Don’t bet the farm on lower taxes

I have said many times that I prefer that a jurisdiction make an effort to have a competitive corporate tax rate (around the average among competitor jursidictions) and then use targeted tax cuts to incentivize specific behaviour (like business investment). I heard last week about PEI’s five year tax holiday for Phds.  That strategic use of tax policy I think has better results.  We already use the tax system to incentivize all kinds of personal behaviour such as investing in RRSPs, education, home renovation and I think in a targeted (not overly complex) way we could and should do the same with corporate taxation.

I bring this up because the feds are hammering this point about lower taxes to almost the exclusion of all else.  The reality is the rise in the Canadian dollar has wiped out any lower tax advantage anyway so cutting taxes to the lowest level in the G7 reduces our ability to make investments in R&D, education and economic development supporting infrastructure and is not as efficacious as they might think.   Take a look at the simple analysis below.  If a jurisdiction deeply cuts its corporate tax rate by 33% compared to its competition it will increase the profit margin by 1%. A small five percent currency valuation shift will cut the profit margin ata  20% tax rate to well below the profit margin at 30% and if we see the kind of currency shift we have witnessed in Canada in recent times, it all but wipes out the profit margin – even at the lower tax rate.

Of course my model assumes a Canadian company selling entirely in U.S. dollars and facing a cost structure in Canadian dollars but that’s not too far off for a large number of Canadian firms that are selling into the U.S. 

If he is trying to attract investment to Canada, I think Flaherty would be far better off pushing R&D investments, tax credits for investing in productivity, etc. than pushing a lower tax rate. 

 

With a 30% Tax Rate

With a 20% Tax Rate

20% Tax Rate + 5% decline in currency advantage

20% Tax Rate + 10% decline in currency advantage

Revenue

$10,000,000

$10,000,000

$9,500,000

$9,000,000

Costs

8,500,000

8,500,000

8,500,000

8,500,000

Net Profits

1,500,000

1,500,000

1,000,000

500,000

Taxes

450,000

300,000

200,000

100,000

Net Profit after Tax

1,050,000

1,200,000

800,000

400,000

Profit Margin

11%

12%

8%

4%

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8 Responses to Don’t bet the farm on lower taxes

  1. mikel says:

    It’s not just the feds hammering this, obviously NB”s entire financial future is based on it. There are other problems as well when governments make all kinds of changes. For example, the deconstruction plant in northern NB says it is more profitable to be in NB than in southern ontario. They DON”T say whether that is because of lower utility rates, or lower tax rates. It MAY be both, but it may be only one, in which case even the little corporate interest they are seeing has nothing at all to do with taxes.

    But again, ‘its politics stupid’. This is part of a very concerted plan to decrease the size and operation of government and privatize as much of it as possible. There is no way that somebody with even Shawn Graham’s limited education can think that NB’s tax rate is going to have industries clamouring to come to northeastern Canada. Mind you, this is a guy so dumb he talks about suing the feds in one moment and then talks about how they are working with them to finance the St. John bridge. However, its WELL known Reaganomics doesn’t work. You’d have to have your head in a vise not to have noticed the massive growth under Clinton and the limited growth under virtually EVERY Republican President.

    Although Harper has been spending like a maniac, its been very targeted spending. NONE of it, proportionately, goes to education and research. Again, with R&D spending, which means PEOPLE, we know what the future looks like-its right under us. Take for example RIM’s investment in Fredericton. There they are smartening up and RIM is getting a payroll rebate-they are not getting a cheque, and IF Graham were serious when he said this means NB means ‘innovation’ then it would be recognized exactly what Chalk Media does-engineering and software. So where are the incentives? Where is the engineering and software spots at community colleges?

    We already know all this, we quoted years ago the study in Maine where taxes were about eighth on the list of reasons companies locate in a specific area. All this means is that a company says to their home state “hey, NB has CIT of X%…match it or we move”. And we know that they RARELY refuse such demands.

  2. ibet says:

    Tax rate or any other kind of taxes to a company is only used to keep upstarts from invading tenured territory. Considering all companies are subsidized pro rata.

  3. richard says:

    You have to wonder, David, why the ‘lower tax spurs the economy’ mantra keeps on being repeated, despite the meagre evidence in support of it. As you know, there are several well-funded ‘think tanks’ in the US and Canada that produce this propaganda 24/7. The compliant mass media repeats the stuff, usually without question. No one likes taxes, and many do not see the connection between the taxes they pay and the services their community receives. Thus the ‘lower tax’ mantra is a fairly easy sell.

  4. Samonymous says:

    Lowering taxes and reducing regulation is more about making New Brunswick a better business environment than it is about specific industries coming in (or being picked). In other words, the more government interference you have, the more likely it is that you will have more disgruntled businesses unhappy with the economic climate. Make things more equal and fair across the board and you will have more winners than any government can ever pick.

  5. ibet says:

    So and so, came back here from BC, to take over a retiring small construction company. Won a contract on a highway overpass with the government, (one which is still perfectly level unlike brunways), was hounded so bad by the government graduate engineer(so and so being an P.Eng of 10 years experience himself), swore he would never bid another government contract and never has, except in Alberta, where common strict sense prevails! And after 8 years in business I have never heard him or anybody else complain about taxes. What you see is all your going to get. Favoritism always!

  6. mikel says:

    Companies LOVE ‘government interference’-as long as it comes in the form of tax breaks or outright subsidies. RIM just expanded in Fredericton and nowhere in there did I hear griping about NB ‘not having the right climate’. For RIM and other tech companies, the problem is a lack of companies doing the work they’d pay to own, and the workers to develop new products. However, the reality is that the last line simply can’t be substanciated because there are so many other jurisdictions out there and only x amount of investment dollars. NB could do EVERYTHING ‘right’ and ‘fair’ and it still doesn’t mean investment or companies will go there.

  7. Rob says:

    It’s a simple cycle:

    Budgets are balanced,
    Taxes are cut,
    Creating a deficit,
    Meaning that social spending must be cut,
    and the budgets are balanced,
    …so taxes are cut.

    The GST cut of 2% created a good part of the federal deficit, not “increased spending”. The same goes for our province. This time, though, we’re divesting crown corps as well as cutting social spending to balance the books.

  8. ibet says:

    Seems, right and fair, would be a good motto. They should just try it some decade. Thats how the citizen is expected to behave.

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