Stimulated by Tax Cuts?

Even as Conservatives jettison some of the worst features of Thursday’s economic statement, they appeared on this morning’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 two 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, deepens the announced austerity from $6 billion to $8 billion.

The $31 billion figure was the 2007 Economic Statement’s estimate of what 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 should also be lower.

No major new tax cuts have been announced since the 2007 Economic Statement. Due to worsening economic conditions, the 2008 Economic Statement’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 government’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 for these programs. Also, they 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.

Sources:

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

3 comments

  • I find the whole, tax cut/stimulus argument, is a dated and inefficient policy response for a small open economy as ours. In a modern globalized economy, one would be hard pressed to see our little tax cuts show up on economic map as a tiny blip, as a good portion of the wealth generating production, the one that has got to be targeted, i.e. in Canada, manufacturing, forestry and the resource sectors, are driven by exports.

    This then leaves a good healthy slice of the tax cut benefits flowing outside the border.

    The kind of stimulus we need are targeted sectoral spending to further develop our productive capacities within these sectors. Whether it is efficiency investments or innovation related investments.

    We also need to expand and create our worker adjustment programs for those workers effected by the current rounds of restructuring, EI, training and other such proven measures.

    Tax cuts are the biggest winners politically and the easiet to implement. So now the tories are doing nothing but rebranding their tax cuts into some kind of weird notion that they somehow knew what they were doing all along. Gees it was just 50 odd days ago that Harper was spouting off about hwo nothing was wrong with the economy. Any body with half a brain knew at least 2 years ago when the auto and forestry sectors started feeling the heat from the over valuation of the dollar, that we were in for some rough water.

    So I would add on to your argument Erin, that indeed this is nothing but attempting to hood wink the public into some grand narrative that they have written so as not to be caught with their pants down, again. They are so out of touch with reality, it is costing them dearly.

    I think they had better quite hiring marketers and hires some economists that actually have some notion of non-market rationality, only to butt up against their great leaps of irrationality.

    They are going to wreck the country, and have done a good job of really screwing up the economy with their narrow perspectives.

    I would give a good few dollars to sit down and have a discussion with Flaherty and try and understand him. Maybe that is what is missing within the economics field- economic psychiatrists, Flaherty and his group are in definite need of some therapy.

    Paul

  • In the context of the coalition it is important to come up with a two percent stimulus package. First how do we get to two percent? Answer: through new spending. Second what do we spend on? Answer see: AFB 2009. The message must be spread far and wide: the unintended consequence of the slowdown, falling revenues, does not constitute stimulus.

  • I’m hearing that some people, from the west particularly, are afraid- an entire generation has experienced the Great Depression.

    An important message is that there is a difference now, governments aren’t waiting a decade before they make major expenditures.
    Except Harper.

    Harper seems to want to drag recession on as long as he possibly can, by every means possible, apparently.

    So we can tell people, from the west and all parts of the country, that this coalition is about doing what Should have been done immediately in the thirties.

    And the sooner we get on with it, the better.

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