Browsing by Author "Dahlby, Bev"
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ItemCorporate income tax and economic growth: further evidence from Canadian provinces(2021) Dahlby, Bev; Ferede, ErgeteThis paper investigates the effect of corporate income tax (CIT) rate on economic growth, using panel data from Canadian provinces over the period 1981–2016. Our empirical approach enables us to examine the long-run relationship between provincial tax rates and economic growth by allowing short-run dynamics to vary across provinces. We find that a reduction in the CIT rate has a statistically significant positive effect on the economic growth rate. Based on our main specification, a one-percentage-point reduction in the provincial CIT rate increases the growth rate by 0.12 percentage point four years after the initial CIT rate cut. ItemThe costliest tax of all: raising revenue through corporate tax hikes can be counter-productive for the provinces(2016) Ferede, Ergete; Dahlby, BevRaising taxes can come at a serious cost. Not just to the taxpayer, of course, but to the economy. Every tax hike naturally leads people or companies to reallocate resources in ways that are less productive, resulting in a loss of income-generating opportunities. At a certain point, raising taxes becomes manifestly counterproductive, with the revenue lost due to the negative economic effects outweighing any tax gains. In cases like that, a government would actually raise more money by lowering taxes, broadening the tax base, than it does by increasing taxes. In fact, an analysis of the tax-base elasticities of the provinces, using data from 1972 to 2010, reveals that this very phenomenon is what occurred in Saskatchewan, which raised corporate taxes to a point where it began to backfire, sabotaging the government’s goal of raising more revenue. It also occurred in New Brunswick, Newfoundland and Labrador, P.E.I., and Nova Scotia. In all these provinces, tax increases on corporate earnings actually ended up yielding less for the provinces than the provincial governments would have collected had they instead lowered corporate income taxes. In five other provinces, governments undermined their own provincial economies over the same period, raising corporate taxes when they would have been better off actually cutting the corporate income tax, and making up the difference with a revenue-neutral sales tax. Alberta, Ontario, British Columbia, Manitoba and Quebec all paid dearly for the decision to hit corporations with higher taxes, by sacrificing what could have been significant welfare gains had they sought to raise the same amount of revenue through higher sales taxes (or in the case of Alberta, a new sales tax). Quebec, at least, has lower tax-base elasticity than the others, however, possibly due to its unique cultural and linguistic characteristics, which may make it somewhat less likely for people and investors to leave the province. The evidence clearly demonstrates that corporate income taxes are far more sensitive to changes in the provincial tax rate than are personal income taxes or general sales taxes. Of course, it is not hard to see why politicians may feel political pressure to raise taxes on corporations, who do not vote, rather than passing tax increases onto residents, who do. But, while taxing corporations may be popular, preferred both by the voters and the politicians, when creating greater economic opportunities for their residents, provinces would have been far better off, over the measured 38-year period, looking elsewhere for additional revenue. As politically contentious as it may be, that means going easier on corporations and instead raising personal income and sales taxes. ItemCutting provincial corporate income tax rates to promote investment, employment and economic growth(2016) Ferede, Ergete; Dahlby, BevThis communiqué is based on the following paper: The Costliest Tax of All: Raising Revenue Through Corporate Tax Hikes can be Counter-Productive for the Provinces by Ergete Ferede and Bev Dahlby. ItemThe effect of corporate income tax on the economic growth rates of the Canadian provinces(2019) Ferede, Ergete; Dahlby, BevThis paper investigates the long-run effects of the corporate income tax (CIT) rate on the economic growth of Canadian provinces using annual panel data for the period 1981-2016. We find evidence of a statistically significant negative long-term relationship between the provincial statutory CIT rate and economic growth. The model has the properties of a neo-classical growth model in that a reduction in the CIT rate “temporarily” increases the growth rate of the economy before returning to its long-run run growth rate. However, the temporary growth effects are economically significant and persistent. According to our preferred specification of the econometric model, one percentage point reduction in a provincial government’s statutory CIT rate increases the growth rate by 0.12 percentage points four years after the initial CIT rate cut and increases real per capita GDP by 1.2 percent in the long-run. We use the model to simulate the recently announced reduction in the CIT rate in Alberta from 12 percent in 2018 to 8 percent in 2022. The simulation results indicate that the growth rate of real per capita GDP would increase by 0.92 percentage points in 2022 and by 0.28 percentage points in 2029. The model also predicts that real per capita GDP would be 2.5 percent higher in 2022 and 6.5 percent higher in 2029. This would translate into employment increases of approximately 58,000 in 2022 and 172,000 by 2029. Our results indicate that provincial governments could significantly improve economic performance by lowering provincial corporate income tax rates. ItemThe effect of population aging on economic growth in Canada(2023) Ferede, Ergete; Dahlby, BevRecent econometric studies, based on data from other countries, have reached contradictory conclusions about the impact of population aging on economic growth, with some finding that it reduces economic growth, while other studies show a positive effect. As well, there have not been any Canadian econometric studies on this crucial issue. The objective of this study is to fill this gap in the literature by empirically investigating the impact of population aging on Canadian per-capita output and the growth of labour productivity based on annual provincial data from 1981 to 2020. ItemThe effects of tax rate changes on tax bases and the marginal cost of public funds for Canadian provincial governments(2012) Dahlby, Bev; Ferede, ErgeteThe efficiency losses from taxation vary directly with the responsiveness of a government's tax bases to tax-rate increases. We estimate the dynamic responses of tax bases to changes in tax rates using aggregate panel data from Canadian provinces over the period 1972 to 2006. Our preferred empirical results indicate that a one percentage point increase in corporate income, personal income, and sales tax rates is associated with a 3.67, 0.76, and 1.17 percent reduction in their respective tax bases in the short run. The corresponding long-run tax base semi-elasticity estimates are higher: -13.60, -3.63, and -3.18, respectively. We use the tax base elasticity estimates to calculate the marginal cost of public funds (MCF) for the provinces' three major taxes. Our computations indicate that the corporate income had the highest MCF and that the sales tax had the lowest MCF in all provinces in 2006. The MCF for the personal income tax ranged from 1.44 in Alberta to 3.81 in Quebec. Our results imply that there would have been significant welfare gains in 2006 from reductions in provincial corporate income tax rates. Our computations also indicate that the equalization grant formula may reduce the perceived MCF of the provinces that receive these grants, and that increases in provincial corporate and personal income taxes can cause significant reductions in federal tax revenues. ItemAn evaluation of three alternative fiscal anchors for Canada(2022) Dahlby, Bev; Ferede, Ergete; Fuss, JakeIn this paper, we evaluate three fiscal anchors that Canadian governments could adopt—a debt reduction target, a ceiling on the ratio of interest payments to revenues, and a balanced budget rule—balancing the primary budget either through expenditure restraint or tax increases. We simulate the adoption of these fiscal anchors using an economic model in which governments’ fiscal policies affect the growth rate of the economy and the real interest rate on public debt. Each scenario has different implications for government debt ratios, economic growth rates, and real interest rates on government debt from 2025 to 2050. ItemThe fiscal costs of debt-financed government spending(2022) Dahlby, Bev; Ferede, Ergete; Fuss, JakeIn this paper, we show that the notion that debt-financed spending has a low fiscal cost is misleading. We review econometric studies of OECD countries that show that the growth rate declines, interest rates increase, and the r - g differential increases as a country’s public debt ratio increases. We also estimate a simple regression model of the r – g gap in Canada based on the annual data from 1991 to 2019. Consistent with the findings of other more elaborate econometric studies, the regression results indicate that the r – g gap in Canada is affected by international financial and economic conditions, as reflected by the r – g gap in the United States, but also by the public debt to GDP ratio. In particular, a one percentage point increase in the debt to GDP ratio of the federal, provincial, territorial, and local government sector is associated with a 6.7 basis point increase in the Canadian r – g gap. ItemHow provincial governments respond to fiscal shocks and federal transfers(2023) Ferede, Ergete; Dahlby, BevIn this study, we investigate how Canadian provincial governments have responded to fiscal shocks, including changes in federal transfers, based on annual data spanning over half a century. We find that provincial governments have responded to a $1.00 increase in their per-capita budget deficits by cutting program spending by $0.18 and increasing own-source revenues by $0.09 the following year. As these responses only partially offset the deficit, provincial debt levels increase, and debt service costs rise. Thus, provinces that face adverse fiscal shocks and/or rising budget deficits in a given period inevitably respond by reducing program spending and/or hiking own-source revenues in future periods. This undermines the arguments advanced by some politicians and policy analysts who believe provinces can run ongoing deficits without having to “face the fiscal music” in the future. ItemThe impact of property taxation on business investment in Alberta(2021) Dahlby, Bev; Ferede, Ergete; Khanal, MukeshAlberta municipalities rely heavily on property taxes levied on residential and non-residential sectors to finance local public services. This paper investigates the effects of non-residential property tax rate on business investment using panel data from 17 Alberta cities over the 1998-2017 period. We find that a one mill increase in the non-residential property tax rate is associated with a $49 decrease in commercial and industrial real capita investment. Based on this estimate, we calculate the marginal cost of public funds for the non-residential property tax, which range from 3.12 for Lethbridge to 1.21 for Leduc. We also find that business taxes that are levied on the rental value of a business property have a negative impact on investment, while higher expenditures on municipal services do not have a significant effect on business investment. ItemIncome inequality, redistribution and economic growth(2013) Dahlby, Bev; Ferede, ErgeteInequality is on the rise in Canada and this state of affairs has provoked outrage and demands for redistribution at a time when governments at every level are searching for reliable long-term growth.This paper examines the links between income inequality and economic growth and whether there is a trade-off between redistributive policies, and economic growth, or whether income redistribution canenable faster growth. The authors survey the existing literature on the impact of inequality on economic growth, and then conduct an econometric analysis of the association between provincial economic growth in Canada and three different measures of income inequality, finding no statistically significant relationships. One measure of income redistribution, the difference between the market income Gini coefficient and the disposable (after-tax, after-transfer) income Gini is positively associated with provincial growth rates — but since the largest transfer programs in Canada are federal programs financed out of nation-wide taxes, it is unlikely that this association carries over to the national level.Much of the growth in income disparity has been driven by innovation that places a premium on highly trained workers. With that in mind, the Goldin-Katz model, used to explain the rising earnings differentials of highly skilled workers in the US, can be combined with the Aghion-Bolton model of capital market imperfections to develop a framework for examining the impact of education spending,and the taxes that finance it, on earnings inequality and economic growth. The authors then review evidence that raising marginal tax rates on high-income individuals would not raise additional tax revenues, but impose substantial costs on the economy, as would higher corporate income taxes.Punishing high earners is a self-defeating choice, although improvements to the social safety net would give more Canadians the chance to join their ranks. ItemThe interplay of interest rates and debt-financed government spending(2023) Dahlby, Bev; Ferede, ErgeteProponents focus on the average fiscal cost of program spending when the interest rate on government debt is less than the economy’s growth rate. They ignore the potentially large marginal fiscal cost of deficit-financed increases in spending that arise when a higher public debt increases interest rates on government debt and lowers growth rates. ItemProvincial tax rate adjustments in Canada(2013) Ferede, Ergete; Dahlby, Bev; Adjei, EbenezerChanges to tax rates are important fiscal events in Canada. They affect the amount of taxes that Canadian households and businesses pay to governments,and the level of economic activity by affecting incentives to work, save, and invest. Thus it is important to understand what factors cause governments to increase or reduce their tax rates.A recent study by Ergete Ferede, Bev Dahlby, and Ebenezer Adjei sheds some light on some of the factors that determine the timing and direction of tax rate adjustments by provincial governments. ItemStimulating the growth effects of the corporate income tax rate cuts in Alberta(2019) Dahlby, Bev; Ferede, ErgeteShortly after its election in May 2019, the new Alberta government began fulfilling its promise to reduce the provincial corporate income tax (CIT) rate. The rate cut began in July 2019, when the government dropped the CIT rate from 12 to 11 per cent. The rate is scheduled to decline to 10 per cent on Jan. 1, 2020, followed by further one-percentage-point reductions in 2021 and 2022, bring the Alberta CIT rate down to eight per cent in 2022. ItemThe stimulative effects of intergovernmental grants and the marginal cost of public funds(2016) Dahlby, Bev; Ferede, ErgeteThis paper tests the hypothesis that the stimulative effects of intergovernmental grants increase with the marginal cost of public funds of the recipient government. We present a simple theoretical framework that shows how a lump-sum transfer stimulates the marginal expenditures of a recipient government through an income effect and a price effect. We then test the prediction of this model using Canadian provincial data and exploit the discontinuity in the equalization grants allocation formula to identify the effects of grants. Our results indicate that the stimulative effects of lump-sum grants on spending increase with the provincial government's marginal cost of public funds (MCF). One policy implication of our results is that higher intergovernmental transfers may be welfare improving if the federal government has a lower MCF than the provinces. ItemStress testing the federal fiscal anchor(2023) Dahlby, Bev; Ferede, ErgeteIn order to provide a realistic assessment of the federal government’s multi-year fiscal plan, we use a Monte Carlo simulation model to investigate how the federal government’s debt ratio might evolve if the Canadian economy is subject to random growth rate shocks similar to those experienced over the last 40 years. The model generates 1,000 episodes of the evolution of the federal net-debt ratio over a 20-year time horizon when the economy is subject to annual growth-rate shocks. It indicates that there is a 30% chance that the federal debt-to-GDP ratio will be higher over a 10-year time horizon and a 53% chance that it will be higher over a 20-year time horizon. The likelihood of no recessions occurring over a 20-year time horizon is only 15%. This means that it is very unlikely that the federal projected debt ratios will be realized. In other words, taking the federal government’s projected primary surpluses at face value, but with random shocks to the growth rate that mimic past experience, the federal fiscal anchor will most likely be violated. The probabilities of one, two, and three or more recessions over a 20-year time horizon are 32%, 28%, and 25%, respectively. When two recessions occur, there is a 60% chance that the debt ratio will increase. ItemThe timing and direction of statutory tax rate changes by the Canadian provinces(2013) Ferede, Ergete; Dahlby, Bev; Adjeic, EbenezerTax rate changes are some of the most significant and far-reaching decisions a government can take. A good understanding of the odds of any such changes is essential for any business debating the timing and location of investments. This paper investigates the factors that affect the timing of statutory tax rate changes by Canadian provincial governments. The authors develop a simple theoretical model to explain the “stickiness” of tax rates — the factors that lead a province to decide against tinkering with the tax system — based on the presence of fixed costs of adjusting tax rates. The results indicate that if the current rate falls within a range of tax rates bracketing the optimal rate, then the government will not adjust its tax rate because the cost of the reform outweighs the potential benefits. To build up a body of evidence, this paper employs a multinomial logit model to examine the likelihood of changes to personal income tax (PIT), corporate income tax (CIT), and provincial sales tax (PST) rates by provincial governments over the period 1973-2010. Regression results indicate that provincial governments that start with higher tax rates are more likely to cut, and less likely to raise, their tax rates. A higher provincial budget deficit reduces the probability of a CIT rate cut and raises the probability of a PST rate increase. Party ideology seems to matter. Provinces with left leaning governments are less likely to cut PIT and PST rates, and more likely to raise PIT rates compared to non-left-leaning governments. The authors also find that a federal PIT rate cut raises the probability of a provincial PIT rate increase, whereas a federal CIT rate cut raises the probability of a provincial CIT rate reduction. ItemWhat are the economic costs of raising revenue by the Canadian federal government?(2022) Dahlby, Bev; Ferede, ErgetePersonal and corporate income taxes are important sources of revenue for the Canadian federal government, accounting for 72 percent of its total tax revenue in 2020–2021. This study investigates the economic costs of raising revenue through the federal personal income tax (PIT) and corporate income tax (CIT). We begin by estimating a measure of the tax sensitivities of the CIT and PIT bases based on data from 1972 to 2019. The econometric model indicates that a one percentage point increase in the federal CIT rate is associated with a 3.36 percent reduction in the CIT base, and a one percentage point increase in the top federal marginal PIT rate is associated with a 1.97 percent decline in the PIT base in the long run. Our estimates of the tax sensitivity of the tax bases are generally consistent with the findings of previous studies, and in particular that the CIT base is more responsive to tax rate changes than the PIT base. We also compare our estimates of the tax sensitivity of the federal PIT and CIT bases with the estimates of the tax sensitives of the provincial tax bases in Dahlby and Ferede (2018). As anticipated, the federal tax bases are much less tax sensitive than the provincial bases, especially in the case of the CIT, because it is easier to shift taxable income or re-allocate investments across provincial boundaries than across international boundaries.