The Liberals have introduced a new theme to the debate on corporate income taxes (CIT): the conjecture that there are 'diminishing returns' to CIT cuts. The politics behind this suggestion are transparent enough, but the economics are extremely murky.
To be sure, economists are familiar with the concept of diminishing returns. But we generally don't use it as a basis for policy recommendations without first asking ourselves why it might be considered a plausible assumption.
Let's start with the theory. Lower CIT rates raise the net rate of return on investment, and these higher rates attract more savings from both foreign and domestic investors; this increased investment increases output, productivity and wages. I can see two ways that we might incorporate diminishing returns into this story: either the world could run out of savings, or Canada could run out of productivity-improving investment projects. Both are possible, but neither is likely to happen in the medium term, if ever.
The first scenario can be dismissed easily enough: one of the sources of the global imbalances that are still troubling policy makers is the 'savings glut' that has laid waste to much of the world's financial system. Even when those global imbalances are resolved, world savings are still going to be large enough that Canadian policy makers can reasonably assume that they are infinite.
As for the idea that Canada is about to run out of productivity-improving investment projects, well, the Liberal Party of Canada would do well to review David Dodge's remarks at last year's Canada 150 conference or read this recent CD Howe study. It is far, far too early to declare victory on this front. Under-investment and low productivity will be at or near the top of the Canadian policy agenda for some time to come.
I've been asked on several occasions if there is evidence that there are no diminishing returns to the benefits of CIT reductions. These requests baffle me. The resources available for doing empirical research are limited, and economists generally don't spend them on questions that are not well-motivated. More importantly, these requests reflect a fundamental misunderstanding of where the burden of proof lies. If the Liberals wish to remain members in good standing of the evidence-based policy community, they will recognize that it is up to them to provide support for their position.
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