Real Effective Corporate Tax Rates in Canada and the United States. After Tax Reform

Grady, Patrick (1989): Real Effective Corporate Tax Rates in Canada and the United States. After Tax Reform. Published in: Canadian Tax Journal , Vol. 37, No. 3 (May 1989): pp. 674-692.

Abstract

Both Canada and the United States have recently undertaken comprehensive reforms of their tax systems. In the case of the corporate tax, the main thrust of the reforms has been to lower tax rates,broaden the tax base, and curtail or eliminate incentives such as investment tax credits.

This article examines the significance for Canada of the corporate tax reforms in both countries. It uses the concept of the marginal real effectivetax rate on new investment to analyze the impact of the corporatetax changes on the size and distribution of the corporate tax burdenin each country, given various assumptions about the rate of inflation and the extent to which investment is debt financed.

It is in the manufacturing sector that competition between Canada andthe United States is most intense and that real effective corporate tax rates probably have their greatest potential impact on the location of investment and employment. Before tax reform, the real effective tax rateon manufacturing investment in machinery and equipment in Canada was considerably lower than the rate in the United States. Under the post-reform regime, however, Canada's advantage is significantly smaller and decreases as the degree of debt financing increases.Indeed, in the absence of the investment incentives introduced by Ontario and Quebec in 1988, Canada's favourable tax position in the critical area of manufacturing investment in machinery andequipment would be lost altogether.

In contrast, tax reform has significantly increased the real effective taxrate on equity-financed investment in non-residential construction in the United States, but not the rate in Canada. In this case, tax reform has transformed what was a tax advantage for the United States into an advantage for Canada.

The overall effect of tax reform in the two countries, given the real effective tax rates, appropriately weighted, for both investment in machinery and equipment and investment in non-residential construction, has been to slightly reduce Canada's tax advantage in the manufacturing sector. This advantage is still a substantial one, however. Two important questions emerge from the analysis. First, what are the implications of the factthat federal efforts to reduce tax incentives for manufacturing investment in machinery and equipment have been offset by subsequent provincial efforts to restore the preferential position of their manufacturing sectors? Second, given that one of the main rationales for the Canadian tax reform package was that it would reduce tax-induced distortion of resource allocation by reducing or eliminating special tax incentives, why has reform actually increased the relative value of the tax credit for investment in the Atlantic region?

• Item Type: MPRA Paper
• Language: English
• Keywords: corporate income; Canada; United States; marginal effective tax rates
• Subjects: H - Public Economics > H2 - Taxation, Subsidies, and Revenue > H25 - Business Taxes and Subsidies

References

Canada, Department of Finance, “The White Paper: Tax Reform,” June 18, 1987.

Canada, Department of Finance, “Budget Papers, The Corporate Income Tax System: A Direction for Change,” May 1985.

Canada, Department of Finance, “Tax Reform 1987: Economic and Fiscal Outlook,” June 18,1987.

Grady, Patrick, “Indexation and the Taxation of Business and Investment Income,” Discussion Paper no. 283 (Ottawa: Economic Council of Canada, 1984).

Grady, Patrick "The Recent Corporate Income Tax Reform Proposals in Canada and the United States," 34 Canadian Tax Journal, (January-February 1986) pp. 111-28.

Hulten, Charles R. and Frank C. Wykoff, "The Measurement of Economic Depreciation," in Charles R. Hulten, ed., “Depreciation. Inflation, and the Taxation of Income from Capital” (Washington, DC: Urban Institute Press, 1981), pp.81-125.

United States, Tax Reform Act of 1986, Pub. Law no 99-514 100 stat, 2058 (1986).