Are High Corporate Taxes Killing Jobs?

In March, Federal Finance Minister Jim Flaherty called Ontario the “last place” in Canada to start a business, due to high corporate tax rates. It's not quite clear why he would single out Ontario, which actually has a corporate tax rate for general active business income of 14%, which is in the middle of the pack for the provinces (KPMG data). Nova Scotia, where he was speaking, has a rate of 16%.

Still, Mr. Flaherty's basic argument is that all provinces, and the federal government, should reduce corporate taxes to attract more investment. He wants all provinces to have a rate of 10% by 2012, and wants to reduce the federal rate from 19.5% to 15% so that the total corporate tax anywhere in the country would be 25%. Might he have a point?

Obviously, lower taxes would tend to encourage investment. Having lots of economic activity creates a high demand for labour, leading to high wages and prosperity.

But taxes do lots of good things too. They pay for health care, education, roads, social programs, etc. Many of these things also tend to create an environment attractive to investment.

Good public health care means that companies do not need to provide that for employees. A well educated workforce is a good selling point. Companies need good, efficient public infrastructure. Social programs reduce poverty, making cities more attractive. Do even corporate executives enjoy seeing slums?

We need to strike some kind of balance between excessively high taxes, which would drive away investment, and excessively low taxes, which would leave governments unable to fund services and exacerbate inequality. We can also think about what kind of taxes to collect. Should we shift some of the burden from corporate income tax to some other kind of tax?

There is some evidence that high corporate taxes reduce prosperity. In a recent paper from the American National Bureau of Economic Research, the authors look for evidence that corporate taxes influence investment and economic growth using data from 85 countries, both rich and poor. They had accountants calculate all taxes that would be paid by a hypothetical corporation in each country, and looked for a relationship between that and investment and growth rate. Their findings suggest that corporate taxes reduce investment and growth.

But there are certainly some very prosperous countries which have very high taxes, and which have had them for a long time. The prime examples are the Scandinavian countries like Sweden. In 2004, total tax receipts were 50.4% of GDP in Sweden. That compares to 33.5% in Canada and 25.5% in the USA (OECD figures). Sweden has much less inequality than Canada or the U.S., and much less poverty. It has a per capita Gross domestic product (average income) of $32,500, compared to $33,500 for Canada and $41,900 for the USA (figures from UN Human Development Report are adjusted for cost of living differences).

Sweden's per capita GDP may look a bit less impressive than Canada's and quite a bit less impressive than that of the USA. But American income is very heavily concentrated at the top. Average income looks good because there are just a few extremely rich people. Most people are not that rich. The same is true of Canada, to a lesser extent.

Using income distribution data from Sweden and the U.S., and the above figures, you can calculate, for example, the average incomes of the poorest 60% of the population in each country. The figure for Sweden is $13,000. For the U.S., it is $11,100. So most people would be better off in Sweden.

There are certainly many things besides tax policy that influence both per capita GDP and income distribution. But the Swedish case shows that it is possible to be very prosperous with high taxes and low inequality.

While Swedish taxes are generally very high, however, corporate income taxes are not. Such taxes amounted to 3.18% of GDP in Sweden, compared to 3.45% in Canada and 2.21% in the USA (calculated from 2004 OECD figures). Sweden collects very high taxes from rich individuals, but keeps corporate income taxes down to encourage investment.

So I think that Jim Flaherty might actually be making some sense when he wants to reduce corporate income taxes. But I think if we did that, we should raise taxes for rich individuals to at least make up the lost revenue. Then we could tackle our growing problems of inequality and poverty without discouraging investment.

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