Philip Cross: Ignore the scaremongers, cutting spending is Canada’s best way out of deficit

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No party is irresponsible enough to pretend that the record $354 billion deficit run up in the past year is sustainable. So it is easy to formulate the key economic question of the federal election campaign: how will the main parties distribute lowering the federal deficit between less spending and higher taxes? While popular discussion associates austerity exclusively with spending cuts, tax hikes equally represent fiscal tightening.

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Economists know the best way to reduce deficits is to rely primarily on spending cuts and not tax increases. An IMF study in 2018 by Alberto Alesina, Carlo Favero and Francesco Giavazzi followed these two main policy regimes in OECD countries between 1981 and 2014. Their conclusion is that “expenditure-based plans generally were less harmful to growth than tax-based plans.” This clearly contradicts the message permeating retail politics that spending cuts are harsher than tax increases.

Furthermore, during a period when the economy is growing as Canada’s currently is, relying primarily on spending cuts meant “output costs were zero, on average.” In other words, spending restraint did not have the “slash and burn” effect on overall GDP that scare-mongering critics claim when denouncing austerity. Canada’s experience in the 1990s was cited by the IMF as a prime example of what it called “expansionary austerity.” The federal government relied on spending reductions to accomplish over 80 per cent of its deficit reduction in the mid-1990s, very much in line with the IMF’s recommendations.

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Conversely, the IMF concluded that “tax-based fiscal corrections were associated with large and long-lasting recessions.” Far from cushioning the effects of austerity, proponents of tax hikes rather than spending cuts are advocating a policy that lowers incomes and raises unemployment. Apparently such a point is too subtle for policy debates during an election.

The other major finding of the IMF was that the best way to lower spending was trimming government entitlements and other transfer programs, because taxpayers perceive cuts to these programs as permanent and therefore likely to lower taxes in the future. Business investment is especially responsive to spending cuts instead of tax hikes, as business confidence “increases immediately at the start of a spending-based austerity plan, in contrast to what happens at the beginning of a tax-based plan.”

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If the top one per cent paying 21.3 per cent is not enough, what is? One-third? Half? We are never told

While economists clearly prefer lowering deficits with spending restraint rather than tax hikes, most parties in Canada are proposing to lower the deficit more with higher taxes than less spending. The NDP puts the most emphasis on tax hikes, saying it would introduce a wealth tax and raise corporate income taxes.

NDP leader Jagmeet Singh justifies a wealth tax by repeating the bromide that well-off Canadians “should pay their fair share.” This deceitful slogan falsely conveys the impression that higher income people don’t already pay the lion’s share of taxes. This is clearly wrong, which is why Singh spins his narrative without corroborating facts. Statistics Canada data, drawn from detailed tax filings with the Canada Revenue Agency, showed that the top 1 per cent of people earned 10 per cent of all income but paid 21.3 per cent of all federal and provincial income taxes in 2018.

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Similarly, the top five per cent received 23.1 per cent of income and paid 40.8 per cent of taxes. The top 10 per cent (which includes people with income as low as $97,900) garnered 34.2 per cent of income and forked over 54.2 per cent of taxes. By comparison, the bottom half of all Canadians only paid 5.0 per cent of taxes while receiving 18.0 percent of incomes. Clearly Canada has a highly-progressive income tax system in which upper income people pay a disproportionately large share of taxes.

The NDP needs to explain how the large tax burden already shouldered by higher income people is not “fair” and what they would consider to be a fair share. If the top one per cent paying 21.3 per cent is not enough, what is? One-third? Half? We are never told. One definition of fair that I have always agreed with is that workers should keep at least half of every extra dollar they earn. Former federal NDP leader Thomas Mulcair observed in 2013 that “Several provinces are now at the 50 per cent rate. Beyond that, you’re not talking taxation; you’re talking confiscation.” Since then, several provinces have raised their tax rate on upper incomes above 50 per cent. By this criterion, upper income Canadians already are paying more than their fair share and deserve a tax cut.

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The Liberal plan outlined in their April budget also relies on tax increases rather than spending cuts. Tax revenues in fiscal 2025 are projected to amount to 15.3 per cent of GDP, up from their pre-pandemic level of 14.5 per cent. Program spending declines as pandemic relief programs expire, but the introduction of new social programs keeps spending at 14.9 per cent of GDP, up from 14.6 per cent before the pandemic.

The political appeal of tax hikes rather than spending cuts during an election is clear. Pretending that higher taxes can be shifted to only a few Canadians, rather than cuts to programs that benefit many, has obvious political appeal. However, the reality is that tax hikes and not spending cuts lowers the income of Canadians.

Philip Cross is a Senior Fellow at the Macdonald-Laurier Institute