipment is down by more than a quarter, relative to the broader provincial economy. Investment has fluctuated with the business cycle, plummeting during the financial crisis and partially recovering since then.

It would be difficult to conclude from the empirical evidence that the past decade of corporate tax cuts has boosted investment in Ontario. I set out some theoretical explanations for this policy failure in The Ottawa Citizen a few months ago.

A better approach would be for the Ontario government to restore a 14% provincial corporate tax rate and invest the additional revenue directly or fund incentives tied to private investment in the province. With the federal corporate tax rate down to 15% this year, fully reversing McGuinty’s corporate tax cuts would produce a combined rate of 29% – lower than Ontario’s combined rate had been until last year.