In a previous blog I noted that Dalton McGuinty, the Premier of Ontario, mistakenly claimed that tax harmonization eventually would create up to 600,000 jobs and generate $47 billion in investment in the province. Jack Mintz, the director of the School of Public Policy at the University of Calgary, produced those numbers. I also pointed out in that blog that I would leave for another day a discussion of the logical flaws in his theoretical analysis. Well this is the blog where I will deal with those flaws.

Mintz’s job creation and investment conclusions were driven by a significant reduction in the effective tax rate on investments in Ontario.

Before I begin, I should it make it clear that I do not believe there is any sound economic reason for a corporate income tax. Corporations are legal entities created to benefit from limited liability. They are not persons. So they cannot and do not pay taxes. However, withholding taxes, equal to the marginal personal income tax rates, should be levied on all incomes paid out to non-Canadians.

Back to Mintz – Craig Alexander, the new chief economist for the Toronto Dominion Bank, writing in the Globe and Mail Report on Business on May 14, noted the following:

– productivity growth averaged 0.7% per year thus far this decade, the lowest average for any decade in the last 40 years;

– Canadian companies invested less than companies in other countries in productivity enhancing and innovative technologies during this decade; and

– the effective marginal tax rate on capital has declined during this decade.

Putting all of these together should raise all types of red flags for economists, including Mintz. Lower tax rates do not seem to have had any positive impact on investment decisions, although Mintz could respond that in the absence of these cuts, Canadian companies would have invested even less. This is difficult to disprove or prove empirically, just as it will be difficult to disprove/prove empirically Mintz’s conclusions in 10 years’ time. So let me resort to logic.

The economists’ model of investment decisions assumes that there is a list of potential opportunities, like manna from heaven, and they can be ranked from most attractive in terms of future cash flows and corresponding net present values to least attractive. The tax rate plays a role in estimating these cash flows and present values. The lower the tax rate, the higher should be the cash flows and present values. Thus, more investment opportunities would be selected. At the margin, a lower tax rate should lead to higher levels of investment spending, or so goes the theory.

There are two problems with the simple theory. First of all, the estimated future cash flows are at best just guesses. They are not known with any degree of certainty. Setting aside the possibility of Black Swan events, no one can predict with any degree of certainty how competitors will act, how economies will behave, and how governments may change rules. Decision-making is always fraught with uncertainty and risks.

But this is the lesser of the two problems. The second, and more important, stems from dissociating investment opportunities from strategy.

Companies must always be searching for a competitive advantage and for the strategies necessary to give them a chance for creating the advantage. Of course, there is no guarantee that any company will succeed, or even if one does, that its success will be long-lasting. This is the essence of competition, or what Joseph Schumpeter labelled “destructive competition”.

Competitive strategies produce the investment opportunities. Changes in tax rates should have little, if any impact on the development and selection of competitive strategies and their associated investments. They should only affect how companies allocate their taxable profits, if any, among their various geographic and business units.

The pursuit of a competitive advantage is a life and death matter for companies. The pursuit of a competitive advantage, with all of the inherent risks, and the possibility of large payoffs are what drive risk taking and investment decisions. Deferring a critical investment because of tax rates does not describe reality.

When there is a fine line between survival and success, will senior management defer an investment because the marginal effective tax rate might be a few percentage points “too high”?

Weak, indecisive and risk averse senior managers impede investments in new equipment and technology. Tax rates serve as a convenient excuse for poor management.

The opinions expressed in this blog are personal and do not reflect the views of either Global Brief or the Glendon School of Public and International Affairs.