The federal government should cut taxes

Posted on November 1, 2014 in Governance Debates – FP Comment
October 29, 2014.  Jack M. Mintz

Transferring federal funds to the provinces weakens accountability. Let the provinces do their own taxing

The anticipated 2015 federal election promises to offer differing visions about the role of the federal government. The Conservatives, likely introducing a spring budget with a planned series of tax cuts over several years, will argue for a smaller federal government with jobs created by the private sector. Liberal leader Justin Trudeau has indicated his party would rescind tax cuts in favour of increased spending on infrastructure and education to promote growth. Thomas Mulcair, leader of the New Democratic Party, has already called for a new social program for subsidized regulated childcare. The table is set for a potentially good debate.

Just how big is government in our lives? Are governments today smaller or larger than the past?

As shown in the graph nearby, federal, provincial and local government expenditure outlays are 41.1% of GDP, as of 2013. This is well above the lowest level in modern history (35.8% in 1972) and now similar to the level in 1989 after expansionary federal and provincial spending on social services in the previous two decades. It is well below the peak of 52.6% in 1992 after a deep recession. With the federal and provincial retrenchment in the mid-1990s, total government spending has come down to 38.6% of GDP by 2007. Since 2007, the government outlays have turned upward, now over two-fifths of the economy.

Governments are big enough. We need smart – not more – spending

Governments also extract a lot of money from the private sector through taxation and non-tax levies (such as user fees and royalties). Total government revenues were as low 35.2% in 1970, trending upwards in the next three decades. It peaked in 1999 at 43.6%, slowly falling thereafter to 38% in 2013 with federal and provincial personal and business tax reductions.

Unlike 1997-2007 when total government was in surplus, the combined fiscal deficit is 3.0% in 2013. The federal government is moving into surplus but the provincial governments face significant deficits. Overall, provincial spending has grown faster than federal spending primarily due to health care and education.

So what does all this mean?

First, Canadians governments are big. It is far from clear we need more spending and taxation as opposed to smarter spending. Total government in Canada remains somewhat bigger than our largest trading partner, the United States (39% of GDP). Some studies in the past, including those by Vito Tanzi at the International Monetary Fund, suggest that the optimal government size should be a third of the economy to maximize growth, given that taxation is distortionary and not all spending is growth-enhancing. We might debate that number but it is legitimate to ask whether we need government bigger today than in 1970 when it was about a third of the economy.

Second, 2013 public spending is higher than revenues. Either spending will need to be cut or revenue increased to balance budgets. Canada’s net public debt as a share of GDP in 2013 is 40%, not as bad as the United States (81%), France (74%) or Germany (49%) but higher than 2007 when net public debt was as low as 27%. It was Canada’s good balance sheet that helped make it easier to accommodate the economic downturn arising from the global recession of 2008-9. We still need to deal with debt problems since interest rates will eventually rise, squeezing out provincial spending priorities. Nor would it be wrong for the federal government to run some surpluses to make up for piling up of debt since 2008.

Third, the real pressures faced for spending is at the provincial level with demands for infrastructure, education and health care. Provincial and local spending (including debt charges) account for roughly 26% of GDP, in contrast to federal spending at 15% of GDP. Given that provincial net debt is almost three-quarters of the total public debt, the provinces face the bigger fiscal challenges.

This gets to the most crucial issue. Is it better for the federal government to levy taxes and turn the revenue to provinces to pay for public services desired by voters? Or should the federal government reduce taxes, making room for the provinces to impose higher levies should they wish so?

This is a classic issue that goes to the heart of federalism. It can be argued that the federal government has greater “tax capacity” than the provinces and therefore should raise revenue to transfer money to the provinces that have the greater demands for spending by the electorate. I have never quite understood this point as provinces now raise more revenue than the federal government and seem to have lots of capacity if they wish to use it.

Instead, federal transfers to provinces and municipalities have undermined political accountability. Provincial and local politicians don’t need to tax their own voters to spend on public services of value to them – instead they can let the heat be taken by the federal politicians who have to raise revenue. If the electorate complains about provincial or local spending policies, the premiers and mayors point to the federal government not giving enough money. The federal government blames the others for not controlling spending. Voters become confused as to who is responsible for what.

You can see where I am going with all this. Governments are big enough. We need smart – not more – spending. To achieve smart spending, we need political accountability where political decision-makers are accountable to their own electorates.

So if the federal government has a bag of money to spend after this year, better to cut taxes and debt. This can best accommodate the provinces, who can then choose whether to tax their population more or not.

Jack M. Mintz is the Palmer Chair, School of Public Policy, University of Calgary. >

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