Elimination of Corporate Tax

The author of this Globe and Mail article, Neil Reynolds, asks an old question: would we be better off to eliminate all corporate income taxes? Without his being too explicit, he certainly leans toward saying yes, we would be better off. I also believe that is the right answer. However, the devil is, as always, in the details. Mr. Reynolds does describe some of the advantages to our economy of the zero-tax regime, but does not address how we can get from here to there without causing havoc. Fair enough, since that wasn't his intent. While I don't have all the answers I do have some thoughts on an implementation plan that would minimize the pain while accentuating the gain, and therefore might be politically feasible.

Before that I want to first make a point that is often lost in the noise of any discussion on this topic. Corporations are not people. It is true that the word itself comes from the Latin word for body, corpus, yet it is simply a legal fiction intended to erect a firewall between a business entity and its officers, directors and owners that, if they adhere to certain rules, protects their personal assets in the case of business failure and permits profiting from the business in a controlled, and taxable, fashion. It is not meaningful to talk of corporate profiteering since corporations don't run out and buy big houses, gamble and live hedonistic lifestyles. Pieces of paper don't do that.

So then, what happens if you eliminate corporate income tax? The immediate (first order) effect (assuming the corporation is profitable, which many are not!) is that the corporation will have more cash. Since cash is an asset the corporation's book value increases. That's it. The money did not vanish into thin air and did not end up in someone's pocket. On the larger stage there is a rebalancing occurring, since provincial and federal coffers will be lighter by the same amount. This is a concern since if you implement the tax elimination plan in one fell swoop there would be pain in the financing of our public institutions, which includes all government-sponsored programs. The solution is to not implement corporate tax cuts in this way.

Instead let's suppose we reduce corporate taxes a small amount so that profitable corporations have a little more cash in hand, and governments have a little bit less. A cynic might claim that greedy and unethical corporate actors will line their pockets with that extra cash. In some cases that may in fact happen. However, if it does it's because those same bad actors already do so. Corporate tax policy does not change this type of misbehaviour; corporate taxation is not an instrument of law enforcement or ethical policing. It is a matter of corporate governance and enforcement of existing laws and securities regulations. That can be done today as it entirely distinct from taxation. Therefore such an argument is a red herring.

If that concern is allayed, what is the likely impact of a padded corporate bank account? If kept in the bank, the company's value will increase by the same amount. Public companies will, on average, see their share prices rise. The amount of the rise is easy enough to calculate: divide the cash by the number of shares. If nothing more is done, your retirement plan (assuming you hold mutual funds or directly own stocks) increases in value proportionately. This includes the CPP which hold shares in Canadian corporations.

Companies are not inclined to hold onto excess cash since it does little work other than generate a small amount of interest and, if allowed to grow too far, can attract predatory and hostile takeovers from larger entities that want access to that ready cash. No, competent managers put the money to work to increase the company's value or distribute it to shareholders by increasing dividends (which, by the way, generate tax revenue for government) - this is a secondary effect of a tax cut. There are many ways for companies to put cash to work, some of which are listed below, along with tertiary effects.

• An increased asset base allow the corporation to take on more debt or make a secondary stock offering (or IPO it is not yet public) on attractive terms to fund expansion to research and new products and markets, thus ensuring future success and growth.
• Reduce prices to competitively bid on new business, while maintaining similar levels of profitability. The company will be able to grow its business, especially in foreign markets, thus growing the Canadian economy and increasing personal wealth. Governments benefit by a greater tax base due to economic growth, which can then better fund public institutions and social programs.
• Attract superior talent with higher salary and stock offers, which will increase the quality of products and services while also innovating on new markets and products. Other tertiary effects are the same as those in the previous point.

Now let me return to the idea of implementing change slowly. Doing it in small increments, especially initially, will allow everyone, politicians, businessmen and the overall population, to see benefits of each change. This can create confidence so that further incremental change is welcomed by all and, if all is done within a government's term in office, will reward the politicians that took on the risk.

I am also realistic is seeing that despite the positive potential the risk of failure must be faced. Perhaps the biggest risk is that a down tick in the economy due to exogenous factors could well be blamed on the initial tax reduction, even if a careful analysis shows that the tax reduction reduced the economic distress. There will also certainly be nay-saying from parties in opposition (just because they're the opposition!) that may get a sympathetic ear even if the overall experiment is working. These politicians would only have to highlight one or two examples of negative impacts on a group of people or companies that may, or may not, be directly attributable to the tax reduction. Politicians live by public perception so the pro and con forces will work hard to sway opinion, regardless of the success or failure of the experiment.

Okay, so this has been an interesting thought experiment, but can it actually be made to happen? Sure, but possibly not in our present political environment. There are politicians who would certainly be willing to act, even as a matter of principle or ideology. A competent politician, which is one who is in tune with the electorate, will not do it today since it is unlikely to be supported by the people. It is more likely to result in political death. Leadership is risky. Despite this situation I would still like to see one of the parties, at either level of government, start talking about it so that it can be seriously contemplated before many more years go by. The entire country could benefit from making our companies more globally competitive.