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Liberal corporate tax plan just election bumph Add to ...

Here is a quote from Michael Ignatieff on the first day of the campaign:

“We stick [the corporate tax rate] at 18 per cent, you save $6-billion, you pay down the deficit and you make the specific targeted investments in our platform.”

There are many, many things wrong with that sentence.

We stick it at 18 per cent, … The rate as of January 1, 2011 is 16.5 per cent. Going back to 18 per cent is an increase, not a pause. The scheduled decrease to 15 per cent in 2012 has been law for a couple of years now, and since major investment projects involve lead times measured in years, stopping now has almost the same effect as an increase. We cannot ‘stick’ at 18 per cent; we have long since moved past that point.

you save $6-billion, … The Liberals seem determined to repeat this number, so it’s important to remember that it means approximately nothing. As far as anyone can tell, its source is the Department of Finance’s October 2007 fiscal update. In Table 3.5, the projected tax relief of the reduction from 18 per cent to 15 per cent for the fiscal year 2012-13 is around $6-billion. There are several problems with this estimate:

• It is based on a 2007 projection for 2012-13. In 2007, corporate income tax (CIT) revenues per CIT rate percentage point were in the stratosphere and still rising; projections for the future were correspondingly optimistic. Using the same approach using more recent data, the PBO puts the sacrificed revenue on the order of $4.6-billion.

• It is based on static analysis, in which it is assumed that there are no behavioural responses to the policy change. As noted here, this is an extremely odd assumption to make in this context. The most important reason for cutting corporate income taxes is to induce those responses: higher productivity, wages and income. Higher incomes will produce higher tax revenues that will partially offset those lost to the CIT cuts.

• It ignores the potential for tax shifting. Multinational firms may choose to book revenues in Canada in order to take advantage of the lower rates, thus increasing the size of the corporate income tax base and therefore revenues. (To my mind, this is the weakest of the arguments in favour of cutting the CIT rate, since it amounts to playing a zero-sum game with other tax jurisdictions. But as long as other countries don’t respond, it’s still an important point to remember.)

My own rough guesstimate for the size of the effect of reducing the CIT rate from 18 per cent to 16.5 per ceny on the federal budget balance is something on the order of $1-billion:

• In a Department of Finance simulation exercise (pdf), the long-run effects of CIT cuts on the budget balance are roughly half of the short-term costs, or $2.3-billion.

• The results of a University of Calgary study (pdf) suggests that the gains from a cut of 3 percentage points in the CIT rate are on the order of 1.4 per cent (see also here). In an economy with a GDP on the order of $1.6-trillion, that works out to an increase in income of about $22-billion. Multiply that by the federal government’s share or GDP (roughly 15 per cent) - and a reasonable ball-park number for the offsetting revenues is $3-billion. The net effect of on the budget balance is around $1.6-billion

Divide that $1.6-billion-$2.3-billion range by two – only half of the 3 per cent cut has been implemented – and you get approximately $1-billion.

you pay down the deficit… There is no possible way that this measure will reduce the deficit. Firstly, the reduction to 16.5 per cent has only recently gone into effect; the structural deficit identified by the PBO existed well before January of 2011. And its scale is an order of magnitude less than the deficit problem we’re facing. At best, it will prevent the current gap – which is of the order of $12-billion-$14-billion – from increasing by an extra $1-billion or so, and only if there were no new spending. But that’s not the case, either.

and you make the specific targeted investments in our platform. The arithmetic involved in using a cancelled tax cut to finance higher spending only makes sense if we’re running a budgetary surplus. It doesn’t make sense in the context of large and persistent deficits.

In terms of communications strategy, that sentence may be effective. But in terms of economic policy, it’s simply wrong.

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