Tax Cuts and Economic Growth, Once More – the Corporate Tax Version

The issue of tax cuts and economic growth, which I’ve discussed recently here and here, looks like it’s going to be an important topic for some time now judging by this week’s announcement from Paul Ryan, one of the Republicans in the U.S. House of Representatives.  While all the attention in the media has been focused on the proposed changes to Medicare and Medicaid (I’ll get to those soon), that’s not really where the deficit reduction is supposed to come from in their plan.  When you look at the plan and their projections, it’s really a dramatic improvement in the health of the economy and employment that drives their projected budgetary improvement.  And what do they propose will instantly get this slow-growth economy to dramatically improve immediately?  Why tax cuts of course!  I’ll have more on the specifics of the Republican proposal soon, but for now I want to note the experience of our polite neighbors to the north with regard to this issue of tax rate cuts and economic growth.

In Canada’s case, they bought into the rhetoric of “tax rate cuts” will grow the economy ten years ago.  But the Canadians bought the corporate version.  Specifically, the cut corporate tax rates dramatically over the past decade.  The goal was to growt the economy.  This is the exact same strategy that Rick Snyder, Scott Walker and a host of other Republican governors are now trying to implement in different states in the U.S.  So it should be enlightening to see what happened when somebody else did it.  What happened?  Let’s turn to the Globe and Mail today (emphasis is mine):

Canadian companies have added tens of billions of dollars to their stockpiles of cash at a time when tax cuts are supposed to be encouraging them to plow more money into their businesses.

Corporate tax cuts are becoming a major issue in the federal election campaign. The Conservatives, arguing that they are the best custodians of an economy that remains fragile after the recession, say tax cuts are crucial to stimulate job creation and make Canada more competitive on the global stage.

But an analysis of Statistics Canada figures by The Globe and Mail reveals that the rate of investment in machinery and equipment has declined in lockstep with falling corporate tax rates over the past decade. At the same time, the analysis shows, businesses have added $83-billion to their cash reserves since the onset of the recession in 2008.

Infographic

In other words, the corporate tax rates did not increase corporate spending on investment.  In fact, the corporate tax rates actually coincided with lower corporate spending on investment.  It’s corporate spending on investment that is what generates and contributes to GDP growth.  So lower corporate tax rates simply functioned to increase profits but those profits are sterile.  They became piles of cash.  Cash that might be used to buy another existing company (and then layoff people) or just allowed to sit idly in the money and bond markets earning more interest.  What lower corporate tax rates do not do is create jobs.

So back to an earlier discussion – does this mean we should stop saying in principles classes that “tax cuts are stimulus”?  No.  It means we have to be more careful in what we say.  A better and more true statement is that:

Tax cuts for middle- and low-income individuals that result in more consumer spending, and tax cuts that are accompanied by deficits (meaning the tax cut isn’t offset by lowered govt spending) will stimulate an economy and grow jobs while tax rate cuts for corporations and high-income individuals won’t.

Unfortunately that’s 50 words long.  That’s way beyond the attention span or understanding of most politicians and media commentators.

2 thoughts on “Tax Cuts and Economic Growth, Once More – the Corporate Tax Version

  1. Once again thanks for posting. My one regret about taking the online course is I cannot ask questions in class. Your blog gives us a great opportunity to think about real applications of the principles we’re learning.

    The question I’ve had as I’ve thought about various business tax cut proposals is “Where is the demand going to come from?”. It would seem that business leaders are asking the same question. I can’t figure out what their incentive is to invest in capital improvements. Wouldn’t they have to believe that there will be more demand? If there was more demand wouldn’t they find a way (loans) to supply that demand despite tax rates?

    William

  2. Pingback: Can We Afford to Raise Taxes On High Incomes? Can We Afford Not To? « EconProph

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