This isn't a tax-cut plan
Do not get me wrong: annoying the provinces is a noble calling, and an important federal responsibility. But the provinces, sadly, can relax. There’s no tax cut involved. To be sure, the feds will not be handing over any unexpected future surplus to the provinces, as the premiers would prefer. But they will not be using it to cut taxes, either, whatever you might have read.
As reported, the plan would entrench in law a rule dictating how Ottawa must dispose of any surpluses left over at yearend. There’s nothing wrong with such rules, in principle. The Star’s editorial board grouses that this “rigid formula” will “handcuff” the government. But the same could be said of any law. Indeed, that’s their intent: to narrow government discretion, and thereby to impose some predictability on government actions. Rules allow private citizens to plan for the future, which is especially important when it comes to the economy.
The problem with this scheme is the choice of rules. Allegedly, the government will allot one-third of any surplus to debt reduction, one-third to spending, and one-third to tax cuts. But this is a fiction. Others have raised the objection that the surplus itself is largely a phantasm, which the government can cause to appear or disappear at its whim: even if it does not allow for it in the budget, it can always spend any incipient surplus over the course of the year, and beyond, which the new act would do nothing to prevent.
But even if that were not true, the plan would still be a fraud. The idea that the government should allocate one-third of each year’s surplus to spending, in perpetuity, without having the first clue of whether such spending is needed, or if so for what, is loony enough. But in fact it isn’t one-third. It’s two-thirds. The “tax cut” that aroused the premiers’ ire -- “why give the money to them, when you could give it to us?” -- is in the form of a tax credit, a cheque the government mails you at the end of the year. Where does it get the revenue to pay you this bonus? From the taxes it collected from you at the beginning of the year. It’s a spending program, that is, just like any other.
True, the credit would then be built into the basic exemption for the following year, and thus would reduce your total tax paid. But that still does not meet the definition of a tax cut, in the economically meaningful sense. That is, for anyone earning more than the basic exemption, it would do nothing to reduce the marginal tax rate: the rate you face on the next dollar of income you earn.
What’s the difference? It’s all money in your pocket, isn’t it? Well, yes. But the two have very different effects. A cut in tax rates reduces the gap between what an investment earns before and after tax, or between what you’re paid and what you take home. The larger the gap, the less your incentive to earn income in the first place. Suppose you need a minimum return of 10% after tax to induce you to invest your money in some business, rather than buy yourself something frilly. At a 50% marginal tax rate, the investment would have to earn 20% before tax to make it worth your while. But cut the tax rate to, say, 33%, and it would only need to earn 15%. Presto: a whole bunch of investments that would not otherwise have gone ahead now get the green light.
Cuts in marginal tax rates, in other words, change people’s behaviour, in ways that increase productivity. They are, themselves, a kind of investment: the revenue the government forgoes pays off in permanent increases in national output. A tax credit, by contrast, neither requires nor rewards such increased effort and investment. The government pays you the money just for being you.
So this isn’t a “tax-cut plan.” It’s a spending plan. As Don Drummond, chief economist at the Toronto-Dominion bank puts it, “it seems designed to ensure that we never see any permanent tax cuts.”
Just don’t tell the premiers, okay? They’re cute when they’re mad.
10/08/2005
