The biggest change in Canada's tax policy over the past generation was the steep reduction in corporate income taxes engineered after 2000 at both the federal and provincial levels. Advocates of CIT cuts promised they would stimulate more business investment and thus generate trickle-down benefits for all Canadians. Free-market economists built theoretical models to show that lower corporate taxes would boost investment, productivity, even wages.
Their argument was always dubious. Actual historical statistics (as opposed to models) indicate that investment responds predictably to growth and interest rates, but not to statutory tax rates. In Canada's case, CIT cuts are especially ineffective because of our reliance on foreign subsidiaries – many of which must pay tax at home on global earnings, and hence don't even benefit from our reductions.
But in the context of the generally favourable fiscal conditions prevailing in the early 2000s, the CIT cuts were politically saleable. After all, governments had fiscal space to do many things: among them, to lower other taxes and provide bits of new program spending. Few Canadians seemed to mind corporations getting a disproportionate share of the largesse.
The federal rate was cut virtually in half after 2000 (to just 15 per cent today). Several provincial governments followed suit. Alberta was the most aggressive, slashing its rate by more than one-third (to just 10 per cent) by 2006. This sparked a destructive race to the bottom among provinces – aided by explicit threats from companies to move head offices to Alberta if other provinces didn't follow suit. Combined, Canada's average federal-provincial rate is now the second lowest in the Group of Seven.
But despite this dramatic change, the promised payoff in business investment is nowhere to be found. Capital spending has consistently disappointed – and it's getting worse. Last year, business non-residential investment declined in real terms. Innovation investment has been shrinking for a decade. In fact, non-residential business capital spending has grown more slowly under the Conservatives (and their CIT cuts) than any other government in Canadian postwar history.
In today's constrained fiscal environment, however, the political calculus of CIT has changed dramatically. Now, most Canadians are getting less from government while being asked to pay more for it. Their willingness to watch corporations receive favourable treatment has evaporated.
Several provinces have already begun dialling back the favours. B.C. abandoned its attempt to match Alberta's threshold, boosting its CIT rate by one percentage point in 2013. New Brunswick lifted its rate by two points. Ontario froze its at 11.5 per cent.
Nowhere has this sea change been more dramatic, however, than in Alberta. Former premier Jim Prentice's austerity budget featured tax hikes on almost everything that moved – except corporations. That did even more political damage than his infamous "look in the mirror" quip. Polls showed that a huge majority of Albertans supported higher CIT rates. Despite desperate efforts by corporate backers to "prove" that CIT cuts work, Albertans elected a government that promised to boost the rate by two points.
Alberta's new 12-per-cent rate may become a new effective minimum for the provinces. Indeed, formally agreeing on a new interprovincial floor would prevent the destructive competition that undercut provincial coffers so badly in recent years. In any event, we can expect more hikes in the coming years.
Meanwhile, at the federal level, Canadians will have another chance to debate CIT rates this fall. The New Democrats will propose a modest hike, and even the Liberals might consider revenue-boosting CIT reforms – if not raising the rate, then at least restricting some loopholes. That would leave Prime Minister Stephen Harper and his Conservatives as the lone champions of this failed trickle-down theory. Mr. Prentice's experience is surely causing them considerable trepidation.