Taxing dividends, at remittance to shareholders, instead takes money from companies that cannot identify new areas for growth, i.e. ones that have already largely succeeded.Justin Tang/The Canadian Press
Kevin Yin is a contributing columnist for The Globe and Mail and an economics doctoral student at the University of California, Berkeley.
Canada is in a slump. Productivity has been stagnating for years, research and development spending as a percentage of gross domestic product (GDP) is trailing our Organisation for Economic Co-operation and Development (OECD) peers and investment-per-worker has fallen dramatically since the early 2000s. While overcoming these challenges requires a multitude of solutions, we can get a head start by simply taxing dividends instead of corporate profits.
The rationale is not new. It’s the same behind the 2-per-cent tax on share buybacks that came into force this year.
In 2022, when the share-buyback tax was first announced, companies, especially oil producers, were buying back stock with their soaring profits. They were accused of enriching shareholders at the expense of reinvesting in their businesses. The tax aimed to steer companies to a more desired path.
But the government didn’t quite get it right. It was all stick and no carrot. Here’s a better way.
The way our current corporate tax system works is that it taxes profits, which is what’s left of revenues after expenditures. But crucially, capital expenditures that expand the company such as purchasing more land, buildings and equipment, are generally not deductible.
This means that our profit tax hurts companies while they are still growing because it results in them having fewer funds to invest in the ways that they would like. A dividend tax solves this issue while still making corporate shareholders pay their fair share.
The difference between taxing dividends and profits is ultimately about timing. A company earns its profits, chooses how much to invest in new production and research, then remits remaining funds to shareholders. By taxing corporate profits, we are taking cash away from companies before we know if they have enough for new opportunities.
Taxing dividends, at remittance to shareholders, instead takes money from companies that cannot identify new areas for growth, i.e. ones that have already largely succeeded. In this sense, dividend taxes are both more efficient and more progressive.
This is not a new idea. It is precisely the argument made in 2021 by Eduardo Davila at the Yale Department of Economics and Benjamin Hébert of Berkeley’s Haas School of Business. In a paper published in the Review of Economic Studies, they show how a dividend tax sorts out and taxes only the “unconstrained firms” – already successful ones that have enough to pay dividends – leaving more breathing room for those that do not have enough cash to cover new research projects or capital expenditures.
Because it is difficult for the government (or anyone for that matter) to figure out which companies have these opportunities from afar, the dividend tax offers a natural way to filter companies, without the need to collect information or make uneducated assumptions about which is which.
By shifting the tax burden away from these younger and more dynamic companies, we give them more cash to put toward new capital and better technologies. This gives them a better chance at expanding and becoming even more profitable, in turn growing Canadian investment and productivity.
A point of confusion here is that it may seem like a dividend tax punishes shareholders, many of whom depend on these dividends for their retirement earnings or general savings, and who already pay some income taxes on their end for receiving dividends.
But this is a misunderstanding. Profits either flow to the shareholder now or they are spent to generate more profits later – which eventually go to the shareholder one way or another because companies exist to make money for their owners. In this sense, taxing the shareholder and taxing the company are essentially the same thing.
Another criticism to this plan might be that it incentivizes companies never to pay dividends and thus taxes, since they would always want to plow their money into new investments, regardless of the likelihood of success. But this isn’t true either.
The company would eventually be issuing a dividend because its value depends on it – there’s no reason to own part of a company that never pays you. And a company that specializes in paying dividends, i.e. an unconstrained one, was going to put its profits toward dividends anyway; this kind of company is indifferent between a dividend and a profit tax.
Only a company that actually has investments to make is affected. And the impact of that would only be positive.