Tuesday, April 26, 2011

Tax cuts stimulate growth? No they don't.

George Bush the Elder (pictured) described the idea as Voo-Doo Economics, but like other too-good-to-be-true patent remedies, the idea that tax cuts for business stimulate investment and growth just won't die.

Over the past 30 years economists have researched and debated the case for tax cuts and generally concluded that the empirical evidence doesn't support the argument. In fact the more we consider the evidence the more risible the case for supply-side tax cuts becomes; read this, for example. Sadly the lack of empirical evidence doesn't deter some fanatics from pushing the case for all its worth, especially since politicians love ideas that go across well in soundbites.

The results of the latest research into the impact of corporate tax cuts on business investment have just been published by the Canadian Centre for Policy Alternatives. Their team has examined data on business capital expenditure as a share of Canadian gross domestic product and as a share of corporate cash flow from 1961 to 2010. Their research finds no evidence over the course of that half century that lower taxes directly stimulated investment. In other words, when investment increased factors other than tax contributed to the increase.

Similar conclusions can be drawn from the experiences of most other countries that have used supply-side subsidies to stimulate private sector investment. By and large these subsidies feed through into increased share prices and higher executive salaries and take the pressure off directors to innovate and improve productivity. So the tax cuts fail to achieve what politicians claim are their key objectives, but come at a huge cost the exchequer. As the CCPA report notes:

"Business fixed capital spending has declined notably as a share of GDP and as a share of corporate cash flow since the early 1980s—despite repeated tax cuts that have reduced the combined federal-provincial corporate tax rate from 50% to just 29.5% in 2010."

In the case of Canada, current proposals to cut the corporate tax rate will incur a tax expenditure of approximately $6 billion each year, yielding a paltry increase of business investment of only $600 million per year. Scarcely a success story, especially when compared to the potential increase in investment that would arise if the government scrapped the tax cuts and invested the revenues directly into public infrastructure:

"If the federal government spent $6 billion on public infrastructure instead of corporate tax cuts, the total increase in investment would be more than ten times as great as the increase in private investment from tax cuts alone. This includes the new public investment itself ($6 billion), as well as an additional $520 million in private business investment that would be stimulated through the positive spin-off effects of the resulting economic growth."

Voo-Doo economics is an idea that should have been kicked into the long-grass decades ago. Its survival is a testimony to the power of corporate lobbying and political laziness. Tax cuts on corporate profits do not stimulate investment; they simply transfer wealth upwards to politically well-connected businesses.

You can read the CCPA report here.


3 Comments:

Anonymous BB said...

This is not the same thing as reducing taxes overall though, letting the man in the street keep morepf what he earns as an incitement to be more productive. The distinction should perhaps be made plainer.

BB

4:09 am  
Blogger Falco said...

Your argument appears to be that tax cuts never stimulate growth, which is just as foolish as McCain's belief that they always do.

"In the case of Canada, current proposals to cut the corporate tax rate will incur a tax expenditure of approximately $6 billion each year, yielding a paltry increase of business investment of only $600 million per year."

Firstly, leaving people untaxed is not an "expenditure", it is, from the perspective of the government, a reduction in income. From the perspective of the people it is a decrease in costs.

Secondly, you appear to be ignoring all second order effects to reach your numbers. The money that is left untaxed does not disappear into a hole in the ground; it is invested, spent, saved, etc. So the tax cuts will cause some of the "other factors" that you mention.

To turn Greg Mankiw's argument around; if you don't believe that high taxes can have adverse affects then why not have them at 100%?

1:48 am  
Blogger TJN said...

@BB

Quite. TJN does not take a position on high tax/high spend or low tax/low spend: that's is something for the electorate to decide. We don't, however, fall for the idea that private expenditure is de facto more productive than public expenditure -- conspicuous consumption, obesity, property market booms, etc, etc, all stand as testimony to the ways in which we as individuals get things badly wrong. We are also concerned that tax cuts now all too often translate into a legacy of failed public services, underinvestment in human capital and physical infrastructure and public debt passed from the current generation to the next. And a final point to reflect on: beyond a certain level it is reasonable to assume that additional income doesn't encourage higher productivity. Real entrepreneurs are in it for more than just money.

best wishes

John Christensen

6:05 am  

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