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Nice post, I appreciate the logic of your estimates and the comparison to the PBO estimates.

Regarding corporate income tax revenues, while I agree with your premise that corporate profits should recover as the economy returns to "normal", won't corporate taxes lag as companies which took losses these past two years carry the forward the loss as a tax deduction? While corporate profits should return, the taxable portion of these profits should remain depressed for several years.

Thanks Kosta! Your point about the lag in corporate profits tax makes sense to me. I hadn't thought of that. I have no idea how big the effect would be. But if you are right, and if it explains the whole discrepancy, then I don't think we should be too worried on that score. It would just mean another couple of years lag before corporate profit taxes returned to "normal".

I'm given to understand (after it was explained to me by a very sharp former student of mine in the lockup at the last Quebec budget) that corporate tax revenues are an important part of why the deficit would last longer than the recession. The story she told me was the same as Kosta's.

For what it's worth, the change in income trust tax status may also have an effect. Currently trusts have tax sheltered profits, but pay large dividends, mainly to Canadians, that are not taxed preferentially (are not eligible for the dividend tax credit). The will become taxable beginning next January, with most converting to corporations. Most trusts have several years worth of tax shields available to be used, so they will continue to pay little CIT for a few years yet. However, the taxation on the dividends they pay will become eligible for preferential taxation. I'm not sure how large this effect is. It's probably proportional to 15 - 20% of profits of the trust sector, trailing off over the next three years.

Andrew: so if I understand this correctly, the closing of that tax loophole will lower tax revenues for 2011 and a couple of following years, but increase them thereafter? So that's another lag in tax revenue, in addition to the one identified by Kosta and Stephen's ex-student. Makes sense. Again though, I look on these more as tax-deferment, so the only net impact on the long-run deficit should be the interest on the deferred taxes. But they would help explain why my estimates differ from the PBO's.

The preferential tax rate on dividends (as a rate on the dividend before gross up) is increasing by about 25 per cent from 2010 to 2012 - that's 25 per cent of the existing rate on the dividend before gross up. For example, it's going from Ontario top marginal 22 per cent (combined federal provincial) to 28 per cent, roughly.

I don't think many people are aware of this.

It's happening because corporate tax rates are scheduled to come down, and dividend tax rates are an inverse function of corporate tax rates. The math on this was actually a big deal during the income trust debate.

So, ironically, the new tax that so many thought unjust in the case of income trusts is now getting a second incarnation in the form of a massive increase in the dividend tax rate, just as trusts are converting to dividend paying corporations. Income trust holders who are awaiting conversion are in for a rude surprise in that sense (although the tax doesn't apply of course to dividends received inside a tax shelter such as an RRSP).

Sounds like that is an attempt to leave after tax dividend income unchanged for Canadians, after corporate rates fall. I'm not sure this is as sinister as you make it sound.

Aren't there still some significant increases coming in planned transfers to the provinces (CHT and CST)? Those might be large enough to make a bit of the difference. Equalization I'm less sure of, they keep changing ther minds on how thats going to work.

Actually corporate tax losses can be carried back three years and this is generally done for obvious reasons. So I'm not sure how much in the way of losses will be available to carry forward and produce your tax lag.

Andrew F - it's an attempt; although it requires one time proportionate 8 per cent dividend increases in order to be effective in that way

I think that the federal government is facing a greater revenue shortfall than the PBO forecast in its November 2nd release. At that time the revenue forecast was $219B for the year ending March 31, 2010, and $233B for the year ending March 31, 2011. (Per table 2-1 in the November PBO report)

The Fiscal Monitor for October 2009 (which was released in December) shows that revenues are down 12% compared to the previous year (over 13% if you exclude EI premiums which ware relatively unchanged). As a result, I would expect revenues for the current year to come in at about $208B, which is less than the $219B forecast.

I do not expect revenues to rebound to $233B for the next year (and I expect that the PBO will revise its forecasts downwards). The reasons that federal revenues will remain well below $233B:
- GDP growth will be revised downward
- Corporate tax rates are dropping from 18% in 2010 to 15% by 2012. In addition the business environment is still challenging for most companies, so profits will remain lean (except for the banks)
- GST revenues are off 16% compared to 2008, which is an indication that consumers are taking a breather
- Personal income tax revenues are down over 7%. It is not reasonable to expect that they will recover quickly. Many people are facing reduced incomes. Seniors are earning less interest income. People who are transitioning to retirement have reduced incomes. People on EI have reduced incomes. Bonus pools are lower. Many people in manufacturing are taking unpaid days off. People who find new jobs in a tough labour market often take a pay cut.

It will be interesting to see the PBO's revised forecasts (perhaps as early as tomorrow) to see how they have reflected more up-to-date assumptions.

I find it distressing that the politicians are unwilling to acknowledge that tax increases might be necessary. The revenue shortfall is much greater than anyone would have predicted in 2009.

I get the definite sense that Robert knows more about this subject than I do! (Again, one of the advantages of blogging is that you can draw out people like Robert, and get their help).

"- Corporate tax rates are dropping from 18% in 2010 to 15% by 2012."

OK. That translates into a permanent 3/18 = 17% drop in revenues, assuming no supply side response of corporate profits to a cut in tax rates. Say another $5 billion on my deficit forecast, allowing for both regular long run nominal GDP growth plus a bit of supply side response to lower tax rates. So my forecast is up to around a $10 billion or so deficit. An extra 1 ppt on GST or so.

You can watch the PBO's Stephen Page on BNN Squeeze Play tonight where he will explain how they came up with the projections.

The BNN interview with Kevin Page can be found at the following web address:


(Thanks to Mick Marrs for pointing out the BNN coverage).

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