Monday, March 7, 2011

The Case for Corporate Tax Cuts

In just three paragraphs economist Murray Rothbard put an end to the corporate tax debate. This was in 1970 with his book Power and Market. But alas, the Keynesian argument continues, so here are my conclusions:

Canada, I hear you. This country already has one of the lowest corporate tax rates in the world and a further cut will keep something like $13 billion from being spent on things like schools, hospitals or make-work projects. Stimulus may be a convincing argument, but it's not based on anything concrete. Here's an article from the Toronto Star that labels corporate tax cuts as “poor economics.” The author sums up the typical arguments against corporate tax cuts, so allow me to point out the fallacies and explain why corporate tax cuts are much better than government spending.

There is no provable link between corporate tax cuts and job creation.

Let's say an entrepreneur needs to decide what to do with his profits. He may choose over hiring new employees or saving the money for future investment. This choice is most likely influenced by profit-motive. If new employees are needed to remain profitable, then he'll probably take this route. But profit incentive is distorted by taxes, wage laws and mandatory rules and regulations. This discourages efficiency and prospects for future employment.

All taxation is a disincentive for production, investment and savings.

Most economists prefer infrastructure spending as a powerful short-term job creator. Which incidentally provides the schools, hospitals, roads and water systems that businesses rely on, too.

Most economists would be wrong in this case as none of the listed projects are short-term job creators. They are, in fact, all long-term job creators. But this isn't necessarily a good thing. A one-time stimulus into these “social services” will expand resources and guarantee the need for further funding down the road. Future employment of plumbers to fix more broken toilets in larger schools does not equal wealth creation.

The so-called “multiplier effect” from rebuilding the country is far higher than cutting corporate taxes. The return on corporate tax breaks is a loss of 80 cents on the dollar. By contrast, infrastructure spending returns $1.50 on every $1 spent, and social housing pays back $1.40.

The multiplier effect – a Keynesian economic fallacy – relies on three destructive interventions in the economy: taxation, inflation and borrowing. All government spending must come from one of these three sources, and none of them can account for the spending returns listed here. Taxation is the multiplier effect in reverse as all government spending is a net-loss. Despite any value found in government, taxation remains an act of wealth destruction. Inflation devalues the money and distorts the price structure as well as many other things. Borrowing by governments means competition with the private sector. The government's unique position in the market as the only entity with the power to tax puts it at an unfair advantage over those who must use voluntary means.

Furthermore, the idea that tax breaks are a loss for government depend on the illusion that this money belongs to government to begin with.

The Irish example: Ireland dropped its corporate tax rate to 12.5 per cent, the lowest in Europe, to attract foreign investment. The result was a housing bubble, a collapsed banking system, and a humiliating $114-billion bailout from the European Community.

The Irish example is a result of artificially low interest rates, not low corporate tax rates. The property bubble was a result of increased bank credit and loose lending standards. No doubt there were probably government incentives as well. The $114 billion bailout has papered over the real problems.

... a 10 per cent cut in the tax-inclusive cost of capital resulted in a 7 per cent increase in capital investment. But investment in what? And where? ... “An across-the-board general corporate tax rate cut rewards companies whether they create jobs or kill them,” says Armine Yalnizyan, a senior economist at the Canadian Centre for Policy Alternatives.

A 7% increase in capital investment is proof that corporate tax cuts are a success. The author's concern about investments is the decision of shareholders. This decision can be influenced by various market interventions that increase costs of hiring and maintaining employees. Ultimately the profit-motive of corporations is what keeps them in business and it'd be illogical as well as impractical for them to behave any other way. Problems with externalities and political lobbying can be directly attributed to government privileges.

There are better ways to stimulate the economy. Canadian households with record average debt of $100,000 could use help in reduced CPP and EI contributions. And if there are to be further corporate tax cuts, they could be directed at job-creating small businesses and start-ups in industries of the future like green-tech and energy efficiency. ... firms should benefit from the lowest tax rate only on investments in Canada and Canadians.

I'm surprised at the CPP reduction advocacy, as many are campaigning for higher CPP contributions. The author concedes that tax cuts work, but wants government to favour certain sectors and practice a form of economic nationalism. A better answer would be across-the-board tax cuts for everyone. The best answer would be no taxation at all, as everything government does can be provided cheaply and more efficiently by voluntary means.

But what are we to call manipulation of the tax code to further enrich already prosperous corporations? Until the Tories can answer that question, the assumption has to be that once more this government is motivated by ideological fixation rather than sound economics.

I was under the impression that all governments were motivated by ideological fixation. The very presence of this bureaucracy is an insult to sound economics.

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