November 2000 Vol 6, No. 1
November 2000 Vol 6, No. 1
TAX CUTS: WHY NOT?
Tax Cuts Would Freeze the Underfunded State of Public Services
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Most Tax-Cut Savings Go to Highest-Income Households
Nobody likes to pay taxes. Just about everybody thinks they pay "too much" in taxes. Who would disagree with the idea of having a few more dollars of take-home income in their pay packet? That's the common-sense thinking promoted by the right-wing "tax revolt," that is now a force to be reckoned with in Canadian politics. Indeed, conservative politicians, newspapers, and business leaders are pulling out all the stops right now in a focused effort to force governments at all levels to cut taxes-significantly and permanently. But what does the tax revolt, and the coming tax cuts, really mean for the average working Canadian?
Though the campaign for tax cuts is led by the rich and powerful-such as John Roth, the outspoken (and ultra-rich) CEO of Nortel Networks-it claims to also speak for the "little guy". Sure, virtually anyone if asked would agree that they'd prefer their personal taxes to be lower rather than higher. But when asked which is more important-tax cuts, or public spending on health, education, and other key services-most Canadians strongly support public services.
For a worker earning the average industrial wage, income and
payroll taxes are lower in Canada than in the U.S. More crucially,
the public services (such as education or health care) which are
financed from taxes are central to our standard of living. The
clear majority of Canadians receive significantly more back from
government (in transfer payments and public services) than they pay
in taxes; happily, this fact may help to limit the long-run
political potential of the anti-tax crusade. Nevertheless, rolling
back the tax revolt, and defending the fiscal capacity of
governments to pay for the provision of public programs and
services, is now a historic priority for progressives in
The Issue: How to Spend the "Fiscal
The federal government, and most of the provinces, endured large budget deficits through most of the 1980s and 1990s. Contrary to conservative rhetoric, these deficits were not the result of "overspending" on social programs and government bureaucracies; in fact, program spending was tightly constrained through most of this period. Rather, a combination of high interest rates and high unemployment did the fiscal damage, pushing up the cost of social programs and government interest payments, while simultaneously dampening tax revenues.
By the late 1990s, Canada's public sector finally overcame these chronic deficits. The federal government led the way, with historic spending cutbacks implemented beginning in 1995. By 1997 the federal budget was balanced, and the government began to generate huge surpluses-which reached a record $12 billion in 1999.
Most of the progress in balancing the federal books came as a result of the deep spending cuts, which accounted for over 60 percent of the improvement in federal finances between 1994 and 1999. In contrast, only modest tax increases were implemented to help balance the books. Indeed, taxes imposed by all levels of government didn't increase at all in the 1990s, staying constant at about 43 percent of GDP (and declining slightly since 1997). The 1990s were thus the first decade in the postwar era in which taxes did not, on average, increase-yet it was the decade in which conservative efforts to stoke an anti-tax mentality reached a crescendo.
By 1999 federal spending on all public programs had declined to its lowest level, relative to our economy, since the 1930s. Total government spending was down to its lowest level since the early 1970s. Once the deficit was vanquished, one would think governments would start pumping money back into the public programs that were so damaged earlier in the 1990s. But this was not to be.
The federal Liberals promised in the 1997 election to spend 50 percent of coming fiscal surpluses on social programs, with the other half going to tax cuts and debt repayment. But in practice they increased social spending after 1997 barely enough to keep pace with inflation and population growth; there was no real reinvestment in the social fabric of Canada, and our health care system, schools, and other public programs continued to decline.
Federal taxes, on the other hand, began to decline measurably starting in 1997. And pressured from the right by the Canadian Alliance, the Liberals began to make ever-larger tax cut promises. Paul Martin's February 2000 budget promised $60 billion in tax cuts over five years. His pre-election mini-budget in October 2000 promised another $40 billion, for a total of $100 billion. Far from spending half of the surplus to repair damaged health care and other programs, the Liberals put almost all the surplus into tax cuts and debt reduction.
At the provincial level, similar tax cuts were being implemented by governments in many provinces-led by right-wing Conservative regimes in Alberta and Ontario. In Ontario provincial income taxes have been cut by over one-third; in Alberta, some conservatives now speculate about doing away with provincial income taxes altogether (replacing them with a regressive provincial sales tax). The public is concerned over the questionable state of hospital care and schools, but this does not stop these governments from allocating ever more to tax cuts.
Looking for Relief
Most Canadians experienced tough economic times during the 1990s. Their frustration with the increasingly difficult task of making ends meet certainly explains why the call for tax cuts might strike a chord with many workers.
But the role of higher taxes in explaining the decline in real Canadian living standards during the 1990s has been overstated. Table 1 decomposes the decline in real per capita disposable incomes in Canada-a decline which reduced living standards by over 3 percent between 1990 and 1998-into its various components. Of the average income decline of $600 (in 1992 dollar terms), the vast majority-a full 98 percent-is accounted for by a decline in pre-tax "market" income. Yes, average personal taxes increased during the decade: by just over $400 per Canadian. But that increase was almost perfectly offset by an increase in the personal transfer income (including public pensions) received from governments. On a net basis, governments can be blamed directly for only $12 (or 2 percent) of the decline in real disposable incomes during this period.
So if we're looking for a scapegoat for the miserable performance of personal incomes in Canada in the 1990s, we have to point the finger at something other than taxes.
How Much is Too Much?
It is taken for granted in much of the public debate over taxes that our taxes are "too high." But "too high" is a relative term. Too high compared to what?
The usual answer is that we pay too much compared to Americans. On a collective basis we certainly pay more than Americans (although the average-income Canadian pays less tax than the average-income American; see Table 2). But we also have medicare, public universities, more generous public pensions, and a range of other things that most Canadians have indicated they are quite willing to pay for. And largely thanks to higher taxes and more generous public programs, Canadian society is still far more equal and inclusive, despite recent cutbacks. Try as they might, Canada's business leaders have not yet succeeded in convincing us of the strange proposition that the United States of America is the prototype against which all social and economic variables must be measured.
Do we pay "too much" compared to a broader sample of other countries? Not especially. Taxes collected by all levels of government in Canada are just below the average level for all industrialized countries: 41.8 percent of GDP this year, compared to 42 percent for the OECD, according to the OECDs own data (see Table 2).
Do we pay "too much" compared to how much we used to pay? Even here the evidence does not justify the unprecedented air time that has been captured by the tax rage campaigners. The tax revolt worked up a real head of steam through the latter 1990s. But ironically, that was the same decade in which taxes increased less than in any previous decade of the postwar era. Indeed, by a variety of measures there was no increase in taxes in the 1990s at all.
Longer-run trends in taxes and program spending by all levels of government in Canada are illustrated in Figure 2. Taxes increased significantly relative to GDP in every decade of the postwar era, until the 1990s. Since 1990, total taxes collected at all levels have remained stable at below 45 percent of GDP.
There is one sense, however, in which Canadians may genuinely pay "too much" taxes, and this may help to explain some of the political success of the tax-cutters. Canadians in aggregate now pay far more in taxes than the cost of the real programs and services which they receive in return for those taxes. As indicated in Figure 2, government programs declined sharply in the 1990s: from a peak of almost 45 percent of GDP early in the decade to below 35 percent at present, and falling. This has opened up a significant and politically unstable "wedge" between what we pay to government, and what we get from government: at present Canadians receive only about 75 cents in real services for every dollar we pay in taxes, by far the lowest since World War II.
That difference between taxes and programs goes to the interest charges paid at all levels of government, and to the growing surpluses enjoyed by the federal and many provincial governments (which reached over $30 billion in 1999). Its no surprise, then, that many Canadians feel they are getting a raw deal from government in return for their hard-earned tax payments. In past decades they willingly paid higher taxes in order to finance a desired expansion of public services (as Canadas social welfare system was constructed in the 1960s and 1970s). But now many are grumpy about paying even the same amount that they used to pay - because they are only getting about 75 cents back in services for each dollar paid in taxes.
The anti-tax crusaders pretend that the taxes we pay are like some gigantic, mythical burden which suddenly appeared on our shoulders one day. The Canadian Taxpayers Federation and the Canadian Alliance party are then the superheroes who fight valiantly to protect us from this evil force. In reality, we pay taxes because we choose to. Canadians empowered their governments to collect taxes, and to spend them on programs and services that would improve our lives. We have never been satisfied with the insecurity, inequality, and imbalance which always typifies a purely privatized, free-market system. And that deeply-rooted sentiment will not suddenly disappear; public opinion polls consistently indicate that most Canadians view reinvestments in health care, education, and child care as more important than tax cuts. Sadly, this preference has largely been lost in the rush by most political parties to cater to the tax-cut demands of the well-off and powerful.
Eventually the one-to-one relationship between tax payments and program spending will be reestablished. And the demands of Canadians for good schools, safe hospitals, clean water, and enjoyable public spaces will continue to influence the decisions of elected governments. Indeed, it is quite possible that the tax cuts of today will be replaced with tax increases in future years, as governments respond to pressure for improved public services. It may seem politically impossible given the current pressure for tax cuts from business and conservatives, but some day in the not-so-distant future Canadian governments will be elected with a mandate to raise taxes in order to pay for desired improvements to public programs and services. In this sense, the tax revolt may be a temporary phenomenon.
Canada Needs a Raise, Not a Tax Cut
During the 1990s, the wages and salaries of employed
Canadians barely kept up with inflation. And high
unemployment meant that fewer people were working. As a
result, adjusted for inflation, the average pre-tax incomes
of Canadians declined through most of the decade. This
hardship contributed to the desire of many Canadians for a
tax cut: if they couldnt get more income from their
jobs, maybe the government could give them an artificial
"raise" by cutting taxes.
Sharing the Burden
Our tax system has many problems, and there are too many loopholes which allow high-income earners and corporations to avoid their full obligation to society. But on the whole, Canada has one of the most progressive tax systems in the world. We rely more on personal income taxes than most countries, which are tied to ability to pay. And we rely less on sales taxes and payroll taxes, which impose a higher burden on lower-income taxpayers. The end result is that high-income earners pay a large proportion of total tax revenues - and this is how it should be.
The distribution of the income tax burden in Canada can be summarized with the following simple formula: the top 10 percent of taxpayers pay close to 60 percent of all income taxes, while the bottom 60 percent of taxpayers pay less than 10 percent of all income taxes. Indeed, Canadians earning less than $25,000 per year (which includes well over half of all adult Canadians) hardly pay any income tax at all-on average, barely 5 percent of their total income. Even middle-class Canadians pay a surprisingly low income tax rate, once all deductions and exemptions are included: income taxes consume about 20 percent of the total income of those earning $50,000 to $70,000.
It is little wonder, then, that the well-off and powerful have focused their fire on rolling back Canadas income tax system - because it is our income taxes that do the best job of placing the tax burden on the shoulders of those who can best afford to bear it. Across-the-board income tax cuts like those advocated federally by the Liberals and the Alliance, and those implemented in Ontario and Alberta, inevitably deliver most of the cash back to the top 10 percent of Canadians - for the simple reason that this is the group which pays most income taxes. The so-called "flat tax," in which all income groups pay the same rate of income tax, would constitute a massive increase in the income tax burden of low- and middle-income Canadians, but a huge reduction in taxes for the top 10 percent (whose average tax rate would be cut roughly in half). Meanwhile, the tax-cutters hardly care about sales taxes like the GST (which impose the heaviest burden on low-income earners). Indeed, some conservatives are now arguing for a system that would eliminate income taxes altogether, replacing them with much larger sales taxes.
Kinder, Gentler Tax Cuts?
Every party proposing tax cuts tries to dress up their package as being beneficial to all Canadians, not just the high-income (and highly-taxed) elite. And some progressive Canadians have accepted that logic, arguing that we should be supporting tax cuts which are targeted at low- and middle-income families. Even the NDP, both federally and in many provinces, has begun to argue for targeted tax cuts. For example, former Ontario Premier Bob Rae recently tried to justify tax cuts as providing a needed boost in disposable incomes for Canadians who have seen their pre-tax labour market incomes stagnate. How strange it is to see a social-democratic leader arguing for a rollback in the ability of government to provide public programs, in order to offset or subsidize the failure of the private free-market economy to deliver rising incomes.
The fundamental nature of our tax system means that the case for targeted tax cuts is a weak one. Most taxes in Canada are paid by the well-off; they are aggressively campaigning against taxes precisely because they have so much to gain from tax cuts. When progressives and unions jump onto the bandwagon, shouting "We want our tax cuts, too," we provide that self-interested campaign with dangerous breadth and credibility. No matter how closely targeted they might be, tax cuts cannot make a significant difference in the concrete standard of living of the clear majority of Canadians. Yet by buying into the logic and language of the broader tax-cut movement, the "kinder, gentler" tax-cutters contribute to the general crisis of public underfunding which is causing a more genuine deterioration in our quality of life and our economic and social security.
All but the top quarter of Canadians still receive more back from government, in the form of public services and programs, than they pay into government. And even the better-off benefit from the security that comes from knowing their quality of life is not entirely dependent on the cash they may (or one day may not) have in their pockets. Taxes are the price of a civilized society. Fighting against tax cuts, and to preserve the funding base for the public programs we need, is thus a crucial priority for those who want society to be as civilized as it can be.
Taxes, Public Programs, and Inequality
Taxes, and the government programs which are financed from tax revenues, play a powerful and essential role in reducing the degree of inequality in society, and enhancing the living standards of most Canadians. This is proven dramatically by recent data on income distribution.
Considering only the incomes that Canadians receive from the so-called "free market" (including wages, salaries, investment income, and other forms of private income), inequality has widened significantly in the past decade. In 1989, the richest fifth of households in Canada earned 18 times as much from the "market" as the poorest fifth. By 1998, that ratio reached 27-to-1.
Inequality is eased considerably, however, by government programs. The combination of income taxes (paid most heavily by high-income earners) and transfer payments such as EI benefits or public pensions (received disproportionately by poorer Canadians) reduces inequality by about two-thirds. After taxes and transfers, the richest fifth enjoys 8.5 times as much disposable income as the poorest - and this ratio has not grown markedly in the 1990s (although it has widened somewhat since 1996). The redistributive power of our tax-and-transfer system has thus largely offset the growing inequality of the private sector.
But the impact of public programs doesnt stop there. Non-cash public services (like health care, education, libraries, recreation facilities, etc.) also form an important part of the total standard of living of most Canadians. These are forms of "consumption" that we dont directly "buy", but which substantially improve our standard of living nonetheless.
For Canadians of modest means, public consumption is very important. In 1998, each Canadian household received on average over $16,000 worth of non-cash public services. This is more than the total average household disposable income of the poorest fifth of society. Hence, the living standard of poor people is doubled by these non-cash public programs. Even for middle-class Canadians, these programs make up 25% or more of total consumption.
Once the value of public consumption is taken into account, the total "income" of the top fifth falls to only 3.9 times as much as the poorest fifth. By cutting taxes - and the programs they pay for - Canada will quickly start to look more and more like the lopsided 27-to-1 society that is already visible within our private sector. For this reason, preserving public programs, and the taxes which pay for those programs, are crucial for creating a more equal society.