Data hasn’t borne out Canadian fears of investment losses caused by American tax cuts

Capital investment changes likely more swayed by oil than by Republican policies: analyst

Fears that recent U.S. corporate tax cuts would dramatically undermine investment in Canadian companies have not been fulfilled, analysts say | NextNewMedia/Shutterstock

Many Canadian business pundits and free-market advocates have sounded the alarm about sweeping corporate tax cuts in the U.S. ushered into law by the Republican-controlled Congress and President Donald Trump’s administration.

Among those fearing the long-term fallout of the U.S. tax cuts is Jack Mintz, president’s fellow at the University of Calgary’s School of Public Policy, who in a recent column said Canadian investment would be “walloped.” Mintz is not alone. In April, RBC CEO Dave McKay made headlines warning that investment dollars were already leaving the country’s energy sector.

Insights from a B.C. economics professor buck the trend of alarm over what many see as Canada’s rapidly eroding investment landscape.

“One hears a lot of anecdotes about companies that have not been investing in Alberta and moving elsewhere…. I’m always a bit skeptical of anecdotes,” said Kevin Milligan, professor of economics at the University of British Columbia’s Vancouver School of Economics. “For every anecdote I hear about some company that’s decided not to invest in Canada, I see other companies that are investing.”

Milligan pointed to Amazon’s (Nasdaq:AMZN) recent expansion in Vancouver and Ottawa as his anecdotal evidence that companies are still investing in the country.

The numbers tell their own story. Prior to America’s federal tax changes, Canada had a more than 12.8% advantage in its average effective corporate tax rate over the U.S., after taking into account credits and deductions that reduce a corporation’s tax liability. According to a March 2017 U.S. Congressional Budget Office (CBO) report, Canada had the third-lowest average corporate rate in the G20 at 16.2%, behind Germany and the U.K., based on information from 2012. The U.S., on the other hand, had an average corporate tax rate of 29%, third highest in the G20. While the CBO did not have a comparable post-Trump tax cuts number, a Penn Wharton study found that the average corporate tax rate in 2018 would be 9.2%, climbing up to 17.3% by 2023. That study calculated the 2017 U.S. average effective corporate tax rate to be 21.2%, almost eight percentage points lower than the CBO’s calculation of the rate before the cuts.

Milligan described the tax landscape in Canada as one in which the U.S. is pulling abreast of Canada’s rates, rather than gaining an advantage.

“The U.S. corporate tax reform did remove a tax advantage that Canada had. Now Canada has, more or less, the same statutory corporate tax rate as the U.S., and the same thing with the effective tax rates on investment,” said Milligan. “So it wouldn’t surprise me if we saw some swing toward the U.S. out of Canada, [but] I’m not sure I’d expect things to happen so quickly.”

Data suggests that expectations of U.S. investment growth might have been exaggerated, at least in the short term.

The annual growth rate of U.S. business investment has declined slightly, dropping a few tenths of a per cent to roughly 6% in 2018’s first quarter, according to Jason Furman, professor of the practice of economic policy at Harvard University.

In an email exchange with Business in Vancouver, Furman said he would expect a short-term increase in U.S. investments because of greater aggregate demand. He expects, in the long run, corporate capital stock to rise 2% to 5% higher than it otherwise would have.

However, despite the tax cuts and pent-up demand, short-term investment increases have yet to be realized in the U.S.

Projected capital investment growth for five major U.S. regions has either flattened or dropped since the beginning of the year.

Texas and New York state have each had a greater percentage of businesses projecting a decline in future capital investment, according to data from the New York and Dallas federal reserves. An index used to measure the percentage of businesses forecasting investment increases over those predicting decreases fell by 21.32% in Texas and by 13.49% in New York state since last December.

Furman cautioned against trying to infer too much about the future from less than half a year’s worth of data. He said political instability, back-loaded offsets and expiry dates for tax cuts all add to uncertainty about the future.

“I would not infer anything about what happens in the long term from three months of data,” Furman said. “But there are an awful lot of people pointing to these types of indices as proof that the tax cuts are working [to boost investment], and I’m having a hard time seeing them working in those numbers.”

Furman’s presentations also highlighted the implications that the large debt created by the tax cuts could have on the U.S. dollar. If the debt hurts the U.S. dollar, this could negate some of the tax benefits for foreign investors.

Numbers from Canada also appear to suggest that fears about fleeing investment might have been overblown. Capital investment across all industries increased just 0.8% between 2017 and 2018 compared with a 3% increase in investment the year before, according to Statistics Canada data.

But despite 2018’s lower growth rate compared with last year, it was a welcome change from the large declines experienced during the recent oil crash, when capital expenditures fell 15.5% from $272.11 billion in 2014 to $229.95 billion in 2016.

The timing suggests that falling oil prices did more to reduce capital expenditures in Canada than the corporate tax changes in the U.S., Milligan said.

He added that taxes are not the only consideration for businesses when deciding to invest or set up shop. Milligan cited the example of technology companies that look at Canada as a friendlier place to attract international labour talent.

If the levelling of the tax playing field makes it more difficult for Canada to attract and retain foreign investment, he said there might be a better way of fighting the problem than simply reducing the country’s corporate tax rate.

Milligan said that if Canada were to follow the U.S.’s lead and allow businesses to immediately write off capital investments in plants and equipment, it would spark new investment.