Post-COVID Corporate Tax Policy

Introduction

It is no simple matter to predict what the post-COVID economy will look like, given the uncertainties at play. We do not know how long the pandemic will be with us, and therefore its overall damage to the economy. We are not sure how much the workplace will change now that businesses are communicating differently. Nor do we know if countries will be more nationalistic in their trading relationships, resulting in higher border walls.

One fact we do know is that governments have already taken on large fiscal deficits to support the economy. It is likely that deficits for several years will continue unabated, even if at a smaller scale. With growing public debt, many people are already predicting higher future taxes to help close the gap between revenues and expenditures.

A favorite subject for taxation is the corporation, especially big ones. Economists might point out that a corporate tax can be regressive when shifted forward as higher consumer prices or lower wages paid to workers as opposed to shifted back as lower returns accruing to owners. The public, however, view business taxes as a way to ensure that owners, who are rich and powerful, will have something to pay — eliminating the business tax is unfair, as “ordinary” people then have to cover the cost of public services. A clear majority of voters believe that corporations should be taxed more, no matter how well or poor the economy is doing.¹

While raising corporate taxes is politically popular, is that the actual outcome we see when a recession hits and public deficits soar? Governments may want more revenues, but they also want economic recovery after a recession. As I will show below, corporate income tax rates continued to fall in most countries after the 2008 financial crisis despite higher deficits. While statutory corporate rates decline, many countries introduced new measures to curb multinational profit shifting and base erosion.² Some countries also imposed, increased, or reduced levies such as capital taxes on corporations or financial transaction taxes on banks. However, in general, the effective tax on marginal investments, including profit and profit-insensitive taxes, continued to decline across most countries.

Governments will be facing a similar conundrum once the COVID-induced recession has run its course. Will they want to raise corporate taxes to deal with deficits? Or reduce them to help spur economic growth?

In the next section, I lay out the experience with corporate tax policies pursued after the post-2008 financial crisis. This will be followed by a discussion of what corporate tax policies could be expected post-COVID.

Corporate Tax Policy From 2010 to 2019

When Lehman Brothers fell in September 2008, it sparked a sharp decline in world stock market values in anticipation of a global recession. World GDP growth in 2009 was -1.7 percent followed by a slow recovery until 2018, with global GDP growth averaging roughly 3 percent, down a percentage point compared to the years 2003-2007.³ Public revenues plummeted in most countries and deficits widened. Net debt among advanced countries soared from 49 percent in 2007 to 74 percent of GDP with similar trends for middle- and lower-income countries.⁴

Generally, many governments raised top personal income tax rates. Some increased value-added and excise taxes. One would also expect corporate taxes to have increased, given the popularity to do so by raising tax rates, scaling back preferences, and/or imposing new or higher profit-insensitive taxes.

Corporate Income Tax Rates

Generally, corporate income tax rates were not increased in light of large deficits. If anything, they fell on average. As shown in Table 1, the average OECD corporate income tax rate among 33 countries remained stable from 2009-2012, followed by reductions each year from 2013 to 2019. The most abrupt change happened in 2018 when the United States, accounting for over a fifth of world GDP, lowered its combined federal-state corporate income tax rate dramatically from 39.2 percent to 25.7 percent.

Table 1. GDP-Weighted-Average OECD Corporate Income Tax Rates 2010-2019

Year	General Corporate Income Tax Rate in %
2009	33.3
2010	33.3
2011	33.3
2012	33.2
2013	32.7
2014	32.6
2015	31.9
2016	31.5
2017	31.0
2018	26.8
2019	25.9
Source: Bazel and Mintz 2020.a Note that general corporate income tax rates includes the statutory tax rate, surtaxes and profit contributions rates for national and sub-national governments. Fully implemented tax rates as legislated are assumed to apply in 2019. aP. Bazel and J. Mintz, “The 2019 Tax Competitiveness Report: Canada’s Investment and Growth Challenge,” SPP Research Paper, The School of Public Policy, University of Calgary (Mar. 2020).

For 94 countries that Bazel and Mintz track, the GDP-weighted average corporate income tax rate fell from 31.6 percent in 2010 to 25.6 percent in 2019. On a simple (unweighted) basis, the average corporate income tax rate declined from 25.3 percent to 23.6 percent in the same period. Of the 94 countries, 12 countries raised corporate income tax rates;⁵ 33 kept them constant (including low-rate countries like Ireland and Bulgaria); and a majority, 49 countries, reduced rates from 2010 to 2019.

Not all of the world is the same. As shown in Table 2, corporate income tax rates changed little between 2010 and 2019 in Africa and MENA countries. The largest reduction occurred in the Americas, largely driven by U.S. tax reform but also reductions in Canada, Argentina, and Jamaica. The average Asian-Oceania corporate income tax rate dropped by over 4 percentage points, of which India was the most significant in 2019. Europe, with lower corporate income tax rates than other regions, except for the MENA region, had a similar reduction in corporate tax rates as Asia-Oceania.

The reasons for corporate tax rate trends are multitude. In some countries with corporate income tax rates, competitiveness and productivity were concerns — the obvious example being India and the United States. Some reduced or kept their corporate income tax rates the same because their neighbors did the same. Some were broadening their tax bases, such as by limiting interest deductions, and provided a corporate rate reduction as an offset, such as in Scandinavia. Newly elected left-wing parties in some countries decided to raise tax rates, such as in Chile, or right-wing parties reduced rates, such as in the United States.

Table 2. GDP-Weighted Corporate Income Tax Rates by Regional Grouping

	2010	2019
Africa	29.6	29.3
Americas	36.9	26.9
Asia-Oceania	30.9	26.8
Europe	27.8	23.5
Middle East and North Africa	21.2	21.0
Source: Bazel and Mintz 2020.

Corporate Income Tax Bases

While tax rates were reduced, other corporate income tax provisions were adopted, many of which broadened the corporate income tax base. These included tightening transfer pricing rules, limiting hybrid securities that led to “double-dip” interest deductions, taxation of certain forms of international income even if non-repatriated (e.g., U.S. taxation of low-tax intangible income), limiting treaty benefits on income paid to low-tax jurisdictions, and limitations on interest deductions. Some countries also reduced depreciation deductions (e.g., the U.K. eliminating depreciation for structures and New Zealand ending a super-deduction for depreciation). Accelerated cost deductions and investment tax credits were also scaled backed for fossil fuel sectors in several countries (e.g., Australia, Canada, and Norway) as part of climate change policies.

On the other hand, some countries adopted accelerated depreciation to encourage investment. The United States reintroduced 50 percent bonus depreciation (for assets with less than 20-year recovery rates) in 2008 (and expanded it for 15 months to expensing in 2010-2011). It was to be phased out by 2020, but 2018 tax reform introduced 100 percent bonus depreciation (it is to be phased out starting in 2023). One of the few countries to do so, Canada, in response to U.S. tax reform, introduced accelerated depreciation for most depreciable assets on a five-year temporary basis in 2018. Many countries introduced accelerated depreciation or tax credits for clean technology. Patent boxes for intellectual property held in country were also introduced in several countries, including tax relief for intangible income held in the United States as part of the 2018 tax reform.

Some countries also restructured their corporate taxes by adopting “rent” bases, whereby both current and full capital costs are deducted from taxable profits. A rent base can be implemented by expensing capital (with no deduction for interest expense). Alternatively, capital can be depreciated with a deduction given for both interest and notional equity costs (the notional deduction is typically based on the government bond interest rate, which after the financial crisis is relatively low). Latvia adopted allowance for notional equity financing costs in 2008. In 2011 Italy adopted a similar approach, except for limiting the allowance to new equity financing only. In 2015 Turkey introduced a 50 percent deduction for notional equity cash injections. Both Italy and Latvia have now abandoned the approach, while Brazil and Turkey have retained their equity cost deductions. Belgium, which introduced the notional allowance for corporate equity finance in 2007, scaled back its allowance to only new equity financing in 2018.

While the rent approach for corporate income taxation has generally fallen flat for reasons discussed elsewhere,⁶ the rent approach is frequently used in resource taxation for mining and oil/gas (for example, in Australia, Canada, Norway, and the United Kingdom).⁷ By expensing capital and other costs (with no deduction for borrowing costs), the company’s payment to the government becomes a percentage of economic rents.

Another approach to corporate taxation has been introduced by Estonia. Instead of taxing profits, only distributions to shareholders are taxed. Effectively, the corporate tax exempts reinvested profits while a tax is applied to dividends or profits deemed to be distributed. Latvia adopted the Estonian approach in 2019.

Nonprofit Taxes on Corporations

Most governments apply nonprofit taxes on corporations, including payroll taxes (which is a tax on employment), asset-based taxes (including property taxes), sales or excise taxes on capital purchases, and taxes on the transfer of property and financial assets.

The most common form of asset-based tax are property taxes on corporations, particularly in Anglo countries like Australia, Canada, the United Kingdom, and the United States. Wealth or capital taxes have also been levied, although these have been disappearing, such as in Canada and France, since 2008. Nevertheless, they remain in Japan, Russia, and several Latin American (e.g., Argentina, Ecuador, and Uruguay), Caribbean (e.g., Jamaica), and Asian (Kazakhstan and Pakistan) countries.

After the 2008 financial crisis, several countries introduced financial and real estate transfer taxes, financial transaction taxes, or stamp duties to help pay for bailouts. Financial transaction taxes are not a new form of tax, as they have existed previously in Anglo countries as stamp duties such as in Australia, Hong Kong, South America, and the United Kingdom. However, they became more frequently used, especially in Europe, Latin America, and Asia.

Real estate transfer taxes are widely used in many countries and raise the effective tax rate on investments in structures and land. From 2010 to 2017, they have been increased in the Czech Republic (3 to 4 percent), Iceland (0.4 to 1.6 percent), Norway (introduced at 2.5 percent), Sweden (3 to 4.3 percent), and the U.K. (4 to 5 percent). On the other hand, they have been reduced in China (9 to 4 percent), India (eliminated at 11.7 percent), Ireland (reduced from 6 to 2 percent), and Spain (1.4 to 1.1 percent).

Sales and excise taxes on capital purchases are typically found in countries with retail sales taxes, such as three Western Canadian provinces⁸ and the United States. China applied a VAT on machinery but made it eligible for an input tax credit in 2009. Specific taxes on certain capital purchases have been more frequently applied in many countries, especially with respect to large or luxury automobiles. Energy and carbon taxes have also become more in vogue, which indirectly increase capital good prices.

Effective Tax Rates on Capital Investments

Overall, corporate tax policies since 2008 have led to lower rates, some scaling back of incentives, and adjustments to or introduction of new nonprofit taxes on corporations. The question, of course, is whether the overall effective tax rate on capital investments has fallen or increased. Taking into account all taxes impinging the capital decision, the marginal effective tax rate (METR)⁹ has generally declined in countries since 2008 (see figure).

For 94 countries, the GDP-weighted average METR has declined from 29.6 percent in 2010 to 27.3 percent in 2017 and 23.7 percent in 2019 (the reduction from 2017 to 2019 largely reflecting corporate tax reductions in United States, as well as some other large countries, such as Canada, France, and India). Among OECD countries, the GDP-weighted METR on capital investments fell from 29.6 percent in 2010 to 27.3 percent in 2017 and to 23.7 percent in 2019.

Revenues

Given the shifts in corporate tax policies, particularly the reduction in corporate income tax rates, did revenues fall? It is not easy to answer this question since there is little data on nonprofit taxes paid by corporations. However, one can at least focus on corporate profit taxes, including taxes on corporate capital gains paid to central and subnational governments.¹⁰

Across OECD countries, corporate profit tax as a share of GDP was virtually constant from 2009 to 2018. It averaged 2.8 percent of GDP with little variation (the lowest ratio was 2.6 percent in 2018 and the highest was 3 percent in 2017). Despite the sharp decline in corporate income tax rates, the stability in the ratio reflects several factors. First, government policies that broadened the tax base helped offset some of the revenue losses resulting from lower corporate income tax rates. Second, lower statutory corporate income tax rates expanded the tax base due to increased investment. Third, the lower corporate tax rate reduced profit shifting to other countries where corporate rates were lower.¹¹ Fourth, corporate owners shifted assets held personally to the corporation in those countries with corporate income tax rates below the personal tax rates — this is especially important at the small business level.

Overall, countries post-2008 used corporate tax policy as a growth strategy, not to raise revenues. Neither did they lose corporate tax revenues.

A Post-COVID Corporate Tax Policy

Economic growth and job creation will be key objectives for managing economies in the coming years. Employment depends on private sector expansion. Growth in itself will provide more tax revenues to governments. As GDP expands, the economy is better able to cope with both public and private debt.

It is important to consider what labor markets will look like in a post-COVID world. The medium-term implications are the following:

• Some business sectors, such as technology and transportation services linked to home delivery, have grown during the recession. Retail and household services markets that do not depend on personal contact will continue to be disrupted by new technologies in future years. The multinational technology sector with large profits and low effective corporate tax rates will be favorite candidates for taxation, such as recently proposed digital taxes on sales, as a presumptive corporate income tax, an expansion of VATs, or both.

• Some sectors were not much affected during the recession or will recover within a shorter period, such as utilities, healthcare and social assistance, education, transportation and logistics, finance and insurance, manufacturing, fishing, forestry, construction, mining, and public administration. Several sectors such as health, transportation, and manufacturing will be strategic to growth and safety.

• Some businesses were severely affected by the pandemic and could take several years to recover, if at all. These include accommodation and food services, tourism, airlines, retail trade, wholesale trade, commercial real estate, and certain household and business services that relied on person-to-person contact. Petroleum, affected by falling demand, inventory accumulation, and international price wars, is expected to take longer to recover. Some sectors with significant costs to comply with health restrictions will look for tax relief or grants.

Employment: Governments will be looking at various labor market policies to help those workers who cannot return to former employers. Corporate tax policies such as new hire tax credits could be an option to help drive employment demand, especially for certain labor demographics. Many workers may also find that they need to rebuild careers, thereby increasing demand for training programs. While most training is done through education systems, training tax credits could be used to encourage businesses to hire students, train apprentices, or fund internal training programs. The latter can be problematical since some costs might be easy to categorize as training even though they would have been done anyway as part of management programs.

Workers and businesses in larger urban centers are already looking at more flexible working hours to improve productivity and lifestyles now that they learned it is possible to work successfully at home.¹² The workplace is typically required in goods and certain service industries like salons and medical offices. Some workers find it difficult to work at home for privacy and other reasons. Nonetheless, it is already expected that many companies will be looking at part-time or full-time arrangements for employees to work at home.

The new work environment could affect urban planning, business travel, and municipal taxation. It enables companies to spread out their work force to hire talent working at home in various jurisdictions. Labor markets could become more competitive as companies hire workers from anywhere in the world, giving a distinct advantage to low-wage economies. The new workplace could also affect corporate residency requirements since management could, for example, live in a country like the Bahamas to control a company operating in the United States.

Deleveraging: As economies recover, they will need to deleverage, as household, business, and government debt has soared. Consumption will not return as quickly, and businesses will be cash-constrained to invest in capital and new technologies. The corporate tax, which falls on profits, makes deleveraging more difficult. On the other hand, governments may relax debt interest limitations (such as deductibility of net interest expense to be no more than 30 percent of earnings before the deduction of interest, taxes, depreciation, and amortization), since they hurt cash-constrained businesses most, deterring their investments. The United States has relaxed its interest limitation rule that was originally adopted in 2018 from 30 percent to 50 percent of adjusted earnings for 2019 and 2020.

Trade and Tax Competitiveness: A desire for secure supplies, shortening of supply chains, and increased nationalistic policies could reduce global trade. However, given that countries have prospered from trade and cheaper consumer goods, it is quite unclear how much trade will be affected in the long run. Smaller countries will seek trade since they cannot provide all the goods and services themselves. Global supply chains might shorten if national security needs to be protected. Those governments that care less about foreign supply and export-led growth will likely view tax competitiveness as less important.

Climate Change and Corporate Taxation: Countries will likely continue to resort to climate change policies to reduce greenhouse gas emissions. Carbon policies that result in higher direct and indirect energy costs for businesses will deter investment. If governments use carbon levies, they have a source of revenue that could be used to improve productivity and competitiveness to offset the harmful impact of carbon policies on investment. As argued in the past, a “double dividend” is possible by substituting environmental taxes for corporate income taxes (given the latter imposes the highest economic costs).¹³

Investment, Technological Adoption, and Corporate Taxation: Investment is key to growth. It allows companies to adopt the latest technologies to improve cost competitiveness, as well as grow new markets. The adoption of digital, robotic, artificial intelligence, and other new technologies in business practices has been in corporate plans this decade that would drive labor productivity gains.

It has been argued that labor displacement from digitalization and robotics would particularly affect the service sector, leading to large losses in employment. Even so, the story is more complicated. As with any new technology, firms become more cost competitive. New products or services are offered to satisfy growing market demand. Overall, technological adoption leads to more employment, despite the initial effect on industries where displacement takes place.¹⁴

In the years following the COVID recession, businesses could be incented to find or adopt new technologies to reduce labor costs, especially if health restrictions remain in place for a lengthy period. However, business balance sheets have been damaged, which potentially postpones the adoption of new technologies (this will not be the case for technology and those companies that have done well during the crisis).

Some policies, such as partial refundable investment tax credits or allowances, could provide cash up front for struggling businesses. Exchanging tax loss pools for reductions in other taxes paid by businesses might help initially with business cash flows.¹⁵ Or corporate taxes could simply be reduced to encourage investment in profitable projects, which should be an objective for growth-oriented tax reform.

Corporate tax reform could also be a relatively low-revenue-cost policy to encourage investment. Obviously, taxes are not the only factor that influences capital formation. Demand for business products, interest rates, infrastructure, political stability, and regulations also affect how much investment takes place. A proper analysis looks at competing factors affecting investment, including taxation. In addition to aggregate demand, financing costs, transparency, and inflation, economic studies have shown that private investment is sensitive to taxation — conservative estimate is that a 10 percent increase in cost of capital (adjusted for the METR, which adds to the cost of capital) causes a decline of 7 percent in capital stock. Other studies focused on foreign direct investment show a higher impact — foreign direct investment flows would rise as much as 25 percent with a one-point reduction in the corporate income tax rate.¹⁶

Corporate Tax and Inequality: The effect of the pandemic and economic relief programs has led to a sharp increase in unemployment more heavily weighted toward less-skilled and less-paid workers. This is seen by the increase in the hourly wage rate during the pandemic, as layoffs were preponderantly more among lower-wage workers. This would suggest an increase in inequality in the coming years as it will take time to reemploy workers. However, it is not clear that inequality will rise, keeping in mind the impact of the pandemic on returns to investment. Capital income has also fallen as business profitability declines. Household and business bankruptcies have increased. Housing and other asset values have eroded, affecting household wealth. Without further analysis of the proportionate losses to labor and capital, we cannot say much about inequality. However, we do know that poverty in many countries will increase as some permanently lose jobs, homes, or savings.

As discussed above, the concern over inequality could push some governments to raise corporate taxes for political reasons, contrary to the 2010-2019 experience. While the legal incidence of the corporate tax surely falls on the corporation, its economic incidence is another matter since a corporation itself is not an economic person. People ultimately pay corporate taxes through higher consumer prices, lower wages or dividends, capital gains, and other capital income accruing to owners.

In small open economies, corporate taxes cannot be easily shifted back to domestic or nonresident owners of capital. If corporations reduce rates of return on capital, investors will shift their capital to other opportunities in international markets where returns are higher. The tax tends to be recovered by raising prices on consumers or by reducing payments to immobile factors of production: wage payments to labor, including layoffs, or rents paid to landowners.

In larger economies or those with financial markets less integrated with world markets (such as due to capital controls), the corporate tax would fall in part on capital owners. Even then, capital is owned not just directly by individuals (who tend to be wealthier) but also indirectly through pension plans and other financial intermediaries. With the corporate tax falling partially on labor and consumers, as well as some lower income investors, the corporate tax incidence could therefore be regressive rather than progressive, making inequality worse.

Smaller corporations that do not have access to international markets are owned by individuals for legal (i.e., limited liability) and tax reasons. Owners have a choice of organizing their business affairs as an unincorporated business (sole proprietorship or partnership) or corporation. All else equal, they prefer a corporation if corporate profits tax and personal income tax on distributed earnings and (accrual-equivalent) capital gains are less than personal taxes on unincorporated business income. Thus, an increase in corporate tax on small companies may be primarily shifted to the owners who have different incomes.

The public may view that taxing corporations improves fairness by making the rich pay more, but empirical analysis confirms that this is not entirely the case. A recent study found that 31 percent of the U.S. corporate tax is shifted forward into higher consumer prices, making the corporate tax regressive to a certain extent.¹⁷ A Canadian study found that an additional dollar of corporate tax payments results in a loss of wages to the order of $1 to $3.85 depending on the province, given the lack of mobility of labor internationally and productivity effects on labor incomes.¹⁸ These results are consistent with much of the literature that suggest that the company tax, especially on large multinationals, may fall from 30 to 70 percent on real wages.¹⁹ For small open economies, the corporate tax is more likely regressive.

Corporate Tax Rate Reductions vs. Accelerated Depreciation: Governments have provided tax relief to business by reducing corporate income tax rates (generally or for certain activities like patent boxes) or providing accelerated depreciation. The advantage of accelerated depreciation is that the company must carry out new investment activity to reduce corporate tax payments, unlike a corporate tax rate cut that reduces profits on old and new capital. However, accelerated depreciation is distortive by favoring assets that have shorter lives, while corporate tax rate reductions are more neutral across business activities and industries. Corporate tax rate reductions also enable a country to attract investments with high yields (economic rents) and profits shifted from other jurisdictions (such as through transfer pricing and financial structures). With post-COVID governments short of cash, accelerated depreciation might be preferable for revenue reasons but it provides little cash flow to companies needing help. To attract high-profit investment, corporate tax rate reductions would be preferable.

Much of the literature treats corporate taxes as a whole even though effective tax rates can vary across industries and assets. Less understood, therefore, is how different corporate tax policies might affect inequality. For example, accelerated depreciation that favors short-lived assets favors the hiring of skilled over unskilled labor, resulting in a worsening of inequality.²⁰ On the other hand, a corporate tax rate reduction is more neutral and therefore has less impact on inequality.

Conclusion

It is far from clear that governments will use corporate taxes to raise revenues given debt accumulation, as well as concerns about growth, productivity, and getting people back to work. That certainly seemed to be the experience of the post-financial crisis era during which government deficits and debt grew while economies had a long recovery period. Yet this recession is so deep and potentially enduring that governments may look to raise corporate taxes to contribute to their budgets.

Even if corporate taxes are not increased (and even potentially reduced), it is unlikely tax policy will remain the same. Governments might initiate new tax preferences for investment, innovation, new hires, and training rather than reduce corporate income tax rates. Or, as discussed above, they might wish to reform altogether their corporate taxes, such as by adopting a rent tax or an Estonian profit distribution tax that exempts reinvested earnings from corporate income tax. If they lose revenues with some reforms, they may raise revenues by broadening tax bases by scaling back preferences or imposing new taxes, such as on multinational technology companies.

Too much is uncertain now to even make any predictions — our only guide being the last economic recovery. But if growth is the overriding concern, governments will lever corporate taxes to achieve it.