Corporate tax cuts are good for workers

Article published exclusively on the Montreal Economic Institute’s website.

Yesterday, the official federal opposition unveiled its plan to get public finances in order and reduce the budget deficit to 1% of GDP within two years. The government, for its part, foresees a return to budgetary balance in the 2015-2016 fiscal year. We must welcome this bipartisan commitment to re-establish a balanced budget. Unfortunately, one of the measures proposed by the official opposition, namely cancelling scheduled corporate tax cuts (set to drop to 15% in 2012), would seriously harm Canadian workers and hamper the economic recovery.

Taxing business revenue has the effect of extracting a portion of the profits generated by companies. When such taxes are raised, it pushes companies to invest elsewhere. We therefore lose the investments that could have increased our productivity. As a consequence, it is workers who in practice bear the costs of raising corporate taxes. This link, however, is not widely appreciated.

Firstly, it must be understood that more productive companies can offer higher salaries and better overall working conditions to their workers. More productive companies can also afford to pay higher prices to their suppliers, which in turn allows those suppliers to offer better salaries and conditions to their own employees. Raising corporate taxes, though, reduces the investments that would otherwise have improved worker compensation.

The Fortin Report on business investment in Quebec, commissioned by the Charest government and released in 2008, clearly documents this relationship. Two Oxford University researchers studied 23,000 companies in 10 industrialized countries. In the short term, 54% of all corporate tax increases resulted in reduced salaries. In the long term, every $1 increase in corporate taxes led to a salary reduction of more than $1. A 2009 study by a Federal Reserve Bank of Kansas City economist came to similar conclusions for the United States. From 1977 to 1991, a one percentage point increase in corporate taxes reduced salaries by 0.27% on average. From 1992 to 2005, because of increased capital mobility and tax competition, the same one percentage point increase in corporate taxes reduced salaries by 0.52% on average.

Increasing corporate taxes might hurt Canadian investors, but their capital is mobile and they can therefore find better opportunities elsewhere. Workers do not have the same mobility and are therefore the main losers of such a policy. On the other hand, if the government sends the opposite signal – by reducing the corporate tax burden – then businesses will be more enthusiastic about investing in Canada. An influx of capital would expand the fiscal pie and thereby partially compensate for lost revenue while also accelerating economic growth, which would lead to higher salaries.

Secondly, workers – who are also investors through their RRSPs, their TFSAs or their pension plans – want to obtain the best possible returns. High corporate taxes reduce the dividends businesses can pay out to shareholders. Among those shareholders are banks and pension plans that invest workers’ savings. With weaker returns, workers will either need to work longer to reach their goals or settle for less. Once again, workers shoulder the costs without even realizing it.

Even though we welcome the emphasis on deficit elimination coming out of Ottawa, this initiative must not strangle the Canadian economy by raising the tax burdens of individuals and businesses. It is only by limiting the growth of public spending and by lowering the tax burden to a reasonable level that we will be able to combine a balanced budget with sustainable economic recovery.

Jasmin Guénette is Vice President of the MEI, Vincent Geloso, economist at the MEI.

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