Taxing the Corporations

Taxing the Corporations a position paper by Tom Manley - see list of position papers

Are Corporate Taxes an Effective Part of a Social Equity Agenda?

Some people claim that tax reductions on corporations constitute an ideological move to the right. There is a lot of rhetoric about taxing the corporations. There is a principled desire among advocates of social justice to tax the corporations. It fits into a perceived model of progressive taxation and redistribution of wealth.

I argue that taxing corporations is simply a government revenue stream like many others, but it does very little if anything to serve a social justice agenda or to re-distribute wealth. Contemporary governments apply taxes on corporate profits more to placate the advocates of progressive taxes and create an illusion of progressive taxes but with no real impact on social equity.

This essay tries to look at the reality, beyond the rhetoric. To make any progress on the subject and get over the hurdle, we must understand the definitions, methods, effects, and consequences of taxing corporations. The subject is also complex and deserves more consideration than the dogmatic comments on right-wing statements about taxing corporations. Even this essay remains a superficial review of the subject.

What is a corporation?

I detect in the debate a strong emotional axe to grind against the big bad corporations as some depository of disproportionate wealth and power. Without numbers at hand, I understand that the vast majority of corporations are family businesses, small and medium private businesses, family farms, and mom & pop shops who incorporated for fiscal and legal reasons. Even cooperatives of all types are structured as corporations with shareholders. It is very easy and inexpensive to incorporate.

I trust that the proponents of taxing corporations are really talking about the very large impersonal transnational corporations, a very small proportion of the total count of corporations. However, there is a long continuum of corporations in terms of size, community roots, ethical behaviour, and personal investments. One cannot draw the line very easily and make the legal distinction. So while the emotional concern may be specific, the legal implementation of that concern cannot be specific. Any tax laws arising from the social agenda hits all corporations.

So please be careful with the language and the target of your concern about corporations. You are talking about Joe Farmer and his family farm.

What are corporate taxes?

Although corporations can be and are taxed in many ways, this essay considers corporate taxes as typically taxes on net profits, on condition that there are profits. I am excluding the Tobin tax (tax on financial transactions) from this discussion.

What is profit?

Profit includes three categories.
  1. The profit of small corporations is usually the take home pay of the family-owner. The business owner can decide to take his/her pay home as a salary which appears as an expense for the corporation, or as dividends which appear as profit for the corporation. Since the owner’s take home pay is usually very risky and quite variable, many owners wait to see the bottom line at the end of year and then declare dividends to themselves instead of drawing a steady salary. So taxing corporate profit is simply taxing the take home pay of the family-owner. Since we already have a personal income tax system in place, why bother taxing the corporation?
  2. The second type of profit in a corporation is paid out to shareholders relative to their investment of capital shares. A company can obtain capital or money in two ways, by borrowing and paying interest on loans or by selling shares and paying dividends on shares. In other word, dividends are simply the cost of capital or the cost of money to run the company, much like interest is a cost of borrowed money. If a person lends money to a corporation, then the corporation pays tax-deductible interest but the investor pays tax on the interest earned. Why would we treat dividends any differently?
  3. The third type of profit relates to compensation for risk. A business owner-employee cannot claim EI benefits if the business closes. The share capital is not guaranteed like the deposit certificate at the bank. Therefore, a reasonable profit, in addition to competitive wages and return on investment, is necessary to compensate for risk and motivate business people to risk their time and their life savings. Government has a role to play here to create incentives for risky equity investment versus regular deposit certificates.

Can profit be fair and competitive?

In a true free market economy, there would be little or no corporate profit beyond the salaries of owner-employees, dividends to cover the cost of money, and premiums for risk. Such healthy competitive markets force every corporation to hold its profit margin, reduce prices for consumers, pay competitive wages for labour, and reduce waste.

When a business generates above average profits, more than competitive rates for owner-labour and owner-capital, then one may be concerned about the social equity of excessive profits. When corporations make indecent profit levels, then it demonstrates that the market system has failed and that one corporation has consolidated too much competitive power. The solution is not to tax them, as the damage is already done and the market failure is only perpetuated. The solution is to fix the system, to ensure a fair and active competitive environment. If a government is expecting a significant income from corporate taxes as implied by a social equity agenda, then by definition, it must create or tolerate a failed market system that facilitates indecent profits.

Should we tax the corporations or the owners?

Corporate profit serves two purposes, to either grow the business with tax-deductible expenses and investments, or to reward shareholders with taxable dividends. When taxing profit, we have the choice of taxing it in the hands of the corporation or the hands of the shareholders, because the profit flows from one to the other. We tax either at full rate, or both at some shared rate, but we should not tax both at full rate because that is double dipping. It really does not matter where we tax the profit as long as it gets taxed. Since we already described dividends as compensation to owner-employees and owner-investors, profits are easily taxed when delivered to shareholders under personal income tax systems. Therefore, corporate tax systems are redundant and unnecessary.

Why does the government tax the corporations?

Contemporary governments decided to tax the corporation instead of the shareholder. Corporations pay tax on net income according to a progressive income scale, but shareholders receive dividend tax credits. They chose this method for three reasons.
  1. This placates the anti-corporate sentiments and makes the ruling party look good in the eyes of advocates of social equity without actually implementing social equity. As discussed in this essay, this is largely illusionary and mostly ineffective.
  2. It ensures that the profits are taxed before they leave the country in the case of off-shore shareholders which is particularly important in our country of extensive foreign ownership. There are alternative methods of dealing with off-shore dividends, such as simply holding back income tax on dividends upon payout.
  3. It generates tax revenues from profits before the dividends are transferred to shareholders who would not normally pay income tax, such as low income seniors collecting dividends from a pension fund. This is a disguised tax on low income persons and it makes corporate taxes entirely counterproductive in a social equity agenda.

Who are the shareholders?

As described earlier, corporate owners are mostly small business and farm owners, even members of cooperatives. In the case of large impersonal corporations, the usual target of the social equity agenda, the ownership is quite surprising. Sure, there are some very rich persons who may be the target of ideas about wealth re-distribution. There is also a very large group of small investors, ordinary people who put their savings and RRSPs into equity funds and shares of Canadian companies. The growth of the RRSP is tax-free until withdrawal. But taxes on corporate profits are actually a disguised tax on small investors, particularly on their return on investment, before it is transferred to them from the corporation.

More importantly, the largest equity holders in our country are actually institutional investors, employee pension funds, the Canada and Quebec Pension Funds, and the like. These pension funds are key distinctive instruments of social equity in our country. These funds invest their savings and count on stable dividends from large corporations to support the pension payments of retired workers including all the low wage union members. Retirees normally pay low income tax rates on pension income – another achievement of our socially progressive agenda in Canada. But they pay tax anyway as the government collects corporate income tax at high rates before the dividends are transferred to the pension funds and then to the retirees. Therefore, it is entirely counterproductive to promote corporate income taxes as a socially progressive tax system.

Do corporations avoid profits?

You bet.

Without figures on hand, I understand that the vast majority of corporations declare losses or very small profits, either because they actually loose money, or they legally manipulate the bottom line. Firstly, corporations have the option of paying salaries to the employed owners instead of dividends, as described above. Secondly, the tax rate on corporate profits is also the discount rate on discretionary expenses. If the corporate tax rate is 25%, then a discretionary expense costs only 75 cents on the dollar as the other 25% was a tax cost anyway; that 25% is paid to a supplier instead of the government. This brings to light the whole notion of tax write-offs. The post-tax discount rate is the real cost of executive perks and material benefits provided to owner-employees. Therefore, corporate taxes motivate discretionary expenses.

There are two ways for corporations to provide value to shareholders.
  1. Corporations can pay annual dividends, or they ensure that the share resale value improves over time. The corporation pays taxes on the former, but no one pays tax on the latter.
  2. Corporations can increase share value by growing their company with tax-deductible expenses in marketing, infrastructure, leases, production capacity, market share, etc. Shareholders have a life-time $500,000 tax deductible capital gain, or an unlimited tax free capital gain if the shareholder is foreign. Therefore, corporations spend the potential profit to avoid taxes while still returning value to the shareholder.

What about transnationals?

An important way to avoid taxes on profits in one country is to pay inflated prices for supplies to a sister company in another country. The local company never makes a profit, but sends important Canadian dollars to another country.

Do tax systems ensure social equity?

Not at all. No matter where the government revenues come from, a socially progressive government must still make distinctive spending decisions on socially progressive programs such as public health, education, child support, poverty elimination, etc. Social equity depends more on how the government spends its money, not so much on how it receives its money. There are financial and political disconnects between the revenues and expenses.

The government obtains revenues from many diverse sources: personal taxes, sales taxes, fees for services, tariffs, corporate taxes, resource taxes, sin taxes, etc. There is some but limited opportunity to implement progressive taxes to disproportionately increase the tax load on the wealthy. Sales and resource taxes as well as service fees cannot be progressive in that they cannot increase the tax rate relative to a person’s capacity to pay. Corporate taxes are certainly not progressive as they do not consider the relative wealth of the shareholder. The only real progressive option lies in personal income taxes where the tax rate can rise with the income bracket.

Who really pays the tax anyway?

Is the shareholder or the company going to pay the tax out of their pocket? Of course not! If the competition for capital on the money markets requires a 10% return on investment, and is the corporate tax on profit is 50%, then the operating profit of the company must be 20% on share equity. Half of the profit (10% of equity) goes to the government and the shareholders get their 10% return on equity. Where does that money come from? They are going to build the tax into the price of the product and pass the cost on to you and I. A tax, any tax, is simply a cost of doing business just like labour costs and labour taxes, interest on loans, property taxes, fuel taxes, etc. Corporate taxes cannot be socially progressive because the wealthy do not pay them. You and I still pay for it as consumers!

Are there other corporate taxes?

There are many points in the economic supply chain to collect tax revenues:
  • taxes on profits, as defined above, with the challenges explained above.
  • taxes on land, property, and buildings, as currently applied by the municipalities.
  • general sales taxes, which is a tax on gross corporate income, charged to the customers at the point of sale, collected by the corporation and sent to the government.
  • labour taxes and other labour costs such as EI and workplace insurance (WSIB) which are again a cost of doing business.
  • resource taxes on fuel, electricity, transportation, stumping fees, mineral and timber rights, water fees, that become a cost of doing business and are passed on to the customer in the price of the product.

Impact of taxation decisions?

All corporate taxes are a cost of doing business. Every business needs to manage its cost of doing business to remain competitive. Since products, materials, capital, and jobs move around the globe easily, the cost of doing business in Canada has important consequences in our competitive position to attract jobs, protect our government revenues, and sustain our quality of life.

We need to address the unsustainable mobility of products and jobs, but that is a different story. In the meantime, we must use our tax system to make Canadian businesses competitive while recognizing that corporate taxing do not contribute to the social equity agenda.

What is the alternative to taxes on corporate profits?

Our natural resources are in strong demand around the world and Canada is a net exporter of raw materials. Our current rate of consumption of natural resources is unsustainable and is destroying the ecological carrying capacity of our planet. Therefore, there is great opportunity to use our tax system to moderate our resource consumption and motivate more sustainable economic activities.

We want a taxation system that:
  • sustains our resources,
  • provides revenues for public services,
  • is socially progressive by distributing wealth,
  • supports the competitiveness of our businesses,
  • motivates business initiatives,
  • and is difficult to avoid by fraud and legal maneuvers.

The essential components of a Green Party tax system would be to:
  • shift taxes from corporate profits to individuals, including dividends sent out of country;
  • maintain a progressive tax system on personal income where the tax rate rises in the higher income brackets. Personal income includes wages, interest income, dividend income, and capital gains.
  • modify the personal dividend tax credit and the personal capital gains allowance as an incentive for business investment but not a personal tax avoidance.
  • shift taxes from labour and business profits to resources, waste and pollution, thus favouring labour and business initiative and urging a conservation of material resources;
  • shift taxes from general sales taxes to resources taxes, and force a rise in prices in resource intensive products versus green and renewable products.
  • support low income people with some form of tax credits or a guaranteed annual income to offset the inflationary impact of taxes on resources.

Yes, by looking at the reality of taxes, beyond the emotional and ideological images, we can create a tax system that is socially progressive and ecologically sustainable.

Thank you.

Tom Manley
Deputy Leader, co-chair of Platform
Agriculture & Food Advocate
The Green Party of Canada

www.greenparty.ca(external link)

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