The Liberal platform released yesterday quotes Bank of Canada Governor Mark Carney: "Canada under-invests in machinery and equipment, training, and innovation -- in fact, all of the underlying drivers of productivity."
And the Liberals are quite right to point to chronic under-investment as a significant challenge for the Canadian economy. As the population ages, we will no longer be able to count on a larger work force as a source of growth; increases in output will have to come from improvements in output per worker. So it puzzles me that they chose to increase the tax that most discourages investment in new productive capacity.
Different taxes have different effects on the economy, and corporate income taxes (CIT) have the worst effects on investment, output and wages. Higher CIT rates increase the 'tax wedge' between the gross rate of return generated by an investment project and the net rate that the investor sees. Global capital markets are highly integrated, so investors -- domestic and foreign -- will respond by shifting their savings away from Canada. Even if the existing capital stock remains in place, it will soon become obsolete without new investment.
Theory predicts that since the supply of capital is most sensitive to changes in its rate of return, taxes on capital income are the most harmful. And as far as we can tell, the data are consistent with the theory. This recent OECD study (one of many) concludes that "[c]orporate income taxes appear to have the most negative effect on GDP per capita."
What is even more troubling is that the Liberals' approach to the productivity problem is to subsidise activity in three "champion sectors". If these sectors are going to be a source of growth, they won't need government subsidies. A system in which profitable, innovative firms in "loser sectors" are penalized in order to support those who enjoy the favour of the government is a recipe for cronyism, not prosperity.
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