More tax cuts?

January 12, 2009 6:48 AM

Canadian finance minister, Jim Flaherty, is set to announce our government's plans to stimulate the economy. That plan is rumoured to contain some major tax cuts. Help me understand why every policy, in good times and bad, always calls for tax cuts.

The Harper government has already made numerous tax cuts, including the famous 2% reduction in the GST. This reduction means the average Canadian now save about $250 a year, but it costs our government about $7.5 billion in lost revenue. And this was done when the economy was strong, the coffers were full, and the government said it didn't need the money.

Now things are bad, the economy stinks and the government must intervene. With more tax cuts.

I don't get it. Tax cuts when things are good, tax cuts when things are bad. Tax cuts in the morning, tax cuts at lunch, I smoke two tax cuts then I smoke two more. Please help me understand why the solution to seemingly every macroeconomic situation is tax cuts. Is it just my left-bending mind which finds this suspicious?

posted by Vindaloo to law & government (18 comments total)

I'm no expert on this but methinks it's a matter of releasing more floating capital into consumer affairs. Also, you may see tax cuts for citizens all over the press but taxes may be increasing for private enterprise, foreign (tariffs, etc.) and domestic.
posted by ezekieldas at 6:55 AM on January 12

In good times, a tax cut is reducing a government surplus.
In bad times, a tax cut is increasing the government deficit.

Both of those are considered sound economic policy for each situation.
posted by smackfu at 7:06 AM on January 12

Say you're willing pay up to $20 for a particular shirt. Say it costs a store $16 to procure the shirt for you, so they would be willing to sell that shirt to you for any amount over $16. Absent any taxes, a mutually beneficial transaction will take place. Let's say at $19. You would rather have the shirt than the $19, and the store would rather have the $19 than the shirt. You buy the shirt, and everyone is made better off.

Now let's say the government imposes a tax of $5 on the sale of any shirt. Now of the $20 you are willing to pay, $5 goes to the government and only $15 goes to the store. The store would lose money on this, so there's no deal. The transaction, which would have benefited everyone, does not happen. This non-transaction is known as deadweight loss. Note that the government does not collect any tax from you in this scenario, so the government is not better off either. This tax hurts the economy. Reducing it or eliminating it helps the economy.

That's the Econ 101 explanation, and it's true whether times are good or times are bad. In the real world there's a whole lot of politics that enters the equation, of course.
posted by Dec One at 7:07 AM on January 12

Dec One, what if only 2 or 3 dollars goes to the government. In other words, at what level does lower taxation not have much of an effect on either consumers, workers, or businesses behavior?

If the tax rate in the seventies was truly confiscatory, and the Reagan revolution really brought more money into the hands of the people, that was great, now if you lower taxes by the same percentage point, you have less of an effect since the bang is simply smaller.

And at some point, where consumers aren't buying even at fire sale prices, banks aren't lending even at basically a zero percentage prime rate, what good is a tax cut in terms of economic stimulus?
posted by xetere at 7:14 AM on January 12

You have to be careful of estimates that state how much revenue the government loses when taxes are cut.

First, some of the deadwieght loss Dec One mentioned would be recovered. Cutting shirt taxes means less tax revenue per shit, but it probably also means more shirts are sold.

With respect to income taxes, the argument is usually that cutting income taxes enables more jobs to be created. Those new jobs are paying income tax as well. So the "cost" of the tax cut has to be offset by whatever new revenue you get. There are also multiplier effects to consider (e.g., cut in income taxes means more people working paying income taxes, but those people are also consuming more so they are paying more sales taxes also, and they are generating revenue for businesses which pay taxes, etc.)

So that's why you cut taxes when things are slow, to stimulate economic activity.

The reason you cut taxes when things are going well is for a political reason. When the economy is hot, The government's total tax revenue is greater (without any change of the rates) simply because there is more activity - more spending, more people working, etc.

But taxes are a bargain struck with the people. The people agree to pay the government what it needs to operate and not more. If the governments revenues exceed its costs (and debt servicing obligations), then the government is taking too much form the people and should reduce the rate to take less.
posted by Pastabagel at 7:24 AM on January 12

In other words, at what level does lower taxation not have much of an effect on either consumers, workers, or businesses behavior?
posted by xetere at 10:14 AM on January 12

Think at the margin. There is always some effect on some entity somewhere. It may not be the effect you want, or the entities you want, by when you change prices, you change costs, and therefore you change behavior.

Imagine a hypothetical family that lives paycheck to paycheck never goes into debt, but never saves any money either. Any tax savings, however small, results savings for them that accumulate and grow over time. Likewise, consider the hypothetical person who's debt is growing and faces bankruptcy. A small cut in taxes may enable him to service his debt , or maintain it at a constant size, thereby fending off bankruptcy indefinitely.
posted by Pastabagel at 7:36 AM on January 12

Dec One, what if only 2 or 3 dollars goes to the government. In other words, at what level does lower taxation not have much of an effect on either consumers, workers, or businesses behavior?

If the tax is $2, then I still buy a shirt, but my friend who is only willing to pay $17 does not (because the store must charge more than $18 or it won't be willing to sell). Nearly all taxes have some deadweight loss. If there is going to be a government, then there have to be taxes and there has to be some deadweight loss. It's also true that taxes create inefficiency and hurt the economy.

And at some point, where consumers aren't buying even at fire sale prices, banks aren't lending even at basically a zero percentage prime rate, what good is a tax cut in terms of economic stimulus?

I'm not sure of the specifics in Canada, but in the U.S. there are significant taxes on employment (about 15% combined between employer and employee for social security and medicare, plus 10% to 33% for federal income tax, plus more for state income tax). There might be a lot of employment that isn't happening due to the deadweight loss of these taxes.
posted by Dec One at 7:37 AM on January 12

I hate the way deadweight loss is spoken about. It ignores that taxes go to useful things. A business pays taxes. Those taxes go to things that the business would have to pay for out of pocket if the government didn't pay for it. Like police and fire services, health care for employees, education that makes the workers as productive as they are, roads that the delivery trucks travel on, and the peace and order that are required for people to make investments in factories and businesses. The list goes on.

A lot of these things, like roads, are direct inputs into the production of something. They're as essential as the cloth those shirts are made of. (How would the employees get to work without roads? How would the product get delivered?)

Deadweight loss works on the chalkboard, but it's actually an ideological argument because it assumes that the things government spending pays for are free. And if you're willing to assume an input is free, why not assume CEO's are free, and start talking about the deadweight loss of their massive salaries?

This is the problem of economics education. You get a tiny look at narrow ideas, but you rarely look at the whole picture. (I have my B.A in Economics.)

Anyhow, our finance minister is a veteran of the neo-conservative Mike Harris years. They left their successors with a huge deficit, and were essentially ready the plug the hole with asset sales. Highway 407, which they did sell, has been hugely profitable. We sold it at a huge loss. They were ready to do the same thing to the LCBO, which also puts billions into the provincial treasury. Short term thinking at its worst.

It's really easy to cut taxes. It's much harder to cut spending to balance that. Anything less is fiscal cowardice. It's shirking hard decisions. It's telling people they can get something for free. Look where that has gotten the U.S.

It is true that deficit spending during a recession is likely a good thing. The govermnent can borrow cheaply and make investments in infrastructure, services, or extend help to the impoverished and unemployed. This gets money into the economy. People spending means more people working. It's a virtuous circle. Keynes argued this is useful because during a recession, the economy is operating at less than it's capacity. Extra government spending employs some of this capacity.

Of course the problem has always been that no one wants to raise taxes, but Keynes argued that you need to run a balanced budget over the business cycle. You need to run surplusses during good economic times. The federal government has been pretty good at doing this. Well, the Liberals were. Conservative governments have messed this up consistently, at the federal, and provincial level, for decades.
posted by thenormshow at 7:38 AM on January 12 [4 favorites]

Help me understand why every policy, in good times and bad, always calls for tax cuts.

I think it's mostly about how the conservatives don't know what they are doing, and their economics policy has more to do with ideology than anything else. Flaherty in particular clearly has no idea what he is up to, judging by how well he managed the economy in Ontario.
posted by chunking express at 7:58 AM on January 12 [4 favorites]

Deadweight loss works on the chalkboard, but it's actually an ideological argument because it assumes that the things government spending pays for are free.

It assumes no such thing. It just explains one side of the story. If a tax results in $1 million of deadweight loss but pays for a school that makes workers $2 million more productive, then that's a worthwhile tax. In the real world, there are lots of taxes like this.

There are also less-worthy taxes, that take more in deadweight loss than they give in government services. Politicians like to claim they are cutting those taxes.

I just think that explaining deadweight loss is an important part of answering the OP's question.
posted by Dec One at 7:58 AM on January 12

In good times, conservative taxpayers (and the conservative politicians who represent them), say "Yay, I love paying less tax! All hail this government that's reducing my taxes! Yay!"

In bad times, conservative taxpayers (and the conservative politicians who represent them), say "Ugh, i have no money. Paying less tax - whew! Thank god for this government reducing my taxes!"

I know there's a lot of economic theory, but i really believe that most of this is politically motivated.
posted by Kololo at 8:07 AM on January 12 [1 favorite]

To mirror chunking express, it's pure ideology. The Conservatives believe lower taxes are always better regardless of the macroeconomic situation.
posted by GuyZero at 9:23 AM on January 12

To mirror chunking express, it's pure ideology.

Certainly looks that way. Mike Harris, after he quit politics, spoke quite openly about his approach to government, making it clear that for his part those Ontario tax and spending cuts were motivated by an ideological tendency to believe that much smaller government would be better. The usual "starve the beast" thing. I'm not sure to what extent Flaherty thinks the same way, but he was at least willing to go along with it, and his record does leave the impression that he held similar ideas. Harper's background and some of his government's actions might lead one to suspect he could have some sympathy for that way of thinking. On the other hand, the present government hasn't so far shown a whole lot of restraint in spending money, along with the tax cuts.

I seem to remember back when the Liberals were in power, there was much noise from the Conservative Party about the government budget surplus being too large. They certainly didn't take long to make that problem go away; despite the usual over-optimistic projections, they appeared to me to have been right on course for a return to deficit spending in the next couple of years even if we hadn't had a global economic meltdown, despite the even stronger than average economic growth that was the situation before last year.

True to form, they are now talking about balancing the budget by selling some crown assets. After those are gone, perhaps the plan, if by some miracle they're still in power, will be to rely on some further optimistic guesses about revenue and costs to keep the projected budget in balance; when those don't work out, they'll look for more things to sell and spending to cut.
posted by sfenders at 10:12 AM on January 12

Help me understand why every policy, in good times and bad, always calls for tax cuts.

Because we pay too many taxes. I'm serious.

My preferred tax cut:

Income tax for the middle classes while increasing income taxes for the top 3-5 percentile.

It would be great if there could be more work down on income splitting. It's ironic that, when I was self-employed, I could pay my (non-working) wife a monthly salary and dramatically lower my tax exposure. Now that I am a salaried employee, I can no longer do so.

While reducing income taxes, the government should increase progressive taxes, such as the GST (sales tax). Slashing the GST to 5% (while ignoring income tax cuts) is the dumbest thing the Tories have done so far.

It would also be great if there were indeed a national carbon tax.

However, never believe a government when it says a new tax will actually increase efficiencies and result in equal or lower net taxes.

Government is arrogant and inefficient, a deadly combination.
posted by KokuRyu at 11:30 AM on January 12

While reducing income taxes, the government should increase progressive taxes, such as the GST (sales tax)

The GST is a classic regressive tax - the amount someone pays doesn't scale with your income and as a percentage of income, lower-income pay more than higher-income people. I have no issues with sales taxes, but let's get our terms straight here.
posted by GuyZero at 11:57 AM on January 12

Ignoring political mumbo-jumbo, the idea is that a tax cut is the easiest way to get more dollars spent. If the gov't makes a $1 billion dollar tax cut, that means there are $1 billion more dollars available for people to go out and do stuff with. Since the economy is circular (meaning every dollar spent by one person is income for some other person/entity), the hope is that by injecting this cash into the economy, things start to spin a little faster.

It's pretty hard to say that a tax cut isn't stimulative to the economy. It's harder to say whether its worth it. After all, when the government collects taxes, they go out and spend them too.

Where the conservatives get all giddy is the "Laffer Curve". It is absolutely correct, in some situations. It says that if the tax rate were zero, government revenue would be zero. Similarly, if it was 100%, revenue would also be zero because the economy would pretty much shut down. The conclusion is that somewhere in the middle, there is a tax rate that is low enough to not slow down the economy, but also high enough to give the government what it needs. The curve is bell shaped, revenue versus gdp, with the top of the bell being the optimum rate. Further, if the tax rate is higher than this theoretical point, then lowering the tax rate will pay for itself with increased economic activity. That only works when it's higher than the optimum rate, however. What happened is that the "lower taxes at all costs" wing of the party chose to understand only part of this concept, and put it out to the dittoheads that all tax cuts pay for themselves. When the Laffer Curve shows this to be untrue in most cases.
posted by gjc at 4:10 PM on January 12

I read something awhile ago that explained that for all the tax cuts that our late Liberal (I'm in Australia, so they are the conservative party) government gave us, the effect of inflation meant that the effective tax was pretty much the same.

I'm not sure if I can explain this well, but as inflation increases how much you are paid, the percentage of your income that you pay in tax also increases because the pay increase is taxed at a higher rate. In other words, in order to keep the status quo, the tax bracket cut off should go up by inflation every year. But they don't, so then the Government can have "tax cuts" that are really just adjusting for inflation.

Apparently the only tax bracket that was significantly better off under our previous government was the top one. I know, what a surprise.
posted by kjs4 at 5:03 PM on January 12

Note that what I wrote is only relevant to income tax.
posted by kjs4 at 9:51 PM on January 12