Jack M. Mintz: We need radical corporate tax reform

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Corporate income tax in Canada hinders economic growth

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Corporate income tax in Canada is a mess. It discourages capital investment, it creates strong distortions and it is extremely complex, which hampers economic growth. With current inflation rates, its distortions are even greater. With so many tax benefits, the overall federal-provincial corporate income tax rate of 26% generates just over 19% of corporate profits.

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Taxes generally distort economic activity: production of the taxed good or service is reduced when tax rates increase. But the value of lost production is greater than the addition to government revenue. The reason is that market transactions involve report earnings and when taxes wipe out production and sales, net earnings also disappear. The distorting effects of taxation are many and varied: intertemporal, interprofessional, interactive and international, they also affect risk taking, financing and the organization of companies.

Corporate tax is insanely complex, requiring thousands of pages of statutes, regulations and interpretation bulletins. That’s great for lawyers and accountants, but not for businesses that prefer to spend time understanding the ins and outs of their markets, rather than the tax system. With the global minimum tax of 15% proposed by bureaucrats from 136 countries, the complexity will reach even higher levels.

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Corporate taxes are currently skewed towards machinery-intensive industries, including forestry and manufacturing, with the greatest benefits going to central Canada. Federal corporate taxes provide the greatest benefits of all to investments in agriculture, fishing, forestry and manufacturing in Atlantic Canada. Tax rates depend not only on the level of profits, but also on whether the revenues come from clean technologies or other politically favored business sectors.

Studies have shown that accelerated depreciation and investment tax credits increase inequality between workers. These incentives, especially for machinery, increase the demand for skilled workers, whose wages therefore rise relative to those of unskilled workers. A more neutral corporate tax that would not only favor certain types of capital investment would create less inequality.

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To build productive capacity in a post-COVID world, we need a big bang approach that would put Canada in a better position to attract investment and reduce business tax distortions and complexity. As I show in detail in a new to study for the University of Calgary’s School of Public Policy, several major revenue-neutral reforms would increase neutrality and reduce complexity.

One such reform is to shift corporate tax to distributed profits: profits from investment activities would only be taxed when distributed to investors. Reinvested earnings would be tax exempt. It is only when the money is taken out of the business and paid out to the shareholders that it is taxed.

Estonia introduced such a tax in 2000. In 1999, before the reform, corporation tax was equivalent to 0.9% of Estonian GDP. In 2019, they represented up to 1.7% of GDP. Unsurprisingly, investment in Estonia increased by 31% between 2015 and 2019, the third highest in the OECD, compared to negative 0.5% in Canada

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  1. The tax bias in favor of leverage increases with higher inflation.

    Jack M. Mintz: Inflation makes tax damage worse

  2. The federal government should turn the taps back on with $100 billion in new social programs and climate grants.

    Jack Mintz: Are you ready for 22% more taxes?

  3. Nothing

    Jack M. Mintz: “Modern supply-side economics” is still the same

To avoid base erosion, my proposal would tax things like share buybacks, which effectively return funds to shareholders in the same way as dividend distributions. And I would retain the current tax treatment of “passive” income and capital gains realized by the corporation on assets unrelated to its own business activities. I estimate that a fixed corporate tax rate on distributed profits that would generate the same income as today would be a combined federal-provincial rate of 27.2%, compared to 26.2% today.

A tax that exempts reinvested profits reduces taxable corporate income, but not as much as one might think. Because of all the tax incentives, corporations’ taxable income is currently on average about 25% lower than their operating profits. But most incentives are designed to encourage investment, so taxing distributed profits eliminates the need for it: reinvested profits are not taxed.

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What I am proposing has the disadvantage of leading companies to favor the financing of their operations by retained earnings rather than by new issues of debt or shares. In addition, investors would benefit from the ability to defer tax on their corporate-source income until the company finally pays it – although with low real interest rates the value of the deferral is all negligible way. Finally, due to the reinvested earnings exemption, capital gains would have to be fully taxed at a personal level (although capital gains income would be adjusted for inflation).

Overall, the system would be much less complex. The big bang approach would encourage more investment and risk taking and keep governments and their tax giveaways out of the nation’s boardrooms. Inter-asset and inter-industry tax distortions would fall by 95 percent.

My proposal is not perfect, but it is better than the current system, which is exceptionally distortive, with high economic, compliance and administrative costs. Taxing only distributed profits would make corporate income tax fairer and simpler, reduce administrative and compliance costs, and maintain corporate tax revenue. Ask business people: that would be a big plus.

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