Article content continued

The fundamental difference between the Canadian and U.S. economies is scale: Canada is, as economic jargon has it, a “small open economy.” The flows of goods, services and capital in and out of Canada are largely unconstrained, but Canada is too small a player to move world prices. The United States, on the other hand, is big enough to shift world markets. And the American market is so large that the (enormous) flows of goods and capital in and out of the U.S. can often be ignored for practical purposes, because they are dwarfed by the size of the domestic economy.

The U.S. is late to the game of reducing corporate income taxes

This difference is crucial for understanding the mechanics of corporate tax policy. Sometime the narrative is represented as a sort of income effect: lower CIT rates increase profits, and these profits are then used to finance new investment. This narrative may sound plausible, but the story as economists tell it is based on how CIT rates affect after-tax rates of return on investment. In an open economy, the after-tax rate of return is determined by the world supply and demand for savings, and a small open economy such as Canada must take this rate as given. Investment projects must offer the world after-tax rate of return (or more) to get funded. Lower corporate tax rates increase investment spending because they make it easier for investment projects to pass this test.

A more subtle implication of facing an after-tax rate of return fixed by the world market is that capitalists are, in the end, unaffected by corporate tax rates: they get the world rate of return. But for workers, the accumulated investment generates increases in their productivity and their wages.