Corporate Taxation and Investment in the 2011 Federal Budget

Amidst all the frenetic disarray of budget day, I had an interesting and informative exchange on CBC’s Power & Politics with John Manley, former Liberal Finance and Industry Minister, and now chief lobbyist for Canada’s corporate elite (as President and Chief Executive of the Canadian Council of Chief Executives).

Host Evan Solomon asked Mr. Manley what he thought of the budget.  He damned it with faint praise on the fiscal prudence score.  “We’d like to see the deficit gone…. This budget gets us there, but not too soon.”

Remember, Manley’s clientele are the recipients of by far the budget’s largest single piece of largesse.  $6 billion per year worth of corporate tax cuts towers far above the many other little trinkets and baubles offered up by Finance Minister Flaherty.  This year and next the Harper government will reduce the corporate tax rate by one-sixth (on top of previous substantial reductions).  For Mr. Manley to then imply that the government could have gone a little faster in eliminating the deficit, struck me as a bit precious.  So I suggested that if he wanted the deficit gone sooner, he could give back some of the $6 billion.

This elicited the following responses from Mr. Manley.  They provide us with some good straw men for us on the left.  But they also represent the fundamental economic-ideological apparatus that we must deconstruct and ultimately defeat, if we are to turn around this rotten ship.  Two of the more important core arguments that underlie the so-far successful effort to sell trickle-down economics, are right there in Mr. Manley’s comments:

1. Private business investment is essential to employment and prosperity, and you need to reward investors mightily if you want it.
2. We will all share in the resulting benefits, because we are all part-owners of those businesses through the stock market.

We need collectively to do much more serious and sustained work to destroy those two claims, in order to win the debate over corporate tax cuts and so many of the other planks of neoliberalism.  I will attempt to do some of this in a forthcoming CCPA paper reviewing the history and determinants of business investment spending in Canada.

Here are Mr. Manley’s responses, verbatim:

“There’s a basic thing about taxation:  If you want to discourage something, tax it.  So if you want to discourage investment and enterprise and growth, tax business.  That’s simple, go ahead.”

Well, actually, no-one I know has proposed a tax on investment or enterprise or growth.  (The old capital taxes, which are long gone, could to some extent have been considered a tax on investment – although they taxed all assets, not just real investment.)  The CIT, in contrast, is a tax on profits.  Profits and investment/enterprise/growth are not statistically correlated – at least not any more.

 

 

 

 

 

 

This figure shows after-tax cash flow (corporate profits less direct taxes, plus CCA) and business non-residential fixed investment, both normalized as a share of GDP.  Businesses used to reinvest their cash flow in Canada (until about 1990 – shortly after we got into free trade).  But they don’t anymore.  The sharp rise in profitability and cash flow since 1990 (to historic levels as a share of GDP) has not been reflected in any sustained improvement in business investment.  So claiming that taxing Canadian business profits profits is akin to taxing investment in Canada has no statistical credibility whatsoever.

“When you look in the budget numbers, and you see where the largest increase in revenue for the federal government is coming from, despite the rate reduction, it’s coming from corporate income tax.  That’s a signal that you’re getting economic growth.”

This is the old Laffer curve argument, that’s received a surprising amount of uncritical attention in recent debates in Canada.  The idea is that corporate tax cuts are “free”, because they unleash such a wave of entrepreneurial energy that government CIT revenues don’t actually suffer.  Of course, there are many factors that determine corporate profits.  Things like rebound from a cyclical downturn.  Things like global commodity prices (especially for Canadian resource companies).  Things like the continuing structural rebalancing of Canadian society, making this an ever more business-friendly environment (like stagnant wages, declining unions, and weaker regulations).  It is true that CIT revenues are not falling, despite the rate cut, because profits are growing strongly.  But to claim that profits are growing strongly because of the rate cut stretches credulity entirely.

 

 

 

 

 

At any rate, Manley’s claim about revenues is not really true.  In the next two years, CIT revenues do grow faster than any other major revenue source (if you believe the Budget Plan, at any rate).  That reflects the very strong cyclical rebound in profits happening right now, relative to the 2009-10 fiscal year (when CIT revenues bottomed out after the recession).  However, in the long-term (looking beyond that cyclical rebound), CIT revenues actually grow more slowly than any other major source of federal revenue.  This is shown in the preceding table, which reports the %age increase in revenues by source over 1-year, 2-year, and 6-year periods.  If profits were growing because of unleashed entrepreneurial spirit and other Laffer-curve mechanisms, the effect should get stronger in the long-term, not weaker.  Instead, the stability in CIT revenues post-2009 despite the rate cut merely reflects the cyclical rebound in profits.  And it is worth noting that aggregate CIT revenues will remain far lower than they were in 2006 when the Harper government came to power.

“Canada with the lower income tax rate ranks in the middle of the OECD.”

Erin Weir has repeatedly shown how misleading this argument is, since the entry of small, less developed, and low-tax jurisdictions into the OECD (powerhouses like Estonia and Slovenia) has pulled down the unweighted average which Mr. Manley invokes.  The weighted average OECD CIT rate is 7 points higher than the unweighted average – and Canada’s existing rate is well below that weighted average.  The claim that Canadian CIT rates are uncompetitive is preposterous.  And the claim that cutting rates will boost our economy, as opposed to reinforcing a race-to-the-bottom in taxation that no-one can win (except the corporations), is dubious.

“What … companies are in the pension plans and RRSPs of Canadians?  Quite frankly, a lot of it is banks and oil companies.  So to say that somehow there’s some elite over there that’s going to get all those benefits, you know … that’s stuff that we used to hear in the 70s.”

This is trickle-down economics meets George W. Bush’s “shareholder society.”  Since we all own shares, we’ll all benefit from making corporations rich.  But hold on.  We don’t all own shares.  And some of us own a lot more than others.  Canada’s 50-odd billionaires own twice as much financial wealth as the bottom 50% of the population (17 million people).  We can’t let them get away with this argument.  That will take ongoing documentation of the astounding maldistribution of financial wealth, and the failure of RRSPs and personal investing as social policy.

Finally, here is perhaps John Manley’s strongest argument against me:

“We hear that from Jim all the time.”

Well, at least I’m consistent.  I took my first undergrad economics course in 1979 (and hence I suppose I qualify for his 70s epithet).  As for Mr. Manley’s conversion from Liberal politician to chief executive of the chief executives – well, I’ll let others weigh in on whether there’s any consistency in that or not.

If you want to see the whole debate in living colour, here’s the link (our segment begins at the 1:35 mark):

http://www.cbc.ca/video/#/News/Politics/Power_&_Politics/1305400780/ID=1853951173

Meanwhile, the next morning, CBC’s radio show The Current ran an equally insightful feature on the politics of budget-making, featuring Manley again, former Conservative Finance Minister Michael Wilson, and former Saskatchewan NDP Finance Minister Janice MacKinnon (who was awfully conservative when she held that post, and has become much more so since).

The striking thing about that program was how all three of the panellists, in varying ways, endorsed Flaherty’s budget.  MacKinnon praised Flaherty for doing a good job of restraining spending in the face of so many politically-motivated demands.  She also commended the government for sticking to its “important fiscal principles” by carrying on with the corporate income tax cuts, even though polls show they are not politically popular.  The mark of a principled (rather than opportunistic) Finance Minister, through this lens, must therefore be his or her willingness to ignore the preferences of the population.  That’s the same kind of tough-love governance thinking that led to the reification of so-called “independence” for central banks.

The show did include a pre-taped clip from me, where I argued that the budget was more politics than policy in the way it treated the issue of fiscal “restraint.”  For political reasons the Conservatives think it’s to their advantage to be portrayed as “prudent fiscal managers,” but for equally political reasons they don’t want to spell out what kind of pain that might involve for actual living human beings.  Therefore, they wave a magic wand at the fiscal forecasts, implying that spending growth can be held to 1% annual growth over a 5-year period (from 2009-10 through 2014-15), without remotely specifying how that would occur.  (That’s equivalent to an 11% reduction in real per capita program spending over that period.)  That’s called having your cake and eating it too: running on a reputation of tight fiscal management, without actually tightly managing the fiscus.

When Michael Wilson was asked for his response to this argument, he borrowed a page from John Manley’s book:  “Mr. Stanford, he comes from a certain point of view.”  Yes, I certainly do.  And what’s more, I say it all the time.  And I started saying it in the 1970s.  OK, now let’s get down to a real debate over ideas.

Here’s a link to the full Current segment, again for those with a taste for self-flagellation:

http://www.cbc.ca/video/news/audioplayer.html?clipid=1855103022

Finally, yesterday’s budget features one more twist in the corporate finance, investment, and taxation milieux: a 2-year extension of the accelerated CCA provision for business capital spending.  This was introduced as part of the government’s initial response to the recession.  They indicated that they were going to hold firm to their plan to abolish it this year (motivated in part by the silly fear that if they made a “temporary” tax cut permanent, then no-one in future would believe that any tax cuts are temporary!).  Then, yesterday, they surprised many (including me) and extended the provision for another two years.

I and others in the labour movement have supported the accelerated CCA provision as a preferred alternative to across-the-board corporate income tax cuts.  At least with a CCA incentive, the company has to invest something in Canada in order to claim any of the benefit.  In fact, in my 1999 book Paper Boom I toyed with the idea of 100% write-offs for all domestic capital spending, combined with a high tax on cash accumulation and distribution.  In this regard, companies would not be taxed for profits that were reinvested in Canada – but would be taxed heavily for profits which were accumulated or distributed.

In the present context, however, the accelerated CCA provision has been layered on top of major and expensive cuts to the base corporate tax rate.  This must rank as one of the greatest instances of double-dipping in fiscal history.  The attempt yesterday by Mr. Flaherty (and several corporate lobbyists) to suggest that the government’s corporate taxation program thereby has broad support (even from the labour movement) is dishonest and manipulative.  The CLC has written a public letter to Mr. Flaherty confirming this.