International Corporate Tax-Rate Fixing Will Bind Canada, Limit Choices and Harm Growth

Commentary, Economy, Ian Madsen

The finance ministers of over 130 nations and territories have arrived at a tentative agreement that will create a tax floor⁠—a minimum corporate tax rate of a proposed 15 per cent. Its proponents, including Ottawa, sadly, claim it will create a “level playing field” and stop what some of them have called a “race to the bottom.”

This race is one in which competition among nations and the supposed game-theory skills of major transnational corporations have caused some nations to face a harsh choice: lower corporate taxes to retain and attract domestic and foreign investors or lose revenue, which will have to be made up by raising personal income and other taxes.

This tentative agreement has other features, including more precise and narrow definitions of intellectual property, digital commerce, transfer pricing and allocation or attribution of revenues, costs, profit or other flows by region or other criteria. There are also the usual bleats of “fair share.”

Several points undermine the case the eager governmental money-grabbers posit. The first is the arbitrariness of the 15 per cent figure. This has not been fully explained. Why was it not 10 per cent or 20? Presumably, the former number would be too low to satisfy some of the nations and the latter too high versus what they currently levy; ultimately, it was a negotiated compromise and not demonstrably based on optimization studies. So, there is no magic to that number; it cannot credibly be defended as inviolable and unalterable.

The next issue is that it would disadvantage some nations that have low corporate tax rates. Indeed, a key part of Ireland’s success story⁠—despite its financial near-death episode in 2008-10⁠—is its 12.5 per cent corporate rate. This rate is lower than that of most other nations, especially advanced rich ones. Ireland’s per capita GDP is now higher than that of the United Kingdom, the United States and even the Scandinavian nations and Qatar. Only Luxembourg’s is higher, and it is also a low-tax locale.  

Raising corporate income tax rates would hurt firms’ profitability, their operating cash flow and thus their available funds to reinvest and grow their businesses. Employment growth and wages would suffer from reduced economic growth. Economic growth that is lower than forecasted will hurt government tax revenues from personal income taxes, excise taxes, property taxes, sales taxes and value-added taxes (VAT). Governments would be tempted or compelled to reduce services or raise those other taxes to make up the shortfall in corporate and other economic growth-sensitive taxes, which would almost certainly fall on working citizens, reducing their standard of living.

The third issue is the notion that corporate income tax revenue is a big and vital part of overall government receipts. In fact, it is not. Using Organization for Economic Cooperation and Development (OECD) data, the Tax Foundation found that it is an average of just 9.6 per cent of total national take.  

So, if Ireland had this OECD average share from firms and had to raise it by 20 per cent, i.e., from 12.5 per cent to 15 per cent, it would gain a little less than two per cent from the exercise, at the expense of damaging its economy and people. Yet here is a minor shocker: Ireland derived 14.4 per cent of its total tax take from corporate income taxes, nearly five per cent more than the OECD average. By keeping its rate low, it has actually increased its total revenue.

Sovereignty is one of the most important concerns. By agreeing to such a tax treaty, Canada and other nations would be bound by its terms and be unable to lower taxes, except perhaps at the provincial, territorial or local level. If Canada were to be in a recession, low-growth stagnation, war or similar emergency, it might want to suspend, drastically cut or eliminate corporate income taxes. Other nations may do it without our consent anyway, emergency or not.

Related to that, subnational regions such as provinces, states, prefectures or other such places could lower their taxes or even make them negative to attract business. This sometimes happens now. The draft treaty could prohibit or limit this, but there could be other ways around it. National governments could transfer large sums to provinces or states, allowing them to dramatically lower or keep low their business taxes. Corporate income taxes could also be re-jigged to have much more generous capital cost allowances, investment tax, research and development or hiring and training credits. There are ways to game the system.

There are also other reasons not to believe the sincerity of the motives of the major proponents of this not very new idea. The new administration in Washington wants to raise corporate and personal income taxes, to supposedly help pare its enormous fiscal deficit. This will make the U.S. far less attractive to investors and companies who may want to enter or expand in the U.S. market. It will also be less attractive to high-income or highly skilled foreign or domestic professionals, entrepreneurs, financiers, inventors and technical or scientifically trained people.  

While the anticipated extra receipts from raising these taxes will not be large despite boosterish estimates, the effort is ideologically motivated. Progressives always like raising taxes and are always less than hospitable, let alone enthused, by business and free markets. If foreign governments are forced to raise their own taxes, American ones will not look quite as bad and so limit political damage.

This also gives cover to governments that are far too lazy, cautious or scared to examine what they are doing, to make them more efficient, to eliminate bad programs, sell off unneeded assets, lower their own costs and to constrain growth in spending. The excuse of the pandemic is wearing thin. The economic recovery is well underway. Gradual lowering of taxes could well bring more benefits and higher revenues than raising them on a politically disfavoured constituency such as corporations.

Finally, corporate income taxes are only one thing, albeit an important one, that domestic and foreign businesses and investors look at before committing or reinvesting money in any region or country. The United States and other rich nations that have kept the interest of their own and foreign investors feature several attractive things: 

  1. Strong rule of law;
  2. Firm property and commercial rights;
  3. Abundant, affordable and accessible sources of energy;
  4. High-quality infrastructure;
  5. Smooth, quick import and export, regardless of tariff levels, including extensive and widespread trade agreements; 
  6. High quality, educated labour forces and technical services;
  7. A stable, understandable and reasonable regulatory regime;
  8. Safety and security;
  9. Relatively stable politics;
  10.  A receptive and business-friendly government and society; 
  11.  Easy, quick and relatively inexpensive permitting and project-approval processes. 

Governments have enough problems meeting all of those requirements. Raising taxes on companies and high-income achievers will only make things worse. It will not raise much additional income and will immiserate the public. Governments have hundreds of billions of dollars or euros at their disposal. They need to make better choices, even if they are hard, and be forthright with their citizens about what can and cannot be afforded. Raising corporate income taxes may look good to a few loud people and groups, but it will harm everyone.

 

 

Ian Madsen is a senior policy analyst with the Frontier Centre for Public Policy.

Photo by Adeolu Eletu on Unsplash.