Until recently, there was a consensus in favour of competitive business taxes. But whenever governments are strapped for cash - which is most of the time for most of them, given their voracious appetite for spending - eyes quickly turn to corporate income taxes as an expedient and presumed painless way to extract more revenue. Two provinces raised corporate tax rates in 2013. Opposition leader Thomas Mulcair proposes raising the federal corporate income tax to 22% while freezing personal income tax rates, implicitly recognizing Canadians have reached the tolerable limits of their tax burden. The erroneous thinking behind hiking corporate income taxes is that corporations and not people ultimately pay them.
But the truth in economic theory and common sense - the two sometimes agree - argue that corporate taxes are actually paid by consumers, workers or investors. When it comes to corporate income taxes, the tax buck does not stop at the corporation, because only people can pay taxes. A corporate income tax essentially asks corporations to collect a tax from persons to remit to governments, much as they do for sales taxes.
Even without a corporate income tax, the wealth from profits would be taxed when the profits are reaped by their owners, either through dividend pay-outs or through higher share prices if the profits are re-invested. Economists have long argued that corporate income taxes represent 'double taxation' of income already subject to taxes. Corporate income taxes also are partly at the expense of workers, since firms look to offset the cost of higher taxes by lowering labour costs, via wage restraint or even moving to low-tax jurisdictions, resulting in lost jobs. Alternatively, firms could pass on income taxes through higher prices, which costs all consumers.
Politically, however, it has proved impossible to convince the public of the futility of shifting the tax burden to corporations [witness the recent outcry over Apple paying little income tax]. The next best alternative is to lower the rate as much as possible, something governments have been doing. A KPMG survey found that the world's average corporate tax rate fell every year from 29.0% in 2000 to 23.0% in 2011. Among the richest countries, the OECD average statutory corporate income tax rate was 27.6% in 2007, down from 33.6% in 2000.
Canada has a slightly lower corporate income tax rate than the OECD average, although it varies by province. On top of the15% federal rate, these rates range from 10% to 16%, standing just below 12% in Ontario and Quebec.
Corporate taxes are not the only form of taxes that businesses face. The average effective tax rate on corporate profits is a measure that captures other taxes imposed on businesses. It's calculated based on total corporate transfers to government as a share of corporate profits. Statistics Canada captures all the revenues governments collect from corporations, so when Ontario calls a tax on firms an Employer Health Tax, it's treated the same as income tax. The effective tax rate is quite close to the statutory rates, demonstrating that concerns that firms evade taxes through loopholes and creative accounting are unwarranted. The share of profits paid to government has fluctuated between 20% and 30% in recent decades, reflecting changes to the tax rate itself and the wide range of differential tax rates and deductions by industry and by province.
In addition, there are occasional calls to target excess profits at the peak of an industry boom, such as high tech in 2000 or mining more recently. However, the track record shows that by the time governments identify the boom and enact legislation to target a particular industry, the boom is already over and the increased fiscal burden only worsens the ensuing bust. This is exactly what happened with Alberta's natural gas industry in 2007 and Quebec's mining industry after 2010. Expecting governments to be smart and nimble enough to fine-tune taxes with industry booms shows a naïve faith in the efficacy of government.
The bottom line is there are several reasons why governments should reduce their reliance on corporate income taxes. Higher corporate tax rates lead to a significant erosion of the tax base [one estimate is every point increase in corporate taxes shrinks the tax base by 13.6%, compared with less than 4% for personal income or sales taxes]. This reflects the relative ease with which firms can move to lower-tax jurisdictions. Also, higher taxes reduce investment, which reduces corporate profits and therefore corporate income taxes. Lower investment also inhibits productivity growth, which dampens wages.
Ultimately, the major stumbling block to lowering corporate income taxes comes down to the public's perception of equity-that it's unfair that an entity, even if it only exists on paper, should earn money and not pay taxes. This concern for 'fair' treatment is misplaced. Corporate income taxes are ultimately paid by people. Moreover, the tax and transfer system for persons is the best way to address questions of equity, since it's uncertain how corporate taxes are distributed among workers, consumers and investors. The personal tax and transfer system does a better job of targeting who gains and who loses from tax changes than the blunt instrument of corporate income taxes.
Senior Fellow, Fraser Institute