Corporate Income Taxes Who Pays?

Transcription

1 Jan u ary 2014 Corporate Income Taxes Who Pays? by Philip Cross Main Conclusions Corporate taxes ultimately are paid by people; calls to increase corporate taxes will lead to higher taxes for investors, lower wages for workers, or higher prices for consumers. Most countries have moved to lower corporate tax rates over the past decade, including Canada. The effective tax rate paid by firms in Canada is very close to the statutory rates. Governments should reduce their reliance on corporate income taxes for several reasons. Increases in corporate tax rates leads to a concurrent erosion of the tax base. Also, keeping corporate income taxes as low as possible minimizes the distorting impact they have on economic behaviour, a rationale that applies to all taxes. About the author Philip Cross spent 36 years at Sta tis tics Can ada, the last few as its Chief Eco nomic Ana lyst. He wrote Sta tis tics Can ada s monthly assess ment of the econ omy for years, as well as many fea ture arti cles for the Cana dian Eco nomic Observer. After leav ing Sta tis tics Can ada, he worked for the Mac don ald-laurier Insti tute. He is a mem ber of the Busi ness Cycle Dat ing Com mit tee at the CD Howe Insti tute. He has been widely quoted over the years, and now writes a bi-weekly col umn for the National Post and other papers

2 Introduction When ever gov ern ments are strapped for cash which is most of them, most of the time, given their vora cious appe tite for spend - ing eyes quickly turn to cor po rate income taxes as an expe di ent and pre sumed pain less way to help bal - ance their books. In Can ada, two prov inces raised cor po rate tax rates in Oppo si tion leader Thomas Mulcair pro poses to raise the fed - eral cor po rate income tax from 15% to 22% while freez ing per sonal income-tax rates, an implicit rec og - ni tion that Cana di ans have reached the lim its of the tax bur den they are will ing to tol er ate. The erro ne ous thinking behind raising corporate income taxes, how ever, is that cor - po ra tions and not peo ple bear their bur den. The debate Eco nomic the ory and com mon sense the two some times agree argue that cor po rate taxes are actu - ally paid by con sum ers, work ers, and/or inves tors. When it comes to cor po rate income taxes, the tax buck does not stop at the cor po ra - tion because only peo ple can pay taxes. In the words of a lead ing expert on tax pol icy, Tax ing cor po - ra tions ulti mately results in the tax - a tion of peo ple (Chen, and Mintz, 2013: 1). Even with out a cor po rate income tax, the wealth from prof its would be taxed when the prof its are reaped by their own ers, either through div i dend pay-outs or through higher share prices if the prof its are retained in the cor po ra - tion and re-invested. 1 This is why econ o mists have long argued that cor po rate income taxes rep re sent dou ble tax a tion of income already sub ject to taxes. Levy ing a cor po rate income tax also comes partly at the expense of work ers, since firms will look to off set the cost of higher taxes by low er ing labour costs. This takes the form of restrain ing wages or even shift ing oper a tions to juris - dic tions with lower tax rates, result - ing in lost jobs. Alter na tively, firms could pass on income taxes in the form of higher prices, which costs all con sum ers. The unavoid able fact that peo ple pay all taxes is one rea - son the Fra ser Insti tute allo cates cor po rate income taxes to peo ple in its cal cu la tion of Tax Free dom Day, a deci sion that has been wrongly crit i cized by the Cana dian Cen tre for Policy Alternatives (Brooks, June 2005). Polit i cally, how ever, it has proved impos si ble to con vince large parts of the pub lic of the futil ity of shift - ing the tax bur den to cor po ra tions. Many peo ple believe it is unfair for a cor po ra tion that earns bil lions in prof its to pay no income tax (wit - ness the recent out cry over Apple Inc. pay ing lit tle income tax in the United States). Given the dif fi cult optics of abol ish ing the cor po rate income tax, the next best alter na tive is to lower the rate as much as pos - si ble. This is what gov ern ments around the world have been doing since 2000, as glob al iza tion has inten si fied. A KPMG sur vey found that the world s aver age cor po rate tax rate has fallen in each of the past 11 years, from 29.02% in 2000 to 22.96% in 2011 (KPMG, 2011). Among the rich est coun tries, the OECD average statutory corporate income-tax rate was 27.6% in 2007, down from 33.6% in 2000 (OECD, 2008: 3). Canada s rate Can ada has a slightly lower cor po - rate income-tax rate than the OECD aver age, although it var ies by prov ince. A stan dard fed eral rate of 15% applies across the coun try, while pro vin cial rates in 2013 ranged from 10% in Alberta to 16% in Nova Sco tia and Prince Edward Island, with rates just below 12% in the two Fig ure 1: Cor po rate income tax by prov ince, BC Source: EY, Provincial CIT Federal CIT AB SK MB ON QC NB NS PE NL Cor po rate Income Taxes Who Pays? 2

3 larg est prov inces of Ontario and Que bec (fig ure 1) (OECD, 2008: 3). The aver age effec tive tax rate on corporate profits is calculated as total cor po rate trans fers to gov ern - ment as a share of cor po rate prof its. The National Accounts data from Statistics Canada captures all the rev e nues gov ern ments col lect from cor po ra tions. So when a gov ern - ment like Ontario s uses the sleight of hand of call ing a tax on firms an Employer Health Tax that ranges from 1% to 3% of pay rolls, it is treated the same as income tax. The effec tive tax rate in 2012 was quite close to the stat u tory rates listed above, which dem on strates that pub lic con cerns about cor po ra - tions evad ing taxes through loop - holes and cre ative account ing are unwar ranted. Firms are pay ing what gov ern ments are ask ing them to pay, prob a bly because the ulti mate bur - den of these taxes is borne by work - ers, con sum ers, and/or inves tors. Fig ure 2: Cor po rate income tax as a share of corporate profits, Source: Statistics Canada, Fig ure 3: Cor po rate income as a share of all government revenue, Gov ern ment's share of the profits The share of prof its paid to gov ern - ment has fluc tu ated between 20% and 30% over the past four decades, reflect ing changes to the tax rate itself and the wide range of dif fer en - tial tax rates and deduc tions (such as depre ci a tion) by indus try and by prov ince (fig ure 2). For exam ple, the manufacturing and processing industry is taxed at a lower rate in sev eral prov inces. Small busi nesses that are incor po rated pay a lower rate of tax than large firms. So it is easy to under stand how shifts in prof its by indus try will lead to changes in the cal cu lated effec tive tax rate Source: Statistics Canada, The unweighted aver age effec tive tax rate in the OECD was just under 24% in 2005, one-third less than its rate in 1982 (OECD, 2008: 3). The drop in the effec tive tax rate has not been as pro nounced as cuts to the stat u tory rate, reflect ing how gov - ern ments have tried to recoup some rev e nue by broad en ing the tax base through less gen er ous depre ci a tion allowances and eliminating loopholes. Cor po rate Income Taxes Who Pays? 3

4 The effec tive tax rate is clearly cycli - cal, plung ing dur ing reces sions and ris ing as the econ omy recov ers. Attempts to tar get excess prof its at the peak of an indus try boom, such as high tech in 2000 or min - ing more recently, would make taxes even more cycli cal. 2 How - ever, the track record in Can ada shows that, by the time gov ern - ments iden tify a boom in prof its and enact leg is la tion to extract more rev e nue from a par tic u lar indus try, the boom is already over and the increased fis cal bur den only wors ens the bust cycle of the indus try. This is exactly what hap - pened to Alberta s nat u ral gas indus try in 2007 and Que bec s min ing indus try after Expect ing gov ern ments to be smart and nim ble enough to fine-tune taxes with indus try booms shows a naïve faith in the effi cacy of gov ern ment. Cor po rate income taxes account for a small share of total gov ern ment rev e - nues in Can ada (fig ure 3). This share fluctuates between about 5% and 10% of gov ern ment rev e nues, depend ing on the buoy ancy of prof its and the effec tive tax rate. Gov ern ment rev e nues from cor po - rate income taxes are highly cycli - cal. Apart from a decline below 6% dur ing the reces sion of the early 1990s and a spike above 10% dur - ing the com mod ity price boom in 2007, cor po rate taxes usu ally con - trib ute about 8% to all gov ern ment rev e nue. The ris ing share of GDP going to cor po rate prof its over the last three decades a clear if poorly under stood phe nom e non through - out the west ern world has but - tressed cor po rate tax rev e nue despite lower tax rates. The needed changes There are sev eral rea sons that gov - ern ments should reduce their reli - ance on cor po rate income taxes. First, every per cent age-point increase in cor po rate tax rates leads to a sig nif i cant ero sion of the tax base. One esti mate is that every increase of one point in cor po rate income tax rates results in a drop of 13.6% in the cor po rate tax base, com pared with only 3.6% for per - sonal income taxes and 3.2% for sales taxes (Dahlby and Ergete, 2012). This reflects the rel a tive ease with which firms (unlike most per - sons) can shift their oper a tions to juris dic tions in Can ada or abroad with lower tax rates. As well, higher taxes lead to less invest ment, which reduces cor po rate prof its and there - fore cor po rate income taxes in the long-term. Another rea son to keep cor po rate income taxes as low as pos si ble is to minimize the distorting impact they have on economic behav iour, a ratio - nale that applies to all taxes. For exam ple, since inter est pay ments are deductible from corporate income and there fore taxes, the cor po rate income tax encour ages firms to issue debt instead of equity (the return on which is taxed). Reduc ing cor po rate cash flow also inhib its firms from invest ing, which has a direct impact upon pro duc tiv ity. This reduces their abil ity to com pete, and low ers wages, which in the long run are deter mined by productivity. Ulti mately, the major stum bling block to lowering or eliminating cor po rate income taxes comes down to the pub lic s per cep tion of equity that it is unfair that an entity, even if it only exists on paper, should earn money and not pay taxes. This con cern for fair treat ment is mis placed. Cor po rate income taxes are ulti mately paid by peo ple. More over, the tax and trans fer sys tem for per sons is the best way to address ques tions of equity, not rais ing cor po rate tax rates. This is because it is uncer tain how cor po rate taxes are dis trib uted among workers, consumers, and inves tors. The desire to insu late vot - ers from higher taxes by rais ing cor - po rate rates could well result in ordi nary work ers los ing income or everyday consumers paying higher prices. The per sonal tax and trans - fer sys tem does a better job of tar - get ing who gains and who loses from tax changes than the blunt instrument of higher corporate income taxes. Notes 1 The OECD also argues that cor po rate income taxes are a back stop to per - sonal income tax, in case firms do not pay out div i dends and indulge in strat e gies to keep share price low, thus help ing share hold ers shel ter their income from tax a tion. It also reduces the incen tive for indi vid u als to incor po rate and reduce their tax rate. Cor po rate income tax also acts as a with hold ing tax on equity income earned by non-res i dent shareholders, which might otherwise escape tax a tion in the source coun - try. If all prof its of a firm were paid to foreign shareholders, conceivably it could avoid pay ing for any of the pub lic ser vices it con sumes in Can - ada, such as infra struc ture. See OECD (2008). 2 The OECD claims that because prof - its in boom ing indus tries are already high enough to attract invest, such taxes on excess rents do not entail effi ciency losses, but notes they would drive invest ment to regions or Cor po rate Income Taxes Who Pays? 4

5 coun tries with lower taxes. See OECD (2008): 2. 3 Alberta raised roy al ties on oil and gas to 50%, but has since reversed some of that increase. Que bec raised its tax on min ing from 4% to 16% since 2010, and also stopped firms from deduct ing losses from money-los ing sites. As a result, Que bec fell from first place in the Fra ser sur vey of most attrac tive juris dic tions for min - ing in 2010 to elev enth place last year. See Green and Wil son (2013). References Brooks, Neil (2005, June). Tax Free dom Day. Cana dian Cen tre for Pol icy Alter na tives. Chen, Duanjlie, and Jack Mintz (2013) Annual Global Tax Com pet i tive - ness Rank ing: Cor po rate Tax Pol icy at a Crossroads. SPP Research Papers 6, 35 (November). Dahlby, Bev, and Ergete Ferede (2012). The Effects of Tax Rate Changes on Tax Bases and the Mar ginal Cost of Pub lic Funds for Cana dian Pro vin cial Gov ern - ments. Inter na tional Tax and Pub lic Finance 19, 6 (Decem ber). Ernst & Young Global Lim ited [EY] (2014). Tax Ser vices. Web page. EY. < Tax/Tax-Calculators>, as of Jan u ary 28, Green, Ken neth, and Alana Wil son (2013). Quebec s Mining Policy Performance: Greater Uncer tainty and Lost Advan - tage. Fra ser Insti tute. KPMG (2011). International Corporate and Indi rect Tax Sur vey. KPMG. OECD (2008). Reform ing Cor po rate Income Tax. OECD Observer (July). Sta tis tics Can ada (2013). Cansim Table : Rev e nue, expen di ture and bud get ary bal ance Gen eral gov ern - ments. Sta tis tics Can ada. < hr2012-rh2012/data-donnees/cansim/ tables-tableaux/iea-crd/c eng.htm>, as of Decem ber 13, About this publication Fraser Alerts are pub lished from time to time by the Fra ser In sti tute to pro vide short, timely stud ies of cur rent is sues in eco nom ics and pub - lic pol icy. Our mission The Fra ser Insti tute s vision is a free and pros - per ous world where indi vid u als ben e fit from greater choice, com pet i tive mar kets, and per - sonal respon si bil ity. Our mis sion is to mea sure, study, and com mu ni cate the impact of com pet - i tive mar kets and gov ern ment inter ven tions on the wel fare of indi vid u als. Founded in 1974, we are an in de pend ent re search and educational organization with locations throughout North America, and international part ners in over 80 coun tries. Our work is fi - nanced by tax-de duct ible con tri bu tions from thou sands of in di vid u als, organizations, and foundations. In order to protect its independence, the In sti tute does not ac cept grants from gov ern - ment or con tracts for re search. The opin ions expressed by staff or author(s) are those of the indi vid u als them selves, and should not be inter preted to reflect those of the Institute, its Board of Trust ees, or its donors and supporters. Distri bu tion These pub li ca tions are avail able from in Por ta ble Doc u ment For mat (PDF) and can be read with Adobe Ac - ro bat or with Adobe Reader, which is avail - able free of charge from Adobe Sys tems Inc. To down load Adobe Reader, go to this link: readstep.html with your browser. We en cour - age you to in stall the most re cent ver sion. Copy right and ISSN Copy right 2014 by the Fra ser In sti tute. All rights re served. No part of this pub li ca tion may be re pro duced in any man ner what so ever with out writ ten per mis sion ex cept in the case of brief pas sages quoted in crit i cal ar ti cles and re views. ISSN Date of Issue: January 2014 Media inqui ries and information For me dia in qui ries, please con tact our Com mu ni ca tions de part ment by tele phone at or com mu ni ca tions@fraserinstitute.org Our web site,, con tains more in for ma tion on Fra ser In sti tute events, publications, and staff. Devel op ment For information about becoming a Fraser In sti tute sup porter, please con tact the De vel op ment De part ment via at development@ fraserinstitute.org; or via tele phone: , ext. 586 Cor po rate Income Taxes Who Pays? 5