Why aren’t corporate tax cuts working?

An article caught my eye recently about how Canada’s cuts to corporate taxes aren’t having the big growth effect that business-friendly think tanks keep saying they should. Canada’s corporate tax rate has fallen steadily in the last decade, resulting in $85 billion in increased corporate saving particularly in the past two years, but comparatively little increase in capital investment or economic activity.

The idea of corporate tax cuts is based in supply side economic theories developed in the later half of the twentieth century, and most famously implemented in the United States by the Reagan administration in the early 1980s. Supply side tax policy favours tax breaks for the economy’s suppliers, namely corporations, especially large corporations which can produce more. By reducing the barriers to production (that is, corporate tax rates) suppliers produce more, which leads to increased employment, higher wages, lower prices for consumers and economic growth. In the extreme case, which George H.W. Bush famously called “voodoo economics” in the 1980 presidential primaries, the growth in GDP is enough to offset the corporate tax cuts, leading to an overall increase in government revenues.

This scenario has never played out successfully anywhere in the world, including in the United States. Reagan’s 1980 across-the-board tax cuts did not result in an increase in revenues for seven years, and by then the national deficit had grown from $40 billion in 1979 to $225 billion in 1986, and the nation’s public debt grew to nearly half of GDP. Most economists now agree that Reaganomics actually didn’t result in any significant economic growth that wasn’t explained by regular economic cycles, while public debt exploded and private saving was reduced to almost nothing. The deficit grew every year until Bill Clinton raised tax rates in 1993, cutting the deficit in half in a single year. When George W. Bush came to the presidency in 2000, his Reagan-style tax cuts resulted in another explosion in public debt (topping $10 trillion), culminating in the sub-prime mortgage crisis and severe recession of the last few years.

Now, while deficits are so high and revenues are so small that rural American towns are literally tearing up their roads, politicians on the extreme right are ignoring proven economic facts of the last 30 years and screaming for even more tax cuts for the super-wealthy, and real American families are poorer and deeper in debt than ever before. Other countries around the world that have slashed corporate taxes and failed to rein in deficits over the last two decades are now starting to feel the effects. Economic crises in Greece, Italy, the United Kingdom, Ireland, Spain, Portugal, Iceland (the list goes on and on) were all caused by ballooning public deficits while corporate taxes were held or reduced, resulting in the infamous austerity measures: higher tuition fees, cuts to social welfare programs, and pensions slashed for millions of people.

Why do fiscal conservatives like Stephen Harper want to bring these economic policies to Canada? The theory that tax cuts spur economic growth has been thoroughly debunked by leading economists, and the experience of other countries shows that tax cuts for the rich create huge deficits that lead to financial ruin. But Harper’s firm support base is generally made up of those people who stand to gain the most from the cuts to corporate and high-income-earner tax rates. The Conservative Party is trying to sell tax cuts to lower-income earners and less right-of-centre voters by saying that tax cuts create jobs and lower prices, and that our economic recovery was due to lower tax rates. That’s mostly bunk.

For one thing, prices are determined by free market forces, which aren’t affected by corporate tax rates. They can be affected by personal tax rates, which can affect purchasing power and thus demand, but the effect is minimal. The effect of a supply-side tax cut would be to increase supply, except that corporations don’t have an incentive to increase supply because that would lower prices, all other things equal. Lower prices means less money for the corporation. So rather than expand, the corporation sits on the money they save, taking it out of the economy, and prices stay the same. That’s the effect we’re witnessing in Canada right now.

Harper’s claims that his tax cuts helped us get through the recession are also a good story. Canada survived the global recession of the late 2000’s because of sound fiscal policy under Jean Chrétien and Paul Martin, whose government ran balanced budgets for most of their 14 years in power. Harper’s successive minority governments since 2006 have been running record deficits built on lowered taxes for the richest Canadians, pushing us toward a Bush-style crisis, but have been unsuccessful so far in attempts to dismantle our economic safeguards. Surviving the economic downturn is Chrétien and Martin’s legacy, and financial ruin will be Harper’s, if we allow his party to continue in power.

About Greg Burrell

Greg is an accountant, cyclist and political observer living in Toronto, Canada with too many cats.
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  • I feel that, this idea is best for all countries. It should be implement in all country. You described very clearly. Thank you for sharing this information.