It would be wrong to postpone corporate tax cuts

By DON DRUMMOND

The Globe & Mail – Wednesday, September 28, 2005 Page A25

In order to appease the NDP, the Liberal government is contemplating further delay in cutting the income-tax rate for large corporations to 19 per cent from 21 per cent. Such delay would be bad policy and a misreading of Canadians' views on economic policy.

Capital formation is key to bolstering a country's productivity and standard of living, but excessively high tax rates on our corporations stifles capital formation. As the C.D. Howe Institute has calculated, Canada has the second highest effective tax rate on investment among 36 industrialized and developing countries. The result? Canada's share of world foreign direct investment has fallen to 3 per cent from almost 8 per cent in 1980; the ratio of machinery and equipment to hours worked in Canada is only 55 per cent of that in the United States. The Centre for the Study of Living Standards estimates that our lower capital intensity explains one-quarter of the gap between our productivity and that of the U.S.

Cutting the tax rate for large corporations would help alleviate that problem. It would also help level the playing field between income trusts and corporate entities. The Finance Department has estimated the government lost $300-million in revenue in 2004 from corporations that became income trusts, whereas it would have lost only $135-million if the large corporate income-tax rate had been cut to 19 per cent from 21 per cent.

As well as lowering the tax rate, Ottawa should also be reducing the tax on dividends. Doing this would end the double taxation of dividends, and enable corporations to allocate their profits to retained earnings, capital gains, dividends or cash disbursements based on strategic grounds rather than merely to take advantage of tax distortions.

The logic of tackling a tax leakage by moves that would actually eat into revenues may not, at first, appeal to the government. But the approach is vastly superior to the other two options raised in the Finance Department's consultation paper on income trusts. Restricting the deductibility of interest or putting a tax on payouts would hammer the value of income trusts -- and that would be bad news economically and politically.

Further, the problem of whether new tax rules should apply to all entities or only new trusts appears intractable with unfairness inherent in any approach Finance might adopt.

I think the economic benefits of cutting the corporate income-tax rate and lowering the taxation of dividends are clear. But is this a Liberal thing to do? There may be concerns that individuals with more than $100,000 of annual income receive 57 per cent of taxable dividends compared to just under 20 per cent of total income assessed.

However, more than one-fifth of dividends are in the hands of those who earn less than $50,000. (Such figures aren't surprising as investors turn to equities in their quest for a return in this low-interest environment.) With lower dividend taxation, stocks could play a bigger role in turning savings into a better life and a secure retirement for many of the not-so-rich. Further, were we to deepen capital and make the economy more productive, the incomes of all Canadians would rise through more and better paying jobs.

Canadians appear to understand that in order to have good jobs we need strong corporations and in order to have strong corporations we need a competitive tax structure. Despite federal trepidation, there was no voter backlash when the Liberals, in 2000, decided to lower the corporate income-tax rate to 21 per cent from 28 per cent, and twice cut the tax rate on capital gains -- which are even more skewed to the wealthy than dividends.

The corporate income-tax cut for large corporations may fall victim to political expediency this fall. But the proposal is solid and, when combined with lower taxation of dividends, can form a key plank in an economic agenda the Liberals could build around productivity and prosperity for all Canadians. So the government should make these moves if not now, then, at the latest, in an early 2006 budget. To achieve a nice Liberal balance they could be paired with actions to lower the outrageous marginal personal income-tax rates faced by lower-income Canadians.

Complementary action is required from provinces that still tax capital directly and apply their sales taxes to investment, and from municipalities that levy onerous commercial and industrial property taxes. Corporations must also do their part. They have not been ramping up their investment spending in line with growing profits and with the falling capital goods prices that are due to the stronger Canadian dollar. The challenge Finance Minister Ralph Goodale put to the corporate community last spring is valid: If the government moves to level the playing field with our competitors, Canadian corporations must be prepared to play hard.

Don Drummond, senior vice-president and chief economist at TD Bank Financial Group, is a former federal associate deputy minister of finance.