The Costliest Tax of all: Raising Revenue through Corporate Tax Hikes can be Counter-Productive for the Provinces

Résumé

Raising taxes can come at a serious cost. Not just to the taxpayer, of course, but to the economy. Every tax hike naturally leads people or companies to reallocate resources in ways that are less productive, resulting in a loss of income-generating opportunities. At a certain point, raising taxes becomes manifestly counterproductive, with the revenue lost due to the negative economic effects outweighing any tax gains. In cases like that, a government would actually raise more money by lowering taxes, broadening the tax base, than it does by increasing taxes. In fact, an analysis of the tax-base elasticities of the provinces, using data from 1972 to 2010, reveals that this very phenomenon is what occurred in Saskatchewan, which raised corporate taxes to a point where it began to backfire, sabotaging the government’s goal of raising more revenue. It also occurred in New Brunswick, Newfoundland and Labrador, P.E.I., and Nova Scotia. In all these provinces, tax increases on corporate earnings actually ended up yielding less for the provinces than the provincial governments would have collected had they instead lowered corporate income taxes. In five other provinces, governments undermined their own provincial economies over the same period, raising corporate taxes when they would have been better off actually cutting the corporate income tax, and making up the difference with a revenue-neutral sales tax. Alberta, Ontario, British Columbia, Manitoba and Quebec all paid dearly for the decision to hit corporations with higher taxes, by sacrificing what could have been significant welfare gains had they sought to raise the same amount of revenue through higher sales taxes (or in the case of Alberta, a new sales tax). Quebec, at least, has lower tax-base elasticity than the others, however, possibly due to its unique cultural and linguistic characteristics, which may make it somewhat less likely for people and investors to leave the province. The evidence clearly demonstrates that corporate income taxes are far more sensitive to changes in the provincial tax rate than are personal income taxes or general sales taxes. Of course, it is not hard to see why politicians may feel political pressure to raise taxes on corporations, who do not vote, rather than passing tax increases onto residents, who do. But, while taxing corporations may be popular, preferred both by the voters and the politicians, when creating greater economic opportunities for their residents, provinces would have been far better off, over the measured 38-year period, looking elsewhere for additional revenue. As politically contentious as it may be, that means going easier on corporations and instead raising personal income and sales taxes.