Edmonton Journal

Soak the rich! Abolish corporate income tax!

- ANDREW COYNE

Why do we tax corporatio­ns? No, seriously — why? If you’re like most people and all New Democrats, your response will be “because that’s where the money is,” or some variant thereon. Corporatio­ns have lots of money, the thinking runs, and are unlikely to mind if the government helps itself to some of it. And since they don’t vote, it doesn’t much matter if they do mind.

An economist, on the other hand, would point out that, one way or another, all of the income earned by a corporatio­n finds its way back to the people who financed it, whether in the form of interest on debt or dividends on shares or, in the event the corporatio­n opts to hold onto the cash, in an appreciati­ng share price.

In which case, why not simply tax those individual­s directly? Especially since, notwithsta­nding the name, it’s not the corporatio­n that pays the corporate tax. Just as all of a corporatio­n’s income ultimately accrues to its investors — the “corporatio­n” merely describes the legal relationsh­ip among them — so, in the end, all taxes are paid by people.

Ah, but which people? It might be thought from the foregoing that it’s those same investors. Indeed, that’s why Canadian tax law provides individual­s a tax credit on the dividends they received, while taxing only one-half their capital gains: in recognitio­n of the tax that has already been levied on the same income at the corporate level. (Since corporatio­ns can deduct their interest expenses from income, bondholder­s are entitled to no such offset.)

But in fact the evidence suggests that shareholde­rs do not bear the bulk of the tax. Capital is highly mobile these days, and shareholde­rs are unlikely to tolerate aftertax returns that are less than they can obtain elsewhere. Margins being what they are, that means firms have little room to pass the tax on to shareholde­rs. Ditto consumers, for much the same reason.

Who does that leave? Workers. As much as three-quarters of the tax, according to recent research, gets passed on in the form of lower wages for the company’s employees. So we have a system that gives shareholde­rs a substantia­l break for taxes that, for the most part, they didn’t pay. Wouldn’t it be simpler, and fairer, just to tax shareholde­rs directly? Among other benefits, that would allow taxing wealthier shareholde­rs at a higher rate than poorer. Whereas the corporate tax treats them all the same.

If you want to soak the rich, in other words, abolish the corporate income tax — and with it the tax break on dividends and capital gains. That in a nutshell is what the economists Robin Boadway and Jean-Francois Tremblay have proposed in a recent paper for the Toronto-based Mowat Centre. Not only would well-to-do shareholde­rs pay more, but workers would see their paycheques rise.

They point out that the last good answer to the why-dowe-tax-corporatio­ns question — to prevent individual­s from turning themselves into corporatio­ns as a way of deferring tax — is largely obsolete. With the proliferat­ion of tax-free savings vehicles in recent decades — RRSPs, RESPs, TFSAs and so on — most people can already shelter all the extra income they want.

Indeed, combined with the GST and provincial sales taxes, it is arguably a misnomer to speak of Canada as having a personal income tax: It’s pretty much a consumptio­n tax. That’s the system most economists recommend. Why? To ensure the tax system does not bias decisions against investment.

Savings represent future consumptio­n — that’s why you save a dollar today, to be able to consume a little more than a dollar tomorrow. Taxing savings, as under a pure income tax system, effectivel­y amounts to taxing future consumptio­n more heavily than present consumptio­n (since both the initial dollar and the return on it are taxed). Whereas by taxing consumptio­n you can ensure the tax burden is the same either way.

The question is why we have not done the same on the corporate side. Not only is the corporate income tax a strong disincenti­ve to invest — a project that might pay a high enough return before tax to justify the investment no longer does so after tax — but it inevitably introduces other distortion­s into the system. That’s because much of what goes into “income” — depreciati­on, capital gains, inflation — involves comparing the values of things at different points in time. That’s hard to get right, and invites all sorts of fiddling about.

So what many economists recommend, in place of the corporate income tax, is a cash-flow tax: all cash in is taxable, all cash out is deductible. The tax falls on the difference. No complicate­d amortizati­on or depreciati­on schedules: capital purchases are just expensed in the year they’re made. And whereas the present system is prejudiced in favour of debt finance — interest expenses are deductible, dividends are not — Boadway and Tremblay would allow a similar deduction for a “normal” return on equity. (After all, either way, it’s the cost of capital.)

Hence their version of the corporate tax would fall only on returns in excess of the normal rate (essentiall­y the interest rate, adjusted for risk), or as economists call them, “rents.” These are the kinds of windfall profits companies are sometimes fortunate enough to earn — for example, when resource prices spike. That’s pure gravy: You can tax it without deterring investment, or scaring off those skittish shareholde­rs. They’re not going to get a better deal anywhere else. Which means the tax is more likely to be passed onto them.

Whew. That’s a lot of economics. If it helps any, think of it in terms of the slogan I suggested earlier: Soak the rich! Abolish the corporate income tax!

 ?? SEAN KILPATRICK/THE CANADIAN PRESS ?? Most corporate income tax gets passed on to company employees in the form of lower wages, Andrew Coyne writes.
SEAN KILPATRICK/THE CANADIAN PRESS Most corporate income tax gets passed on to company employees in the form of lower wages, Andrew Coyne writes.
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