The federal deficit is small, manageable problem with a simple solution. So why are politicians being so boneheaded?

The editorial cartoon in yesterday's Le Soleil has the best take I've seen yet on the issue of how to deal with the federal deficit. The target is Michael Ignatieff, but it could just have well have been Stephen Harper, because their positions on this issue are identical. Here is my approximate translation of the dialogue:

Ignatieff: I've promised to eliminate the deficit of $56b without increasing taxes and without cutting services. Any suggestions?
Aide: How about you stop talking crap?

And crap it is, because the deficit will not go away without tax increases or cuts in services.

Most of the deficit is of course due to the recession: reduced economic activity generates lower tax revenues, and there is also an increase in spending (eg: increased EI payouts, the various stimulus programs). When the recession ends, tax revenues will bounce back a bit, and some of that spending will come back down.

But it won't be enough. It seems pretty clear that that even after the recovery, the federal government will still be running a deficit. The PBO is currently forecasting a deficit of around $16b in 2013-14, even after four years of real growth at an average of more than 3%/yr. Its estimates for the structural balance - after stripping out the effects of the recession - are around $12b/yr.

Now, a deficit of $12b-$16b isn't really an insurmountable problem: it works out to something less than 1% of GDP. Compared to the deficits of current-day US or Canada in 1991, it's not really that big a deal. We've dealt with worse.

But dealing with the deficit means actually doing something. The available options are to

1. increase taxes, or
2. reduce services.

At this point, we should perhaps dispense with the 'control the growth of spending' option that it pleases some politicians (Liberal and Conservative alike) to present as a Third Way, because it is simply another version of option 2). For a given tax structure, we can expect tax revenues to grow with GDP. But as was explained over here, the costs providing a given set of government services will also track GDP: the only way to keep expenditures growing at a rate slower than revenues is to steadily cut services. (This is, of course, the recipe that the Liberal governments of the 1990's used.)

So what should we do? I suppose we could cut services, but what's left to cut? The size of the federal government is already smaller than it was in the days of John Diefenbaker's government.

Or we could simply reverse the 2-point cut in the GST. The lost revenues from those cuts are in the neighbourhood of $12b-16b, which also happens to correspond to estimates for the budget hole we have to fill. Cutting the GST was always a bad idea, and reversing that decision would be the easiest and most effective way of solving the federal government's deficit problem.

It's not often that we're faced with a small, manageable problem with a simple, obvious solution. Sadly, our political system is so dysfunctional that it can't be mentioned in public, and it makes me grieve for my country.

Comments

[Patrick]

I know! I know! We could tax carbon! It'll help save the planet AND eliminate the deficit. Heck, it'd probably generate enough revenue so that we could even through business a bone and lower corporate income taxes. It's a no brainer!

Oh wait.

[Stephen Gordon]

*snerk*

[asp]

http://krugman.blogs.nytimes.com/2009/09/29/the-true-fiscal-cost-of-stimulus/

[Curmudgeon]

Canadian political culture being what it is, chances are that whichever party wins the next election will increase the GST, even though the option is off the table for public discussion.

However, I'm not convinced that hiking the GST is particularly desirable. Flattening the tax structure further is not a good idea from a social policy perspective. Additional tax brackets for extremely high income earners (>$500K) and a wealth tax on the obscenely rich (net worth, excluding primary residence, over $2 million) would be fairer.

[Robert McClelland]

There's an even simpler solution than raising taxes or cutting spending. We can just delay tax cuts that are planned but haven't come into effect yet.

[Mark]

Curmudgeon, how about reversing the GST cuts AND additional high income tax brackets!

Stephen, the concern I have about hiking the GST is the impact it would have on Ontario and BC next year after harmonization. Since I agree the original cuts were bad policy/economics and they longer you wait the harder reversing the cuts will be, I think they should be reversed ASAP. But the impact could be more significant than we think.

[Stephen Gordon]

Oh, it doesn't have to happen right away, or all at once.

[finance]

Yes I agree, we should tax OTHER PEOPLE, that's always a good and popular solution; since "we" don't pay anything more. I am relatively certain that about 58% of Quebec's population is all for an income tax increase, since they don't pay any income taxes (again other peoples' money). The reality is that the only solution is to implement an across the board increase in tax revenues; which include all forms of taxes (income, GST, and services).

One thing for sure is that taxing people who earn more than $2 million a year (how many are there in Canada anyway?) is a non-solution (apologies to Curmudgeon). Most of the tax benefits accrue to the middle class, as such they are the ones who should share the bulk of the tax burden - they get the most, they should pay the most.

GST is regressive, but every Canadian should participate in the rebuilding of Canada's balance sheet. With such a large percentage of the population not paying any income tax it is the only fair solution to every Canadian.

[Neil]

Won't happen. I don't pretend to understand why the general public is so boneheaded on the subject of consumption taxes, but they are. Raising the GST is simply BAD POLITICS. And always will be no matter how carefully you explain that consumption taxes are better than income taxes.

People might not really like income taxes, but the fact is they don't much notice them after a couple of paychecks at the new rate, and for most people filing their annual return - the only time people are likely to get particularly upset about paying income taxes - means getting a bonus deposit in their account.

[Nick Rowe]

In one respect, I'm even less worried than you are Stephen. If you allow for 2% inflation, we could run a $10 billion deficit with the real debt staying constant. And if you allow for 3% real growth plus 2% inflation (both in the long run), we could run a $25 billion deficit with the debt/GDP ratio staying constant.

But that IMF graph of Canada's fiscal liabilities gave me pause. (A commenter here posted the link a few days back, but now I can't find it). On a strict debt/GDP ratio Canada is doing very well. But according to the IMF, if you add in Canada's "age-related" liabilities (or something) we are doing very badly. This doesn't sound totally plausible to me, but it does make me wonder.

[Andrew F]

Maybe a carbon tax would be an easier sell. The tax is hidden in prices, after all, and it works much like a consumption tax.

[Matthew]

"I suppose we could cut services, but what's left to cut? The size of the federal government is already smaller than it was in the days of John Diefenbaker's government."

They could cut me, but then I would have read your blog from home and pay for high-speed internet. Trust, me Stephen, there is plenty to cut without imperiling any real services that people need.

"It's not often that we're faced with a small, manageable problem with a simple, obvious solution. Sadly, our political system is so dysfunctional that it can't be mentioned in public, and it makes me grieve for my country."

I agree that Iggy's full of it when he says he can balance the books without tax increases or spending cuts, but really, this doesn't make our political system dysfunctional. Politicians will b.s., but in due course a government will use its control of parliament to do what is needed to eliminate the deficit. If this was the US, it wouldn't get done because of congressional obstruction. Look at California for an example of a dysfunctional political system.

[westslope]

That cartoon is hilarious!

Ignatieff is a light weight. The Liberals need to shop a new leader. Sooner than later.

[Andrew F]

Iggy is not a lightweight. His policies are as dumb as the public demand them to be.

[Mick Marrs]

Why is everything the government produces called a service? To me a service is something I want and pay for or perhaps a service someone supplies for free, like my neighbour using his snow blower to clean my driveway in the winter.

I'm still trying to figure out what services the government provides ME. I know it provides a lot of the classical services such as law, protection, roads. And I know lots of people receive services such as social services, EI, subsidies, grants, ... So Perhaps the government supplies SERVICES and well as DIS-SERVICES or NON-SERVICES or WASTE. Based on this distinction the gov. can keep SERVICES at the same level and decrease/lower the level of DIS-SERVICES. This would be a net benefit because we are always being told that WASTE is bad and un-green.

Problem solved, tax rates stay at current level, don't need to spend money studying this impact or that impact and deficit reduced, somewhat.

Or instead of paying contractors $100 - $200/hr why don't they hire people for $80,000 per year + benefits of say $50,000 which is still less than they spend on contractors. I know they this is happening otherwise I wouldn't keep on hearing stories of civil servants quitting and coming back as contractors.

[Matthew]

Mick:

The good thing about outside contractors is that the gubmint only has to pay them when it needs them. And it doesn't have to pay them benefits. In a lot of federal work units you may have 30 people plus managers and support staff on the payroll 12 months a year (with the richest pension scheme known to man) and working full tilt for a total of maybe 5 months, while surfing economics blogs for the remaining 7, depending on what projects materialize, are cancelled, etc.

[westslope]

"Iggy is not a lightweight. His policies are as dumb as the public demand them to be." -Andrew F

So are Stephen Harper's policies. Except Harper appears to have a much finer sense of where he can slip in bad, but popular policies.

Here's my guess. Harper understands very well all the problems and potential issues with social insurance/income transfer schemes like Employment Insurance. I'm not convinced that Ignatieff fully understands the issues.

My out of window gazing suggests to me that Employment Insurance--EI (former Unemployment Insurance--UI) program generates more than its share of cynical remarks by Johnny Canuck and Madelaine Tremblay ordinary members of the public,, particularly in certain regions where many tend to cycle in and out of EI annually.

Of course, I could be biased by the view that UI fishing category benefits constituted a major factor in the near destruction of Atlantic Cod and Pacific salmon fisheries. Perhaps it would be more accurate to suggest that UI simply hastened the near destruction of those two fisheries.

Overall, I would argue that Harper is managing to deftly out-maneuver Ignatieff.

[Phillip Huggan]

Your "structural balance" estimate USA deficit spending forever and 0% chance of staglation and hyperinflation. Our country is turning into a Republican shithole. Maybe it is good if we default and China buys us. We are the most evil people on Earth, hands down.

[Phillip Huggan]

Typo: Missed the word "assumes", between "estimate USA" above.

Cutting Canadian services means doing what AB is doing, cutting hospitals funding and construction, without pissed-away oil rents to fund such... action. Already a looming $80B/yr healthcare deficit. If Harper had invested the money he gave to his corporate oil buddies into healthcare cost savings (many undercapitalized Canadian companies and potential Crowns here including enacting a Crown to bust some porky health Union wages), maybe only a $60B/yr looming deficit. Services spending will rise regardless, and will rise more the longer we don't save a stitch in time. At $6B revenue a % point of GST rise I figure under Dion we'd be forced in a decade a 20% GST, under Iggy 25%, and assuming continued Harper 30%.
My answer to your question Stephen, is that rich Canadians used to be the most (give or take Swedes) progressive rich people on Earth a decade ago, are now the most evil in developed world.
GST exempts food necessities and other stuff, that's why is prolly progressive. To me the key next decade is rejigging the GST exemptions to ensure Canadian longevity rises and happiness (CPC supermaxes give everyone mental illness free and incarcerated) increases.

The long-term N.Rowe solution of growing our way out of deficit to me requires a surtax on all companies rent-earning, all our biggest companies, and incentives to all wealth-creating companies. If Liberals (or CPC lol) suggests that, will lose the evil J.Manley Canada Club endorsement to evil CPC and lose any election. We are in race to stupidity and winning very well thx to Dec/05 RCMP and 2008 M.Duffy/L.Asper/I.Fecan (two coin flip elections otherwise). Our banks can't win marketshare anyway, competitors get bailed out. Medical services (big clusters in TO, Wpg, Cgy) isn't such a zero-sum game: if we cure cancer and USA cares AIDS, is win-win. That cure money under CPC instead will go to Cgy urban sprawl, SUVs, and future expensive desalination when Bow/Oxbow dry up.

[Matthew]

"...rich Canadians used to be the most (give or take Swedes) progressive rich people on Earth a decade ago..."

I thought all the rich people in Canada decamped to Bermuda years ago.

[Phillip Huggan]

Okay you got me. J.Flaherty said he is leaving health transfers alone in his secret plan to slay CPC $54B/yr deficit. Isn't the same thing as saying he would rise health spending at rate of rising boomer palliative care demand (last yr of life is 50% of one's lifetime health costs), but where I expected cuts to come from. If we scale down defense spending after 2011 that is only $1-2B/yr...I assumed GST rise because it is easier for politicians to piss off public than piss off our not so productive banks (are a Crown but earn monopoly private profits) and our typewriter-mentality oil sands (talk a good talk but balk the balk at Branson's Virgin counsel to invest all profits in renewable NRG) with corporate tax rise...I don't expect the small town mentality to stop putting innocent people (like me) in prison and collect tax revenue from reefer....where do you get the $20-$54B/yr shortfall from? What is the structural shortfall assuming USA sustainable economy? Does the CPC have a way to Charter Canada as a too big to fail USA Investment Bank?

I like the idea of a federal debt slaying Green Shift mainly out of human extinction concerns arising from two week old depressing cloud trade-wind research (warmer world reduces AGW-fighting clouds says Hadley Centre's publicly funded computer sim)...but last election MSM and CPC brainwashed Canadians human extinction is good....so where do you find the pocket change? Or is Flaherty saying deficit is one of those rhetorical Zenn puzzles? Harper was on Fox News chiding them to lower debt (I agree but with tax rise not food stamps cut or whatever), so that takes away the grow-our-way-to-surplus solution. CPC gonna hire Paul Martin?

[Phillip Huggan]

To me is pure Harpocracy to chide Obama on *Fox News* for deficit while not promoting cost-savings of Canadian health care plan. UK Conservatives promote public healthcare. Obama promotes Canadian healthcare. Those excess USA dollars, over a $Trillion/year above rest of world costs minus extra obesity, going to useless insurance industry could be going to Canadian imports sales....a win win for everyone who doesn't make a living screwing over working class sick people. Sadly I'll be working for Labor Ready at best when the time comes to address Canadian Health costs: J.Baird 2007 environment platform shifted my studies from boomers to screwed-by-boomers generation.