Understanding Corporate Tax Cuts: embracing conventional wisdom and coming to radical conclusions

Warning this post contains scenes of graphic illustration, it is not intended for short attention spans or people who can not locate coordinates in two dimensional space.  Viewer patience is therefore highly advised.

The debate on corporate income taxes brings out a really nice teachable moment in that it provides an occasion to clarify the terrain of past present and likely future debates on macroeconomic policy.  In what follows I will hew closely to the standard story, but what I intend to show is that even within the terms of the conventional collective memory there is an important contradiction that helps clarify what the real debate over corporate cuts ought to be about.  Let me see if I can deliver.

The conventional account of history runs something like this.  By the 1970s and early 80s unions had become too strong, unemployment insurance and welfare programs too generous and together they produced highly distorting macroeconomic outcomes: high unemployment, high inflation and low output (referred to at the time as stagflation).  Let me just accept this account for argument sake because I think it represents the story in the back of the head of most policy makers and economists over forty.  Let us represent this conventional story by line A in the diagram below.  Notice the oscillating line around A.  That represents the economic cycle.  From the vantage point of policy makers and economists over forty  the problem with the Keynesians is that they were preoccupied with stabilizing those oscillations when they should have been preoccupied with moving the economy towards line B.  Line B represents an equilibrium in which both employment creation and output proceed in a balanced manner.

Point Y represents the bad equilibrium that Keynesians were unwittingly fixated.  In their drive to stabilize the macro economy via employment they gave short thrift to output and thus created an inflationary environment which produced increasing high levels of unemployment, low levels of output and high levels of inflation. In time policy makers and economists shifted their attention away from cyclical stabilisation to structural change .  That is, from attempting to smooth the oscillations around line A to moving the macroeconomic trajectory from line A to B.

Notice that point Y does not entail a lower level of employment but rather a higher level of output.  And this was what was so seductive about the supply side arguments of that time.  What they in fact said was that it was possible to maintain employment and increase output provided the appropriate structural reforms were undertaken.  Everybody and I mean everybody wanted lower inflation and higher employment.  And in the face of stagflation the punters got onside and away we went.

My argument is simply this.  After the largely successful attack on trade unions was accomplished, after the reform of both welfare and unemployment insurance programs were completed and within the context of free trade and capital mobility the real impact of he structural changes was to move the economy to line C point Z.  That is to say, even granting neoliberalism was not some radical attempt to reconfigure income and wealth distribution between economic classes the structural reforms were more successful than its antagonists imagined and thus instead of landing on trajectory B point Y we landed on trajectory C, point Z.

When therefore there is the call to cut corporate income taxes it explicitly assumes that the Canadian economy is still stuck on trajectory A point X.  But if in fact we are on trajectory C, point Z; we are thus in fact stuck at a bad equilibrium.  The move to further juice up output without a commitment to juice up employment is like the Keynesians of yore trying to smooth the oscillations around a bad equilibrium. But this time around it is employment which is lacking not output capacity.

What does this have to do with corporate tax cuts?  Corporate income tax cuts are suppose to be a stimulus to increase the output capacity of the Canadian economy over the medium to long term.  But if as is widely recognized output is not the problem but employment why are we even talking about supply side measures (i,e. corporate tax cuts)?

I think economists are still fighting the last war and not the war we are in.  And as any historian of war will tell you an army that does so will loose.

Update: this is not as radical an idea as it may appear: see this article in the business section of the Globe online.  The difference with Canada is that I think are debt growth is papering over the underlying bad equilibrium.

Money for nothing, gifts for free, I want my CITs

As long as I can remember anything of social significance (since 8I think), corporate Canada has been demanding a little help from its friends with respect to productivity.  The facts are the Canadian private sector has been a world class laggard in terms of producing productivity growth.  Through the eighties and nineties it paid out minor fortunes to the CD Howe and Fraser Institute to pump out reams of varying degrees of plausible hypotheses for the lack of productivity growth.   The usual suspects interrogated were in no particular order of importance: government deficits, strong unions, generous unemployment benefits, generous welfare benefits, the lack of free trade deals, over regulation and lastly (time wise) overly onerous corporate tax rates.

With each campaign eventually corporate canada got what it wanted.  Unions were made prostrate, the eligibility rate and benefit levels of the unemployed and poor were slashed, one free trade deal after another was inked, the deficit was slayed, regulations were either denuded or unenforced and corporate tax cuts were lowered.

Yet after thirty years of eventually getting everything they wanted and economy that is the envy of the world the poor dears need more because as it would seem thirty years down the road productivity growth is worse not better than it was.

We live in a remarkable country, its people reward failure like no other people.  If Egyptians were Canadians they would be sending flowers, not stones and cocktails, to Mubarak and his economists sycophants.

Can You Create a Job for Less than $210,000?

Are you a small business person who needs help financing a solid business plan? Can you get viable within 7 years and 1.4 million in free funding? Can you promise to create at least one additional job that will self-fund after 7 years? If you answered yes to these questions then you could single handedly double the efficiency of the Conservative government’s new job creation plan and save the government 3 billion a year after 7 years.

If the answer is yes send the Federal government your proposal. The total cost for using CIT cuts as a jobs creation program will cost the federal government 21 billion dollars over 7 years. The best and shiniest of lipstick that can be put on this pig is an estimate that 100,000 jobs will be created over that same 7 years as a direct result of CIT cuts from 16.5% – 15%. That works out to a cost of 210,000 per job created.

For the love of the good, give me 200,000 for one year and I will employ myself and one other person and be viable by year two.

The 1/10th of 1 Percent Solution: Corprorate Tax Cuts, Investment and Jobs

Yesterday I was consumed by the demand side (Krugman and Rowe are late to the party) today I am consumed by the headline grabbing supply siders supply sider Jack the rain-maker Mintz. The FP quotes Jack Mintz quoting Jack Mintz. In his latest research paper he says that he estimated that 100,000 new jobs will be created by an increase of 30 billion in investment over 7 years owing the decrease in CITs from 16.5 to 15%.

On its own, the final cut to corporate income tax rates, from 16.5% to 15%, would result in $30-billion in additional business investment and 102,500 new jobs over a seven-year period, the paper estimates.

For the sake of argument lets just agree with Jack (how could I disagree I can’t find his paper). What he is saying is that we need an additional 30 billion in investment to create 100,000 new jobs which means that each new job created by the private sector needs 300,000 in new investment.

Notice it will take 7 years for this to happen and that it works out to roughly 14,300 jobs per year. This pretty paltry. Sure I guess every little bit helps but 14,300 jobs is less than 1 tenth of 1 % of total employment in Canada. The price tag for these cuts according to the Department of Finance over the next 7 years is wait for it…31.8 21 billion.

In effect Mintz is arguing that all of the CIT cut will go directly to new investment and generate another 10 billion which is a fairly dubious assumption to make to say the least.

Nonetheless, the best face that can be put on CIT cuts is 1/10th of 1 percent of total employment at a cost of 21 billion over 7 years. You have to ask yourself this: if the government proposed a jobs creation scheme that would not make a dent in unemployment and would cost 3 billion a year would you not be right to point out that government was extremely inefficient or generous? That is, for the price tag, the government could create 14,300 jobs a year with a funding envelope per job at over 400000 200,000$. Read that again.

The bigger point is that right now we probably could do with some heavier lifting in terms of labour market policy. Whether this should be through direct job creation (surely we can find someone in the private or public sector that can create a job for less than 200,000$ a year) or an increase in the pool of eligible workers for EI is an open question. And a much more interesting election topic than the 1/10 th of 1 percent solution currently on offer.

PS. You might also want ask yourself which service cuts or tax increases you want to pay for a worlds most costly job creation scheme.

The Fraser Institute thinks deficits should be the cause celeb of Canadian elections. Do you?

Maybe. But it all depends on how the issue is framed. Over at the FP online Niels Veldhuis and Jason Clemens are all sweaty under the collar from working overtime on trying to convince us that slaying the deficit is the single biggest issue facing Canadians and the conservative government. In their subtly* titled comment “Cut spending now” they argue provocatively that the government must reduce the deficit to zero not some time in future but over the next two years.

A true austerity plan aimed at balancing the budget would have taken a page from former prime minister Jean Chrétien and finance minister Paul Martin’s 1995 plan. The reforms by Chrétien/Martin eliminated a deficit much larger than the current one (4.8 % of GDP compared with 2.8%), within three years.

Chrétien and Martin’s 1995 plan proposed cutting program spending by almost 9% over just two years to get a handle on federal spending. These weren’t reductions in spending growth. These were actual reductions in spending.

Even more impressive is that Chrétien and Martin outperformed their goal and reduced spending by 9.7%.

This represented a remarkable fiscal transformation that, in part, made Canada the envy of the developed world. Spending reductions, balanced budgets, and debt repayment contributed to our outstanding economic performance from 1997 to 2007.

To emulate this success, Canadians need a serious commitment to balancing the books. The sooner the government gets its fiscal house in order, the sooner it can take action to reduce taxes and improve the country’s competitiveness. To that end, Mr. Flaherty should put forth a true austerity budget that actually cuts spending to balance the budget over the next two years.

It would be sad indeed if the Fraser Institute and the National Post succeeded in making a balanced budget in two years the frame of the fiscal debate and the central issue in the upcoming election. Here is why. Scale the deficit out of GDP and the miraculous Canadian recovery does not exist. In fact without the deficits run by the provincial and federal levels of government nominal GDP would still be at Q4 2007 levels. Nothing makes the point more poignantly then a graphic.

The deficit hawks want to make the case that we are in perilous times, that immediate and austere, tough manly action is required tout de suite within the next two years to drive the governments’ fiscal houses into balance and then some.

But what about the macroeconomic balance: just where is the stellar private sector growth of +/-  3% of GDP per year over the next two years going to come from to make up for the decline in government spending?  Analysts over at Scotiabank have a nice little table in their Global Forecast Update estimate that in 2011 and 2012 that without federal deficit spending real GDP growth is going to be 0.7% of GDP and 1.5% respectively.  None of this of course takes into account what would be the real implication of a 3% reduction in aggregate demand in each of 2011 and 20012.  If there is any multiplier at all to deficit spending those forecasts would have to be adjusted even further southward.

This is not 1995, debt to GDP is lower and so too is the deficit.  Further it looks as though that it was only in Q4 2010 that the Canadian economy managed to climb back to its q3 2008 level which was only achieved by deficit spending.  And even with that deficit spending we are nowhere near back to 1995.  So why all the hand waving and warmongering over the deficit?

Much of it is a genetic trait of neo-conservatism, much of it do with the lack of originality in the Canadian conservative movement in that it seems only capable of echoing is conservative cousins south of the border, and much of it has to do with a certain amount of nearing or in retirement age sub-urban idiotic ranting myopathy.  I am not convinced they can even divine their own narrow self interest at this point.

The fact is we do not even hear the private sector clamouring for public restraint at this time.  Business knows that without government deficits into the near future revenue growth is going to be anaemic.  Sure they are protesting to keep their scheduled tax cuts but that is about who is going to pay for the stimulus not about deficits per se.

Should deficits become the cause celeb of the Canadian elections they should only be so in two ways.  Do we need to commit to higher projected deficits in the short term to get the unemployed and underemployed back to work? And who is eventually going to pay for them?

* I say subtly titled because they, unlike my undergraduate students, had the sense not to throw an exclamation mark on the end which demonstrates a little restraint on their part… so credit where credit is due. Pun intended.

Flaherty`s Flatulence is no Laffering Matter: The Revenge of Zombie Gas Coming to an Election Near You

I am not going to spend much time dissecting the claims made by the Finance Minister in the block quote below. Indeed over at the PEF both Erin Weir and Andrew Jackson have pointed out the myriad of ways in which the Finance minister is simply dissembling on the issue. At the heart of the matter is not an economic “law” but rather a cocktail party joke once told by a republican operative and an economist to the Ford administration.

Two things clench the deal for me. Even if we believe abstractly that there is a Laffer curve no one has shown that we are in fact on the right hand side of the dissecting line vertically running through the centre of the curve. Second as Andrew and Erin have pointed-out the Department of Finance itself does not believe it either as all their estimates say exactly the opposite: decreased corporate income taxes will lead to decreased *not* increased corporate income tax revenue. So whatever appeal the Laffer curve has to economists owing to their counter-intuitive Straussian like need to be separated from the uninitiated masses, the rather conservative chaps in the Department of Finance are not buying it. Not that that is the ultimate test of veracity, it is just that if a Conservative Finance minister can’t get one of the most conservative ministries to stump for him or his beloved curve it would seem to indicate the we are indeed dealing with a Zombie idea born out of Voodoo economics aka the supply-side school.

“There’s a false assumption there which is really dumb – that is, by reducing business taxes , we reduce business tax revenue to the Government of Canada. That’s simplistic and, in fact is wrong. If we look at the tax revenues of the Government of Canada – corporate income tax revenues – they have gone up during the time that we have been reducing the tax burden.”

Perhaps what the minister is saying is that in an economic upswing that even though the percentage of corporate income taxes as a percent of GDP will decline they will nonetheless get absolutely bigger even if their relative share is diminishing. I can imagine this happening. But so what? The real issue here is who is going to pay for the deficit. If corporate tax rates do not provide the same relative share of total income tax revenue as a percent of GDP then that shortfall will have to be made-up somewhere else. What Flaherty is really saying is that either public austerity or further increases in individual taxes either through sales or income taxes are in the cards.

Now no conservative government is going to run an election on the promise of tax increases so it is going to have to be the former. So the real stench hanging in the air from Flaherty’s emission of Zombie gas is the question as to which services are going to be cut? I do not expect the conservatives, given Flaherty’s dissembling, are going to be honest with the electorate. Rather it is going to be a cake and eat it too election campaign–more of the hear no evil; see no evil; do lots of evil–we have seen so much of in Canadian politics.

But hey it is a democracy and if the electorate wants to fall for all this hand-waving who am I to criticise?

Extend and pretend

It is bad when the most pertinent of commentaries gets no response. What is ironic here is that at the micro level banks are telling their public stop pretending we are not extending even though they face near zero costs or in the case of the US negative costs.

You leave out an important scenario: in a zero interest rate environment, no bank is bad. This is why otherwise insolvent banks like Bank of America or Citi can stay solvent. It doesn’t matter the proportion of non-performing loans on the asset side as long as its cost of funds is minimal. Banks are thus engaged in a race with time to capture a positive return to recapitalize before interest rates rise.

Posted by: Guillaume | November 08, 2010 at 10:48 PM

Yep extend and pretend. That is the future but it is not as yet the present.

David Henderson makes one good point on Canada’s budget triumph

Note, if you are pressed for time just scroll to the last paragraph for the punch-line.

Seems like everyone is picking on poor David Henderson of GMU for his working paper Canada’s budget triumph. The thrust of the paper is that Paul Martin Jr’s 1996 budget proves that through austerity you can spur economic growth. Or simply stated, that austerity = stimulus. As Stephen Gordon–and Stephen is no pinko progressive–pointed out, the paper is disingenuous in two major respects.

First, private sector employment had already recovered by 1996. And second, interest rates had fallen nearly 9% from the onset of the recession prior to the 1995-96 budget. This in and of itself probably helps explain why private sector employment had recovered prior to the 95-96 austerity budget. As Stephen also points out interest rates would fall another 500 basis points after the austerity budget to their lowest level in living memory (exaggeration but close given what counts for memory these days). The culmination of which was a massive depreciation in the CAD dollar such that Canadian exporters got a 10% boost in their competitiveness without having to lift an eyebrow. The bottom line is this: Henderson’s paper is wrong because the austerity budget came after the recovery had well begun in Canada and was further helped along by interest rate cuts and a depreciating dollar.

What Stephen does not explicitly remark on unfortunately–although he does implicitly by including public sector employment in his graph–is that the austerity budget and the cuts to the public sector contained inter alia helped keep labour markets very depressed. Indeed, it would take nearly 8 years for unemployment to drop to its post recession levels.

Paul Krugman picks up on Stephens remarks over at his blog which is fitting given that Henderson specifically tries to link the Canadian experience of 1996 to current American problems. As both Stephen and Paul point out the two simply are not amenable: private employment is not back to its pre-recession levels and the FED has no more room to reduce interest rates. It was a little disheartening that neither Stephen nor Paul chose to ask the question if the 1996 austerity budget nonetheless fit with the Canada of today. That is a more interesting question; namely, will austerity today produce the same results as it did (not) back in the mid 90s. My answer would be no for the following reasons.

Canada has been witness to a steady appreciation of its dollar. This means that much of the capacity in the manufacturing export sector is likely not coming back. To the extent that commodity exports will continue to thrive is of little importance from a labour market point of view because as pointed out in a previous post these sectors are employment lean sectors. That is, you need a 5 % increase in total value added, just to get one percent of growth in employment. So unless agriculture fishing and forestry are driving the commodity exports then resources are not going to make up for the loss of manufacturing jobs.

Second, and related to the first. Commodity markets are relatively strong (that is prices are high). This was not the case back in the 90s. Interest rates are already very low (1%) so there is not much stimulus to be gained there either and the BOC is not talking about funky QE tricks either (which probably would not work anyway). The implication on interest rates is doubly bad news for Canada. Not only is there not much room to cut rates, not much evidence to suggest it would but but there is also thus no instrument (politically viable that is) to depreciate the CDN dollar. The Canadian dollar is thus out of the stimulus picture as well.

The Canadian austerians, from the Federal government (and members of the loyal opposition), to the provincial governments, down to the op-ed pages of the Globe and Mail are busy clamouring for both tax cuts and fiscal austerity. And it looks like the corporate tax cuts are a done deal.

And this brings me to the one thing Henderson got right in his paper (pp17-19) but Stephen and Paul failed to note. Namely, Martin RAISED taxes including corporate and capital gains taxes but not personal income taxes in the 93 and 94 budgets. So I guess you can raise taxes on capital and not retard private sector employment growth. Who knew?

The Anatomy of a Middle Class Shakedown: Quebec Budget

In my last post on the Quebec budget I focussed in the regressiveness of the of the 2010-1011 budget vis-a-vis working poor families. There it was demonstrated that the budget was regressive in that some working poor families and individuals would actually face an increase in their taxes even after the Orwellian named Quebec Solidarity Tax Credit (QSTC) was taken into account. Today I want to focus on the regressive nature of the budget as it applies to the middle class.

One of the striking things about the tax increases in the last budget is the degree to which (for those families above a minimum wage income) the budget is progressive to the 60,000$. It is progressive in the sense that as income increases so too does the percentage of new taxes as a share of income. However, after 60,000 the new taxes go regressive with those earning above 60,000 paying a smaller amount of taxes as a share of their income. As the graph clearly shows, a family of four with an income of 60,000 will pay almost 1% more tax as a share of their income whereas a family with an income of 125,000 will pay 0.6% more tax as a share of their income.

The reason for this is explained by three factors. First almost all the taxes announced were regressive, that is, individuals pay the same rate regardless of income. Second, the 200$ health premium is not phased in. Third, nor is there a smooth phase out of progressive tax credits and transfers. The result is, well, the graph below.

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(Click on image to enlarge)

For single individuals the situation is even more weird. As the graph below illustrates the budget re-enforces what can only be described as an economic basket case when it comes to taxing single individuals in Quebec. Between 10,000 and 15,000, thanks to the QSTC the budget is progressive. But because of its ham fisted implementation and the three points outlined above the taxes are regressive from 15,000 to 40,000. The result is that those earning 40,000 will pay less taxes as a share of their income than someone making less than minimum wage! Then the trend goes progressive between 40 and 50,000. At which point the tax trend goes permanently regressive with someone making 125,000 a year paying a lower percent of the new taxes as a share of income than someone making 50,000.

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This budget is what many economists have called an adult budget and an efficient budget. Professionals in illegal lines would probably characterise this budget as an efficient shakedown.

As is by now well known one of the stories of globalisation is a polarizing of income with those in the top of the income distribution pulling away from the middle class. In turn, the top half of the middle class has been doing quite well (a post on that later) while the bottom half of the middle class has been subjected to stagnant or decreasing incomes. What this budget does is reinforce the in-egalitarian distribution of market incomes.

To be clear the plaint here is not that raising taxes is necessarily a bad thing: quality public services cost money. The question here is over the distribution of the tax burden. By refusing to use the progressive income tax system and instead rely on a hodge-podge of user fees and consumption taxes the government has chosen to let those towards the top of the income distribution shoulder a smaller percent of the burden.

This is tax regression in action, and if not checked it will likely become an important aspect of the story of how Quebec became much less equal place live. For the economists who lauded the budget, most of which it should be mentioned earn over $75,000 a year, I suppose this is just the price of efficiency.
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Note: data is taken from budget tables 36 and 38. Impacts were estimated using budget methodology for individuals at 15,000 and families at the 31,000 levels. A hydro increase of 58$ was added to the tax increases. The budget numbers do not include the proposed 25$ per medical visit fee.

Quebec Budget Take 2: More Regressive than Progressive

In my last post on the Quebec Budget I was in error when calculating the threshold at which the budget became regressive for the working poor. Specifically I set the threshold two low. Instead of 25,000$ for a working family of four it should have been set at 30,345.

Also I should have included a definition of working poor. While most poverty measures are considerably higher I will define working poor as anyone earning the minimum wage or less. In Quebec the minimum wage is around 18,000$. Thus a family of four with two working adults making $36,000 or less is defined here as working poor.

Also there are two issues here: the degree of progressiveness in taxation and the degree of poverty alleviation or (cash transfers). The first is metric of who pays and how much as a share of their income and the second is how much is redistributed. Consumption taxes such as gasoline and sales taxes, user fees, and health premiums are examples of regressive taxes. The regressiveness of these tax measures can be partially, totally, or more than offset by redistribution in terms of transfers (cash or tax credits). Moreover as my initial post noted the gasoline tax will presumably have beneficial externalities if and only if it drives down gasoline consumption and or increases public transit efficiency and infrastructure.

Ok so enough with the preamble: The Quebec budget is both progressive and regressive for the working poor and it almost entirely comes down to the health premium and the fact that it is not a function of income accept at the lowest income levels where the 200$ premium will not be charged. If you click on the PDFQuebec Budget you will see that I have reproduced table 36 and 38 of the budget document with two estimates included: for a family of four with two working adults @ 31,000$ a year and for a single working individual @ 15,000$ a year (both in bold).

One of things that jumps out is just how sneaky the government was in using 10,000$ wage increments. For a family of two it made it look as though it was only @ 40,000$ the health premium kicked-in and for a single individual @ 20,000. But as table 30 of the original budget document indicates the health premium kicks in 30,345 for a family of four and just under 15,000$ for a single individual.

If we then do the workout for as I have done in the estimates made in the PDFQuebec Budget”> it becomes clear that for working families making below the 30,000 threshold the budget is seemingly mildly progressive to the tune of 145$. But a family of four making 31,000$ is made 155$ worse off. So what is happening here is that the working poor are subsidising other members of the working poor. That is an odd way of defining a budget as progressive and to say the least a very odd definition of redistribution. Single poor people are even worse off. A single individual making 15,000$ a year is made 83$ worse off and @10,000$ a year 149$ better off.

The other sneaky thing in the budget tables is that they divide the Solidarity Tax Credit (QSTC) by the number of taxpayers not by the number of individuals in the house. To see why this matters consider the column “compensation per individual.” So a family of four below just below the $30,345 cut off will be made only 37$ better-off per individual member of the household.

But the real point is this the budget is regressive for some members of the working poor and progressive for others. At this is even more the case if one factors in the hydro increases which the minister claims will be offset for poor households via the QSTC. Both the scheduled and then budget + increases to hydro amounts to 70$ a year for an average household. so that means the model family of four at the just below the $30,345 cut off will see only be 80$ better off or 6.66$ a month better off.

Now I am not an expert on poverty but I do know the 6.66 a month, less than 2$ per household member, is hardly a poverty alleviator. Moreover the QSTC is not inflation indexed until 2013 so we can claw-back another 6 to 9% in terms of real purchasing power. That too goes against the claim made in the budget that the Quebec government is maintaining the income of poor quebecoise.