Follow BCs Lead on Incentive-Based Tax Cuts
Most finance ministers say now is not the time to cut taxes. But the experience of British Columbia provides a different perspective. In 2001, after a decade of dismal economic performance, the newly elected government enacted a series of bold, incentive-based tax cuts. The results have been nothing short of remarkable. If Canadian governments are worried about the health of the economy, they should follow B.C.'s lead and cut taxes.
Specifically, the B.C. government reduced the corporate income tax rate from 16.5 per cent to 13.5 per cent. As a result, B.C. went from having the second highest corporate income tax rate among the provinces to having the third lowest. The province also eliminated the economically damaging general corporate capital tax.
The largest portion of the reductions was a 25 per cent across-the-board reduction in personal income tax rates. Again, British Columbia went from having the second highest top marginal personal income tax rate (19.7 per cent) to the second lowest (14.7 per cent), behind only Alberta (10 per cent).
The economic fortunes of the province changed dramatically. The province went from having the lowest per person GDP growth among the provinces between 1997 and 2001 to being one of the fastest growing economies in the country between 2002 and 2006.
Not surprisingly, the influence of the personal and corporate income tax rate cuts on B.C.'s economic turnaround has been hotly debated. Many people, particularly those who opposed the tax cuts, simply point to strong commodity prices as the sole reason for the province's economic improvement.
However, a new Fraser Institute study by one of Canada's leading economists, University of Alberta professor Bev Dahlby, assesses the economic impacts of the 2001 tax cuts and finds that the tax cuts had, and will continue to have, a profound impact on economic growth.
Specifically, Dr. Dahlby found that B.C.'s 2001 corporate income tax rate reductions will increase gross domestic product per person by 18 per cent above the level that would have resulted without the tax cut. Likewise, the personal income tax rate reductions will increase GDP per person by 7.6 per cent above what would have prevailed in the absence of the cuts. In total, over the long term, British Columbians will see their average incomes increase by more than 25 per cent as a result of the tax cuts.
Additionally, Dr. Dahlby analyzed the impact of tax differences and changes among the 10 Canadian provinces from 1977 to 2006. His analysis indicates that a 10 percentage point cut in a province's corporate income tax rate results in a one to two percentage point increase in the per person GDP growth rate. Similarly, a 10 percentage point reduction in the top personal income tax rate causes a one percentage point increase in the growth rate. To gauge the magnitude of these results, consider that a two percentage point increase in per person GDP growth would double per person income in Canada in just 15 years, compared with 27 years at current growth rates.
Dr. Dahlby also found that corporate and personal income tax rate cuts lead to significantly higher levels of investment in the economy. A 10 percentage point reduction in the corporate tax rate increases private investment relative to GDP by 5.8 percentage points, while a 10 percentage point cut in the top personal income tax increases private investment to GDP by 5.96 percentage points.
Talk of heightened economic uncertainty will likely dominate the budget season and is likely to be used as an excuse not to cut taxes. However, the results from B.C. show that incentive-based tax cuts yield large and ongoing economic benefits. In addition, by improving incentives and making investment more attractive, governments will yield greater revenues, since the economy will grow at a faster rate.
The message from B.C.'s experience is clear: All Canadian governments should reduce corporate and marginal personal income tax rates in their 2008 budgets. Doing so will ensure that Canadians will continue to benefit from a strong economy.
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