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Economy Lab

There's more than 'theory' behind corporate tax cuts Add to ...

One common dismissal of cutting corporate income tax rates is that the benefits are only ‘in theory’.

On her blog, my Economy Lab colleague Armine Yalnizyan recently wrote “It is fast becoming the legendary goal for tax reform in some opinion-makers’ minds, and they are saying that economic theory proves them right. Not so fast.”



It is a peculiar argument to make, when there are dozens of empirical studies using real world data that have found lower corporate income tax rates lead to higher levels of investment and economic growth. These studies carefully control for other factors, are peer-reviewed, and published in the top journals in economics. Here are a few:



Djankov et. al. in a 2010 cross-country study use data collected through Pricewaterhouse Coopers on 85 countries along with datasets on foreign direct investment and entrepreneurship to calculate the impact corporate taxation has on a number of variables. After implementing a number of controls, they find that a “10 percentage point increase in the effective corporate tax rate reduces the investment to GDP ratio about 2 percentage points… and the official entry rate by 1.3 percentage points…” They find that reduced investment in countries with higher corporate income tax rates is not due to access to capital, rather that high corporate tax rates reduce incentive for investment. They also find that high corporate tax rates are associated with higher firm debt-to-equity ratios (in other words, higher corporate tax rates encourage firms to use debt financing).





Lee and Gordon (2005) who, using data from 1970-1997, find a 10 percentage point reduction in the corporate tax rate raises the growth rate of GDP by 1-2 percentage points.



Mark Parsons in a 2008 Department of Finance study examined a Canadian corporate tax cut that did not apply to manufacturing industries. This provided a perfect natural experiment, as we can compare industries that received a corporate income tax cut with those that did not. Parsons found that the corporate income tax cut led to higher investment, as the seven percentage point reduction in corporate tax rates in 2000 reduced the cost of capital for large firms by 2.4 per cent. The study finds that a 10 per cent reduction in the user cost of capital leads to a 7 per cent increase in the capital stock.



My colleague Stephen Gordon has listed dozens of others on his reading list. While lower corporate income tax rates lead to higher levels investment in theory, they also lead to higher levels of investment in practice.



Mike Moffatt is a chemical industry consultant and a Lecturer in the Business, Economics and Public Policy (BEPP) group at the Richard Ivey School of Business



Eds note: Join Mike Moffatt and Armine Yalnizyan of the Canadian Centre for Policy Alternative today at 11 a.m. for a live discussion on corporate income tax at globeandmail.com



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