Sunday, January 30, 2011

Corporate Tax Cuts - Do They Really Create Jobs?

In the past number of weeks, there has been a great deal of mainstream media coverage, in both Canada and the United States, about federal government implementation of corporate tax cuts in an effort to both create jobs and to remain competitive so the jobs existing in both countries don't go shopping for a more tax-friendly regime elsewhere.  Governments are trying to convince voters of the validity of their "drop the taxes and they will come" philosophy when it comes to corporate taxes and jobs.

Let's take a look at the corporate tax policy and unemployment in a country that has been in the news lately regarding its rather weak economy and its inability to manage its own debt, requiring a massive bailout - Ireland.  I'll compare Ireland's experience with corporate tax levels and employment with its fellow European Union Member States.

Let me open this posting with the observation that Ireland's current fiscal state is largely a product of an under-regulated banking sector and an over-heated housing market.  Those issues may well have affected Ireland's unemployment rate, however, one would think that if corporate taxes are low enough, that companies will continue to create jobs for non-domestic consumption; no matter how bad the local economic situation is, corporations should prefer to do business (resulting in the creation of jobs) in low tax regimes.

Let's start by looking at the corporate tax rates for all EU Member States.  From the European Union's Europa website, here is a chart showing the top statutory corporate tax rates for all EU Member States:


In the 27 countries that make up the EU, the average corporate tax rate in 2010 was 23.2 percent; this rate is down 8.7 percentage points from 31.9 percent back in the year 2000.  To compare, the average personal income tax rate in 2010 was 37.5 percent, down 7.2 percentage points from 44.7 percent in 2000.  The top three corporate tax rates are found in Malta (35 percent), France (34.4 percent) and Belgium (34 percent) and the lowest three corporate tax rates are found in Bulgaria and Cyprus (both 10 percent) and Ireland (12.5 percent).  From the average corporate tax rates noted above, you can see that Ireland's corporate tax rate is just over half of the average of all 27 EU Member States and third lowest overall.

The largest decreases in corporate tax over the past 10 years were recorded in Bulgaria (down from 32.5 percent to 10 percent), Germany (down from 51.6 percent to 29.8 percent) and Cyprus (down from 29 percent to 10 percent).  Ireland's corporate tax rate dropped from 24 percent in 2000 to 12.5 percent, a drop of 11.5 percentage points or 47.9 percent.  In that period of time, Ireland's personal income tax dropped by 3 percentage points or 6.8 percent from 44 percent to 41 percent.  Corporations in Ireland are experiencing a massive drop in taxes at the expense of individuals who have barely seen their tax level budge.  In fact, recent increases to Ireland's VAT will pretty much negate any individual income tax savings.  It's always interesting to see how much of government's revenue burden is being borne by individuals versus massive and highly profitable corporations.

Now let's look at Ireland's unemployment situation for September 2010 and compare it to all other EU Member States as well as the United States and Japan:


Here's a map showing the same thing.  The darker green colours show higher unemployment and the yellow colours show lower unemployment.  Note again, that while Ireland isn't the darkest green, it is a rather appropriate shade of green:


Here is the link for the chart that the unemployment graph data came from and here's the chart showing the country-by-country monthly unemployment data for 2010:


I'm using the statistics from September 2010 since the country data is the most complete.  For the month of September 2010, the average European Union (27 country) rate was 9.6 percent.  The highest unemployment rate was 20.6 percent in Spain, second highest was Lithuania at 18.3 percent and third highest was Latvia at 18.2 percent.  Ireland comes in with the 6th highest unemployment rate of 13.9 percent after the aforementioned Spain, Lithuania and Latvia as well as Estonia and Slovakia.

Now let's look at the unemployment rates for the countries with the highest corporate taxes.  Malta (corporate tax rate 35 percent) has unemployment of 6.5 percent, France (corporate tax rate 34.4 percent) has unemployment of 9.7 percent and Belgium (corporate tax rate of 34 percent) has unemployment of 8.4 percent.  All three of these "corporate tax nightmares" have unemployment that is far lower than Ireland's rate of 13.9 percent and in the case of Malta, less than half.

To summarize this data; Ireland has the third lowest corporate tax rate, well below the EU average, but has the sixth highest unemployment rate, well above the EU average.  One cannot conclude that Ireland's low corporate tax rate has not particularly led to job creation since the joblessness is, at least in part, due to other factors in the economy.  As well, one cannot particularly conclude that the ultra-low corporate tax rate has bailed out Ireland's economy by creating untold thousands of jobs, particularly now when the country needs jobs the most.  Despite the very low tax rate in comparison to its neighbours, Ireland's corporate tax policy is not benefitting the 13.9 percent of unemployed Irish workers.  Yes, it is possible that Ireland's current unemployment situation could be far worse without low corporate taxes but we'll never know the veracity of that relationship just as we'll never really know how much the low tax rate was actually responsible for job creation now or in the past.  My suspicion is that the uncertainty of the relationship between corporate tax levels and job creation will apply to Canada and the United States as well.

Voters in Canada, the United States and other nations where governments are touting low corporate tax rates as the panacea for all the economic and unemployment woes facing their economies had better think twice when examining this issue.  As seen from the example of Ireland, jobless rates are affected by many factors, corporate tax rates being only one of them.  The best laid plans of government do not always come to fruition, and in this time of rapidly mounting deficits and debt, corporations should not be excused from paying their share of government revenues.  It should not be the responsibility of individual tax payers to cover a larger proportion of government revenues while corporations use their tax savings to pad their profits and ultimately their share prices.

Nothing in economics is certain and the relationship between corporate taxation and job creation is no exception.

17 comments:

  1. Very interesting and some really useful statistics. Thanks

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  2. I am constantly amazed at the depth and breadth of your research -
    your knowlegable perspective is much appreciated.

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  3. This is too simplistic an analysis of corporate tax rates vs unemployment. For example, had you compared pre-recession numbers, you would have come up with very different results for Ireland. There are other variables why there is high unemployment in Ireland, and much of it has to do with housing bubble, with many jobs lost and not regained, as well as movement of companies to lower wage areas of the EU and non-EU low wage countries. Also, the elimination of jobs by companies that have decided to consolidate or downsize to stay competitive. If we factor in Ireland's high wage, we can easily discount any gains that corporations make in reduced corporate tax, there is just no sense in investing in Ireland at this point. One of the reasons many American companies invested in Ireland in the first place is that it was an English speaking country without the high labor costs of the UK. But today, that advantage is gone, and so will the jobs.

    The real issue that we should all be looking at is the migration of businesses to third world aka cheap locations where companies can pay slave wages for their products and services. The best solution at this stage is a reintroduction of tariffs for non-nationally produced goods and serves and large penalties for national companies who outsource labor and services as well as more strict implementation on what a company can and can't outsource to lower-waged countries. This is the real reason why many corporations keep getting richer and so-called first world countries keep getting poorer.

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  4. The thing about corporate tax is that you can't tax a business!!! The tax is ALWAYS passed on to either employees, customers, or shareholders. Someone in society has to and always will bear the tax burden!

    Now, for a hypothetical scenario: If you had a manufacturer that wanted to establish a plant in Canada but export everything produced; Should you corporate tax it?

    My answer is No! Should you corporate tax an entity that is doing nothing more than providing jobs and increasing the cost of labor?

    JR

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  5. Thanks for taking on this issue. I know I'm no economist or anything, but I do know that demand for a good or a service is what creates jobs. While favourable economic factors can well improve job prospects by way of research and development or investment in alternative markets, taxes are but one component of the economic factors, and I would guess far from the most important one. Also, reducing corporate taxes might have a profound impact in some cases, but my guess is the starting rate and the ending rate are important for that to happen. Going from 67% to 12% say, would be a big deal. Going from 25% to 15%, not so much. Finally, in Canada at least, isn't this really just the 'trickle down effect' theory that has already been disproved, by another name?
    Jenn

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  6. 7. Wow! You are definitely a magician. I have always liked to know others feelings and thoughts, but I must say your article is one of the best I have read. And I suggest others to read it. OffShore

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  7. Anonymous - Jan 31

    Yes, I realize that corporate tax rates are just one component of job creation but, interestingly enough, some noted economists feel that the level of taxes is only responsible for 20 percent of jobs created. In this time of mounting debts and deficits, we ALL have to pay our share and when we read stories of companies paying minimal taxes at the same time that they are padding their executive team compensation packages, it somehow does not seem fair or just.

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  8. This is a perfect example of how one can use statistics to "prove" anything.

    Unemployment is a function of myriad factors, including productivity, legal restraints, unionism, Monetary Sovereignty, geo-politics, exports/imports, taxes and on and on. To produce a table, mixing nations with varying degrees of all these factors, and ascribing unemployment to lack of corporate taxes is ludicrous.

    What the author wishes you to believe is this: Taking money from corporations does not reduce their ability to hire.

    Think about it.

    Also, think about the fact that in a Monetarily Sovereign nation, corporate taxes are 100% unnecessary and 100% harmful to the economy. Now there are statistics you can believe.

    Rodger Malcolm Mitchell

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  9. Political Junkie, I'm in agreement with several comments here and disagree with your analysis. Like one person said, pre- and post-recession comparisons would help. I also think the problem is more complex due to the plethora of intervening variables at play. Many people don't realize that corporations don't pay taxes; we the consumers do. So the higher the tax rate, the higher the price of goods and services. I think higher tax rates may have a closer relationship with inflation than unemployment.

    Anonymous said, "The best solution at this stage is a reintroduction of tariffs for non-nationally produced goods and serves and large penalties for national companies who outsource labor and services..."

    Agreed. But first, right-to-work laws need to be passed in all 50 states. The unions must be neutered once and for all.

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  10. Paul and Rodger:

    I realize that my use of statistics is solely to prove my take on corporate taxes and employment, however, government's analysis and manipulation of the data is much the same but taking the opposite viewpoint that lower corporate taxes are the salve that will heal all wounds in the job market. I disagree.

    I certainly wouldn't argue that in the case of the Celtic Tiger that a huge number of jobs were created by lowering corporate taxes but (and that's a BIG but), where are those jobs now? From what I've seen throughout my life, jobs go one of two places; where taxes are lowest and/or where labour is cheapest. Just because the United States, Canada or any other nation lowers corporate taxes doesn't mean that permanent jobs are created in any jurisdiction. That is, perhaps, one of the downfalls of globalization - it's just too easy for corporations to move jobs to wherever they get the most bang for their "buck".

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  11. Without a thorough analysis of other factors it is naive to attempt to reach conclusions.

    Your points:

    "It's always interesting to see how much of government's revenue burden is being borne by individuals versus massive and highly profitable corporations"

    "Corporations in Ireland are experiencing a massive drop in taxes at the expense of individuals who have barely seen their tax level budge"

    are naive at best. Idiotic more likely. ALL taxes are paid by people. The labeling as "corporation tax" merely identifies the mechanism for collection.

    How are corporation taxes taxes on people? The more tax, the less to reinvest for growth and the less to pay as dividends to shareholders...ultimaely they are people.

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  12. All of you who are claiming this is too simple, quoting a myriad of other variables, are still making it too simple in order to prove your own points...

    Not all taxes are born by customers. In a real competitive market, the price is set by everyone and the company does actually absorb part of the cost... it comes out of the producer surplus that exists below the equilibrium price for those producers who could produce the product for a higher cost.

    In a market with higher labour elasticity, this usually means that wages are pushed down. Combine that with decent pay equity legislation, and you can actually successfully tax corporate boon. So, someone who says taxes are always born by people is more correct, but still not completely.

    In cases where the labour is inelastic and capital is more elastic, your taxes may just restrict productivity until the per-unit cost of capital (which is a fixed cost) raises back up to what it was before the tax. Which could mean lower supply or more labour, which means more jobs for HIGHER taxes (but lower productivity).

    My point being, no economist has a model with enough variables. It's different per-product, not just per-sector or industry. So you really need to just try it, review it, measure it, and fix it like every other well run business strategies.

    Oh yeah, and yes, in non-perfect competitive markets (like oligopolies) I'd agree that the cost is always put on the customer, but that's bad government policy for allowing oligopolies. We need smart government, not less government.

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  13. It's always interesting to see how much of government's revenue burden is being borne by individuals versus massive and highly profitable corporations.

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  14. There is really no need for Taxes in the 1st place,this $hit didn't get rolling until WW2!

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  15. Although people generally don't like to pay them, taxes are necessary for three reasons. The first, and most-obvious reason, is the fact that they pay for the government services that we rely upon. The second, is they have a dampening against inflation. Think about it: If all levels of government were to eliminate taxes tomorrow, where would the cost of living be? The answer is, it would likely skyrocket, due to the enormous increase in the supply of money. The third, is they are required to pay-down government debt. To all those right-wing individuals and corporations who believe taxes are unnecessary: Your attitude is a very-destructive one, indeed. Governments who tax less typically get into debt more, eventually leaving themselves crippled as they struggle to meet the ever-increasing interest payments on that debt, thus leaving less financial resources for more-important things. The U.S. recently came very close to defaulting on its debt obligations due to congressional nut-jobs who refuse to raise taxes under any circumstances. Those of you who refuse to pay your fare share of taxes today are simply transferring the tax-burden to future generations. It is time to grow-up and take responsibility for yourselves. End this narcissistic madness NOW! Pay your fair share of taxes.

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  16. Interesting analysis; however, I agree with a few others that you can always manipulate statistics to show whichever point you wish to portray. Unemployment is a very difficult topic (especially as it also deals with education levels in the various different countries considered, population age,etc.... in a globalised economy even how prepared is the population to deal with international markets? among tons of other variables). I believe that if Ireland had higher corporate tax rate, they will have far more complex issues and higher unemployment. What has made them change their position in the list of unemployment (not to be in Spain's shoes) is the incoming list of top corporate headquarters to their land. Also you may want to think that the Irish case is work in progress. Give them 5 years with this tax rate and most multinationals in Europe will have their headquarters or subsidiaries based there. Even by not doing much promotion (i.e. investing in infrastructure, research, etc), they are attracting them with a low corporate tax rate. It is impossible to compare their case to other countries that are completely different, but I think that Germany made a smart move to lower their corporate tax rate, the world has changed and governments need to learn to obtain money in alternative ways to corporate tax. Public-Private initiatives could be a start, but hardly you see our lazy governments making the effort to develop them. The trend will continue as it makes sense especially in a extremely mobile global village, businesses will go where they can grow for themselves and not to pay the corporate tax where they are located.

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