Ten Tax Myths

 I t is important to look at this argument not only on its merits, but from where it comes. The political parties, commentators, and corporate think-tanks promoting this notion have for over 10 years demonstrated a complete lack of interest in Canada’s appallingly high unemployment rate. In fact, they have all supported our high-interest rate policy that deliberately maintains a high unemployment rate.

Instead of any real concern about unemployment, the tax-cutters are much more interested in ensuring that social programs and transfers to the provinces are increasingly starved of their necessary funding. The best way to ensure this is to systematically reduce the government’s revenue. That would, in addition, maintain Canada’s high debt level, always a useful tool to support the demand for more spending cuts.

But do tax cuts really create jobs and stimulate growth? It depends. It depends on who gets the tax cuts. Personal tax cuts at the lower end of the income scale do have a stimulating effect because poor people tend to spend every extra dollar they receive.

Tax cuts at the high end, however, have a much less stimulative effect because wealthy individuals are already saving much of their income. Any extra income is likely to be saved, as well. It is argued that the wealthy will invest their extra money and create jobs but, as we saw earlier, this argument doesn’t hold up in an economy where demand is stagnant — and kept stagnant by government policies — and export markets are down.

If those recommending tax cuts were really interested in creating jobs, they would be calling for revenue-neutral tax changes — i.e., reform of the tax structure that would maintain the current levels of total revenue necessary for government programs, but shift the burden away from low- and moderateincome earners. But this is not what they are calling for. Common to all these proposals is the lowering of total revenue, and thus of the ability of the government to provide for citizens. The more honest of the would-be tax cutters, like the Reform Party, call for simultaneous tax cuts and lower government spending.

The other problem with tax cuts to higher- and even middle- income earners is that Canadians now have record levels of debt, a result of trying to maintain their standard of living on ever-decreasing real incomes. Much of the tax cut money would likely go to paying down these high debt levels and decreasing the level of new borrowing.

Governments do create jobs - millions of them

If you think about the argument that governments can’t create jobs, it’s pure nonsense. Teachers, university professors, nurses, doctors, parks workers, civic employees, those employed by Crown corporations such as utilities — all are doing jobs “created” by government and paid for with tax revenue.

The question really comes down to which is the best and most socially useful way to create jobs. Tax cuts can have a stimulative effect, but how do tax cuts compare to government spending on hiring more nurses and teachers and child care workers? Or maintaining highways and buying new transit buses?

A study by the Ottawa economic forecasting firm Informetrica compared the job-creation effectiveness of government spending to that of tax-cutting. Government spending turns out to be a far more effective job creation tool, especially in the areas of social spending, than cutting taxes. The study compared the job-creating effectiveness of tax cuts of $100 million to government spending of the same amount, tallied over three years. Spending on additional government employment, health and education would each result in 70,000 new jobs over the three years. The same amount spent on day care would create 130,000 jobs, and on goods and services in the private sector, 59,000 jobs.

Tax cuts didn’t do nearly as well. The best job creation tax cut was in the GST, where a $100 million cut would produce 53,000 new jobs. An across-the-board personal income tax cut creates 40,000 jobs, and a corporate tax cut 22,000[23].

Besides the actual numbers, Canadians need to judge these job creation techniques by what else they produce. Tax cuts are not neutral; they mean fewer public services, poorer communities, a weaker safety net for the most vulnerable, fewer public parks — in other words, less public space. Private, individual consumption would go up, yes, but part of this increase would be spent to make up for the lost public services. What good does it do poor people to get a small tax cut if they have to spend more on health services that used to be covered by Medicare, or school supplies that used to be paid for by the school?

The assumption behind tax cuts is that people only want choices in their private purchases. But clearly people want choices in public services just as much: witness the strong support for Medicare and public education. As tax policy professor Neil Brooks asks, where is the evidence that people want more cars and fewer buses, more private theme parks and fewer wilderness areas, more toll roads and fewer public highways, more private clinics and fewer hospitals? In fact, the evidence strongly suggests just the opposite.

Part of the call for tax cuts is tied to the notion that the government is taking money “out of the economy.” The Reform Party repeatedly talks about government jobs not being “real jobs.” Both these notions are just silly. If true, we would have to see a job in tobacco advertising as a “real job” and that of a nurse treating cancer patients as not real. In fact, government jobs are so prevalent in the economy that 23 of the 51 Reform MPs elected in 1993, now so critical of government jobs, had themselves previously worked at such jobs.

As for taxes taking money out of the economy, just the opposite is true. Millions of jobs result from government spending. A study done by David Robertson in 1985 demonstrated just how many jobs. While the study is now somewhat dated, the conclusions still hold. That year, governments in Canada spent $86 billion in the private sector — accounting for 6% of the total output of all services, 14% of utilities and transportation; 21.6% of publishing and printing; 48% of redimix concrete — and so on, throughout the economy[24].

This government spending in the private sector accounted for over one million jobs. In addition, $30 billion in government salaries spent in the economy created another half million jobs, and transfer payments (another $30 billion) a similar number. These were direct jobs and did not count the multiplier effect of those government dollars working their way through the economy. If UI payments were included, the numbers would be even larger.

Another action the government could take is to further lower interest rates. While we often hear that Canada is now enjoying the lowest interest rates in 15 years, this is extremely misleading. Real interest rates are calculated by subtracting the inflation rate from the official rate set by the Bank of Canada. With the inflation rate under 1%, the real interest rate in Canada at the end of 1998 was 5.5% — over twice the historic rate maintained through most of the postwar period up until 1980.

The long-term real interest rate averaged 1.6% between 1950 and 1980. Between 1990 and 1997, it averaged 6.8%. In fact, real interest rates are now higher than they were in the early 1980s when nominal rates were up to 20%. (See Table 4.3.) If we are to deal seriously with the jobs issue, we must examine where Canada’s unemployment — twice the U.S. rate — comes from. Analysts of all political stripes have identified Canada’s extremely aggressive deficit reduction efforts and its high interest policies as the key culprits. Jeff Rubin, chief economist with CIBC’s Wood Gundy brokerage firm, stated in 1997 that Canada would have been much closer to the “full-employment U.S. economy” had governments not gone overboard on cuts to government spending.

The productivity connection One of the more recent buzz-words in the anti-tax campaign has been productivity. This is the measure of how productive the average worker is, usually calculated as output per employed person. Measuring and comparing productivity between countries is complicated, and not without controversy. The OECD claimed in a 1999 report that Canada’s productivity was lagging far behind that of the U.S. But, subsequently, Statistics Canada produced figures that showed just the opposite, confirming numbers produced by the Ottawa-based Centre for the Study of Living Standards. In the midst of this debate, anti-tax crusaders selectively relied on the OECD data to make the case that Canada must lower taxes to increase productivity. In truth, tax levels have very little to do with productivity. Productivity is determined by a number of factors, including the skill of the work force, the modernization of plant and equipment, and the application of new technologies. Increasing productivity therefore depends upon private and public investments in technology, research, education and training. Taxes simply have no discernible impact. A Standard and Poor’s DRI study notes that “[l]ow-tax countries have widely varying productivity performances. This implies that there are a number of other factors...that are important”[25]. In fact, if low taxes were the solution, there would be no controversy over Canada’s productivity performance. There are already very generous tax breaks for corporate research and development in Canada. Large companies, like Nortel, which grab the lion’s share of such tax breaks, end up with extremely low effective income tax rates. For example, Nortel paid income tax at an effective rate of 6% on its profits of $583 million in 1994. But Nortel uses its tax breaks to develop technology and then export production jobs to low-wage countries, thus undermining efforts to improve Canadian productivity. As of 1995, the Canadian taxpayer had subsidized each job remaining at Nortel’s Canadian operations to the tune of $140,000[26].

The enormous cuts to social spending, combined with ruinously high interest rates, created a completely unnecessary high level of unemployment that cost the Canadian economy $400 billion in forgone national income between 1990 and 1996, according to Professor Pierre Fortin, former President of the Canadian Economics Association. It stands to reason that bringing interest rates down to the historic real rate (inflation plus 2%, or about a 3% Bank of Canada rate) and reinstating social spending to 1980s levels would do more for job creation and economic stimulus than any combination of tax cuts.

A recent example of the power of governments to affect jobs and growth was the B.C. economy in 1998. Widely characterized as being in a recession because of weak resource sectors, the province’s economy baffled pundits by scoring the fastest job growth in the country, even ahead of alleged powerhouses Alberta and Ontario, to which it was unfavourably compared.

The puzzle was not that difficult to solve. The B.C. government increased funding in health and education, and, partly because of that, job growth in the public sector rose by 11.7% with only a minor increase in the deficit. The result was a 3.6% job growth rate, compared to Alberta’s 3.1% and Ontario’s 3.5%.

[23] Infometrica, “Economic effects of selected fiscal and other initiatives”, 1997.
[24] David Robertson, “The Facts”, publication of the Canadian Union of Public Employees, July-Aug, 1985.
[25] Cited in E. Beauchesne, “Canadian tax load same as US”, Vancouver Sun, May 26.
[26] Canadian Auto Workers, Parliamentary submission regarding the future of Canadian manufacturing operations at Nortel, 1995.

Ten Tax Myths