Can Increasing Taxes on the 1-Percent Cover the Deficit?

In an article in the Globe and Mail, provocatively titled “Justin Trudeau lives in a fact-free world on taxes” (Dec 16, 2016) Mark Milke, says that Trudeau “claims taxing one cohort less and another more is a recipe for economic growth. Skip how all the tax talk ignores the spending side of the budget where Mr. Trudeau and prudence are mortal enemies.” A little reflection on the article shows that, in fact, it is Milke whose analysis is wrong.

Increases in Taxes on the 1-Percent Can Cover the Deficit

Milke goes on to look at some numbers:

• Federal deficit for next year (forecast): $27.8 billion
  • Tax paid by “1-Percent” ⁽¹⁾:             $26.2 billion

From this, he concludes that even if the tax on high-income earners is doubled the deficit will not be covered. Doubling the taxes paid by the “1-Percent”  “would be an unwise move that would send even more doctors and others south of the border”.

Of course, doubling the taxes on the high-earners is a foolish move. However, the deficit would be covered by borrowing:

• Yield on 10-year bonds:                                  1.58%
• Annual payment to cover deficit⁽²⁾                $1.33 billion per year
• Increase in taxes on the “1-Percent”:           5%

An increase of 5% on taxes will not “send even more doctors and others south of the border”. Since most high-earners save a large part of their income, their life-styles would not change, only their savings rate would be reduced.

Is Deficit Spending a “Recipe for Economic Growth”?

The deficit spending is meant to be “invested” in infrastructure. If this is done properly, it should increase growth and the overall tax take should increase. Herein lies a major problem – will the infrastructure “investments” really be investments which have a return, or will they be just more spending and waste? Already, some are clamouring for the need for “social investments”, by which they mean community centres, counselling offices, parks etc. This would, of course, be a tragic mistake.

The sort of investments that need to be made include improving/building roads, bridges, railways. Many private developments, especially in a country like Canada,  are uneconomic because there is no transportation available. For example, the Buffalo Creek thermal pilot in the 1980’s could only be operated in winter with air access; any oil that was produced was buried in a large pit. I am sure there are many mineral discoveries that would be economic and could be developed if there was adequate access. Government provided roads could be the catalyst for many developments.

Research can also bring large benefits. The massive expansion on the oil sands was made possible by the SAGD process, which was tested in the field by the Alberta Oil Sands Technology and Research Authority (AOSTRA), when no company was willing to pilot the process on its own.

What are the Longer Term Implications of Deficit Spending?

Of course, deficits of this magnitude cannot be continued indefinitely. Increasing taxes on high income earners by 5% every year is not sustainable. However, it is also not necessary.

• Canadian GDP in 2015⁽³⁾:                                                              $1778 billion
• Projected deficit as fraction of GDP ⁽⁴⁾:                                       1.5-1.6%
• Velocity of Money:                                                                        1.6
• Increase in GDP due to Infrastructure investment:                    2.4 – 2.6%
• income taxes collected in 2015:                                                   $126 billion
• Income taxes collected after infrastructure investment:           $129

The extra taxes collected make the need to further increase taxes unnecessary. Note that this is a very simplistic analysis. The extra growth will decrease the need for Government spending as unemployment is reduced and GST revenues increase. Furthermore, the increase in GDP does not take into account growth due to the improved infrastructure. Thus the growth in GDP and federal government revenue is conservative i.e. under-estimated.

Notes:

1. Number is for those with income over $250,000, which is a reasonable proxy for the top 1-percent of earners
2. Amortised over 25 years. Calculated by CIBC Mortgage Calculator
3. From “Pocket World in Figures” 2015 Edition, The Economist.
4. Range is due to mixing 2015 and 2016 numbers