My most recent posts here have dealt with cash flows and corporate taxation. Before looking deeper into the relationship between them, I want to consider whether corporate income tax is really that important. Does it make any difference to our society?
Last time out, we saw that the tax rate for large corporations in Canada had been as high as 50% in the middle decades of the 20th century. In the late 1980s, the Mulroney government (Conservative) lowered them to around 35%. This is roughly where they have been ever since.
However, let’s keep in mind that this is only the basic tax rate. Most corporations pay an effective tax rate that is much less than that.
Effective Tax Rates
For many decades, certainly as far back as 1960s, the basic tax rate has been “abated” by 10% in order to allow Canadian provinces to add their own corporate tax rate. Most provinces set their rates in the 10% to 15% range, so this puts the total slightly above the basic federal rate. But few companies pay this full rate.
Around the year 2000, the Chretien government (Liberal) introduced a percentage reduction into the tax calculation. This lowered the effective tax rate for most companies without changing the basic tax rate. It’s not entirely clear to me why they didn’t just change the basic rate. Perhaps the government simply likes the flexibility of applying the reduction to selected industries or certain types of income. Small businesses are given an even bigger reduction than large businesses, for instance, except on their investment income, which is taxed more heavily than the basic rate.
Let’s focus on the deduction given to large businesses.
The size of the percentage reduction has been adjusted over the years by the governments of Martin (Liberal), Harper (Conservative), and Trudeau (Liberal), but the overall trend has been to reduce the effective tax rate considerably. So, while the basic corporate tax rate is now 38%, the effective corporate tax rate is now closer to 25% in most provinces.
To help visualize this trend, here is a graph of the effective tax rate for general corporations (that is, not small businesses, and not investment firms) since 1981. It shows a steady decline since 2000. This is not my own chart, but judging from the values it displays, it appears to be based on Ontario provincial rates. Other provinces would be slightly above or below this line, but the shape of the curve would be similar.
This decrease seems significant. To understand whether it is, however, we need to consider how much money is actually raised by the government, and how much of this comes from corporate tax.
Government Revenues up to 1975
The following graph shows total federal government revenue in Canada from 1867, when the Canadian government was founded, through to 1975. Unfortunately, that’s when one of my key data sources abruptly stops, but this is enough information to understand the point I’m trying to make.
The graph shows that government revenues jumped dramatically during World War II, but dropped after the war. WWII demanded a total war effort, coordinated by the federal government. This was a major conceptual change in Canadian politics, the realization that government could be an active player in the economy rather than just a passive provider of laws and regulations. WWII thus signaled a change in the role of government.
From 1950 onwards, government revenues grew substantially almost every year. During these decades, the government continued to be an active player in the economy, as it had been during the war. However, this period reflected the government’s pursuit of social goals rather than military ones. The state became the provider of social programs for higher education, healthcare, unemployment insurance, and pensions.
Not all of these were delivered by the federal government alone, but the graph nonetheless shows the financial impact of such changes on the federal government. It had to become bigger to do the things we asked of it.
Government Revenues under Neoliberalism
Since the 1970s, the role of government has changed again. Successive federal governments, both Liberal and Conservative, have followed the lead of Thatcher and Reagan in pursuing “free market” ways of accomplishing social and economic goals. This is what we refer to as neoliberalism. Tactics have included privatizing government services and cutting taxes.
Despite these policies, government revenues (and expenditures) have continued to climb. The following graph extends the previous one to show the revenue of the federal government up to 2009.
The lighter coloured segment in the middle is missing data, which I’ve filled in with a straight line. The later years of the graph show that revenues continued to climb steeply as they did before, despite the now familiar austerity policies of successive governments. The only interruptions in this growth are immediately after the global financial crises of 1987, 2000, and 2008. The little drop in 1975, immediately to the left of the missing data, occurred right after the first oil crisis, so these drops are all caused by global economic events, not government policies.
So the question is, if the government reduced corporate tax rates in the late 1980s, and has been reducing them even further since 2000, why don’t we see a drop off in overall government revenue?
I’ll post the answer tomorrow.
The graph of tax rates from 1981 to 2016 comes from the Tax Policy Centre, a research institute in the US funded by government money and wealthy donors. Why they are keeping track of Canadian tax rates, I don’t know, but I am happy to borrow their chart.
The data on Canadian government revenues comes from Statistics Canada. Series H1-18 covers 1867 to 1975, while the more recent data comes from Table 385-0001.
Photo of a tree suffering from such a loss of income that it has gone negative, taken in Amsterdam in 2012.