Monday, 21 March 2011

Borrowing money to pay for tax cuts

In the 1993 election, the federal deficit--then $42 billion, or more than $10,000 per person--was a major issue. I remember voting for the Conservatives, thinking that they were more likely to make the deficit a high priority. In fact, Jean Chretien and the Liberals won the election, and by keeping spending flat, while revenues rose, Chretien and his finance minister, Paul Martin, were able to run surpluses from 1998 onward. Stephen Gordon provides a summary of the history. When the Liberals were defeated by Stephen Harper and the Conservatives in 2006, there was a $13.2 billion surplus.

Today, we have a $55.6 billion deficit.

Of course, the current deficit is partly due to the global financial crisis, but according to Kevin Page of the Parliamentary Budget Office (an independent watchdog appointed by Harper), there's a structural deficit of about 1-2% of GDP: that is, after the recession is over, the government will still be running a deficit of about $14 billion.

Stephen Gordon concludes that the structural deficit is due to Harper's GST cut. Economists strongly opposed the idea at the time; of course, Harper paid no attention.
How big is the hole that has to be filled? Unlike, say, corporate income taxes, the effect of the GST on the budget balance is fairly easy to calculate. Since the behavioural responses to changes in the GST rate are small (this property is why they are such a favourite with economists), the numbers in this earlier post - around 0.75% of GDP or $12b - won't be a bad guess. The PBO's estimate is $14b - and again, their estimate also corresponds to the size of their estimate of the effect of the GST cut on the budget balance.

The story of the GST cut just keeps getting worse. It wasn't a good idea at the time, and it blew a $12b hole in the federal balance that will have to be filled somehow.
I don't understand how Harper can call himself a fiscal conservative. Cutting taxes doesn't make you a fiscal conservative, not when we still have a mountain of public debt (about $500 billion) to pay off; now that we're running a deficit, continuing with boutique tax cuts (like the rumoured tax credit for children's art classes in the next budget) is basically borrowing money to buy off middle-class voters.

Yes, we have a major recession going on. I'd give Harper credit for the "Economic Action Plan", i.e. the stimulus spending; in a recession, it makes sense to temporarily borrow and spend money (e.g. on infrastructure) to make up for the loss of private demand. But a permanent tax cut--like the GST cut, or like the current corporate income tax cuts--is just as foolish as an increase in program spending (like Harper's plan to spend billions to keep more people in prison). In both cases, it means an increase in the long-term structural deficit, borrowing money which we're eventually going to have to pay back.

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