What Does it Cost Society to Raise a Dollar of Tax Revenue? The Marginal Cost of Public Funds

The marginal cost of public funds measures the welfare loss a society incurs in raising an additional dollar of tax revenue. Tax increases distort economic decisions and erode tax bases because of tax avoidance and tax evasion by taxpayers. This Commentary uses econometric estimates of the effects of higher provincial tax rates on the provinces’ corporate income tax, personal income tax, and sales tax bases to calculate the marginal cost of public funds (MCF) for these taxes. The results indicate that the cost of increasing provincial tax revenues through a corporate tax rate increase is very high, and in some provinces, corporate tax rate reductions in 2006 would have increased the present value of the provincial government’s total tax revenues. The results also suggest that significant welfare gains would accrue from reducing provincial corporate income tax rates. As well, increasing provincial corporate and personal income tax rates can cause significant reductions in federal tax revenues because the federal and provincial governments levy taxes on the same tax bases. Finally, Canada’s system of the equalization grants might reduce the perceived MCF of recipient provinces.Fiscal and Tax Competitiveness, marginal cost of public funds (MCF)

Alberta’s Fiscal Responses to Fluctuations in Non-Renewable Resource Revenue

We investigate how successive Alberta governments have responded to shocks in non-renewable resource revenue over the period 1970 to 2017. Our results show that Alberta governments have increased spending by 63 cents in the fiscal year following a one dollar increase in real per capita non-renewable resource revenues.  On the other hand, when non-renewable resource revenues have declined year over year, Alberta governments have not adjusted spending or other own source tax revenues. As a result of these asymmetric responses to fluctuations in resource revenues, the province’s stock of financial assets has declined and its net debt has increased by $10,834 per capita or in total$46 billion dollars. The policy implication of our results is that provincial governments should put increases in non-renewable resource revenues in a fiscal stabilization fund or Alberta Heritage Saving Trust Fund rather than spending two-thirds of any short-term increase in revenues.  This would result in a less volatile spending pattern and a sustainable fiscal policy with better services and lower tax rates

Fiscal Policy Trends: The Long-Term Consequences of Fiscal Responses to Resource Revenue Fluctuations

Over the last half-century, the Alberta government has been heavily reliant on non-renewable resource revenues, which have averaged about 30 per cent of the provincial government’s total revenue. This reliance poses a fiscal challenge as resource revenues are volatile and uncertain due to the vagaries of global energy price shocks, pipeline disruptions and other events such as the federal government’s National Energy Program. This commentary shows that the Alberta government’s budgetary responses to fluctuations in resource revenues have had long-term deleterious consequences for the province’s fiscal health

The Effect of Corporate Income Tax on the Economic Growth Rates of the Canadian Provinces

This paper investigates the long-run effects of the corporate income tax (CIT) rate on the economic growth of Canadian provinces using annual panel data for the period 1981-2016. We find evidence of a statistically significant negative long-term relationship between the provincial statutory CIT rate and economic growth. The model has the properties of a neo-classical growth model in that a reduction in the CIT rate “temporarily” increases the growth rate of the economy before returning to its long-run run growth rate. However, the temporary growth effects are economically significant and persistent. According to our preferred specification of the econometric model, one percentage point reduction in a provincial government’s statutory CIT rate increases the growth rate by 0.12 percentage points four years after the initial CIT rate cut and increases real per capita GDP by 1.2 percent in the long-run. We use the model to simulate the recently announced reduction in the CIT rate in Alberta from 12 percent in 2018 to 8 percent in 2022. The simulation results indicate that the growth rate of real per capita GDP would increase by 0.92 percentage points in 2022 and by 0.28 percentage points in 2029. The model also predicts that real per capita GDP would be 2.5 percent higher in 2022 and 6.5 percent higher in 2029. This would translate into employment increases of approximately 58,000 in 2022 and 172,000 by 2029. Our results indicate that provincial governments could significantly improve economic performance by lowering provincial corporate income tax rates

SIMULATING THE GROWTH EFFECTS OF THE CORPORATE INCOME TAX RATE CUTS IN ALBERTA

Shortly after its election in May 2019, the new Alberta government began fulfilling its promise to reduce the provincial corporate income tax (CIT) rate. The rate cut began in July 2019, when the government dropped the CIT rate from 12 to 11 per cent. The rate is scheduled to decline to 10 per cent on Jan. 1, 2020, followed by further one-percentage-point reductions in 2021 and 2022, bring the Alberta CIT rate down to eight per cent in 202

Income Inequality, Redistribution and Economic Growth

Inequality is on the rise in Canada and this state of affairs has provoked outrage and demands for redistribution at a time when governments at every level are searching for reliable long-term growth. This paper examines the links between income inequality and economic growth and whether there is a trade-off between redistributive policies, and economic growth, or whether income redistribution can enable faster growth. The authors survey the existing literature on the impact of inequality on economic growth, and then conduct an econometric analysis of the association between provincial economic growth in Canada and three different measures of income inequality, finding no statistically significant relationships. One measure of income redistribution, the difference between the market income Gini coefficient and the disposable (after-tax, after-transfer) income Gini is positively associated with provincial growth rates — but since the largest transfer programs in Canada are federal programs financed out of nation-wide taxes, it is unlikely that this association carries over to the national level. Much of the growth in income disparity has been driven by innovation that places a premium on highly trained workers. With that in mind, the Goldin-Katz model, used to explain the rising earnings differentials of highly skilled workers in the US, can be combined with the Aghion-Bolton model of capital market imperfections to develop a framework for examining the impact of education spending, and the taxes that finance it, on earnings inequality and economic growth. The authors then review evidence that raising marginal tax rates on high-income individuals would not raise additional tax revenues, but impose substantial costs on the economy, as would higher corporate income taxes. Punishing high earners is a self-defeating choice, although improvements to the social safety net would give more Canadians the chance to join their ranks

Alberta’s Fiscal Responses to Fluctuations in Non-Renewable-Resource Revenue

We investigate how successive Alberta governments have responded to shocks in non-renewable resource revenue over the period 1970 to 2017. Our results show that Alberta governments have increased spending by 63 cents in the fiscal year following a one dollar increase in real per capita non-renewable resource revenues. On the other hand, when non-renewable resource revenues have declined year over year, Alberta governments have not adjusted spending or other own source tax revenues. As a result of these asymmetric responses to fluctuations in resource revenues, the province’s stock of financial assets has declined and its net debt has increased by $10,834 per capita or in total$46 billion dollars. The policy implication of our results is that provincial governments should put increases in non-renewable resource revenues in a fiscal stabilization fund or Alberta Heritage Saving Trust Fund rather than spending two-thirds of any short-term increase in revenues. This would result in a less volatile spending pattern and a sustainable fiscal policy with better services and lower tax rates

Cutting Provincial Corporate Income Tax Rates to Promote Investment, Employment and Economic Growth

This communiqué is based on the following paper: The Costliest Tax of All: Raising Revenue Through Corporate Tax Hikes can be Counter-Productive for the Provinces by Ergete Ferede and Bev Dahlby

The Costliest Tax of all: Raising Revenue through Corporate Tax Hikes can be Counter-Productive for the Provinces

Raising taxes can come at a serious cost. Not just to the taxpayer, of course, but to the economy. Every tax hike naturally leads people or companies to reallocate resources in ways that are less productive, resulting in a loss of income-generating opportunities. At a certain point, raising taxes becomes manifestly counterproductive, with the revenue lost due to the negative economic effects outweighing any tax gains. In cases like that, a government would actually raise more money by lowering taxes, broadening the tax base, than it does by increasing taxes. In fact, an analysis of the tax-base elasticities of the provinces, using data from 1972 to 2010, reveals that this very phenomenon is what occurred in Saskatchewan, which raised corporate taxes to a point where it began to backfire, sabotaging the government’s goal of raising more revenue. It also occurred in New Brunswick, Newfoundland and Labrador, P.E.I., and Nova Scotia. In all these provinces, tax increases on corporate earnings actually ended up yielding less for the provinces than the provincial governments would have collected had they instead lowered corporate income taxes. In five other provinces, governments undermined their own provincial economies over the same period, raising corporate taxes when they would have been better off actually cutting the corporate income tax, and making up the difference with a revenue-neutral sales tax. Alberta, Ontario, British Columbia, Manitoba and Quebec all paid dearly for the decision to hit corporations with higher taxes, by sacrificing what could have been significant welfare gains had they sought to raise the same amount of revenue through higher sales taxes (or in the case of Alberta, a new sales tax). Quebec, at least, has lower tax-base elasticity than the others, however, possibly due to its unique cultural and linguistic characteristics, which may make it somewhat less likely for people and investors to leave the province. The evidence clearly demonstrates that corporate income taxes are far more sensitive to changes in the provincial tax rate than are personal income taxes or general sales taxes. Of course, it is not hard to see why politicians may feel political pressure to raise taxes on corporations, who do not vote, rather than passing tax increases onto residents, who do. But, while taxing corporations may be popular, preferred both by the voters and the politicians, when creating greater economic opportunities for their residents, provinces would have been far better off, over the measured 38-year period, looking elsewhere for additional revenue. As politically contentious as it may be, that means going easier on corporations and instead raising personal income and sales taxes

Who Pays the Corporate Tax? Insights from the Literature and Evidence for Canadian Provinces

Who bears the burden, or incidence, of the corporate income tax (CIT)? This is an important, if not somewhat contentious, policy issue. In this paper we provide a discussion of the existing research on the question, viewing it through a Canadian policy lens. We also use some new results from a companion technical paper, which undertakes one of the few empirical investigations of the issue using Canadian data, to discuss the implications of increases in corporate taxes for wages in Canadian provinces.While it is clear that people, not corporate entities, ultimately bear the burden of corporate taxes, a key question is which people? The answer to this question has important implications for the equity, or fairness, of the tax system. Much of the recent focus in policy discussions concerns the allocation of the burden of the CIT between owners of capital and labour. Since income from capital tends to be concentrated with wealthier individuals, if the burden of the CIT falls mostly on the owners of capital, it increases the progressivity of the tax system. On the other hand, if the tax is borne mostly by labour through lower wages, the CIT is less progressive.Much of the research into the incidence of the CIT has employed theoretical simulation models. Early models of this type, which were based on a closed economy with fixed supplies of labour and capital, suggested that most of the burden of the CIT would be borne by the owners of capital throughout the economy, and not just the shareholders of firms in the corporate sector. Subsequent extensions of those models into a small open economy setting, where capital and goods are highly mobile between jurisdictions (countries, provinces), predict that most of the burden of the CIT will be borne by other inputs that are relatively inelastic in supply, such as labour. These small open economy models are particularly relevant for Canada. Viewing the results of these models through a Canadian lens, we conclude that there is good reason to expect that much of the burden of corporate taxes in Canada, particularly those levied by provincial governments, will fall on labour through lower wages.While useful, the predictions of these simulation models should be viewed with caution, largely because of the sensitivity of the results to the underlying assumptions. A nascent empirical literature has emerged that provides econometric-based estimates of the distribution of the burden of corporate taxes. While this research is relatively new, our reading is that the evidence is mounting that corporate taxes are indeed borne to a significant extent by labour through lower wages. However, there is very little empirical work done in an explicitly Canadian context.In a companion technical paper we employ Canadian data to examine the impact of provincial corporate taxes on wages. Our results suggest that, consistent with the predictions of the open economy simulation models, provincial corporate taxes adversely affect the capital/labour ratio, which lowers the productivity of labour which, in turn, lowers wages. Accounting for the shrinkage in the corporate tax base in response to an increase in the tax rate, we calculate that for every $1 in extra tax revenue generated by an increase in the provincial CIT rate, the associated long-run decrease in aggregate wages ranges from$1.52 for Alberta to $3.85 for Prince Edward Island. Applying our estimates to the recent 2 percentage point increase in the CIT rate in Alberta we calculate that labour earnings for an average two-earner household will decline by the equivalent of approximately$830 per year, which amounts to a $1.12 billion reduction in aggregate labour earnings for the province. By way of comparison, other research has estimated the impact of the recently imposed carbon tax in Alberta – the subject of considerable scrutiny – to be approximately$525 per household