December 8, 1997
Do Lower Rates Equal More Revenues?
Facing small budget surpluses for the first time in years, elected officials seem surprisingly confused about what to do with them.
The people at large are not confused. According to an Angus Reid Poll last month, 43% of Manitobans want government to cut taxes while 42% want debts to be paid down. Only a small minority (10%) wants more spending on government programs. In other regions, only Québecers were more interested in lower taxes.
Why is Finance Minister Eric Stefanson so reluctant to respond to the wishes of the electors? He says he wants to pay down the debt, but he has also publicly stated there is no evidence that major tax cuts create jobs. By believing this he ignores much evidence to the contrary.
The government has hinted that it prefers ineffectual job creation strategies like infrastructure programs over lower taxes. It's not averse either to spending savings from debt reduction propping up inefficiencies within our low-performing education, health and welfare systems rather than fundamentally rethinking and redesigning them.
These old strategies keep taxes unnecessarily high. They're also a recipe for decline because the world has become an open market where brains and talent are completely mobile. Maintaining high taxes here will erode the tax base by accelerating the export of corporate headquarters and high-skilled jobs to lower-tax places like Calgary or Minneapolis. And moving stateside is doubly attractive because American dollars are 40% more valuable.
Our public policy people and many of our elected representatives took public finance training in earlier times and have a decidedly static worldview. They have trouble comprehending that governments must lower their rates in the new environment or lose revenues as their wealth-producing classes leave.
The model used by Mr. Stefanson's department to calculate the impact of tax reductions seems to miss what economists refer to as "incentive effects." In simple language, progressively higher tax rates penalize productive activity and eventually reduce incentives to work, producing less revenue. Lower rates, conversely, maximize revenues by stimulating work efforts. Government ends up a winner by getting a smaller cut of a bigger pie.
Finance Department projections assume that each one- percent reduction in income tax produces a "loss" of $20 million to the treasury. Thus a measly 4% cut would cost $80 million. Strong evidence from elsewhere suggests this model is wrong.
In Ontario between 1992 and 1993, Bob Rae's NDP government raised provincial income tax rates by 9.5%. Revenues fell by 12%! But what happened when the Harris Government did the opposite? Are revenues falling as it phases in a 30% cut in Ontario's portion of the federal tax (reducing it from a combined 58% marginal rate to 40.6% next year)?
Not at all.
In October, York University's Patrick Monahan observed that after Ontario cut its portion of the income tax rate by 15%, revenues increased by $725 million, about 4.5 %. More money into people's pockets boosted other tax revenues. Including sales taxes, tax revenues expanded 5%, or $1.8 billion.
New Ontario numbers came out in November. Despite a 15% rate cut so far, they show income tax receipts up almost 7%, corporate tax over 28% and sales tax receipts 6.5% higher. January brings the next phase of the Harris government 30% rate cut, reducing the provincial rate by 22.4% since 1995. Expect revenues to continue increasing.
Cautious incrementalism has been a hallmark of the Filmon government. We now need courageous leadership willing to admit that the ideology of high tax rates is an ideology of the past with no application today.
Besides we can use the extra revenue provided by lower rates.
The Frontier Centre for Public Policy
is an independent public policy think tank whose mission is "to broaden the debate on our future through public policy research and education and to explore positive changes within our public institutions that support economic growth and opportunity."