In 2023, a book on the Kenney government edited by Ricardo Acuna and Trevor Harrison will be released. I contribute one chapter on Alberta’s Job Creation Tax Cut examining critically whether this one-third cut to corporate income tax has had any positive impact on Alberta’s economy in terms of investment, jobs and wages. In this post (which is not part of the book chapter), I explore the theory behind the corporate income tax cuts. The critical element in my view is in assessing the nature of capital and labour in Alberta and in particular the energy sector, most notably the oilsands.
Background
In the UCP’s 2019 election platform, a key policy plank was to cut the corporate income tax from 12 per cent to 8 per cent over four years. Two economists- Jack Mintz and Bev Dahlby of the University of Calgary’s School of Public Policy were cited as authorities promising more jobs, more investment, more economic growth, and ultimately more CIT revenue. Bill 3 to reduce the CIT rates by one-third was introduced and passed in 2019. In 2020 with the Economic Recovery Advisory panel, chaired by Mintz, recommending an acceleration of the tax cuts to buttress the economy ailing from the COVID-19 pandemic.
Theory
There is a voluminous literature on the subject of corporate tax cuts and this brief survey provides only key gleanings from the literature. The theory and application are complex, nuanced and requires marrying together macro-economic theory with micro-economic behaviour. Much of literature is inaccessible to those who do not have advanced degrees in economics or statistics.
The classic argument for tax cuts, whether personal or corporate, is they stimulate consumption and investment with the net effect being to boost overall economic growth and tax revenue. Economists focus on the resulting shifts to employment, investment and economic growth. In the Alberta context, this measure falls under the general policy of fostering growth by creating an environment for fostering entrepreneurship and not by “picking winners and losers.”
Low-tax theory is attractive to politicians, especially conservative politicians, because it offers the prospect of jobs and greater economic growth seen as pre-conditions for re-election. This idea was popularized during the Reagan administration and associated with the work of Arthur Laffer. Laffer’s contribution was the idea that there is a “revenue -maximizing function” for tax rates. As rates reach a certain level, overall revenue begins to fall as high taxes disincentivize work and investment. This theory has frequently been labelled “trickle down economics” by critics or “voodoo economics.”
Central to building econometric models is the idea that as tax rates change, the tax base either expands or contracts in response to the tax changes. The responsiveness to tax changes is known as elasticity. This general theory is normally validated with the combination of econometric formulae, regressions of key variables and applying statistical software to run the calculations. Relevant statistics include corporate tax rates, wages, employment, number of employers, GDP growth and investment. Early models were simplistic and used two-sector models characterized as “closed systems.” As computing power and data availability grew, it become possible to produce more “dynamic” models with the assumption of an open economy where capital and labour were mobile.
To my knowledge there has not been an authoritative empirical study of Alberta’s tax cuts to corporate and personal income taxes in the 2000s. Studies by Ferede, Dahlby, McKenzie and Mintz all rely on Canadian provincial data.
A second strand of the literature investigates the incidence of the tax increase or decrease- that is, who wins or loses from a specific policy choice. According to a 2017 McKenzie-Ferede study, a one dollar rise in corporate taxes could reduce wages by up to 96 cents (McKenzie and Ferede, 2017, 19). This is a significant claim because the implication is that the main beneficiaries of CIT rate cuts are labour, not capital.
Over time, the literature has shifted from initial views that capital bore the brunt of a corporate tax increase to more recent analysis like McKenzie and Ferede, which posits the majority of benefits (costs) of a corporate tax cut (increase) fall on labour.
In their paper, Ken McKenzie and Ergete Ferede identify five central issues to assess distributional effects of tax cuts or increases.
1. degree of capital mobility;
2. substitutability between domestic and foreign products;
3. size of the country;
4. degree of substitutability of labour for capital; and
5. factor intensities or capital intensities of the industry in a jurisdiction (McKenzie and Ferede, 2017, 4-5).
The following sections examine the these issues/hypotheses by investigating the nature of capital and labour in Alberta to critically analyze the salience of tax cuts theory to the Alberta economy.
1. High levels of capital mobility mean the incidence of tax increases falls more heavily on labour. However, capital mobility needs to be examined from multiple perspectives. Alberta’s dominant industry – oil and gas-is capital intensive. Vast capital outlays on plant and equipment and pipelines are required to extract oil, natural gas, and bitumen shipped mainly to U.S. markets. Once the capital is in situ, it stays there and practically immobilized in the sense that the resource, plant and equipment cannot be moved from the mine or well site. The extent to which oilsands capital is fully mobile, given its geographic concentration in north-east Alberta, and the industry’s recent consolidation, is therefore questionable. this has important implications for future provincial environmental and energy policies.
Mobilization of new capital to expand production can be financed internally by the firm or externally through bank lending, equity and debt markets. Working capital and retained earnings are internal sources of financing new investment. Right now, the energy industry is now in a manic phase of paying down debt, buying back shares, and raising dividends to shareholders.
Another distinction relevant to Alberta is new capital formation versus existing capital formation. An issue of new equity, debt or borrowing through bank credit facilities can finance an acquisition which creates no new capital. These financing instruments may also fund the expansion of an existing business or a “greenfield” factory, adding to the stock of existing capital, creating jobs, and increasing GDP, both objectives of the Alberta Job Creation Tax Cut (AJCTC).
There is also the differentiation between tangible and intangible capital. Tangible capital is land,plant, and equipment. Intangible capital is intellectual property held in the business (patents) or leased. According to a 2018 paper by U.S. economist Joel Slemrod, United States’ intangible investment in the mid-1980s was about 80 percent of tangible capital. By the early 2010s intangible capital was about 140 percent of tangible capital. This dramatic shift has enormous implications for structuring tax policy especially for new businesses where the creation of intellectual property is central to the business model.
In a 2008 Statistics Canada report, Baldwin et al found, like Slemrod, that intangible capital is growing at a much faster rate than tangible capital. By 2001 intangible investments were nearly twice as large as machinery and equipment investments and nearly 4 times as large as building and structure investments. (Baldwin et all, 2009, 9-10).
According to Slemrod, taxable income derived from intangible capital is easier to shift for tax purposes than physical capital. In assessing the achievement of the policy aims of the UCP government- more jobs, more investment, and more GDP growth- theoretical transmission mechanisms should take into account the secular shift in the nature of capital from tangible to intangible capital. As intangible capital grows in importance, there is a theoretical case for attracting “intangible” capital but the key question is where are the jobs coming from? Is intellectual property- like bitcoin attrraction- simply seeking low taxes and while it may generate more tax revenue for Alberta, is the intellectual property being created in the province?
2. Substitutability between domestic and foreign products. This refers to whether the goods produced are commodities, goods lacking discernable differences in quality. In the case of oil and gas, bitumen, and finance products, these products are commodities, whose prices are set internationally. This means the open economy model is more congruent with reality. According to McKenzie and Ferede, the greater the substitutability of goods and services, the greater the share of CIT rate increases borne by labour.
3. The size of the country refers to whether a country has “pricing” power to influence returns to capital. Canada’s GDP share in the world economy, at about two per cent, means Canadian capitalists cannot influence the international rate of return. Canadian capital, to attract both domestic or international capital must meet internationally set rates of return. The expected minimum rate of return, known as the “hurdle rate,” for major projects is given and therefore the burden of CIT changes would fall on labour because CIT rates improve or detract from the after-tax return on capital.
4. Substitutability of labour for capital. The less substitutable labour is for capital, the more wages must fall to entice firms to substitute labour for “lost capital.” In capital intensive industries like energy and finance, lower labour substitutability does mean more of the costs of a tax increase would be borne by labour. However, the literature also considers how competitive the actual market is for the products produced. In the case of oligopolies like oil and gas and finance, the extra rents extracted from the consumer (and possibly governments) would be bargained over. Alberta has a relatively low percentage of labour union memberships which would in favour capital.
5. Factor intensities refer to the capital intensity of the sector. Capital intensive sectors, where the labour base is smaller, would create downward pressure on wages. In the case of Suncor for example, salary and benefits represent about 12 per cent of total expenses with contract services accounting for slightly more than 12 per cent of total expenses. Capital depreciation, depletion and amortization costs represent about 17.5 per cent of total expenses. The fact that oilsands capital is immobile might induce more capital substitution from the tax cuts, meaning a smaller work force but perhaps a better paid work force.
In general terms, there is a favourable balance in favour of capital in Alberta, but there are other issues and players which tend to get ignored.
Other issues
There are several; other issues affecting how the theory works in practice. First, mobility of labour is critical to the question of who bears the benefit or burden of rate changes. Labour, particularly highly skilled labour is more mobile than unskilled and low paid labour. This applies in the finance sector, trades and engineering in the oil and gas sector. To the extent that tradespersons and engineers work in highly specialized areas of the fossil fuel sector, mobility is limited to other jurisdictions like Texas or the Middle East. However, shortages of labour limit the ability of firms to reduce wages when CIT rates are increased.
Second, there is the assumption that the corporation itself is immune from bearing any cost or reaping benefits of rates changes because the corporation is “not a person” and therefore does not ultimately absorb the tax. Rather, it is only capital owners or labourers who bear the costs or benefits under these models. However, in oligopolistic industries like oil and gas and finance, consumers could also be expected to absorb the effects of tax rate increases.
This characterization of a simple dyad of capital and labour which shares costs and benefits fails to distinguish what could be termed first and second order effects. First order effects require the corporation to decide what response is in its best interest. Modern corporations are complex legal entities which make decisions on allocating capital and labour to existing or new investment opportunities. As Joel Bakan explains in The New Corporation,
Corporations are created by law. Through law, groups of shareholders are granted single identities, corporate personhood, which in turn shields them from legal liability for debts and wrongs the businesses they invest in are responsible for. Shareholders are further protected by the “best interests of the corporation” rule, which demands directors and managers always prioritize their interest. That rule results in the corporation having a fundamentally self-interested institutional nature, which significantly constrains what leaders can do when trying to nurture their companies toward goodness. (Bakan, 2020,31).
Bakan is highlighting the legal shield owners of firms are provided under modern systems of corporate law. Corporations are governed by self-interested directors who act in the interests of owners and are owners themselves, often significant owners. Owners may derive financial benefits from limiting dividend payments instead deriving income from capital gains usually taxed at lower rates than dividend income. These calculations of what to do with a tax cut are controlled by both the senior management and directors. These calculations have little to do with the theory of sharing the pie with labour but always about what is in the “interest of the corporation” which is the interest of owners not “stakeholders,” as some of the more recent corporate governance literature espouses.
Corporations are not monolithic and publicly available information about them varies widely. Alberta’s economy is comprised of both large “public corporations” and privately controlled corporations. Closely controlled private corporations are usually owned by families and not required to divulge their financial affairs publicly. Decision-making by local private and public corporations on the allocation of newfound cash flow from CIT rate cuts will be different from decision-making in corporations whose head office lies outside the province (banks, insurers, telecommunications companies, national retailers). Local-decision-making would likely be more sensitive to reducing or increasing wages to workers while national companies would operate on a national salary grid. Family-owned corporations would also likely to be expected to press for lower taxes because they would see immediate benefits from lower taxes. This would explain the preference of business owners contributing to conservative political parties who espouse low taxes.
It is the capitalist-owner-corporation which responds first to a change in the CIT rate. For tax increases. choices include shuttering facilities, laying off workers, or reducing hours. In the case of tax cuts, choices include increasing investment in the jurisdiction, creating more jobs, increasing executive pay, increasing dividends, or buying back shares. Labour only experiences the policy change in response to decisions made by corporations. Labour is effectively passive in these transactions. The idea that labour would make great gains as claimed by McKenzie and Ferede is highly persuasive to both corporate advocates and to conservative politicians but bears more scrutiny in practice.
Absent from the literature is consideration of the role other parties play in the distribution of costs and benefits- governments and consumers. The government clearly gains or loses revenue from a policy change. Gravelle notes:
Parts of the literature do identify the government as a party. This inclusion relates to the concerns of immediate deficit increases and the impact on government borrowing costs. Direct empirical research would best aid the analysis of tax incidence to help inform the choice of parameters used in CGE models. The continuing use of direct empirical analysis of the corporate income tax would also be useful to further the development of empirical techniques and encourage the acquisition of enhanced data with which to test the validity of the estimates provided by CGE models. However, the current research has not provided clear answers to the general question of the allocation of the corporate income tax burden, and it remains extremely difficult to use aggregate information to determine a narrow and uncertain factor. Jennifer Gravelle, 2011, 29. Emphasis added.
There is general acceptance in the literature that if tax cuts increase deficits the full benefits of the tax cuts on economic growth will be moderated due to higher borrowing costs (Gale and Sanwick, 2014, 4). In the case of a medium sized provincial government though, an expanded deficit, even as large as contemplated in Alberta’s 2021 budget, would not cause general borrowing rates to rise. However, for Alberta, absent a return to a surplus, borrowing costs measured by the spread against federal government debt, would increase. This effect was dismissed by Dahlby and Ferede as immaterial. In any case, barring a significant and persistent drop in oil prices, Alberta is not expected to see materially increased borrowing rates relative to its provincial peers.
Another issue is the well-established behaviour of corporations of moving taxable income to jurisdictions where marginal tax rates are lower, a phenomenon known as tax shifting. Tax shifting occurs when a firm, operating in multiple jurisdictions, use financial techniques among provincial affiliates of the same controlling corporation. Tax rules governing allocation of taxes between provinces, based on payroll and sales, create some flexibility to allocate income to lower tax jurisdictions. The concern is that this financial activity does not enhance productivity of capital or labour In a well cited paper, Mintz and Smart state:
Further, since corporate groups are not required to consolidate income for tax purposes, a number of tax planning devices are essentially unrestricted for firms that incorporate separately in different provinces. Consistent with the model, we find that taxable income of corporate subsidiaries that do not allocate income is significantly more elastic with respect to tax rates than income of other, comparable firms that do allocate income by formula and those that are not corporate subsidiaries. These results are suggestive of the role of income shifting in the investment decisions of large, multi-jurisdiction firms, and of its implications for tax policy choices of affected governments Jack Mintz ands Michael Smart, 2002, 15. Emphasis added.
Such techniques benefit a small number of the largest corporations with the capacity and resources to structure themselves to minimize overall tax payments to Canadian governments. This behaviour also benefits tax practitioners and shareholders but does little to create new investment. Finance companies, such as banks and insurers also have some capacity to shift loans and investments to jurisdictions with lower tax rates like Alberta. Between the second quarter of 2019 and the third quarter of 2021, non-mortgage loans for business purposes grew by 8.7 per cent. For Canadian banks, business loans across Canada rose by one per cent suggesting there was some tax shifting going on. The difference in the behaviour is even more stark given that Alberta’s economy was experiencing recessionary conditions worse than the national average in 2020.
Summary
There is a plausible and intuitive case that at higher marginal tax rates incentives to invest are reduced and thus reduce the overall tax base causing overall taxes to fall. Yet even with the increase in the CIT rate in 2016, the Alberta rate of tax was consistent with neighbouring provinces. However, the theory ignores the benefits of government spending or investing the foregone revenue. The theory assumes that the private sector will use the money more efficiently than the government. This may not be the case. For example, an important incentive for companies to locate to Alberta includes public infrastructure and a well-educated, highly skilled work force. It is possible that the long-term rate of return generated from a dollar spent on education or public infrastructure may be higher than a dollar spent on private investment. This is never discussed as part of the trade-off between low taxes and economic development.
| Table 1- Corporate Income Tax Marginal Rates by Province- 2019 | |
| Province | Corporate Income Tax Rate (%) |
| British Columbia | 12 |
| Alberta | 11—8 |
| Saskatchewan | 12 |
| Manitoba | 12 |
| Ontario | 11.5 |
| Quebec | 11.6 |
| New Brunswick | 14 |
| Prince Edward Island | 16 |
| Nova Scotia | 16 |
| Newfoundland and Labrador | 15 |
Source: Government of Alberta, Fiscal Plan 2019-22, p, 190.
The notion that corporate tax cuts are good for workers masks a naked self-interest on the part of the business community. It creates cover for gaining a significant financial benefit from governments. The incidence theory fits nicely into new ideologies of corporate social responsibility (CSR) and the environmental, social and governance (ESG) movement which have gripped boardrooms over the past two decades. These ideologies portray corporations as benevolent forces acting in the public interest which Bakan (2021) has aptly criticized in a recent book and documentary. In general, Alberta’s business sector, particularly the oilpatch, has exhibited tremendous competence in shaping policy to its own interests and not the public interest. The UCP’s alacrity in reducing CIT rates is properly seen as a payback to corporate cheerleading and financial contributions of executives and wealthy Albertans during the 2019 election.
Finally, small business the driver of significant employment pays only a two per cent rate. The beneficiaries of the CIT rate cuts are large corporations often directed, headquartered, and owned outside the province. How much leakage goes to residents outside the province needs inquiry through transparency of ownership.
References
Bakan, Joel. 2020. The New Corporation: How “Good” Corporations are Bad for Democracy.” Canada. AllenLane.
Baldwin, John R. and Wulong Gu, Amélie Lafrance and Ryan Macdonald. December 2009. “Investment in Intangible Assets in Canada: R&D, Innovation, Brand, and Mining, Oil and Gas Exploration Expenditures.” Ottawa Statistics Canada, Catalogue no. 15-206-X — No. 026. https://www150.statcan.gc.ca/n1/pub/15-206-x/15-206-x2009026-eng.pdf Accessed 31 March 2022.
Gravelle, Jennifer. June 2011. “Corporate Tax Incidence: A Review of Empirical Estimates and Analysis.” Washington, D.C. Working Paper Series, Congressional Budget Office.
McKenzie, Kenneth J. and Ergete Ferede. April 2017. “Who pays the corporate tax? Insights from the literature and evidence for Canadian provinces.” Calgary: University of Calgary, The School of Public Policy, SPP Research papers, Vol 10, Issue 6.
Mintz jack and Michael Smart. 6 September 2002. “Income shifting, investment, and tax competition: theory and evidence from provincial taxation in Canada.” https://www.google.ca/url?sa=t&rct=j&q=&esrc=s&source=web&cd=&ved=2ahUKEwjhyO_gwvj2AhUyO30KHc0OC30QFnoECAQQAQ&url=https%3A%2F%2Feconomie.esg.uqam.ca%2Fwp-content%2Fuploads%2Fsites%2F54%2F2017%2F09%2Fsmart.pdf&usg=AOvVaw2WUw0UNemax6ZWhgu3QCnU Also appeared in Journal of Public Economics. Volume 88, Issue 6, June 2004. pp.1149-1168.
Slemrod, Joel. Fall 2018. “Is This Tax Reform, or Just Confusion?” Journal of Economic Perspectives—Volume 32, Number 4, Pages 73–96
United Conservative Party. April 2019. Alberta Strong & Free.” https://www.unitedconservative.ca/2019-platform/