Contempt for Corporate Canada is Costly

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Patrick Basham, Jason Clemens, and Joel emes

Quick, hide your corporate profits!

We are rapidly approaching the period when Canadian corporations begin to report what will inevitably be billion dollar profits. The media-inspired collective howl that normally accompanies these announcements illustrates the contempt Canadians have for big corporations. We love to hate corporations, especially when they announce huge profits and disclose executive salaries.

What underlies this disdain and the repeated calls for higher corporate taxation is a fundamental misunderstanding of who actually pays corporate tax, and the effects of corporate taxation.

Who really pays corporate taxes?

It is a fallacy that corporations in and of themselves pay corporate tax. After all, a corporation is nothing more than a legal instrument used to create a business. In practice, those who receive wages, dividends, or goods and services from corporations carry the burden of corporate taxes.

Businesses can do only one of two things with profits: pay the owners in the form of dividends, or reinvest in the company. Corporate taxation reduces the amount available for both.

It’s easy to see how corporate taxes are passed on to investors. The amount of profit available to business owners is reduced by the amount of corporate tax. The fact that over 50 percent of Canadians own shares, either directly or indirectly through pension and mutual funds, means that this indirect tax is levied on a significant number of Canadians.

Corporate taxes also adversely affect workers. The reduced amount available for reinvestment due to taxes affects workers by inhibiting the purchase of new machines and equipment, and limiting the introduction of new technology. This reduced level of reinvestment affects workers’ productivity and, ultimately, their wages.

Finally, the presence of corporate taxation can increase the price of goods and services to consumers.

So, corporate taxation only serves to ensure that investors, workers, and consumers all lose. Successive governments have implicitly agreed with this view by never challenging the findings of the 1966 Carter Commission’s Report on Taxation which essentially came to the same conclusion: individuals ultimately pay business taxes.

Nuts and bolts of corporate taxes

Those advocating corporate income tax increases argue that corporations pay less than in the past. As a share of total government revenue, corporate income tax has declined from 13 percent in 1961 to 9.3 percent in 1997. However, this is a result of larger growth in other taxes, particularly personal income tax, rather than a decrease in corporate income tax. As a percent of GDP, corporate income tax has increased from 2.9 percent in 1961 to 3.1 percent in 1997. The burden of corporate income tax has increased.

Corporate income tax is, however, only one form of tax assessed on business. To get a more accurate picture of the total business tax bite, one must examine all taxes paid by business, which include capital, property, and sales, as well as corporate income tax.

Changing mix of business taxes

In 1950, 60 percent of all business taxes were derived from corporate income tax. By 1995, corporate income tax represented only 25 percent of total business taxes. Other taxes, particularly capital and property taxes, increased significantly and comprised a larger share of the total business tax bite.

The reason for the change in the mix of business taxes is stability. Corporate income tax depends on profitability, which depends on the state of the economy. Corporate income tax is, therefore, a much less stable source of revenue than other business taxes.

When all forms of taxation are included, the growth in business taxes is much larger than when we solely examine corporate income tax. For example, total business taxation as a percentage of the total income generated by business activity - a more accurate measure of business taxation - grew from 13 percent in 1950 to 18 percent in the 1990s; an increase of 39 percent. Clearly, the tax burden placed directly on business, and thus, indirectly on individuals and families, has increased.

Given the deleterious effects of business taxes on workers, consumers, and even those lowly shareholders - remember that over 50 percent of all Canadians own shares - and the fact that many of Canada’s principal trading partners are reducing corporate taxes, it is essential that the federal government introduce changes to business taxation.

The Mintz Report on business taxation

Fortunately, there is a ready-made plan. Professor Jack Mintz of the University of Toronto submitted a detailed proposal for business tax restructuring in December of 1997 which has to date been totally ignored by the federal government. It sets out a clear, reasonable, and effective plan for restructuring the business tax system in Canada.1 The plan contains two major reforms.

The first is the elimination of the federal government’s tax-based industrial policy of choosing business winners and losers. The federal government currently chooses winners in industries, such as manufacturing and processing, by assessing corporate income tax at a substantially lower rate than is applied to other non-manufacturing industries, such as finance and computer software development.

The federal government specifically applies a corporate income tax rate of 22 percent on manufacturing and processing firms while assessing non-manu- facturing firms at 28 percent. Interestingly, the very industries being penalized by the federal government are some of Canada’s most vital and thriving sectors. Mintz recommends eliminating the differential tax rates and provides a framework to achieve this without adversely affecting government revenue.

Once provincial corporate tax rates are added, the average corporate income tax rate for manufacturing firms is roughly 35 percent while the rate for non-manufacturing firms is approximately 43 percent. Although Canada’s manufacturing sector is in a relatively competitive tax position with our chief competitors, the general corporate tax rate, or the rate that is applied to all non-manufacturing firms, severely hampers the ability of our more dynamic and innovative sectors to compete internationally.

The second recommendation the Mintz Report makes is to lower corporate income tax rates to levels competitive with our trading partners. Both the report and a recent update recommend reducing the corporate tax rate to 30 percent for all companies. The reduction in corporate income tax is imperative if Canada is to remain competitive given the recent action by a number of countries to reduce their corporate tax rates.

Conclusion

Over the next few weeks, Canadians will likely demonstrate their "love-to-hate" relationship with some of our most productive and competitive companies. No doubt the usual media and lobby group suspects will call for an increase in corporate income tax.

It’s doubly important, therefore, to remember who really pays the price of corporate income tax: workers, consumers, and shareholders - ordinary Canadians. Rather than stirring up outrage toward successful corporations, we should concentrate our collective energies on producing more such success stories and taxing them (i.e., ourselves) less by implementing the recommendations of the Mintz Report.

Notes

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Last Modified: Wednesday June 9, 1999.