Friday, December 19, 2008

Don't Cut Taxes

One of the few good things about this recession is that there has been very little discussion of cutting taxes as a way to stimulate the economy. This might be because the US has tried this and it did not work and so public commentators have seen experience and decided against offering this advise (which would be learning from history, also a positive thing) It might be because we are getting some common sense in public discourse on taxes. I don't know. Whatever reason, the old common sense "cutting taxes is good for the economy" seems to have gone away at least temporarily and in its absence we can have a serious and hopefully accurate discussion of what is good for the eocnomy.

Cutting taxes is actually a truly horrible way to stimulate the economy. Few economists actually think it works. The "cut taxes" argument instead comes from public commentators (pundits) of various sorts and journalists. People who actually study the economy have little faith in it. Why? Because tax cuts have little effect on spending habits and what effects they do have can be odd or even contradictory. I'll give you an example to illustrate my point. Suppose that one wanted to cut taxes to stimulate the economy. By stimulating the economy, here, we mean increasing consumer spending in order to increase the amount of goods purchased so that businesses make more money and hence get more stock from their suppliers who in turn have to hire more workers to produce this stock, thus increasing employment. For those with a more detailed knowledge of economics, I know that is a dramatically simplified explanation but it serves its purpose.

The problem with tax cuts is that it does not do this. Suppose, for instance, that the government wanted to stimulate the economy through a tax cut. And further suppose that there are about 20 million tax paying Canadians. A $100 tax cut for each tax-paying Canada would cost the government $2 billion, a fair piece of change. There seems to be some logic here. I happened to win $100 at a basketball tournament recently (the ever present 50/50 draw, as those who frequent minor basketball tournaments will know). What did I do? I spent it. I took my wife and daughter out to dinner (my son was off with his friends), picked up a couple of extra things for the house, splurged on one of those fancy coffees at the local coffee shop, etc. Three days later my $100 was gone, right into the economy. Should not a $100 per tax payer cut work like this and stimulate the economy but instead of Andrew Nurse spending his windfall, you'd have 20 million other Canadians doing the same thing?

No, because tax cuts don't work like this. Instead of getting $100 on a Saturday evening right before supper, what you do is pay less taxes throughout the year. Most people are paid twice a month so they get 24 pay cheques (or, electronic invoices as we do here at Mount A), So instead of having $100 in my pocket I have an extra $2 and change in my bank account every 15 days. Will that $2 change the way you spend? What will you add to your grocery list for $2? Will you go out and buy your spouse a snazzy new gizmo with that $2? Or, will you get your friend a more generous Christmas present or drop a bigger donation than you otherwise would have in the plate at Church? (Sidenote: I have been trying to create an argument that Churches are good for the economy because they are ruthlessly efficient spenders. Everything that comes in one door goes out the other to support food banks, educational programmes, youth groups, drop-in centres, clothing drives, missions, etc., but I have not gotten that argument worked up yet.)

It is unlikely. My daughter might spend the $2 if she discovered she had it but she's nine and $2 is a fortune to her. My son, who is 15 would not. He'd pocket the change. Most adults would ignore it. It is simply not large enough on an individual tax-payer basis to change consumption -- spending -- patterns.

What about a bigger cut? OK, let's double it, now you have $4 every two weeks going into your bank account and the government is now in the hole $4 billion. What big ticket item would you buy because of this? You might buy an extra coffee at Tims but that won't make any difference because Tims will not need to hire anyone extra to serve you. The server just needs to pour one extra coffee or two or three. How long does it take you to pour three extra cups of coffee in a two week period? You might buy an extra chocolate bar while grocery shopping and if that were done on a mass scale it might have some minor effect, but I suspect most people will keep to their regular grocery list. Certainly, no one is going to take the family out to dinner one extra time because they have an extra $2 week (in our best case scenario). Will you buy a new car or refinance your mortgage for an addition because of this? Will you take an extra vacation to PEI this summer (I love going to PEI) because of this money?

Again, we are in a situation where the tax cut is ineffective and we have cost the government -- which means we taxpayers who will need to pay this back someday -- a lot of money. So .. why do people continue to argue for tax cuts as some supposed holy grail of economic stimulation? Well, as I said, in part they don't. The disastrous record of the Bush administration and the silly GST cutting policies of the Harper government -- in which the state's capacity to respond to economic problems was zapped for purely political reasons -- have thrown some measure of cold war on the idea. In other instances, those continuing to argue for tax cuts do so from the perspective of ignorance. They either don't know their economics or have not done their math or both. Whether because of bad math or bad economics, their advise should be disregarded. I suspect those who continue to argue for tax cuts do so out of an ideological predisposition, which again, is good reason for care in heading their advise. Ideology detached from reality is ... well ... fantasy. And, does anyone want to put something as important as the national economy in the hands of someone who lives in a fantasy world?

The good news, as I said at the beginning, is that we are now getting past the fantasy world. We can now have a serious and hopefully effective discussion about the balance between the state and the market, what each can and should do, what is more effective and efficient. Canadians should welcome a more realistic debate even if it is the unfortunate fallout of failed economic ideas.

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