U.S. Can Learn a Tax Lesson from Canada

Feb. 15, 2012
The combined federal-provincial rate in Canada is just over 25%, compared to over 40% in the United States.

Canada has aggressively cut corporate taxes since 2000 and it has paid big dividends, according to a report from the Manufacturers Alliance for Productivity and Innovation (MAPI).

The report points out the steady widening of the Canada-U.S. corporate tax rate gap as Canada has slashed the federal statutory rate nearly in half while the U.S. rate remained unchanged.

The combined federal-provincial rate in Canada is just over 25%, compared to over 40% in the United States.

"Comparisons of effective marginal tax rates on capital, which take into account differences in depreciation, inventory deductions, and other elements affecting the tax base, yield essentially the same conclusion: a 15 percentage point advantage in favor of Canada," said Jeremy A. Leonard, MAPI economic consultant.

"There was no drop-off in Canadian revenues in the wake of corporate tax cutting in the 2000s," Leonard added. "The peak-to-peak increase in corporate tax revenues during the 2000s expansion was 44%, and revenues' share of GDP actually increased relative to the 1990s to exceed the U.S. level."

Leonard points out that 'businesses do change their behavior because corporate tax cuts make additional investment projects profitable on an after-tax basis. The concomitant increase in economic activity and profits, which is often accompanied by additional hiring, increases the taxable base of corporate income. The net effect on federal revenues of a corporate tax cut is ambiguous and depends on how strongly investment reacts to it."

The estimated revenue-maximizing corporate tax rate based on an analysis of 20 OECD countries was 33% in the late 1980s but fell steadily beginning in the 1990s, reaching about 25% in the 2000-05 period. Cross-sectional analysis of OECD countries shows that the relationship between rates and revenues conforms to the Laffer curve, which posits that there is a revenue-maximizing rate somewhere between 0 and 100%.

"We are falling behind by standing still, Leonard concluded. "The U.S. federal rate has remained unchanged since 1986 at 35%, while all of our trading partners have lowered theirs over the past 15 years, most of them multiple times. Policymakers in the United States should take heed, and realize that corporate tax cuts will provide important benefits to business competitiveness without harming the medium-term budget outlook."

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