Canadian Corporate Tax Cuts Show Success of Strong Economic Policy

COMMENTARY Taxes

Canadian Corporate Tax Cuts Show Success of Strong Economic Policy

Oct 15th, 2018 3 min read

Commentary By

Adam Michel

Policy Analyst, Roe Institute for Economic Policy

Mathieu Bedard

Economist with the Montreal Economic Institute

Key Takeaways

Despite the near halving of the Canadian rate over this period, fiscal revenues generated by the tax did not diminish.

In the Canadian case, the tax was cut over a much longer time frame, and announced sufficiently in advance for investments to be put in place.

Since these investments allow workers to be more productive by producing more goods and services more quickly, companies are able to pay higher wages.

As President Trump mulls a second round of corporate tax cuts, this time targeting capital gains, his initial reduction of the corporate tax rate from 35 percent to 21 percent remains controversial in many quarters. Senator Elizabeth Warren, for one, wants to roll it back, should she be reelected to the Senate on November 6 (or to the Oval Office come 2020), and wealthy donors have vowed to help Democratic candidates running against Republicans who voted for the tax bill.

Initial estimates show that revenues from the corporate income tax are down relative to GDP. Yet partisans of the tax cut have suggested that it would stimulate investment, and that the resulting economic growth would potentially more than make up for the loss in revenues. In this context, one of the most underappreciated Canadian economic success stories — the sustained reduction in Canada’s federal corporate income tax rate from 2001 to 2012 — is particularly relevant for an American audience.

Despite the near halving of the Canadian rate over this period, fiscal revenues generated by the tax did not diminish. This is due in no small part to the fact that, as expected, the reform led to more business investment and more economic growth, not to mention higher wages. In 2000, Jean Chrétien’s Liberal government in Ottawa began lowering the Canadian federal corporate tax rate from its long-time plateau of 28 percent. Through a series of successive reductions, it fell to 21 percent in 2004. Stephen Harper’s Conservative government, elected in 2006, further lowered the rate until it finally reached 15 percent in 2012.

Canadian revenues have held up remarkably well in spite of these deep cuts. From an inflated $43.4 billion in 2000, tax revenues had tumbled to $32.3 billion in 2001 because of the dotcom bubble (all figures in constant 2017 Canadian dollars). They had climbed back to $45 billion in 2017, despite the ups and downs of the 2008 financial crisis and the 2014 oil price bust which had a pronounced effect due to the importance of the oil and gas sector in the Canadian economy. As a share of GDP, corporate income tax revenues have remained fairly constant between 3 percent and 4 percent, after a small initial drop in 2001.

So why the stark contrast with recent American developments? In the Canadian case, the tax was cut over a much longer time frame, and announced sufficiently in advance for investments to be put in place. In the American case, the tax cut was deep and sudden. Indeed, the current administration was at the time widely portrayed in the media as being incapable of passing any significant piece of legislation. Yet investments take some time to be put in place and to bear fruit, so it is not very surprising that government revenues would decline initially.

It’s impossible to predict whether over the longer run revenues will turn out to be as stable as they have been in Canada. How the still-nascent trade war plays out is one of the countless unknowns. But there are reasons to be optimistic. The latest annualized economic growth figure, at 4.1 percent for the second quarter, is one of them. The Canadian example is another.

In Canada, the tax cut stimulated private investment, which picked up after 2000 following a miserable performance in the 1990s. As a share of GDP, Canadian private investment rose from about 10.5 percent of GDP to 13 percent by 2012. This was, of course, partly due to the commodity boom, but it was also partly due to the improved fiscal climate for investment.

The reason Canada’s corporate income tax reduction had broad bipartisan (Liberal and Conservative) support is that it was widely understood that although corporations may be legally responsible for remitting the tax, workers ultimately pay a large share of it. This is confirmed not only by Canada’s experience, but also by international research, including ample evidence from the United States.

The way this works is that corporate tax cuts attract more investment in buildings and equipment. Since these investments allow workers to be more productive by producing more goods and services more quickly, companies are able to pay higher wages, and often will want to hire even more workers. Increased returns on their pension funds, retirement accounts, and other investments also provide them with more money for retirement.

The corporate tax reform that took place in Canada was largely a success, helping to grow the economy. Investment has improved despite two recessions at the beginning and end of the last decade, and despite the substantial effect of the commodity price bust on Canada in recent years. While leading to more investment and higher wages, it also provided steady levels of government revenues. There is every reason to believe that American workers, businesses, and the federal government will enjoy the same kinds of benefits.

This piece originally appeared in The Hill on 8/14/18