As the 42nd Canadian general election reaches its final week, the five major federal parties have released documents outlining in greater depth their proposed policies. Several of the parties have released fiscal plans and costings of their election promises. Among the major considerations of Canadian voters as they enter the ballot box on October 19th is the tax policy that the next government will adopt.
Corporate income tax rates have fallen dramatically in Canada over the past decades, from 41% in 1960 to a low of 15% at the time of writing. This has rendered corporate tax hikes a politically attractive option for raising new revenue. While it may be tempting to raise a greater proportion of federal revenue from corporate taxes, doing so would be inadvisable for a number of reasons.
First, corporate taxes tend to be associated with large deadweight loss – that is, loss associated with the distortionary effects of taxation on agents’ choices. In the mutual production model set out by Jane Gravelle and Laurence Kotlikoff in a 1989 paper, the most optimistic measure of the excess burden of corporate taxation pegged it at 84% of collected revenue. This value is enormous. As a point of comparison, the National Bureau of Economic Research’s TAXSIM model finds the deadweight loss of the personal income tax to be 32.2% of revenue collected.
The impact of a corporate tax increase on economic growth is likely to be negative. A 2008 working paper from the NBER found that higher corporate taxes are associated with lower levels of manufacturing investment, lower levels of foreign direct investment, lower business density (firms per person), and lower firm entry rates. All of these effects are associated with reduced GDP growth. The effect of corporate taxation on business density is particularly strong. A ten percentage increase in corporate tax rates reduces business density by 1.9 firms per 100 people, compared to an average density of 5 firms per 100 people.
It must additionally be noted that corporate taxation is not as progressive as one might expect. Taxation cannot ultimately fall on an abstract legal entity; the burden of a corporate tax must eventually be borne by individuals. An empirical study by R. Alison Felix of the Kansas City Federal Reserve estimated that an increase in marginal corporate tax rates of a single percentage point decreases wages by 0.7%. This implies that labour effectively pays 2 to 2.5 times the amount of corporate taxes collected in the form of decreased wage growth. This phenomenon renders corporate taxation quite regressive. Rather than being borne by shareholders, the cost of corporate taxes is instead borne by workers. Even the portion that falls upon shareholders does not necessarily target high-income individuals; institutional shareholders, including pension funds, own a large percentage of outstanding stock.
There are a number of more efficient taxes that the one may consider to raise extra revenue. A $20 per ton carbon tax is unanimously supported by the IGM Economic Experts Panel. A land value tax – similar to a property tax, but levied only on the value of the underlying land and not the improvements built on it – would produce no meaningful economic distortions and could increase the efficiency of land use by incentivizing landowners to improve their land to its most profitable extent. Both of these taxes are widely supported by economists and could additionally act as tools to advance both environmental and equitable goals. Although corporate taxation is politically popular, a policy-minded government should refrain from increasing rates if it wishes to produce the best possible outcomes for Canadians of all stripes.