Deficit Hysteria and the Liberals

March 28, 2010

Well the three day policy meeting of the Liberal party held before a carefully pre-screened physical audience in Montreal has just ended with a speech by leader Michael Ignatieff. The successful part of the weekend was the use of networking technology which permitted thousands of people across the country who were unable to attend in person to participate at the virtual reality margins of the conference through a chat line, skype or e mail. A number of the speakers were also interesting including a few who actually had some good ideas about increasing volunteerism, Canadian foreign policy, pension reform, the Arctic , environmentalism and social justice . The disappointing part of the event however was the ongoing obsession of some young Liberals attached to the Paul Martin and Ignatieff wing of the party who continue to obsess over Canada's modest and stimulative public sector deficit which is helping to bring about an economic recovery in the country and our debt level which is even less of a problem at a little over 34 % of the GDP.
Unfortunately, Michael Ignatieff in his speech has committed the party to arguing that the deficit is a problem (when clearly it is not) and calling for a freeze on corporate tax reductions , possibly a popular idea but not necessarily good economics as you emerge from a recession.

I, of course, repeat this ad nauseam but the cure to an unbalanced budget is to rebalance the budget by creating jobs,keeping interest rates low, lowering the unemployment rate to 5 % or preferably below this level, fixing all of our infrastructure, investing in training and education, our defense forces and quality health care and allowing the resulting boom to generate a flood of tax revenue.

The Liberal leadership and some of its inner circle including apparently some young Liberals who think that neo-con ideas like ending universality in health care and slashing deficits are cutting edge new thinking continue to control the policy process. Some of what Ignatieff proposes to do in the areas of financing students, early childhood education and   investing in better health care including home care and several other progressive proposals are good and supportable ideas. But why risk them by making deficit reduction such a priority since the deficit is largely if not entirely due to the global economic recession which also impacted Canada.

Too bad.

The Federal corporate tax rate is now 18 %. Corporate taxes yield about 29 billion dollars in revenue.The Conservatives had scheduled the corporate tax rate to fall to 15 % by 2012. This represents a a reduction in the federal tax rate of about 16 %. If you eliminate it and make the critical but controversial assumption that doing so will not cost any new investment or job creating expansion nor result in cutbacks of existing investments and activity the net gain in revenue might be of the order of 16 % of 29 or about 5 billion dollars.

But these are heroic assumptions that probably would not hold since the corporations shift their taxes forward to final consumers of their products who facing an increase in taxes will spend less leading to lower sales and higher unemployment than would otherwise prevail and thereby lower income tax revenues by some amount. The net gain is therefore likely to be smaller. some analysts would dispute this arguing that one has to decompose the impact of the tax into its various components including its impact upon the deficit to assess its overall impact and the degree to which it is shifted.(See the essay available on line by A.J Laramee, The incidence of the corporate profits tax revisited A Post Keynesian approach,   originally published by the Jerome Levy foundation in 1999. See http://ideas.repec.org/p/wpa/wuwpma/9906012.html)   One thing is clear if the actual deficit is reduced then corporate profits are likely to actually fall as aggregate demand is subtracted.

Obviously yields vary from year to year depending upon corporate profitability and the business cycle.The provincial rate on corporate income varies from province to province.

Income taxes yield well over 120 billion dollars. It makes much more sense to focus on reducing unemployment than freezing corporate tax rates particularly since much of the corporate tax rate is shifted forward to their consumers, although in a recession that is diminished. A three percentage point fall in the unemployment rate creates several 100,000 new jobs. 575,000 more jobs to be precise.People with jobs pay taxes.A very large amount of additional tax revenue would flow from this which exceeds the uncertain tax revenues projected by the corporate tax freeze.

The employed no longer collect employment insurance or social assistance. Employed people suffer much less from health problems and family stress thereby saving money otherwise expensed by governments on each of these areas. It is about time that the Liberal party establishment came to terms with these facts and adopted full or at least low unemployment as their overall strategy.