A Taxing Problem

The case for corporate taxes gained some ground recently. For decades now, government and business leaders have been telling us we need to keep corporate taxes as low as possible in order to attract and retain investment, and spark new industries, research and development, and, most importantly, more jobs. We’ve run with this idea, particularly as a strategy for post-recession recovery, without giving enough consideration to whether it actually works.

As it turns out, many Canadian companies are more eager to sit on their capital than use it. A recent Globe and Mail article by Doug Saunders highlights this tendency, reporting that “at least 45% of Canada’s largest companies are hoarding cash rather than investing in employment or capital.” Together, Canadian companies hold more than $525-billion in cash reserves. The trend is the same in Europe and even more extreme in the U.S., where a whopping $5.1 trillion is estimated to be sitting in reserve.  And this is happening in a time when it makes sense for companies to invest—when prices and interest rates are down and labour is cheap.

As Saunders points out, this stockpiled capital is money that is not being used to construct factories, build homes, cure diseases, fix food shortages or address a host of other problems we face in the world today. And it’s not being used to create jobs.

In fact, one study that tracked 198 of the 245 companies on the S&P/TSX composite index that had year-end data from 2000 to 2009, revealed that those 198 companies are making 50% more profit and paying 20% less tax than they did a decade ago. Yet the number of jobs created by these corporations was actually lower than the average employment growth in Canada.

Which brings us to a reasonable question voiced by economist Paul Krugman : “If corporations already have plenty of cash they’re not using, why would giving them a tax break that adds to this pile of cash do anything to accelerate recovery?”

Well, perhaps tax breaks encourage companies that do invest to stick around, one might argue. However, the role that taxes play in decision-making for business investors has been highly overestimated. According to KPMG, income taxes represent approximately 12% of location specific‐costs, behind labour, facilities, and transportation in business investment decisions. Taxes do play a role, but maybe not as significant a role as we once thought.

It follows that corporate tax cuts—at least the extent to which they’ve been implemented in Canada— do not make sense, and by diminishing government revenue have seriously limited our ability to invest in needed public goods and social programs. Canada now has one of the lowest tax environments in the developed world. What does make sense is repealing recent cuts to corporate tax rates and subsequent cuts to public spending. It also makes sense to tax cash reserves, including overseas cash reserves. Such taxes would create greater incentive for corporations to stop making golden dunes and invest in the community, where money actually translates into something of value.