Stockwell’s Deficit “Solution”: Tax Cuts

This morning, the Canadian Foundation for Economic Education hosted a Bay Street breakfast meeting with Stockwell Day, President of the Treasury Board of Canada. Jim serves on the Foundation’s Board of Directors, but could not make today’s session. So, Armine and I ended up having breakfast with Tories at Torys. (Some other participants may not have been Tories, but I could not pass up the pun.)

I have occasionally been sworn to secrecy for similar meetings. But Day announced that we could report his comments, just not those of other participants. Unsurprisingly, major themes of his presentation were ending stimulus spending and cutting regular spending to balance the budget.

To me, the surprise was that Day presented tax cuts as a major part of the government’s deficit-reduction plan. He asserted not just that tax cuts are necessary or desirable, but that they will actually increase government revenues.

I asked Day whether I understood him correctly, given Finance Canada’s latest projection that post-2006 tax cuts will reduce revenues by $44 billion per year when fully implemented (see Table A2.2). He responded by talking about the Laffer curve. As I pointed out this afternoon on the Business News Network, Day’s claim is pretty ridiculous (watch video).

Of course, Finance’s static projections do not assume that lower tax rates increase economic activity and thereby broaden the tax base. If tax cuts have stimulative effects, then they will cost somewhat less than projected by Finance. However, that does not mean a net revenue gain.

For example, the Conservatives cut the GST from 7% to 5%. To pay for itself, this rate reduction would have to increase consumer spending – the tax base – by 40% (i.e. 7/5 = 1.4). Cutting the GST probably did increase consumer spending slightly, but not by anywhere near that much.

The federal corporate income tax rate is being slashed from 22% to 15%. To pay for itself, this rate reduction would have to increase taxable corporate profits by 47% (i.e. 22/15 = 1.47). I have seen no evidence of Canada’s corporate tax cuts increasing investment, and hence future profits, at all. However, 47% is crazy by any standard.

One of Day’s favourite stories is that high-income airline pilots flocked to Alberta to take advantage of his flat tax. It strikes me that pilots are a uniquely mobile profession; an exception rather than a representative example.

Also, WestJet went public in 1999, the same year that provincial treasurer Day introduced the flat tax. As WestJet expanded from its Calgary hub, the number of airline pilots based in Alberta certainly increased. But it is far from clear that this increase had anything to do with taxes.

Similarly, federal revenues may well surpass projections (particularly if the Conservatives learned from Paul Martin’s playbook). However, that does not suggest tax cuts paying for themselves.

UPDATE (Sept. 28): Quoted in today’s Globe and Mail on the need for further stimulus to create jobs.

10 comments

  • Nothing like asking a serious question and getting a cocktail party joke for an answer.

    He could have answered that workers would either experience 44 billion in wage increases or 44 billion in prices decreases or some combination of both and at least had a Worthwhile Canadian Economist back him up:)’

  • Whenever we are interpreting someone else’s argument, philosophy teaches us to apply the ‘principle of charity’ to ensure that we attack the strongest version of their argument, not a straw man version of it. Serious proponents of supply-side economics who use the Laffer Curve to argue that cutting taxes will increase government revenues can’t argue that that will happen over the short term – that can easily be disproven so much as anything can be disproven in economics (which is itself debatable). Instead, the argument that I have seen, including in literature linked to be Stephen Gordon, is that cutting taxes could increase revenues over the long term – defined as a working lifespan – insofar as it increases things such as the economic returns of education. This argument might be wrong – maybe people just aren’t motivated that way. But I think it’s a more interesting one to consider than Day’s airplane pilot anecdote.

  • I completely agree that Day did not make the strongest or most interesting arguments for tax cuts. However, when the President of the Treasury Board speaks, I think that it is legitimate to respond.

  • “philosophy teaches us to apply the ‘principle of charity’ to ensure that we attack the strongest version of their argument…”

    Philosophy does not teach us that, our philosophy teacher does. But she does not teach us that we have to make other arguments for our opponent only that we attack the strongest version of the argument they have tried to make. Which is what Erin did. Why should he attack the weak arguments of SG when he was writing about SD’s argument defending CIT cuts?

  • Erin you are right to note that stuff coning out of Day’s mouth does matter- no matter how upside down- or scrambled it is. He wields the axe and also has the keys to the gold room underneath the Bank of Canada on Sparks street. (I once went to a job interview at the BOC and got to have a look inside the gold room- wow it was some shiny room- like a grocery store with row after row of gold bars.)

    Potentially I am reading too much into this, but given he has opened up the PSAC contract, he is trying to send out some kind of austerity message to influence bargaining.

    I truly believe that once this second round of deflationary recession pressure that is coming from South of the border and potentially from our over leveraged consumers, we will see all forms of deficit cuttiing recede into a muted background of nothingness.

    Mark my words, in three months or so, you will not be hearing Professor Day- have anything within his vocabulary that mentions deficit cutting. Especially given the health of our ability to spend- it will be all stimulus talk soon enough.

    However I may be reading too much into it and he could be actually considering much of these ideas.

    We all recall the famous Stephan Gordon CIT insanity that washed across these blogs pages. I hope we don’t get into that again because I cannot stand the Gorden grand standing arguments based on mysterious concrete of nothingness.

    paul

  • Erin Weir and Travis Fast. Thank you for your responses. I think that you are both right that it is worth considering the comments of the President of the Treasury Board of Canada in order to parse the attitude and intent of our government. I think that your post, Erin, is a compelling one, and that is what got me to respond. This subject is worthy of debate and that you are making a good contribution to that discussion. Thank you.

  • It is unprecedented to have negotiations with the largest union in Canada, the PSAC before contracts are up! That, in itself has one deep in contemplation. Day knows civil servants have abruptly stopped retiring; he knows they can now collect their Canada Pension AND stay working without missing a beat and he knows tax cuts TICKLE the fancy of the grey power segment of society! What to do? Hem. He’ll deplete the civil service as quickly as is possible while making equity and diversity a faint memory of the past. He will then aid our S.Harper to a majority government in the next election while most of us will still be reeling from keeping up with all three parties antics and frivolity!! Wow. What a ride!!

  • Krugman’s post today reminds us (which I thought I had said on here a few times) that

    “And when we’re experiencing depression economics, by which I mean a situation in which it’s hard to create sufficient demand to achieve full employment — mainly because short-term interest rates are up against the zero lower bound — the essentially amoral nature of economics becomes even more acute. As I’ve said repeatedly, this is a situation in which virtue becomes vice and prudence is folly; what we need above all is for someone to spend more, even if the spending isn’t particularly wise.”

    He also states that getting this wrong as we see Professor Day and his jet ski with his austerity drooling, can lead us to a massively bad outcome.

    I do think that burying pop bottles filled with cash in old mines is probably not the way to go. The point is- we need to have smart spending, we need a plan and we need a direction and we need to get down to Washington and coordinate it with our neighbours in a massive spending program that will take the North American economy out of this funk. As indicated the massive decline in manufacturing in the past 5 years is not sustainable. We need those jobs back and the associated high value adding down stream jobs.

    Given we are integrated, I do not see why we cannot coordinate with the US on this, and that way at least be at the table of the huge whack of stimulus that will be coming down the pipe. There is no alternatives for Obama but more massive spending. The trade wars with China, and the global race to devalue ones dollar will not be a winning strategy for North America. We need to innovate and build with smart stimulus. So I do think Krugman should be getting on this factiod instead of just promoting stimulus- he should be promoting smart stimulus.

    Paul

  • Maybe what Day is hoping for is to attract more profitable businesses and individuals by lower taxes. Tax-free offshore zone has the disproportionately high share of such. Businesses and wealthy individuals are somewhat mobile and in the longrun they prefer to flock in the areas with lower taxes.

    Some problems however with such way of thinking. First of all, if countries start stealing wealthy businesses and individuals by means of tax cuts, would it not turn into some kind of distructive tax war? Maybe some international policy is necessary on this issue.

    Secondly, very drastic tax cuts are dangerous for the budjet, but moderate tax cuts will not make Canada competitive with United States and offshore zone anyway.

    Finally, although economy is stimulated by lower taxes during the times of growth, low takes also make economic shocks more painful. With high taxes economu does not overheat as much, because the excessive cash is collected by the government in the form of taxes. During the recessions the government can spend the collected cash and stimulate the economy. Therefore it is extremely dangerous to cut the taxes now, during the times of economic instability. Just before the great depression there were almost no income taxes and this led to small group of the population accumulating large funds and the rest of the population getting heavily indebted. Only redistribution through up to 91% taxes and transfer payments could get the recession reversed.

  • Mintz thinks it is plausible for corporate tax cuts:
    http://briandell.blogspot.com/2008/02/jack-mintz-on-corporate-taxes.html

    I might add that the OECD (see http://www.oecd.org/LongAbstract/0,3425,en_2649_34325_41487020_119684_1_1_37443,00.html) ranks corporate taxes as the worst possible taxes for economic growth, increasing the plausibility that dynamic scoring for them could approach 100% or more

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