Could Ottawa’s balanced budget help provinces reduce deficits?

Posted on November 19, 2013 in Governance Policy Context – Report on Business/Economy/EconomyLab
Nov. 19 2013.   Paul Boothe

The headline from the federal Finance Minister’s update of economic and fiscal projections last week was that the federal budget will swing into surplus in 2015-16, a year earlier than previously projected. The federal government’s seven consecutive years of deficits will finally come to an end – right on time for the next general election.

There has been a lot of speculation in the media about whether the federal government will be announcing tax cuts as part of its campaign to win another mandate. However, as politicians are fond of saying, there is only one taxpayer. With most provinces facing extended deficits, should taxpayers be looking for tax cuts while provincial debts are rising? Or should provinces take up the extra tax room, holding overall tax rates level until their deficits are eliminated, too?

Your answer to this question depends on your views regarding the size and role of governments, and fairness toward future generations of taxpayers. Here are some arguments to consider.

Size and role of government

For some conservative thinkers, small government is the best government. Governments should focus on their core responsibilities such as law and order and security, and leave the rest for the private sector.

Consistent with this view, the federal government was at pains to point out in its update that it plans to shrink program spending relative to GDP to below pre-recession levels. Sometimes called “starve the beast,” this approach is based on the notion that the best way to shrink government is to reduce its revenues through tax cuts, forcing program cuts in order to eliminate deficits. If you want to reduce the size of government, you probably oppose provinces holding overall tax rates level until their deficits are eliminated. Rather, you hope that deficits will force provinces to also cut programs to return to balanced budgets.

A related argument can be made regarding the role of government. For example, most observers would argue that infrastructure has not kept pace with Canada’s continuing urbanization, and that significant investments are needed. Given that the benefits of infrastructure are felt mainly at the provincial level, much of this infrastructure is funded by provincial taxes. If you believe that provinces should be investing in infrastructure now rather than waiting until their deficits are eliminated, keeping overall tax rates level in the face of federal tax cuts may make sense. If you believe that improved infrastructure is not a priority or that it should be provided privately (e.g. more toll highways, etc.), provinces should not adjust their tax rates to keep the overall tax burden constant.

Fairness to future generations

Economists’ favourite saying is that there is no free lunch. This applies to government deficits as well as everything else. Government borrowing today will result in higher debt payments in the future, either through interest or principal repayment. Thus, deficits benefit current taxpayers at the expense of future ones. If you oppose transferring the burden of recession-induced government borrowing to the next generation, you probably favour provinces holding tax rates level until both levels of governments are back in balance.

Obviously, there is lots of room to argue the pros and cons of holding overall tax rates constant until both federal and provincial deficits are eliminated. The federal government was clear in its recent update that it plans to shrink the federal role further, making future federal tax cuts virtually inevitable. However, it is an open question as to whether the total tax burden should decline before provincial deficits are eliminated. Let the debate begin.

Paul Boothe is professor and director of the Lawrence Centre for Policy and Management at the University of Western Ontario’s Ivey Business School. He previously served as deputy minister at Saskatchewan Finance and associate deputy minister at Finance Canada.

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