{"id":378,"date":"2018-03-07T11:23:36","date_gmt":"2018-03-07T18:23:36","guid":{"rendered":"https:\/\/blogs.ubc.ca\/kevinmilligan\/?p=378"},"modified":"2018-03-07T11:26:44","modified_gmt":"2018-03-07T18:26:44","slug":"notes-from-c-d-howe-investment-focused-corporate-taxation","status":"publish","type":"post","link":"https:\/\/blogs.ubc.ca\/kevinmilligan\/2018\/03\/07\/notes-from-c-d-howe-investment-focused-corporate-taxation\/","title":{"rendered":"Notes from C.D. Howe: Investment-focused corporate taxation"},"content":{"rendered":"

Notes for talk to C.D. Howe Institute, National Council Meeting
\nMarch 7, 2018
\nKevin Milligan, UBC Vancouver School of Economics<\/p>\n

(Printable PDF version here<\/a>.)<\/p>\n

—<\/p>\n

With the big US tax reform now law, many are wondering what Canada should do in response. Minister Morneau has taken a cautious approach so far. I think that\u2019s appropriate. But do think there is a strong case for action. \u00a0Let me tell you why.<\/p>\n

Let\u2019s start at the beginning. Why do we have corporations at all? The answer is that we have corporations to facilitate productive investment. \u00a0If society\u2019s goal for corporations is investment, it makes sense to structure our fiscal system around investment.\u00a0 Let\u2019s grow investment, rather than taxing profits.<\/p>\n

The current corporate income tax has four problems, from an economist\u2019s point of view.<\/p>\n

First is that it imposes tax on the normal return to investment when there is equity financing, which discourages investment.<\/p>\n

Second is the distortions of CCA depreciation schedules, which only work efficiently when they exactly match true economic depreciation\u2014a very tough goal to achieve. Otherwise, they distort investment across asset classes.<\/p>\n

Third, the current corporate income tax favours debt financing over other sources, which leads to inefficient capital structures and increases the risk of debt-induced bankruptcy.<\/p>\n

Finally, today\u2019s corporate income tax is complex, devouring too many resources in administration both in firms trying to comply with the rules, and with the CRA trying to administer them.<\/p>\n

Over the last forty years, economists have worked on alternatives to the corporate income tax that can eliminate these problems. One of these alternatives is known to economists as a \u2018cash flow\u2019 tax. In a pure cash flow tax, the deductibility of interest is eliminated, but corporate investment is fully deductible in the year of investment\u2014full expensing of investment. This tax system grows investment rather than taxing profits.<\/p>\n

An investment-focused corporate tax eliminates three of the problems with income taxation, and cuts down on the fourth.<\/p>\n

The taxation of the normal return to investment is eliminated. For the marginal breakeven investment project, the discounted flow of future returns exactly equals the cost of the investment\u2014that\u2019s the very definition of a breakeven project. So, by fully exempting investment you\u2019re effectively fully exempting the future normal return to investment. Again, for the breakeven project the net present value of the flow of income exactly equals the cost outlay. That\u2019s the magic. Excess profits will still be taxed. But normal returns are not.<\/p>\n

CCA depreciation schedules are eliminated. This removes an investment distortion across types of assets.<\/p>\n

Because there is no longer an interest deduction, both debt and equity are put on an equal footing. This eliminates the capital structure distortion.<\/p>\n

So, an investment-focused business tax can solve three big problems with the current income tax approach. On the fourth problem\u2014complexity\u2014we can reduce the administrative burden of CCA schedules, which is a step in the right direction.<\/p>\n

Of course\u2014there are many details that need to be worked out. Among the most pressing:<\/p>\n