Excess Corporate Saving and Excess Corporate Tax Cuts

In the recent Canadian federal election, further reductions in the corporate income tax rate proposed by the minority Conservative government became a major campaign issue.  The federal CIT rate had already been deeply cut in recent years (from 29.2% in 2000 to just 16.5% at present).  The Conservatives wanted to take it to 15%, despite also emphasizing the need for fiscal prudence (ie. spending cuts) to address the large Canadian deficit.  [Note: provincial governments in Canada also levy CITs, which average about 10%, making the combined rate about 26.5% at present — below the weighted OECD average.]

All the opposition parties opposed this move, and all presented fiscal platforms based on partly rolling back CIT cuts to fund other, more important fiscal priorities (such as education, health care, and public pensions).  The neoclassical economics establishment circled the wagons to ridicule these arguments as economically illiterate, claiming that NOT cutting CIT rates would undermine business investment spending.  But progressive economists responded that there was no evidence that previous CIT cuts had stimulated any new investment whatsoever.  In practice, realized CIT savings have only exacerbated the trend toward cash accumulation and deleveraging that has been so visible in Canada’s non-financial corporate sector (as in the U.S., Europe, and other developed capitalist countries).

Here is a detailed paper I wrote for the Canadian Centre for Policy Alternatives reviewing Canadian corporate cash flows and investment over the last half-century, highlighting the current trend of excess corporate saving, and showing econometrically the non-significance of CIT reductions in explaining those outcomes.  I find that the crowding-in effects from spending the same amount of money directly on public investment, elicit almost as much new private investment as would CIT cuts.  I also post below the Executive Summary of the paper. 

I would welcome comments and suggested references from heterodox economists on this issue.  There is an extensive mainstream literature on the determinants of business investment (some of which finds that so-called cost-of-capital effects are quite weak), but not many recent hetereodox studies that I could locate.  Your suggestions are most welcome.

PS: The Conservatives, unfortunately, won a majority of seats in Parliament in this election, on the strength of 39% of the popular vote and a divided opposition (Canada has a first-past-the-post system).  Nevertheless, I think our debate over the CIT issue helped expose the self-serving hypocrisy of this particular plank in the neoliberal economic platform.

Executive Summary

This paper reviews longer-run empirical trends in fixed non-residential capital spending by Canadian businesses.  Since the first of several rounds of business tax reforms and reductions was implemented in 1988, business investment has declined by 1 full percentage point of GDP – even though after-tax business cash flow has increased (in part as a direct result of the tax reforms) by 3 to 4 percentage points of GDP.  The proportion of after-tax cash flow which Canadian firms re-invest in fixed non-residential capital has declined from near 100 percent before the tax reforms, to less than 70 percent today.  Since 2001, Canadian corporations have received a cumulative total of $745 billion in after-tax cash flow which they have not re-invested into Canadian fixed non-residential capital projects.  This growing wedge of excess corporate savings has translated into several outcomes which have undermined the vibrancy of Canada’s recovery from the recent recession – including excess accumulation of cash and short-term financial assets, a noted increase in the rate of payout of corporate dividends, and a sustained reduction in leverage by non-financial corporations.  The paper conducts an original econometric analysis of historical Canadian data on business fixed non-residential investment, and confirms that tax rates have had no direct, statistically significant impact on investment.  Moreover, the indirect impact of tax rates on investment (experienced via their enhancement of after-tax business cash flow) has become less important in recent years.  Business investment is more sensitive to GDP performance, interest rates, exchange rates, and oil prices than to cash flow.  In recent years, after adjusting for these other investment determinants, only about 10 percent of additional business cash flow has been converted into incremental business investment.  Thus the proposed 3-point reduction in corporate tax rates would stimulate only about $600 million of new investment.  From a policy perspective, government would elicit ten times as much new investment by allocating the same amount of money directly to public infrastructure investment.  In addition to the $6 billion in incremental public investment directly financed by such spending, this strategy would also elicit $520 million in new private investment thanks to the positive impact of stronger GDP growth on business investment.  As a means of stimulating growth, employment, and even private business spending, the historical evidence suggests that business tax cuts are both economically ineffective and distributionally regressive.