Yesterday's headline in the Globe and Mail provides a nice segue from my post on ethnic diversity and the Nordic model to how Canada's federal structure could be a useful tool in generating the sort of public consensus that the Nordic model requires. Unfortunately for me, the source of the headline is somewhat problematic:
Empower provinces, CEOs say: Ottawa should scrap the GST and eliminate health and social transfers to the provinces, Canada's top CEOs suggest, as part of a proposal that would overhaul the country's fiscal federation.
The Canadian Council of Chief Executives suggests eliminating the goods and services tax as part of a move to shift tax power to the provinces. This would give premiers the surplus tax room they need to raise extra revenue on their own to replace federal health and social transfers, the group says.
Of course, the fact that this proposal comes from a bunch of CEOs is enough for some progressives to condemn it in no uncertain terms. The counter-argument goes as follows: if social programs are devolved to the provinces, they will be obliged to compete with each other for investment, and cutting social programs is the price they'd have to pay to play this game. This 'race to the bottom' can only be prevented by centralising control over social programs at the federal level.
My immediate reaction to this story is one of scepticism: we already know that when it comes to economic performance, government size doesn't matter. If there's no reason for a government to have to choose between being attractive to investors and having social programs, then why would they see the need to sacrifice the latter for the former?
Even so, the 'race to the bottom' hypothesis sounds plausible enough to be accepted as conventional wisdom in certain circles. But the more you examine it, the less credible it appears.
Let's first ask ourselves what the provinces will be competing for. The crude, realpolitik answer to that question would be the principal factors of production: physical and human capital. How would the devolution of social programs affect a province's ability to attract and retain investment and skills?
In the case of physical capital, the answer is pretty straightforward: not at all. The key to attracting and retaining investment is low corporate tax rates - a lesson that the Nordic Countries have already learned. Even if you were concerned with the distributional aspects about reducing corporate taxes, there's little reason to think that corporate tax rates are progressive. Investors don't care if a certain jurisdiction provides a cradle-to-the-grave, gold-plated system of social programs - all they care about is the after-tax rate of return. Moreover, this sort of competition is already going on: provinces are already competing for investment. Nothing would change.
The case of skilled workers is a bit trickier, but in my view, still manageable. It is of course hard to sustain personal income tax rates that are significantly different from those in neighbouring jurisdictions. But since we happen to have a low-tax jurisdiction to the south of us, we already know quite a bit about this issue. For example, we know that personal tax rates play only a small role in the 'brain drain' phenomenon: people who leave Canada to go to the US almost never cite taxes as a reason for moving. More generally, we know that labour supply is pretty inelastic: as long as personal taxes aren't absolutely punitive, skilled workers won't be inclined to incur the significant costs of hauling up stakes and moving. (And there's also reason to believe that skilled workers prefer to live in communities with decent public services). So if it were necessary, there's likely to be room to increase income taxes. And again, the provinces are already competing for skilled workers. Nothing would change there, either.
But in any case, the point of this particular proposal is that raising taxes would not be necessary - existing GST revenues would be transferred from one level of government to the other. There's no additional reason for the provinces to compete for physical or human capital. Again, nothing changes.
What would change is that the level of government that is more likely to generate a consensus for social programs would be better able to pay for them. I don't see any particular reason to fear that scenario.