Tax reduction versus tax credit

I don’t want to beat this to death.  I have already covered this several times before but after another discussion today with some adamantly defending corporate tax cuts, I have to restate my argument.

The stated reason for an across the board corporate tax cut is to stimulate new business investment.  If you hear the proponents talk that is what they will say.  New Brunswick will be the most competitive location for taxes and that will lead to more business investment.

I say the best way to use the tax code to stimulate new business investment is to use investment tax credits or other tax incentive programs.  Here is the difference:

Let’s say that a large corporate tax cut ends up putting $50 million back in the pockets of NB companies.  As I pointed out elsewhere that is only about $1,250 per average company per year. Or less than the value of a cup of Starbucks coffee per day.  Well, my opponents response to this was that the intended benefits are for larger firms.  Okay.  Let’s test that assumption.

Let’s say I am among the 50 firms in New Brunswick or so that make a million in annual profit in the province (companies that are based here).   For each million in profit, that tax cut will equate to about a $50,000 reduction in taxes owed.  Not bad but are you really going to run out and reinvest $50,000 in a company that generates $100 million or more in sales?  A little simplistic, it would seem.

Now, think about the investment tax credit scheme.  Let’s say we leave the tax rate the same but we give a 40% investment tax credit for targeted industries like certain kinds of manufacturing, ICT, export oriented professional services, etc.  Under that scenario, the company gets a 40% tax reduction for eligible investments in the company (expansions, productivity improvements, etc.).  This way, the company gets a $400,000 tax reduction for every million in new investment.   This is a eight fold greater benefit than just the tax cut.  In addition, the province gets guaranteed new investment (rather than the cut tax and hold your fingers approach).

Come back to the $50 million.  If you allocated that much for ITCs (investment tax credits), that means you would end up with a minimum of a guaranteed $125 million in new investment each year ($50 million over 40%).

So the province is not out any more tax revenue but gets a guaranteed minimum $125 million in new investment. 

So what is better, chopping $50 million across the board and crossing fingers or allocating $50 million to ITCs each year and guaranteeing at least $125 million.

Final point.  My debater said that the real target of the tax cut was national and international investors.  That doesn’t matter, my ITC model works there as well.  The foreign investor comes in, invests $100 million and gets $40 million in ITCs – let’s say spread over a number of years (because it is virtually impossible for a $100 million project to generate enough profit to cover the ITCs in the first year).  In that scenario, the province loses the corporate income tax revenue from the company moving into the province for a few years but gains all the tax revenue from other sources (personal income, HST, property) which are more consequential to the provincial budget anyway.

Food for thought (retrospective).