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The effects of tax rate changes on tax bases and the marginal cost of public funds for Canadian provincial governments

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  • Bev Dahlby

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  • Ergete Ferede

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Abstract

The efficiency losses from taxation vary directly with the responsiveness of a government’s tax bases to tax-rate increases. We estimate the dynamic responses of tax bases to changes in tax rates using aggregate panel data from Canadian provinces over the period 1972 to 2006. Our preferred empirical results indicate that a one percentage point increase in corporate income, personal income, and sales tax rates is associated with a 3.67, 0.76, and 1.17 percent reduction in their respective tax bases in the short run. The corresponding long-run tax base semi-elasticity estimates are higher: −13.60, −3.63, and −3.18, respectively. We use the tax base elasticity estimates to calculate the marginal cost of public funds (MCF) for the provinces’ three major taxes. Our computations indicate that the corporate income had the highest MCF and that the sales tax had the lowest MCF in all provinces in 2006. The MCF for the personal income tax ranged from 1.44 in Alberta to 3.81 in Quebec. Our results imply that there would have been significant welfare gains in 2006 from reductions in provincial corporate income tax rates. Our computations also indicate that the equalization grant formula may reduce the perceived MCF of the provinces that receive these grants, and that increases in provincial corporate and personal income taxes can cause significant reductions in federal tax revenues. Copyright Springer Science+Business Media, LLC 2012

Suggested Citation

  • Bev Dahlby & Ergete Ferede, 2012. "The effects of tax rate changes on tax bases and the marginal cost of public funds for Canadian provincial governments," International Tax and Public Finance, Springer;International Institute of Public Finance, vol. 19(6), pages 844-883, December.
  • Handle: RePEc:kap:itaxpf:v:19:y:2012:i:6:p:844-883 DOI: 10.1007/s10797-012-9210-7
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    References listed on IDEAS

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    Blog mentions

    As found by EconAcademics.org, the blog aggregator for Economics research:
    1. How much new revenue would be generated by an increase in federal corporate taxes?
      by Stephen Gordon in Worthwhile Canadian Initiative on 2013-12-08 03:55:09

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    Cited by:

    1. Bougette, Patrice & Charlier, Christophe, 2015. "Renewable energy, subsidies, and the WTO: Where has the ‘green’ gone?," Energy Economics, Elsevier, vol. 51(C), pages 407-416.
    2. Bev Dahlby & Ergete Ferede, 2016. "The stimulative effects of intergovernmental grants and the marginal cost of public funds," International Tax and Public Finance, Springer;International Institute of Public Finance, vol. 23(1), pages 114-139, February.
    3. Juan Carlos Suárez Serrato & Owen M. Zidar, 2017. "The Structure of State Corporate Taxation and its Impact on State Tax Revenues and Economic Activity," NBER Working Papers 23653, National Bureau of Economic Research, Inc.
    4. repec:kap:itaxpf:v:24:y:2017:i:4:d:10.1007_s10797-017-9460-5 is not listed on IDEAS
    5. Kenneth J. McKenzie & Ergete Ferede, 2017. "The Incidence of the Corporate Income Tax on Wages: Evidence from Canadian Provinces," SPP Research Papers, The School of Public Policy, University of Calgary, vol. 10(7), April.
    6. Krause, Manuela & Büttner, Thiess, 2017. "Does Fiscal Equalization Lead to Higher Tax Rates? Empirical Evidence from Germany," Annual Conference 2017 (Vienna): Alternative Structures for Money and Banking 168214, Verein für Socialpolitik / German Economic Association.
    7. repec:clh:resear:v:10:y:2017:i:6 is not listed on IDEAS
    8. repec:clh:resear:v:5:y:2012:i:14 is not listed on IDEAS
    9. Ergete Ferede & Bev Dahlby & Ebenezer Adjei, 2015. "Determinants of statutory tax rate changes by the Canadian provinces," Economics of Governance, Springer, vol. 16(1), pages 27-51, February.
    10. Salvador Barrios & Jonathan Pycroft & Bert Saveyn, 2013. "The marginal cost of public funds in the EU: the case of labour versus green taxes," Taxation Papers 35, Directorate General Taxation and Customs Union, European Commission.
    11. Dementiev, Andrei, 2016. "Strategic partnerships in local public transport," Research in Transportation Economics, Elsevier, vol. 59(C), pages 65-74.

    More about this item

    Keywords

    Tax base elasticity; Marginal cost of public funds; H21; H71;

    JEL classification:

    • H21 - Public Economics - - Taxation, Subsidies, and Revenue - - - Efficiency; Optimal Taxation
    • H71 - Public Economics - - State and Local Government; Intergovernmental Relations - - - State and Local Taxation, Subsidies, and Revenue

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