Montréal, 30 septembre 2000  /  No 68
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David MacRae is a software consultant who works out of his home in St. Laurent, Quebec.
by David MacRae
          For two years, Canadians have carried on a debate over what to do with the federal surplus: cut taxes, increase services, pay off the debt, transfer money (or so-called « tax points ») to the provinces, restore EI... 
          The din has gotten even louder now that Finance Minister Paul Martin has told us just how large the surplus is – $12 billion last year, instead of the previously announced $3 billion. It has been $11.3 billion so far this year and there are still three quarters to go. All of a sudden, we're drowning in dough.
          Yet the fact is that, at least with respect to taxes, the whole debate is a red herring.  
          Cutting taxes will make the surplus even larger. The government will receive more money, not less. Therefore, cut taxes now and worry about what to do with the surplus later. 
          In fact the main reason why the federal government is suddenly running such a huge surplus is because Alberta and Ontario, which together generate more than half of Canada's GDP, took the initiative in the early to mid-nineties to cut taxes on their own. As a consequence their economies have exploded with new investment, which in turn has increased their own tax revenues. 
Thank the provinces 
          This new economic investment has generated increased tax revenue, not only for Alberta and Ontario, but even more so for the federal government, which obtains most of its revenue in these two provinces. The feds didn't even have to reduce tax rates to gain the benefit of a rate reduction. They got it both ways. Provincial tax rate reductions led to increased tax revenues, especially for the federal government since it didn't reduce rates. 
          The fact is that the Chrétien Liberals owe a huge vote of thanks to the Harris and Klein Conservatives. Otherwise, they'd be deeply mired in the swamp, just like the Mulroney government was before them.  
          Other provinces have also benefited. The booming Alberta and Ontario economies have made increased demands on suppliers in other provinces and consequently their economies have grown in response. The effect is especially strong in Montreal, which has many close connections to the Ontario economy. Mike Harris has not only saved Jean Chrétien from electoral ruin but Lucien Bouchard as well. A rising tide lifts all boats, even leaky ones.  
          Of course, this boomlet is temporary. Unless economic fundamentals change in the other provinces, the long-term effect will be to encourage suppliers to move their operations to places with better policies. Provinces which refuse to admit the errors of their ways will eventually return to the doldrums. 
          In the 1995 Ontario provincial election, Mike Harris used the slogan « Common Sense Revolution » to describe tax-cutting policies. That's exactly what it was – a common sense approach. Why on earth wouldn't you cut taxes rates if the effect would be to increase tax revenues?  
          Never mind the fact that, at the same time, people would also have more money in their pockets. The reason why cutting taxes increases revenue is that per capita GDP rises so fast. People have so much more money that they can pay more taxes in absolute terms while simultaneously keeping a greater percentage of their income. It's a pretty good deal. 
          It is intuitively obvious that there is a level of taxes that maximizes government revenues. Let's call this the optimal taxation rate, optimal in the sense that it optimizes revenues. The « proper » taxation rate, whatever you think that means may well be below this level (libertarians would certainly think so) but it cannot be above it. That would only mean less money for whatever services you think government should supply. 
          It's also obvious that this optimal rate is less than 100%. If the government took everything, no one would work. Empirical studies conclusively show that the following statements are roughly true: 
1. Any capital gains tax, no matter how small, actually reduces tax revenues; 
2. Marginal income tax rates, including payroll taxes, should not exceed 30%; 
3. Total taxation should exceed not about 30-35% of GDP.
Reducing makes good sense  
          There are good reasons, both theoretical and empirical, as to why these three rules are true. Examination of these reasons is the subject of another article, perhaps a whole other book. I do not have the space here to delve into it too deeply but let's take a look at a couple of examples.  
     « The reason why cutting taxes increases revenue is that per capita GDP rises so fast. People have so much more money that they can pay more taxes in absolute terms while simultaneously keeping a greater percentage of their income. » 
          American governments collect about 32% of their GDP in taxes. In Canada, it's about 45%. Yet American tax revenues exceed Canadian revenues by $1700 per person! Furthermore, the difference has widened since American rates were cut in the early 1980s.  
          The Alberta case is an even better example. Despite repeated tax reductions over the last seven years, Alberta has managed to clear out its debt while simultaneously increasing spending. Yes, oil revenues have helped but the effect has been minor. During most of that period oil revenues declined. Last year, Alberta announced that they would implement a single income tax rate of 11%. As a result of the windfall they got from the recent rise in gas prices, they have decided to reduce this rate – to 10.5%. 
          ‘Nuff said. Once you violate one of these rules and set a tax rate above these limits, tax revenue goes down, not up. People start looking for ways to avoid the confiscation of their hard work and their wealth. They hire lawyers and accountants. They take their investments elsewhere. They cease to work overtime (or to work at all). They start looking for tax dodges instead of performing productive work.  
          There is also a fourth rule, or rather a principle. Taxes on production (capital gains taxes, income taxes, payroll taxes and other business taxes) are very damaging to the economy. While only the capital gains tax is sufficiently destructive as to actually reduce tax revenue, the others are pretty awful too. All of them destroy at least 50¢ worth of economic activity for each dollar of taxes that they extract. It's a mug's game. 
          User fees, property taxes, and consumption taxes (sales taxes, the GST, excise taxes, custom duties) are not nearly so bad. Their typical cost is about 15¢ of economic activity for each dollar raised. This difference should be obvious to anyone who thinks about it. A tax on anything is a disincentive to indulge in the activity taxed. 
The politics of envy 
          If you have to make a choice between a tax on production (the creation of wealth) and a tax on consumption (the destruction of it), which should you prefer? This decision should be self-evident – we should prefer to create wealth than to destroy it. Despite this, the lefties far prefer to tax production than consumption. This is pure and simply the politics of envy. 
          It is an indication of the atrocious level of political debate in this country that we never hear about these rules. Canadian tax policies violate all three of them – and massively so. In addition, we depend on production taxes to a far higher degree than any other country in the OECD. 
          Even the Canadian Alliance's proposals do not come close to living within the rules. To their 17% single tax, you have to add payroll taxes and provincial taxes to calculate the true marginal income tax rate. This makes it more like Solution 40 or Solution 50, than Solution 17. Far beyond the 30% limit. They would need to eliminate the payroll taxes to come close to observing the rules. Of course, they would also have to eliminate the capital gains tax as well and to make other reductions. 
          One disappointment I have with the Canadian Alliance is that they refuse to make the case that reducing taxes will increase revenues. They obviously know it. Stockwell Day occasionally brings it up but he focuses more on how people have the right to keep their own money. This is true but it's open to the old leftie rebuttal – their nonsense about the rich being « selfish », as if it wasn't selfish to forcibly expropriate other people's property. 
          Economic pundits, even those who should know better, also fail to make the case that reducing taxes increases revenues.  
          In last week's Financial Post, Diane Francis ran an op-ed piece entitled « Cutting fuel taxes is pointless exercise ». The reasoning is that the number one priority is to cut capital gains taxes and that we should use the surplus to do exactly that. Fuel taxes take a back seat.  
          Well, she's right about the number one priority but wrong about the effect on the surplus. If the capital gains tax was eliminated, tax revenues would go up and the surplus would increase. So we should eliminate capital gains taxes because they reduce government revenues. Because they intrude on our freedom and our right to privacy. Because they are a blunt tool whose only effect is to destroy prosperity. What we do with the surplus is a completely separate issue. There are worse ideas than using it to reduce fuel taxes. 
          Similarly, another Post columnist, Andrew Coyne, has repeatedly argued that we should use the surplus to wipe out the debt (although he now thinks that it's big enough to be able to do other things as well). Yet he has also pointed out on occasion that cutting taxes increases revenue. Be consistent! Until taxes come down to the optimal rate, you don't have to choose between cutting taxes and reducing the deficit. Assuming you don't increase spending, cutting taxes will reduce the deficit. Rapidly. Look what happened in Alberta. It took six years to clean it out. 
          And this is what you find in the Post! Most other commentators yap incessantly about fairness and equity, whatever that means. They quote idiotic UN « studies » which claim that Canada has more poverty than Poland and worse health-care than Cuba. They whine about corporate fat cats and how this money is needed. 
          Still, the whole debate is irrelevant. Once taxes have been reduced to a reasonable level, you can start to ask what to do with the surplus. If you think that the proper answer is to beef up welfare and EI to encourage people to remain in poverty, well you can make your case when we reach that point. Until we do, this whole controversy is utter nonsense. 
Pitiful Quebec 
          In Quebec, the level of the debate is simply pitiful. Lucien Bouchard just announced that he was willing to cut gas taxes – on the condition that the feds give him the money to do so. Well isn't that just sooo generous of our dear premier? 
          Of course, the only reason why the feds have money and he doesn't is that Canada as a whole has cut taxes, even if the government of Canada hasn't. Bouchard's problem is that he isn't directly able to extort payments from the parts of the country which have driven our recent economic boom. His solution: to get the feds to do it for him. This from a separatist! What will he ever do if he actually convinces Quebeckers to take him up on his option? 
          If Mr. Bouchard did the same thing as Ontario and Alberta did, he too would be would be faced with the problem of how to deal with a big surplus. Instead, he balanced the budget by buying out teachers and nurses while simultaneously upping user fees and taxes and bringing in several new entitlement programs. For this, he pats himself on the back. 
          You have to conclude that this whole game has nothing to do with supplying services to the public or charity for the poor. If it were, we would be looking at how best to raise the necessary money.  
          No, the game is about control. They can control you better when they are taking 50% (or more) of your money instead of a mere 30%. They can play around in your bank account, meddle in your relationship with your employer and scrutinize every purchase you make. Count on it; that one is coming – they're just waiting for the right technology.  
          It's striking to note that, while Alberta has reduced the capital gains tax to 3%, they haven't abolished it. It probably costs them more to collect this tax than they receive in revenues from it. So why bother? To keep the right to snoop into other people's business. 
          If the game were really about money, they wouldn't be in government at all. They'd be out making some. 
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