Research Online at MacEwan :: Browsing by Author "Ferede, Ergete"

Browsing by Author "Ferede, Ergete"

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Block grants and education expenditure
(2016) Ferede, Ergete; Islam, Shahidul
This article investigates the effects of block grants on education expenditures using panel data from Canadian provinces over the period 1982 to 2008. Our main empirical identification strategy relies on the use of the allocation formula for equalization grant—a component of the Canadian federal block grant. The results indicate that block grants have stimulative effects on provincial education expenditure. Our results suggest that a one dollar increase in per capita federal grants is associated with an increase in per capita education expenditure of about Can$0.21, which is roughly proportional to the share of education in total provincial spending. The results are robust to various sensitivity checks.
Corporate income tax and economic growth: further evidence from Canadian provinces
(2021) Dahlby, Bev; Ferede, Ergete
This 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.
Cutting provincial corporate income tax rates to promote investment, employment and economic growth
(2016) Ferede, Ergete; Dahlby, Bev
This 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.
Determinants of statutory tax rate changes by the Canadian provinces
(2015) Ferede, Ergete
Tax rate changes are some of the most significant and far-reaching decisions a government can take. In this paper we investigate the various fiscal and political factors that influence a government's statutory tax rate change choices. We employ a multinomial logit model to empirically investigate the likelihood of changes to personal income tax, corporate income tax, and provincial sales tax rates by Canadian provincial governments over the period 1973-2010. Our results indicate that provincial governments that start with higher tax rates are more likely to cut, and less likely to raise, their tax rates. Another important implication of our results is that ideology matters-provinces with left-leaning governments are less likely to cut and more likely to raise their tax rates. The results are robust to various sensitivity checks.
Entrepreneurship and personal income tax: evidence from Canadian provinces
(2019) Ferede, Ergete
This paper employs the dynamic panel estimation method to investigate the effects of the top personal income tax rate on entrepreneurship as proxied by the employer business entry rate using data from Canadian provinces over the period 1984–2015. The empirical findings of this paper show that the top income tax rate has a negative and statistically significant effect on entrepreneurship both in the short and long term. According to the preferred estimate of this study, a one percentage point increase in the top statutory marginal income tax rate is associated with a 0.13 percentage point decrease in the business entry rate in the short term and a 0.41 percentage point decrease in the long term. Based on the long-term results, on average, a province that raises its top personal income tax rate by one percentage point can expect to have about 405 fewer new employer businesses enter its economy. This is a significant loss for an economy that has been experiencing a decline in entrepreneurship for a long time. The key findings of this paper are robust to various sensitivity checks.
Income inequality, redistribution and economic growth
(2013) Dahlby, Bev; Ferede, Ergete
Inequality 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.
Provincial tax rate adjustments in Canada
(2013) Ferede, Ergete; Dahlby, Bev; Adjei, Ebenezer
Changes 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.
Stimulating the growth effects of the corporate income tax rate cuts in Alberta
(2019) Dahlby, Bev; Ferede, Ergete
Shortly 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.
Tax progressivity and self-employment: evidence from Canadian provinces
(2013) Ferede, Ergete
We examine the effects of personal income tax progressivity—in the sense of rising marginal income tax rate—on self-employment. The impacts of income tax progressivity on self-employment depend on the relative effects of taxing success and the presence of tax evasion opportunities. Empirical estimates using Canadian provincial data for the period 1979—2006 indicate that there is a negative association between income tax progressivity and self-employment. This suggests that the adverse impact of income tax on entrepreneurial risk-taking outweighs the tax evasion opportunities for the self-employed. An important implication of our results is that a reduction in income tax progressivity encourages self-employment. The empirical estimates are robust to the various sensitivity checks.
The costliest tax of all: raising revenue through corporate tax hikes can be counter-productive for the provinces
(2016) Ferede, Ergete; Dahlby, Bev
Raising 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.
The effect of corporate income tax on the economic growth rates of the Canadian provinces
(2019) Ferede, Ergete; Dahlby, Bev
This 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.
The effects of tax rate changes on tax bases and the marginal cost of public funds for Canadian provincial governments
(2012) Dahlby, Bev; Ferede, Ergete
The 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.
The fiscal costs of debt-financed government spending
(2022) Dahlby, Bev; Ferede, Ergete; Fuss, Jake
In 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.
The impact of property taxation on business investment in Alberta
(2021) Dahlby, Bev; Ferede, Ergete; Khanal, Mukesh
Alberta 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.
The incentive effects of equalization grants on fiscal policy
(2014) Ferede, Ergete
The equalization system has long been considered a vital underpinning of the Canadian federation: a means to create some purported fairness or justice among the provinces, by redistributing the wealth of provinces with larger fiscal capacities to allow those with weaker fiscal capacities to provide roughly equivalent services to their citizens. However, the mechanics of the equalization formula have long been suspected of being flawed. Since grant-receiving provinces can adjust the way their fiscal capacities are calculated and reflected in the equalization formula — by adjusting tax rates and spending, for instance — governments are confronted with incentives to design their fiscal regimes in ways that maximize the size of the grants they receive, even if the fiscal policies are designed for less-than-optimal economic efficiency. The incentive for grant-receiving governments to “game” the formula, even unconsciously, is apparent; what has remained largely unresolved is to what extent is it actually occurring. This analysis shows that indeed it is occurring, and to a measurable degree. It finds that equalization grants provide recipient provinces with incentive to raise their business and personal tax rates. This is because when a government raises its own tax rate, it raises the national standard average tax rate, which is used in the equalization allocation formula. That, in turn, raises the individual “have-not” province’s equalization-grant entitlement. Exacerbating the problem is that the tax-raising provincial governments tend to underestimate the deadweight cost that the tax hikes will have, potentially worsening the fiscal situation of a province that already faces difficult economic challenges. This analysis also finds that the equalization-grant allocation system encourages spending among recipient provinces, particularly on health-care services, resource conservation, industrial assistance, environment and housing. Results show that for every $1.00 increase in equalization grants, recipient provinces further increase spending by an additional $0.64 in total expenditure.
The incentive effects of equalization grants on tax policy: evidence from Canadian provinces
(2017) Ferede, Ergete
This article provides an empirical analysis of the incentive effects of equalization grants on business and personal income tax rates using panel data from Canadian provinces. We exploit the discontinuity in the equalization grant allocation formula to identify the exogenous income and incentive effects of equalization grants on tax policy. Our empirical results indicate that equalization grants provide provincial governments an incentive to raise their business and personal income tax rates. The results also suggest that if the equalization program in its current form was abandoned, then business and personal income tax rates would be lower in the grant receiving provinces.
The response of tax bases to the business cycle: the case of Alberta
(2013) Ferede, Ergete
One major concern that policy makers face is whether they can plan their future tax receipts and spending in a predictable manner. In the absence of tax rate changes, tax revenue volatility arises due to volatility of tax bases. In the face of fluctuations in economic activity, the amount of tax revenue that a provincial government collects depends on how the various tax bases respond to the business cycle. We investigate the relationship between the business cycle—measured by the deviations of Gross Domestic Product from its long-run trend—and Alberta’s major tax bases for the period 1976–2008. Our analysis indicates that the Alberta’s corporate income and sales tax bases show the most and least responsiveness to the business cycle. The policy implication of this is that, if the objective of the Alberta government is to have less volatile and somewhat reasonably predictable tax revenue sources, diversifying its tax bases to include sales tax looks promising.
The stimulative effects of intergovernmental grants and the marginal cost of public funds
(2016) Dahlby, Bev; Ferede, Ergete
This 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.
The timing and direction of statutory tax rate changes by the Canadian provinces
(2013) Ferede, Ergete; Dahlby, Bev; Adjeic, Ebenezer
Tax 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.
The volatility of Alberta’s tax bases: Implications for tax policy choices
(2022) Ferede, Ergete; Ascah, Robert L.
Over the last two decades, on average, the largest single source of revenue for Alberta’s government comes from non-renewable resources when oil and natural gas prices are high, while PIT and CIT provide the second and third major sources of revenue for the government. Resource-dependent economies such as Alberta rely heavily on resource revenue to fund their various public services and infrastructures. As a result, their budgets are often exposed to the vagaries of fluctuating world commodity prices. Previous analyses of Alberta’s resource revenue volatility focus on finding ways to reduce the volatility of this type of revenue (Landon and Smith 2010). This chapter focusses instead on the crucial role that taxes can and do play in providing stability for government budget planning. Such a study is crucial for Alberta in particular, given its current economic and fiscal prospects.

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