HOW MUCH WILL TRUMP TAX CUTS COST US?

WILLIAM WATSON

“So, what effect will Trump’s corporate tax cuts have on business in Canada?” a non-economist golf associate asks.

“Nice swing,” I respond. “Maybe keep your head down a little more.” And then:

“As I may have mentioned before (like a hundred times already!) economics isn’t an experimental science, at least not the part of it having to do with what happens when a big country like the U.S. makes a large policy change such as lowering its corporate tax rate from 35 per cent to 21 per cent, something it has never done before and, even if it had, not in these exact historical circumstances (10 years into a recovery, the Fed easing off on easing, the president mercurial if not maniacal, mid-terms nigh, you name it).”

“Many economists,” I continue, “have worked on inferring from past episodes in different countries what the approximate responsiveness to taxes is. Though the precise answer varies from study to study a consensus very likely would be that Trump’s tax cuts will hurt us.”

By now of course my friend is focused on his next shot and may have forgotten what the question was. And my hand waving has turned any answer he might have remembered into a forgettable squib. However honest it might be, “I don’t know” leaves most people, especially friends in the physical or biological sciences, thinking economics is a low-value enterprise.

So for the next couple of years when this question arises I’m going to provide a much snappier answer: Estimates do vary but the consensus is that a onepercentage-point higher corporate tax, other countries’ rates fixed, will cost you about 1.5 per cent in pre-tax corporate income, which in Canada is currently running at $242 billion a year — so a cost of $3.6 billion. And, I will add with emphasis: that’s only from firms reorganizing their affairs for the altered tax environment, it’s not from any real changes in investment they might make.

Thus if our biggest neighbour, looming massively on our horizon, drops its corporate tax rate by 14 points, the arithmetic is depressing: 14 times $3.6 billion means it will cost us a little over $50 billion, which is 20 per cent of those pre-tax profits.

If those numbers get my friends’ attention, I’ll add the fine print. This relationship of one-percentagepoint difference in taxes giving rise to a 1.5-per-cent (not percentage point) difference in pre-tax income comes courtesy of a new IMF meta-study by the multinational trio of Sebastian Beer, Ruud de Mooij, and Li Liu, all of the IMF. Its being a meta-study means it encapsulates the results of previous studies, in this case 37 previous studies looking at 402 individual country/tax rate/profit relationships.

There are obvious disadvantages with studies of studies. If you include lousy studies, you get lousy results. If you include old studies, you may get results that no longer hold. In fact, the 1:1.5 ratio is more what’s been happening lately. Older studies produced a smaller effect, which suggests firms may be getting better at tax-gaming their income around.

There’s also the problem — a problem with all averages — that no single country/tax rate/profit relationship may exhibit exactly this 1-to-1.5 responsiveness. Some might be more sensitive, others less. Intuition says that for two countries so intimately enmeshed as the U.S. and Canada, with so many companies operating on both sides of the border, sensitivity might be on the higher side of 1:1.5. But that’s surmise. The IMF paper doesn’t say so.

It does say how companies cause their profits to move to where they are taxed less. Among what must be hundreds of techniques, they can: raise the price of goods they ship to subsidiaries in high-tax countries, thus boosting their costs there; do R&D in hightax countries but move patent rights to low-tax ones; lend money to high-taxed subsidiaries with interest going to low-taxed ones; shop around for the most favourable tax treaties; defer repatriating taxes; do a corporate inversion; move their headquarters, and so on and so on, not quite ad infinitum.

Countries will try to police these often-legal ways of avoiding taxes but who’s going to be more persistently and imaginatively inventive: high-priced tax lawyers or much lower-salaried government tax auditors (however stalwart and dutiful they may be)? And what does it say about who’s winning the regulation game that tax sensitivity seems to be rising?

One slightly reassuring aspect of this study is that it focuses mainly on non-real events — i.e., on changes in how income is reported, not actually on the real economic activity actually taking place. But it’s not all that heartening that a country may keep the jobs and investments but lose its claim on profits. And of course in some cases it may lose all three.

THE ARITHMETIC IS DEPRESSING: A LITTLE OVER $50B.