Comment/Commentaire: Fiscal Competitiveness and Total Competitiveness: A Note

Canadian Public Policy

Comment/Commentaire: Fiscal Competitiveness and Total Competitiveness: A NoteAuthor(s): Evan MorrisSource: Canadian Public Policy / Analyse de Politiques, Vol. 34, No. 4 (Dec., 2008), pp. 511-517Published by: University of Toronto Press on behalf of Canadian Public PolicyStable URL: http://www.jstor.org/stable/25463637 .

Accessed: 15/06/2014 19:42

Your use of the JSTOR archive indicates your acceptance of the Terms & Conditions of Use, available at .http://www.jstor.org/page/info/about/policies/terms.jsp

.JSTOR is a not-for-profit service that helps scholars, researchers, and students discover, use, and build upon a wide range ofcontent in a trusted digital archive. We use information technology and tools to increase productivity and facilitate new formsof scholarship. For more information about JSTOR, please contact [email protected].

.

University of Toronto Press and Canadian Public Policy are collaborating with JSTOR to digitize, preserveand extend access to Canadian Public Policy / Analyse de Politiques.

http://www.jstor.org

This content downloaded from 91.229.229.101 on Sun, 15 Jun 2014 19:42:01 PMAll use subject to JSTOR Terms and Conditions

http://www.jstor.org/action/showPublisher?publisherCode=utp

http://www.jstor.org/action/showPublisher?publisherCode=cpp

http://www.jstor.org/stable/25463637?origin=JSTOR-pdf

http://www.jstor.org/page/info/about/policies/terms.jsp


Comment/Commentaire

Fiscal Competitiveness and

Total Competitiveness: A Note

Evan Morris

EcoTech Research Ltd.

Regina, Saskatchewan

Mots cl?s : comp?titivit?, fiscalit?, imp?ts, investissement, industries manufacturi?res, multinationales

Keywords: competitiveness, fiscal, taxes, investment, manufacturing, multinational

Multinational trade agreements such as the

North American Free Trade Agreement

(NAFTA) and the World Trade Organization (WTO) have made it easier for corporations to export to and

invest in other countries. As a result, many econo

mists believe that fiscal policy has become more

important in influencing corporate investment deci

sions. The approach used by many economists in

analyzing investment in manufacturing assumes that

differences in fiscal competitiveness between juris dictions will result in a shift in investment to areas

with lower fiscal costs. Most of the studies deal with

corporate tax rates, but several include other fiscal costs

such as property taxes, subsidies, etc.

Many governments have tried to increase invest

ments in their jurisdictions by reducing corporate taxes, offering investment subsidies or both. For ex

ample, corporate income tax rates in Organisation

for Economic Co-operation and Development

(OECD) countries dropped from an average of 33.6

percent in 2000 to an average of 30.8 percent in 2003

(OECD 2004). Governments at the sub-national level

also compete with one another on a fiscal basis.

The methods that are used to study the effect of

geographic variations in fiscal competitiveness are

based on the assumption of "all else being equal."

While this is a useful methodological tool to explore the possible links between economic variables, such

an approach may lead to incorrect conclusions when

other things are not equal.

If we assume that firms shift production and in

vestment to lower-cost locations, they will compare

these locations on the basis of total competitiveness rather than just on fiscal competitiveness. A country or region may have a higher marginal effective tax

rate than other locations, but it may still be the most

competitive location in which to invest. If "all else

is not equal," then policies resulting from this ap

proach are unlikely to have the desired effect in the

real world.

I will use the analysis of Duanjie Chen and Jack

Mintz (2005) as a case study to illustrate the neces

sity of comparing total competitiveness as well as

fiscal competitiveness when making fiscal policy. Chen and Mintz's study compares the fiscal cost of

Canadian Public Policy -

Analyse de politiques, vol. xxxiv, no. 4 2008



512 Evan Morris

doing business in Ontario and five US states in 2003.

The authors go beyond the traditional comparison of corporate or personal income tax rates for differ

ent jurisdictions. They include corporate income

taxes, personal income taxes, capital taxes, employer

payroll taxes, and sales tax on inputs and on con

sumers. They also include subsidies and benefits that

governments provide to employers and employees, such as grants, health benefits, education of the

workforce, unemployment insurance, social security,

and workers' compensation. This makes the com

parison of fiscal costs between jurisdictions more

accurate than a simple comparison of corporate in

come tax rates.

The authors base their approach on multinational

corporations that have several plants operating in

various jurisdictions. The authors state that "a busi

ness will locate production where costs of

production are the lowest," and that if all else is

equal, the costs of production in a jurisdiction will

be higher if that jurisdiction has a higher marginal effective tax rate.

Using this approach, the authors conclude "that

fiscal policies create a disadvantage for Ontario rela

tive to other jurisdictions in the United States. The

disadvantage is quite significant. For large corpora

tions, Ontario's fiscal system results in a higher cost

of doing business by almost 25 percent..."

The authors point out than an assumption under

lying their use of the marginal fiscal cost of

production in creating recommendations is "all else

being equal." However, this is an unrealistic assump

tion. Costs of production, including new investments,

vary considerably from jurisdiction to jurisdiction. Even within Ontario there are large differences in

costs from one location to another, such as the cost

of land, property taxes, and availability of labour and

markets. It is highly unlikely that corporations will

find all these costs equal and make a production de

cision based on the marginal fiscal cost between

locations. It is more likely that they will seek to

maximize their total profit from an investment. Fis

cal costs are only one of many costs, and it may be

more profitable to invest in areas with a higher mar

ginal tax rate.

As a simple illustration, suppose that it costs $5

per unit to produce a product in location A, and $10

per unit in location B. Assume that the total amount

of taxes and subsidies is the same in both jurisdic

tions, and has a value of $1 per unit. The marginal fiscal cost (as defined by the authors) in location A

is $l/$6, or 0.17, while in location B it is $1/$11, or

0.09. While location B has a much lower marginal fiscal rate, the total cost of doing business in loca

tion A is $6, and in location B it is $11. For a

corporation, location A is a more attractive place to

do business, even though location B has a lower

marginal fiscal cost.

Where differences in taxes are large enough to

result in differences in overall costs, multinational

corporations may shift production from higher-taxed to lower-taxed areas, and may invest in lower-taxed

areas. When corporations calculate overall costs, they

need to determine the actual fiscal cost, not the mar

ginal fiscal cost. In order to determine which

jurisdiction is more competitive, we need to calcu

late fiscal and non-fiscal costs in dollar amounts

rather than as marginal rates.

If the measure of marginal fiscal cost is unlikely to be used by multinational corporations when

making production decisions, how useful is it as a

tool for governments when making fiscal policy? If

the costs of production are not roughly equal between

jurisdictions, a government's decision to make policy based on the marginal fiscal cost may lead to poor

policy choices. Using the previous example, the gov ernment of location A may decide it has to drop the

marginal tax rate from 0.17 to 0.09 in order to re

main competitive with location B. To do this it would

have to reduce taxes to half the present amount. Such

a reduction in taxes would have severe social conse

quences, and is completely unnecessary in this case.





Fiscal Competitiveness and Total Competitiveness: A Note 513

In fact, jurisdiction A has room to increase the tax

rate considerably and still be cost competitive with

jurisdiction B.

Chen and Mintz do not state in their paper what

the actual costs are for labour and capital in each of

the six jurisdictions. However, when I compare the

costs of production using the same data sources that

Chen and Mintz used (US Bureau of Labor Statis

tics), I find that their assumption of "all else being

equal" is not supported by the data. I will first com

pare labour costs among the various jurisdictions,

as labour costs make up almost 80 percent of busi

ness costs according to Chen and Mintz.

The data in Table 1 are based on US Bureau of Labor

statistics for May of 2003 (see Data Source #1). All

wages are reported in US currency. The mean hourly

wages exclude any employer costs for supplementary benefits. There is a 23 percent difference in average

wage rates between the lowest wage state (Georgia)

and the highest wage state (Massachusetts).

The values for the marginal fiscal cost on labour

are taken directly from Chen and Mintz's article. One

can estimate the mean hourly fiscal cost on labour

by multiplying the mean hourly wage by the mar

ginal fiscal cost. The total hourly cost of labour is

equal to the mean hourly wage plus the mean fiscal

cost. Georgia had lower total hourly costs than ei

ther Illinois or Michigan, even though Georgia has a

higher marginal fiscal burden than these states. For

the five states studied by Chen and Mintz, the dif

ferences in hourly wage costs between states was

influenced far more by the mean hourly wages than

by the marginal fiscal costs.

Chen and Mintz recommend that Ontario should

reduce taxes in order to remain fiscally competitive.

Let's see what the effects of tax cuts would be on

the cost of doing business in the five US states.

Michigan had the lowest marginal fiscal burden on

labour of 15.0 percent. If the other four states cut

their taxes to equal Michigan's rate, the total fiscal

cost of labour would drop in these states. However,

the cost rankings remain almost identical. Cutting taxes to make these states more fiscally competitive

will not change the total competitive positions of

these five states.

Is the situation any different for Ontario? The US

Bureau of Labor Statistics does not make comparisons

Table 1 Wage Costs Before and After Marginal Fiscal Burdens

(selected US jurisdictions for 2003)

State Mean Marginal Marginal Total Index Total Cost if Index

Hourly Fiscal Burden Fiscal Burden Hourly Total Hourly Marginal (Georgia= Wage on Labour on Labour Cost Costs Fiscal Burdens

(%) ($) (Georgia=100) are Identical

Georgia 16.77 Illinois 17.95

Michigan 18.32 California 19.54 Massachusetts 20.59

Source: Author's compilation.

16.0 2.68 15.4 2.76 15.0 2.75 19.6 3.83 16.7 3.44

19.45 100 20.71 106 21.07 108 23.37 120 24.03 124

19.29 100 20.64 107 21.07 109 22.47 117 23.68 123





514 Evan Morris

between US states and individual provinces. However, the Bureau has carried out an international compari son of wage rates for production workers in

manufacturing. The results for Canada and the

United States are summarized in Table 2.

Table 2 Hourly Compensation Costs for Production Workers in

Manufacturing, 2003-2005

Hourly Compensation Costs, 2003-2005

(US Dollars)

United States Canada Index

_($1_($) (US =100)

2003 22.20 19.53 88 2004 22.82 21.77 95 2005 23.65 23.82 101

Source: Data Source #4, pp. 7-8.

These compensation costs include "employer ex

penditures for legally required insurance programs and contractual and private benefit plans and other

labor taxes." According to the US Bureau of Labor

Statistics, Canadian compensation is increased to

account for other important taxes on payroll or em

ployment. Even when these extra costs are included, US hourly compensation costs were 14 percent

higher than in Canada in 2003.

Over the last 15 years, hourly manufacturing wage costs have sometimes been higher in Canada than in

the United States. Changes in the marginal fiscal

burden in Canada or the United States do not ex

plain this variation. Almost the entire variation in

labour costs can be explained by changes in the ex

change rate between the Canadian and US dollars.

This correspondence can be seen in Figure 1. There

is a very strong linear relationship between the ex

change rate and the difference in hourly pay rates

between the two countries (r2= 0.933, 1990-2005).

Figure 1 Hourly Pay Rates and Exchange Rates

(Canada and US, 1990-2005)

Canadian Pay Rate

Exchange Rate

1990 1992 1994


1996 1998 2000 2002 2004


Analyse de politiques, vol. xxxiv, no. a 2008




The above comparisons of US and Canadian wage rates in manufacturing do not take account of pro

ductivity differences between the two countries. Unit

labour cost provides a measure of cost competitive

ness that combines labour cost and productivity (Van

Ark and Monnikhof 2000). According to the US

Department of Labor, unit wage rates in the US were

higher than in Canada from 1992 to 2003. The dif

ference in unit wage costs between the two countries

was again related to exchange rates (Figure 2). Since

2003 the rise in the value of the Canadian dollar led

to almost identical unit labour costs in both coun

tries in 2004. Unit labour costs became higher in

Canada in 2005 and 2006. An analysis by Sparks, Bikoi and Moglia (2002) of US and non-US com

pensation costs in manufacturing confirms that hourly

wage costs were lower in Canada from 1993 to 2000,

and that movements in the exchange rate had a major

effect on US-Canada competitiveness.

It is safe to conclude that exchange rates have

had a far greater impact on wage competitiveness than changes in fiscal policy.

The above data only provide information on la

bour costs. Several studies have attempted to

compare a number of costs of doing business be

tween Canada and the United States. Recent studies

carried out by KPMG (2004, 2006) showed that in

2004 overall business costs were 9 percent lower in

Canada than in the United States, and in the second

half of 2005 overall business costs were 5.5 percent lower in Canada. Their 2004 study also included

costs from cities in each of the jurisdictions studied

by Chen and Mintz. Overall business costs were low

est in Toronto (Table 3).

Costs of production in 2003, both before and af

ter the inclusion of fiscal costs, were lower in Canada

Figure 2 Unit Labour Costs and Exchange Rates, 1990-2005

1990 1992


1994 1996 1998 2000 2002 2004





576 Evan Morris

Table 3 Overall Business Costs in Selected Cities

State/Province City

Ontario

Georgia Illinois

Michigan California Massachusetts

Toronto Atlanta

Chicago Detroit San Diego Boston

2004 Index

(Toronto=100)

2005 Index

(Toronto=100)

100 106 111 113 113 111

100 100 104 106 107 112

Source: KPMG, Competitive Alternatives Study (2004, 2006).

than in the United States. As a result, in 2003 there

was no need to cut costs, including taxes in order

for Canadian corporations to remain competitive with US producers. In fact, there was room to in

crease corporate taxes.

Reviews of the literature indicate that the impact of fiscal policy on investment is unclear. While

several studies have shown a link between taxation

rates and investment levels, many other studies show

only a weak link between the taxation rates in vari

ous jurisdictions and the level of investment in those

jurisdictions. See, for example, Iqbal (2003), Lee

(2007), and Wheeler (2005). The correlation between

taxation levels and investment in manufacturing is

particularly poor.

Several reasons have been given for this weak link

between fiscal incentives and new investments. One

explanation is that corporations select and eliminate

potential investment locations on a number of non

fiscal characteristics, such as the level of political risk,

location of natural resources, close proximity to mar

kets, and accessibility to major highways near

projected manufacturing locations. Only after these

characteristics have narrowed the field is fiscal policy a factor in the decision to invest. If these other charac

teristics are more important than fiscal policy, then

there will be a poor correlation between fiscal policy

and the level of investment. Another explanation for

the weak relationship is that many studies often deal

with only one aspect of fiscal policy, such as the level

of corporate taxes in a location or the level of incen

tives such as grants or tax holidays given to companies. The argument is made that companies will invest in

locations where the marginal fiscal burden is lowest,

and that all fiscal policies of a jurisdiction must be

accounted for when calculating the marginal fiscal cost

to a company investing in the region.

While these factors undoubtedly contribute to the

poor correlations between fiscal policies and invest

ment levels, the weak relationship between effective

tax rates and levels of investment between locations

may also be due to the fact that fiscal costs are only a small part of total production costs, and these other

production costs vary considerably from jurisdiction to jurisdiction. There may be a strong relationship between investment levels and marginal fiscal cost

when other costs are roughly equal, but only a weak

or non-existent relationship when other costs are

unequal, and are larger in magnitude than the differ

ences in fiscal costs.

In conclusion, differences in non-fiscal produc

tion costs vary widely between jurisdictions. Since

fiscal costs are much smaller than non-fiscal costs,

we need to compare total costs in order to deter






mine which location is more competitive. The total

cost per unit of production, measured in dollar terms,

will be a much better indicator of competitiveness than the marginal fiscal cost. When governments

make fiscal policy decisions they should not base

these decisions solely on fiscal competitiveness, or

they may lose corporate tax revenues unnecessarily.

References

Chen, D. and J. Mintz. 2005. "Assessing Ontario's Fiscal

Competitiveness." Canadian Public Pol icy/Analyse de

politiques 31(1): 1-28

Iqbal, M. 2003. What Drives Foreign Investment? The Role

of Taxation and Other Factors. Ottawa: Conference

Board of Canada.

KPMG. 2004. Competitive Alternatives: The CEO's Guide to

International Business Costs. 2004 edition. Toronto: KPMG.

? 2006. Competitive Alternatives: KPMG's Guide to In

ternational Business Costs. 2006 edition. Accessed 19

April 2008 at www.competitivealternatives.com/

default.asp.

Lee, Y. 2007. Geographic Redistribution of the U.S. Manu

facturing and the Role of State Development Policy.

Bureau of the Census Paper No. CES 07-06. Wash

ington, DC: Center for Economic Studies.

Organisation for Economic Co-Operation and Develop

ment (OECD). 2004. Recent Tax Policy Trends and

Reforms in OECD Countries, No. 9. Paris: OECD.

Sparks, C, T. Bikoi, and L. Moglia.2002. "A Perspective

on U.S. and Foreign Compensation Costs in Manufac

turing." Monthly Labor Review. Washington, DC: US

Department of Labor, Bureau of Labor Statistics.

(June):36-50. Accessed 19 April 2008 at http://

www.bls.gov/pub/mlr/2002/06/art3full.pdf Van Ark, B. and E. Monnikhof. 2000. Productivity and

Unit Labour Costs Comparisons: A Date Base. Em

ployment Paper No. 2000/5. Geneva: International

Labour Office.

Wheeler, L.A. 2005. Potential Effect of Eliminating the

State Corporate Income Tax on State Economic Activ

ity. Fiscal Research Center Report No. 115. Atlanta:

Georgia State University.

Data Sources

1. US Department of Labor, Bureau of Labor Statistics.

May 2003 State Occupational Employment and Wage

Estimates. Accessed 19 April 2008 at http://www.bls.gov/

oes/2003/may/oessrcst.htm


Technical Notes for May 2003 OES Estimates.

Accessed 19 April 2008 at http://www.bls.gov/oes/

2003/may/oes_tec.htm


International Comparisons of Hourly Compensation

Costs for Production Workers in Manufacturing.

Accessed 19 April 2008 at http://www.bls.gov/ news.release/ichcc.toc.htm


Hourly Compensation Costs for Production Workers:

Index U.S. = 100, Manufacturing. Accessed 19 April

2008 at ftp://ftp.bls.gov/pub/special.requests/

Foreign Labor/ind3133naics.txt


International Comparisons of Hourly Compensation

Costs for Production Workers in Manufacturing, Tech

nical Notes. Accessed 19 April 2008 at http://

www.bls.gov/news.release/ichcc.tn.htm


International Comparisons of Manufacturing Produc

tivity and Unit Labor Cost Trends, Supplementary

Tables, Unit labor costs in manufacturing, U.S. dol

lar basis, 16 countries or areas, 1950-2006. Accessed

19 April 2008 at ftp://ftp.bls.gov/pub/special.requests/

ForeignLabor/prodsupptlO.txt


Foreign Labor Statistics, Estimating Procedures.

Accessed 19 April 2008 at www.bls.gov/fls/flsestpr.htm.





Documents

Comment/Commentaire: Fiscal Competitiveness and Total Competitiveness: A Note