Much ado about corporate taxes
Jim Stanford, the chief economist for the CAW, concluded, in a study prepared for the Canadian Centre for Policy Alternatives, that corporate tax cuts do not spur investment. On the other hand, Jack Mintz and most other economists in Canada continue to argue the opposite case: corporate tax cuts do spur investment. Who is right?
Jim is, of course!
The basic theoretical model states that if the present value of the future incremental cash flows created by the investment exceeds the cost of the investment, a firm should proceed with the investment for it will increase the value of the firm. In this model, cuts in corporate tax rates should increase the incremental cash flows, and thus, more investment expenditures should result.
There are two serious flaws in this basic model. which underlies the positions of Mintz and most other economists. The incremental cash flows that enter into the analysis are guestimates. They are made up numbers! Therefore, there is a high degree of risk built into these guestimates and the subsequent investment decisions.
In light of the significant uncertainty inherent in the estimated cash flow numbers, prudent firms would proceed only with those investments where the present values of the estimated incremental cash flows far exceed the costs of the investments. A cut in corporate tax rates unlikely would shift the balance towards more investments. Indeed, the corporate tax rate should play a minimal role, at best, in this decision-making process.
Investment decisions are part of the execution of strategic initiatives. As such, investments are a life and death decision for firms. Either a firm makes an investment to create or enhance its competitive advantage, and thus improve its financial and competitive positions, recognizing that the decision might turn out to be a failure; or it does not make the investment, thus risking its future competitive and financial positions. Corporate tax cuts only should affect where a firm records its revenues and costs.
Does this mean that I am opposed to corporate tax cuts? On the contrary, I believe they serve no useful economic purpose. This leads to the second major flaw in the basic model.
This model assumes that a “corporate entity”, created to benefit from limited liability, actually pays the tax. There is much evidence that shows this not to be the case. The stakeholders in the firm absorb the tax – shareholders, employees, customers and suppliers. Consequently, a cut in corporate tax rates should not have any impact on the estimated incremental cash flows of a firm. Such cuts might affect the cash flows of the many stakeholders, but not of the firm itself.
The ongoing political and economic debate over corporate tax rates is a waste of time. Lower corporate tax rates will do nothing to enhance the competitiveness and productivity of the Canadian economy. But corporate tax rates in general serve no real purpose other than a rallying call for leftists.
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.