Pick up just about any newspaper today, and you would think the debate about how to use the federal surplus is one between economic efficiency and social justice. Business lobby groups press the case for tax cuts as the recipe for stronger growth, while social groups say we need investment in social programs to redistribute income and provide decent public services to all.
In a sense, this is not terribly surprising. Businesses would not get very far if they said their real aim was to boost already buoyant corporate profits, and to further inflate bloated senior management salaries. For their part, social groups have long called for investing the fiscal surplus in programs to reverse growing inequality and respond to pressing needs such as child poverty and homelessness.
The only saleable case for proposed corporate and high-income tax cuts such as lower taxation of capital gains is that it would grow the economic pie, as Tom d'Aquino of the Business Council on National Issues put it to the House of Commons finance committee last year.
Yet, while we should all acknowledge that private investment is important to growth, the economic evidence for the growth-boosting properties of tax cuts is remarkably weak.
In the short term, public spending has a greater impact on growth than tax cuts, since part of a tax cut will be parked in savings account or spent on imported consumer goods -- neither of which make Canada's economy grow. The real debate is over what drives longer-term growth.
The tax cutters point to the United States, where taxes were just 28.4 per cent of gross domestic product in 1994, as proof of the power of low taxes. But according to the most recent Organization for Economic Co-operation and Development data, average annual growth of real income per person in the United States in the 1990s through 1998 has, at 1.7 per cent, been no greater than in many smaller European countries with much higher tax levels.
For example, real income growth per person in the 1990s has averaged 2.3 per cent in Denmark, 2.1 per cent in the Netherlands and 3.2 per cent in Norway even though taxes in these countries came in at 49.9 per cent, 44.7 and 41.3 of GDP, respectively, in 1994.
The case for low taxes is even weaker when it comes to productivity growth. In the 1990-98 period, real GDP per hour worked grew by an average 1.2 per cent in the United States, compared with 2.1 per cent in Denmark, 1.3 per cent in the Netherlands, and 2.7 per cent in Norway.
It is, of course, possible to pick and choose examples. But more complicated statistical studies such as those surveyed in a major 1997 OECD study, Taxation and Economic Performance, find, at best, only a weak and tenuous link between tax rates and long-term economic performance. Even OECD and International Monetary Fund economists generally concede that macroeconomic policies are the major determinant of private investment, and that taxes on capital income are only a small part of the cost situation faced by business in making investment decisions.
It follows from this general line of argument that, while tax systems can obviously be improved, tax incentives to investment may just cost a lot of money in handouts to the already well-off, while producing no investment payoff. A classic example was the Mulroney government's lifetime $500,000 capital gains tax exemption. In a 1995 overview of studies commissioned by the Department of Finance, Jack Mintz, now the president of the C.D. Howe Institute, concluded that there was "a substantial revenue loss for the federal government," which "failed to stimulate investment in a significant way."
By contrast to the growth story, the link between a large tax-transfer system and low-income inequality is very strong. Data from the Luxemburg Income Study show that in Denmark, the Netherlands and Norway, the top 10 per cent of the population have after-tax incomes that are about three times higher than those of the bottom 10 per cent. In the United States, the top 10 per cent have incomes more than six times higher than the bottom 10 per cent. (Canada, with a middling overall tax rate of 35.1 per cent in 1994, had a gap of about four to one between the top and bottom 10 per cent.)
In the 1990s, a handful of countries, including the United States, have been able to achieve strong growth and low unemployment. But the smaller European countries have done this while maintaining a strong set of social programs and public services. Private investment has played a role, but so has public investment financed from a much larger tax base than in the United States.
There is growing evidence that the idea of a fundamental trade-off between efficiency and equity -- the basis for supporting tax cuts for the affluent and for corporations as opposed to reinvestment in social programs -- is wrong-headed. Social equity itself can have many positive impacts on growth and productivity.
It is constantly argued that the skills and capacities of people are the single greatest resource of a country in the new, global, knowledge-based economy. Yet the development of so-called human capital is inevitably compromised if large parts of the population experience poverty or ill health, or are unable to access high-quality education and training systems. There is every reason to believe that high levels of public investment in education, health and child care will have an impact on productivity, and that leaving these areas to the market will lead to exclusion and weaker economic performance.
Further, many studies have shown that private sector productivity is directly boosted by public investments in transportation, communications and basic civic infrastructure, much of which is rusting away in Canada because of a decade of public underinvestment. And public investment in research and development and technology programs is needed to offset weak private sector investment, which is marked in Canada despite the richest R&D tax credits in the world.
The central point is that the current debate over whether to spend the surplus on spending or tax cuts should be more closely rooted in the economic evidence. Most Canadians want a growing economy and a fairer, more decent society. That will involve high levels of public investment. Calls for the lion's share of the federal surplus to go to tax cuts for the well-off should be rejected.
Andrew Jackson is senior economist at the Canadian Labour Congress in Ottawa. Report on Business welcomes submissions of 800 to 900 words for its Personal View guest column. Those interested can leave a phone message at (416) 585-5432 or send a fax to (416) 585-5695. The electronic mail address is