Coporate Income Tax, Dutch Disease, and Left-Wing Economic Incoherence

I was thinking some more about NDP tax policy the other night and I was struck by the dichotomy between left-wing thinking on tax and monetary policy and their implications for corporations.

The NDP and its fellow-travelers have, for years now, been lamenting the strength of Canada’s dollar, suggesting that it has hollowed out the Canadian manufacturing sector, undermining jobs.  Whether it’s NDP Leader Thomas Mulclair complaining about “Dutch Disease” or labour economists Erin Weir  or Andrew Jackson proposing ways to control the Canadian dollar, the economic brain-trust on the left seem to agree that a rising dollar is bad for both Canadian corporations in the manufacturing sector and, ultimately (though perhaps foremost) their workers.

Now, this post isn’t about the correctness of that position.  Their analysis is correct, as far as it goes (they don’t complete the analysis, so their ultimate conclusion about the impact of a higher dollar is likely wrong, see Stephen Gordon’s post on the fallacy of Dutch Disease).  But I’m not interested, for now, in their ultimate conclusion, I’m interested in their analysis, because it illustrates why the NDP’s proposal to increase corporate income tax is misguided.

Mulclair, Weir and Jackson all agree that a high dollar is, all else being equal, bad for corporations,  and therefore workers, in the manufacturing sector (all else isn’t equal, but let’s set that aside for now).  And its easy to understand why they believe that. If a Canadian corporation’s costs (notably labour costs) are priced in Canadian dollars, and the prices of their products are set in, say, US dollars (as they would be if the Canadian corporation is competing in the broader international market), a rising dollar will cut into after-tax corporate profits.

Corporations exist to make money, so they’re going to respond to falling after-tax profits to ensure that they keep making money.  In the long run, they may try to increase profits by cutting wages (Caterpillar?) or, if unsuccessful at that, by reducing investment in Canada (where returns are now lower) in favour of pursuing more profitable investments abroad (where returns are now higher).  The end result will be lower wages and higher unemployment (or both) for Canadian workers.

I think it’s fair to say that Jackson, Weir and Mulclair never suggest that the cost of a higher dollar will be borne by corporations or their shareholders (or, at least, not exclusively).  They don’t believe that corporations (or, more accurately, their management or shareholders – corporations don’t talk) are going go say: “Aw shucks, guess we should just get used to making less money and live with lower profits”.  Rather, they believe, quite reasonably, that the costs of a higher dollar will be borne by Canadian workers through lower wages or higher unemployment.

So why do they think the same isn’t also true with higher corporate tax rates?  Re-read the preceding analysis but replace “a higher dollar” with “a higher corporate tax rate”.

A higher corporate tax rate will reduce after-tax corporate profit (duh!).**  Corporations exist to make profits, so they’re going to respond to lower after-tax profits caused by higher taxes in the exact same way that they respond to lower profits caused by a higher exchange rate, by reducing wages or reducing investment (hence, in the long run, wages and employment in Canada).

This isn’t the reasoning of “right-wing” economists or corporate shills, this is the very sound intuition of the leader of the NDP and some of the more prominent progressive economists in Canada about how corporations respond to lower profits caused by a higher dollar.  And that logic applies equally to a higher corporate income tax, although I’ll eat my hat the day that any of those people say that out loud.

What’s fascinating is that both a higher corporate income tax and looser monetary policy/lower dollar are high profile, indeed signature, issues for the NDP and the Canadian left.  That otherwise intelligent people- even the leading economic thinkers in left-wing ranks – are able to hold diametrically opposing (and, indeed, inconsistent) theories about how corporations react to lower profits with respect to two of their most important economic issues is a testament to the economic incoherence of the Left in Canada.


**  In fairness, Weir also has a theory that the Canadian corporate income tax doesn’t matter so long as its less than the US corporate income tax, on the basis that it’s credible against US tax.

There are three problems with that theory.  First, that logic only holds true in respect of investment from the US.  The US corporate income tax rate is among the highest in the developed world and is an outlier relative to other developed or developing countries (it also ignores the point that you have to look at the effective corporate tax rate, not the statutory rate).  Second, many US corporations (especially small and medium sized US corporations who often look to Canada as a first place to invest outside of the US) are structured so that income is attributed to their shareholders – often non-taxable entities such as pension plans, foundations, etc.  To those shareholders, Canadian corporate income tax is a pure cost (as it is, I might add, to Canadian non-taxables such as pension plans and RRSPs).  Third, and more importantly, his theory ignores the details of the US rules.  Yes, foreign tax is creditable against US corporate income tax.  But US corporations only pay US tax in respect of income earned by foreign subsidiaries when those amounts are repatriated to the US.  So long as those funds aren’t repatriated to the US, the US corporate tax rate is irrelevant to their investment decisions.  Not surprisingly, given the high US corporate tax rate, US corporations go out of their way to avoid repatriating funds to the US.  If those funds aren’t repatriated, foreign (i.e., Canadian) corporate income tax rates still matter to US corporations.  Unfortunately, nice theories about tax law that ignores the way that tax laws actually work are not uncommon in left-wing discussions of tax policy.

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