Ignatieff has it backward on corporate income taxes

Recently, Liberal leader Michael Ignatieff gave Canadians a sneak preview into what is shaping up to be an economically-damaging election platform. With the spending-induced federal deficit already pegged at $49 billion this year, and with expectations of deficits for at least the next five years, the Ignatieff Liberals think now is the time to spend another $1 billion a year on a new “Family Care Plan.”

That Ignatieff touted the pledge as “affordable” and “fiscally prudent” is certain to leave many Canadians scratching their heads. How is another billion dollars in annual spending fiscally prudent? It was Ignatieff, after all, who earlier this year criticized the $1 billion cost of the G-20 summit. “These numbers are off the scales,” Mr. Ignatieff said in May, as he criticized the Conservatives for a “total lack of proper management of public finances.”

Maybe the Liberal leader thinks he’s more prudent with his priorities because an Ignatieff-led Liberal government would come up with the money by cancelling the previously scheduled corporate income tax rate reductions.   

In theory, the Liberal’s math seems simple: need money, increase taxes.

While this type of thinking might be expected from students in a first year introductory economics course, it was unfortunately one idea cooked up at the Liberals’ “deep thinkers summit” back in March. Apparently, no economists participated.

In reality, increased taxes change the incentives people face; the result is negative economic repercussions. Specifically, higher corporate income tax rates decrease the after-tax rate of return that investors receive. That reduces their incentive to invest and grow and leaves firms with less money for productivity-enhancing investments in plants, machinery, equipment, and new technologies (such as computers and software). Workers ultimately suffer because productivity is a key driver of wages.

Plainly, the Liberals have it backward. If we want more revenue to spend on programs, we need businesses to invest, expand, and create more jobs. Reducing, not increasing corporate income taxes, is the solution.

The economically damaging effects of corporate taxes are well documented. For example, a recent study, The Effect of Corporate Taxes on Investment and Entrepreneurship, published by the National Bureau of Economic Research, analyzed data from 85 countries. The study found that increased corporate tax rates reduce both investment and entrepreneurial activity.

Another recent study, Do Tax Structures Affect Aggregate Economic Growth?, from the Organisation for Economic Co-operation and Development (OECD), explored the direct relationship between various taxes and economic growth for 21 developed countries over the period 1971 to 2004. While personal income, consumption, and property taxes all had negative effects on per person income growth, corporate income taxes had the most damaging effect.

A growing economy characterized by more investment, increased job creation, and higher incomes for workers eventually leads to more government revenue of all types, including personal income tax, GST, and corporate income tax revenues.

This is why governments across Canada of all ideological stripes have done just the opposite of what Mr. Ignatieff is proposing. His Liberal predecessors, former Prime Ministers Jean Chretien and Paul Martin, understood the importance of reducing corporate taxes. That’s why they dropped the federal rate to 21 per cent from 28 per cent.  Many provincial governments have also cut corporate income tax rates in recent years, including NDP governments in Saskatchewan and Manitoba.

Mr. Ignatieff would be wise to chat with Ontario Liberal premier Dalton McGuinty who first increased corporate income taxes shortly after coming into power. He later realized the destructive impacts of that move and did a u-turn last year, announcing a rate cut to 10 per cent from 14 per cent by 2013.

Mr. Ignatieff and the Liberals may want to spend more, but they need to understand that a de facto increase to corporate taxes is not the way go.