Stimulated by Tax Cuts?
Even as Conservatives jettison some of the worst features of Thursdayâ€™s economic statement, they appeared on this morningâ€™s TV news programs reiterating that their tax cuts are worth 2% of GDP – the amount of stimulus recommended by the International Monetary Fund.
Almost a year ago, Marc began noting the dubiousness of casting tax cuts from the 2007 Economic Statement as pre-emptive stimulus for the ensuing economic slowdown. However, the 2% claim achieves new heights of absurdity.
The annual figure of $31 billion (which equals 2% of GDP) for 2009-10 consists not only of tax cuts from the 2007 Economic Statement, but of all tax cuts since Budget 2006. In other words, the Conservative math stretches back to include measures enacted two and a half years ago.
But it excludes the measures announced last week. The 2008 Economic Statement proposes spending cuts and additional revenue of $6 billion in 2009-10. Taking these twoÂ figures as presented leaves $25 billion of stimulus (about 1.6% of GDP).
However, both figures must be updated based on other information in the Economic Statements. The reduction of Equalization payments, relative to Budget 2008 projections,Â deepens the announced austerity from $6 billion to $8 billion.
The $31 billion figure was the 2007 Economic Statement’s estimate of whatÂ post-2006 tax cuts would cost in 2009-10. To the extent that projected consumer expenditures, personal incomes and corporate profits have since declined, the projected value of GST, personal income tax and corporate tax cuts shouldÂ also be lower.
No major new tax cuts have been announced since the 2007 Economic Statement. Due to worsening economic conditions, the 2008 Economic Statementâ€™s revenue projections for 2009-10 are 3.5% lower for the GST, 5.0% lower for personal income taxes, and 13.0% lower for corporate taxes.
Applying these same percentage reductions to the 2007 tax cut estimate suggests a value of $28 billion in 2009-10 (versus the $8 billion of austerity). Consistently applying the governmentâ€™s own assumptions suggests net stimulus of $20 billion (below 1.3% of GDP).
This arithmetic illustrates a more fundamental problem with using tax cuts as economic stimulus. For any given reduction in tax rates, the amount of stimulus depends on the size of the tax base. As the economy deteriorates, the tax base shrinks. Therefore, as the economy worsens and requires more stimulus, tax cuts automatically deliver less stimulus.
By contrast, spending allows the government to inject a given number of dollars into the economy. Enhancing income support programs commits the government to spend more as times get tougher and more people qualify forÂ these programs. Also, theyÂ put money in the hands of those most likely to spend it.
A limitation of tax cuts is that, if the recipients pocket the extra money rather than spending it, there is no stimulative effect. The Conservatives keep emphasizing that their tax cuts are permanent whereas other countries have implemented temporary measures. But a temporary GST cut might motivate people to go out and make purchases before the GST rises again. A permanent GST cut provides less incentive to spend.
2007 Economic Statement cost of tax cuts: Table 3.1
2008 Economic Statement austerity: Table 2.1
2007 Economic Statement revenue projections: Table 2.4
2008 Economic Statement revenue projections: Table 3.4