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Great post. SEP seems closely related to the desire to believe that I can "have my cake and eat it too."

Steve, thanks for this, the SEP field was one of my favourite Hitchhiker's Guide ideas (almost as good as how to fly: just throw yourself at the ground, and miss). A couple of comments.

First, there are good reasons to be concerned about corporate use of tax havens.

From Statistics Canada, http://www.statcan.gc.ca/daily-quotidien/110415/t110415a1-eng.htm, the top five destinations for Canadian foreign direct investment are the US, the UK, Barbados, the Caymen Islands, and Ireland.

The expansion of international tax agreements after 9/11 has, arguably, made it easier for corporations to engage in complex tax minimization strategies. It's a serious issue - and saying 'corporate income will get taxed when it is paid out to individual shareholders' doesn't help if corporations just sit on great wads of cash, or if the individuals themselves have trust funds and live in the Caymen Islands also.

Second, your post begs the question: whose problem is it? For the Conservatives, implicitly, the problem is for future generations, who will eventually have to pay off - or live with the consequences of - the debt we're building now. For NDP, implicitly, the problem is for... I'm not so sure - the rich?

This reminds me of the "Trash of the Titans" episode of the The Simpsons, where Homer's campaign slogan is "Can't someone else do it?"

"First, there are good reasons to be concerned about corporate use of tax havens."

The difficulty (I have with it) isn't so much there's a concern, rather that there's absolutely no plan to deal with the issue beyond a slogan.

For me, it was the $2b/year number. AFAICT, it was a complete invention.

If SEPs were the sole elements in a political campaign, I suspect that party would be vigorously endorsed by CAVE People. I like to think that a majority government can reduce SEPs, as I think back to the Martin/Chretien assault on the deficit.

Health care spending is surely the worst SEP, and the two dominant parties both represent opposite sides of the same reality-averse coin. The Tories represent the argument that there is no problem aside from "sustainability through efficiency", and the NDP represent the argument that there is no problem aside from sustainability through redirected new funding from other programs. That is no way to run a railroad.

Infinite regress. The existence of SEPs is itself somebody else's problem.

Hah!

Hold on, now - so if the Conservatives are able to balance the budget by 2014-15 as promised, without resorting to programme cuts or tax increases, will you to admit that governments are as capable of wasteful spending as any other organization, and that it's possible to achieve efficiencies by squeezing them? You've always been pretty quick to dismiss this as a possibility, so I'd like to understand what test needs to be passed in order to demonstrate the hypothesis to your satisfaction.

My intuition is that it is much easier for a government to fail to make good on such a promise than it is to succeed, but that this failure is not indicative of a fact that this sort of promise is empty. If a government does succeed, then it needs to be recognized that promises of "efficiency-finding" aren't always political expedients.

So - what conditions do you need to see to revisit your opinion on this?

If there are all these low-hanging efficiency fruits, why did the Tories not pluck them 5 years ago? And why won't they tell us where they are?

Second, your post begs the question: whose problem is it? For the Conservatives, implicitly, the problem is for future generations, who will eventually have to pay off - or live with the consequences of - the debt we're building now. For NDP, implicitly, the problem is for... I'm not so sure - the rich?

Well, the NDP's claims for the revenues they would generate were wildly optimistic, so future generations would have to deal with that. And of course, the incidence of what corporate taxes would be generated isn't on the rich.

As the old adage goes, a recession is when someone else loses a job, a depression is when you lose yours.

Also I don't think the differencebetween a program cut and an effiency saving is well defined here. The easiest way for the governmentto reduce expenditure is through attrition.Say 25 000 civil servants retire and you don't replace them. Is that an efficiencysaving or a program cut?

^^
That would be another example of SEP.

Frances: "From Statistics Canada, http://www.statcan.gc.ca/daily-quotidien/110415/t110415a1-eng.htm, the top five destinations for Canadian foreign direct investment are the US, the UK, Barbados, the Caymen Islands, and Ireland.

The expansion of international tax agreements after 9/11 has, arguably, made it easier for corporations to engage in complex tax minimization strategies. It's a serious issue - and saying 'corporate income will get taxed when it is paid out to individual shareholders' doesn't help if corporations just sit on great wads of cash, or if the individuals themselves have trust funds and live in the Caymen Islands also."

I'm not sure the fact that Canadians invest funds in tax havens (like Barbados or the Cayman Islands) neccesarily indicates that Canadians are avoiding Canadian taxes since Canada's existing anti-avoidance rules are intended to, and do, prevent Canadians from avoiding taxes simply by shifting assets to tax havens (in particular, Canada's foreign accrual property income (FAPI) regime and its offshore investment fund property regime which, in different ways, force Canadian taxpayers to recognize certain forms of foreign income on a current basis, even if it isn't actually received in Canada). They may be minimizing foreign taxes (or, in some instances, hiding assets from a soon to be ex-wife - it happens), although that's hardly something for the Canadian fisc. to get too upset about (since, in many instances, that foreign tax would be creditable or otherwise recognized in determining ones Canadian tax liability). The days when you could flagrantly avoid taxes by setting up a trust in Barbados are long gone (and the CRA has been running wild over the past few years assessing dozens of taxpayers - with some success in those cases that have gone to court - who have tried).

As for tax-treaties, yes, they do help Canadian residents minimize their taxes though, typically, they help Canadian residents minimize foreign taxes, not Canadian ones (non-residents, of course, can minimize their Canadian tax liabilities relying on treaties, although, query whether that's problematic - to some extent that's the whole reason countries enter into tax treaties). On the other hand, treaties typically provide for the sharing of information about the residents of the respective countries and can use that information to prosecute tax cheats under their respective tax laws. Indeed, one of the significant changes in Canadian international tax policy (and that of other countries) in recent years has been the advent of tax information exchange agreements (TIEAs) with traditional tax havens, which Canada can use to obtain information about it's residents who like playing fast and loose with our tax rules (the quid pro quo is that Canadian companies who have subsidiaries in TIEA jurisdictions are entitled to access Canada's excempt surplus rules which, previously, were generally only available in respect of subsidiaries in treaty jurisdictions).

In any event, there are diminishing returns to trying to crack down on tax havens as the Department of Finance has learned at some cost. It spend the better part of the last decade blowing its brains out trying to develop new anti-avoidance rules (the so-called "foreign investment entity" rules and the "non-resident trust" rules) to catch avoidance schemes that the existing rules didn't catch (or so it claimed, the tax community has never conceded that point). They gave up only after they were told by the tax community that (a) no one could understand the proposed rules, (b) they might catch some tax cheats (although there was a general consensus that it wasn't obvious why such cheats weren't caught by the existing rules), but they would certainly catch people who shouldn't be subject to these rules (in particular, pension plans and other non-taxables), and (c) given the uncertainty they would create they would almost certainly discourage legitimate offshore investment. After being told by the Senate that, until these problem get fixed, these proposals would not be passed (in a fine example of the Senate doing its constitutionally appointed job) Finance gave up and satisfied itself with some minor tweaks to the existing rules (albeit, only after diverting a decade of time and effort from other, more profitable, activities).

Mike Moffat: "If there are all these low-hanging efficiency fruits, why did the Tories not pluck them 5 years ago? And why won't they tell us where they are?"

Because they didn't, heretofore, have the security of a majority government. It's a lot easier to do something politically unpopular when you have 4 1/2 years for the memory to fade than it is when you might have to fight an election on the point. Cynical, but probably true.

As for their proposed "savings", I'm convinced that the Tories low-balled (or is it high-balled?) their deficit numbers for 2010-11 in the March budget. If you look at the latest fiscal monitor, as of February 2011, the 2010-11 deficit was running $12 billion lowers in that the 09-10 deficit at the same time last year. Ok, you might say, but the Tory budget predicts that the final 2010-11 deficitwill be about $15 billion less than the 2009-10 deficit (i.e. $40 billion vs. $55 billion) so that appears to be on pace. Except that the 2009-10 deficit figures included $6 billion that was tacked on in March 2010 to account for HST compensation payments to Ontario and BC (in the 2010 Budget, the Tories had announced that the deficit for 2009-10 was going to be $49 billion and change - with the HST payments ammortized over a number of years. The auditor general forced them to include it all at once.

In that light, I figure that the final defict number for 2010-11 will probably be closer to $36-37 billion. And no doubt the government will claim much (wholly undeserved) credit for its fiscal prudence and for closing 30-40% of their $11 billion gap. How they'll deal with the rest of the gap is another question, but we'll see.

Stephen: "And of course, the incidence of what corporate taxes would be generated isn't on the rich."


A Canadian CIT hike raises the average global CIT, the incidence of which is on capital, plus it causes a wealth transfer from local labour to international labour. In a closed economy the incidence of corporate taxes is *entirely* on corporate and non-corporate capital (Harberger, 1972). Capital is mostly owned by the rich. So the average global CIT is incident on the rich. The differential between the global mean and a particular countries CIT, may have its principal incidence on others, but the Harberger 1972 result is still perfectly valid in the context of the global economy. Perhaps you don't agree, but the CBO is on my side, so at the very least, your statement is not in the category of obvious, undisputed fact.

As I see it, we have a coordination failure. If all countries moved their CITs in concert, the incidence would be 100% on capital. Instead we find ourselves in a destructive disequilibrium, in which we poach capital from each other, in order to gain a short term advantage for our labour (at the expense of everyone elses), the end result of which might be a 0% CIT (or lower? why would the game have an equilibrium at zero?). Global capital, the *only* beneficiary of the overall trend, is of course cheering it on all the way to the bank, and Canada appears to be leading the charge.

Here's the last bit of the abstract of the CBO paper cited above: "This alternative method suggests that, even in an open economy, capital could bear virtually the entire tax burden and that the open-economy assumption is not sufficient to shift the burden of the corporate tax from capital to labor. "

So to get back to the topic of the post... Foreign labour: the ultimate SEP.

Are the Liberals more honest than the other major parties or are the just worse at lying?

K: Harberger (1962) is not the last word on the subject. I've put together a reading list here

Stephen: No, I agree. My point was that it *is* the last word on the theoretical problem of CIT incidence in a closed economy. If you quickly reread the abstracts in your reading list (or read some of the review articles), everything you cite is either open economy theory or empirical studies on the effects of lowering the CIT on the local economy *only*, ie ignoring the impact on the rest of the world. I dont see anything challenging the original Harberger (1962!) result.


It's easy to ignore the rest of the world when cutting a tax - the impact is almost impossible to measure so it's truly an SEP. But when everyone is doing it, the only impact is the closed economy effect and no amount of open economy theory or empirical studies on local effects can change that.

Of *course* they're open-economy results - Canada is an open economy. And I am somewhat taken aback by your dismissal of all that empirical work.

But if you're going to go the 'One World' route, take another look at the Feldstein (1974) article. The assumption of a fixed capital stock is clearly not reasonable, and it is that assumption that buys the Harberger (1962) result.

This post made me really sad.

Oh well, I live in Alberta, land of the three monkeys and absolutely everything here is an SEP which is likely a derivative of the NEP through which taxpayers in the rest of Canada built the heavy oil industry and was somehow responsible for the world oil price dive of the late 1970's. Decrying the NEP is ok, because Alberta can sell oil through pipelines also funded, in large part, by taxpayers in the rest of Canada.

Alberta's biggest claim to fame: we can add a 4th money to the original trio and call him the Alberta Monkey. He remembers no evil, and is thus open to being told bad things were caused by one or the other of the province's favourite boogeymen.

Don Thompson:
You can add the very special 5th monkey devoted solely to forgetting how the rest of Canada got them out of bankruptcy in the '30's...
and the 6th to not know how a distorted exchange rate destroys industry in the central provinces...

Alberta is an SEP only for them...


Stephen:  

I'm not dismissing the empirical results or the fact that Canada is an open economy.  I just think that the open economy research is of limited relevance in determining the effect of policy except in the very short run. It's like a firm in a competitive market computing the expected market share impact of cutting its prices based on the assumption that competitors wont respond, even as they see their own market share drop. Economists wouldn't permit that analysis in the market for goods. Why do we permit it in the market for capital?

The open economy research doesn't say that a low CIT is a positive benefit to labour.  It says having a CIT that is *lower than average* is a positive for domestic labour. But relative CIT is a zero sum game (at best). Gains to any one country are 1) at the expense of others and 2) not sustainable in the face of international tax competition.  In the long run the only effect will be a drop in the average global CIT, and some random dispersion around the mean as countries jockey to be the latest, greatest CIT tax haven. So the question is: are you advocating that everyone should cut their CIT rates, or just Canada?

Here's another analogy: a bunch of farms all draw water from the same lake.  Both theoretical and empirical studies note that those who draw water at a greater rate have higher crop yields.  None of these studies notice, or even discuss the impact of any one farm's pumping on the level of the lake. You say it's obvious that we (everyone?) should increase pumping. I, on the other hand - while not denying the correctness of the pumping research - insist on a "One Lake" perspective, and that we should consider the possibility that the competitive equilibrium is suboptimal.

Thanks for pointing out Feldstein 74.  I am trying to get access to it but I surmise from other papers that they calculate a long run equilibrium incidence that is still principally (though not entirely) on capital. The effect is due to the reduced long run equilibrium ratio of capital to labour. I'm open to (but skeptical of) the idea that in the extreme long run any taxation that reduces growth *at all* is bad, since in the long run we will have infinitely more wealth if we forgo that tax, so *any* amount of ultimate trickle-down will exceed the tax benefit. I suspect that the long run in Feldstein, is very long indeed (in the Keynesian sense).  Either way, it doesn't change the fact that the incidence is still, principally, on the owners of capital.  

The "CBO paper" is not actually an official CBO position.  It's written by a CBO researcher.  Sorry for misrepresenting it.  It is, however, an excellent paper, and might be worthwhile including on your reading list.

Unemployment in large part is a Somebody Else's Problem.

The first part of solving the problem is admitting you have a problem.

@Geoff NoNick: if the Conservatives are able to balance the budget by 2014-15 as promised, without resorting to programme cuts or tax increases, will you to admit that governments are as capable of wasteful spending as any other organization, and that it's possible to achieve efficiencies by squeezing them?

I think you're mischaracterising the argument that the conservatives can't balance the budget without program cuts or tax increases. Or at least, assigning two arguments when there's really only one. There's no doubt the government has inneficiencies, and large ones. Anyone can see that. But anyone who's worked for businesses of varied size has also seen that businesses are inneficient, and their inneficiencies correlate very closely with size. The federal government is massive, so the idea that it can run efficiently is laughable. Worse, because of its size, people keep delegating responsibility for finding efficiencies down the chain. Managers aren't going to cut their own jobs or cut someone who helps make their job easier, so they delegate again until cuts are borne by front-line staff, thus cutting the quality and accessibility of government programs.

@Bob Smith: [Why didn't the conservatives cut the low-hanging efficiency fruit alread?] Because they didn't, heretofore, have the security of a majority government. It's a lot easier to do something politically unpopular when you have 4 1/2 years for the memory to fade than it is when you might have to fight an election on the point. Cynical, but probably true.

If they were efficiency savings, it wouldn't be politically unpopular. Only program cuts (or tax increases) affect enough people to be politically unpopular. Efficiency savings are a vote-getter.

Your statement implicitly accepts that in order to balance the budget, actual program cuts have to be made, something which has been denied by the Blue team.

"The Conservative SEP took the form of its promise to not increase taxes, not cut any programs and to eliminate the deficit by means of "controlling spending and cutting waste". This is of course a time-honoured custom, but these sorts of promises are usually made by opposition parties. Out-of-control, wasteful spending would ordinarily be a subject that a five-year-old government would try to avoid talking about. But it is still an effective gambit: since no-one thinks government waste is their problem, no-one thinks too hard about what it means"

Stephen - I gently disagree because you have taken the phrase "waste" in the ordinary meaning rather than understood it as the political code of politicians. "Wasteful spending" - especially for Conservatives - is spending on policies or programs that the party does not support. Once this is understood, the targets for Strategic Review and Program Review become much more clear - hello (good bye) Heritage Canada, HRDC and similar programs.

During the campaign, Harper promised an additional $5 B reductions for each of next 2 years i.e. $10 B out of federal spending over 2 years of 1/2 trillion. I hypothesize that there is at least $10 B of GoC programs (actually much much more) that the Conservative Govt wants to eliminate - in political code - as "wasteful".

Second point. In mid April, Finance announced that the year's deficit would come in at $28 Billion - not the $40 B announced previously and $ 5 B less than announced only 1 month previously in the Budget. This is a swing of $12 B or $5 B (depending on which forecast is used), in a relatively short period of time.

And they have not yet fully adopted accrual accounting in the GoC and capitalized the big ticket stuff such as military acquisition or capital construction e.g. prisons.

Some years ago, there was a segment between Sir Humphrey and Bernard (Yes Minister) on when cuts are not cuts but in fact, the duty of every public servant to pursue i.e. "waste, fraud and abuse".

Stephen:

Here's another point: To the extent that Canada's economy is natural resource based, the CIT may act as a land tax. Ie a tax on oil company profits ought to be pretty efficient because oil capital can't pick up and go. The oil is here. So from that perspective you'd expect Canada to try to maintain a relatively higher CIT than those who find themselves in greater competition for capital. Of course, the fact that we don't impose adequate taxation directly on resource extraction shows that it's not really about fairness or efficiency in the first place.

Ian: That's not what the Conservatives said. I'm afraid I'm naive enough to think that politicians should speak plainly and not in code.

K: I'm sorry, but I've been writing about corporate taxes so much recently that I just cannot get into yet another debate about it just now.

Understood. Thanks for the discussion.

Stephen - but in mid campaign, Harper did say that Strategic Review and Program Review would be used to identify further savings from wasteful spending (or words to that effect). When challenged by CBC Terry Milewski (I recall), he said to the effect, that in the $250 B annual spending, inevitably there are programs that are no longer effective i.e. wasteful.
Interpreting this language - and the meaning and purpose of Strategic and Program Review - clearly suggests the elimination of programs that are no longer effective.
And that does even address - following Andrew Coyne - the many many billions in tax expenditures identified in the annual publication by Finance http://www.fin.gc.ca/taxexp-depfisc/2010/taxexp10-eng.asp, that could be pruned, nor rapid growth yielding unanticipated new tax revenues nor the move to accrual accounting in the big depts of the GoC that will transform capital expenditures from being expensed to being amortized.
I am not suggesting campaign misrepresention. Rather, again to use Coyne, we are using terms that are Ottawa "govspeak".
Restated somewhat simplistically, cuts are understood as reductions of programs that are still useful while elimination of programs identified by Strategic and Program Review, are understood as reductions of wasteful spending that should be brought to and end.

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