Greater economic growth requires Productivity NOT political deficit financed public spending

As fall approaches, all levels of government will begin preparing their budgets. Expect the usual grandstanding by special interest groups seeking new spending and tax cuts. The one not at the table will be the Future Taxpayer who will be stuck with any debt piled up by today’s deficit-happy politicians. Our existing deficits already total three per cent of GDP for all levels of government.

Actually, more than public deficits are being called for. Politicians want to expand government in the belief that the biggest economic bang is through public spending. What’s not getting a big push is tax cuts, which can be quick to implement and create better incentives for the investment, work effort and risk-taking needed for growth.

I have been warning for some time of a coming Canadian debt bomb. All government debt is now over 110 per cent of GDP compared to 90 per cent in 2007 (although below a peak of 135 per cent in 1995). Household debt now exceeds GDP. Corporate indebtedness has been climbing since 2011.

Governments are fooling themselves that Canada has substantially more room for more debt by looking only at “net debt” figures. These underestimate the size of our debt bomb since pension assets (CPP, QPP and employee pensions) are subtracted from debt while future pension liabilities are ignored. If we add back these liabilities, then the all-government net debt is close to 70 per cent of GDP, far higher than the 44 per cent politicians tout to make Canada look prudent.

None of these calculations includes the tsunami of liabilities associated with unfunded health care and other age-related spending. Meanwhile, the unfunded liability from Old Age Security just got bigger, after the Trudeau government’s reversal of the eligibility age to 65 from 67 years.

Obviously, the current public debt is more tolerable at today’s ultra-low interest rates. Maybe these rates will continue for years, as we seem stuck in a Japan-like funk of low growth and low inflation. Nevertheless, even at today’s values, these low debt charges cost taxpayers considerably. Total public debt charges in Canada are over $60 billion (eight per cent of public spending), money that could be used for health care, education and a less onerous tax system. Interest costs will balloon if governments take their feet off the money-supply accelerator, as recently seen in the EU and U.S.

With monetary policy failing to jolt economic growth, Keynesian economists argue for looser fiscal policy instead, meaning bigger deficits and public spending. Will fiscal expansion and deficits work? Japan’s recent, fruitless attempts suggest it won’t.

Governments are fooling themselves by thinking Canada has plenty of room for more debt

There may be a good reason for that. The Keynesian model assumes people are myopic, ignoring the consequences of deficits on future tax liabilities. It is hard to believe, though, that smart traders would ignore excessive debt build-ups that ultimately lead to economic stress, higher taxes and currency devaluations.

Nor does it seem that fiscal stimulus works well in open economies. An expansion of public deficits creates a capital inflow, pushing up the dollar, reducing international demand for exports and increasing domestic demand for cheaper imports. When the federal government announced $30 billion deficits last winter, the Canadian dollar rose despite a continuing decline in commodity prices.

But maybe I am wrong. People can be myopic and currency shifts can happen for a variety of reasons. So even if we believe that deficits can grow the economy, is it better to increase public spending or reduce taxes?

Keynesian's argue that spending increases are more powerful than tax cuts, which might be saved rather than spent. This assumes that the government spends only on consumption (which is never the case) while tax cuts create savings “leakage.”

However, tax cuts work through an economy faster in the short run compared to spending programs like infrastructure. Moreover, if the economy is to grow faster, we need higher productivity, since growth is simply the combined growth in the working population and growth in productivity (in Canada, the two are expected to be little better than 1.5 per cent). Infrastructure spending creates capacity for long-term growth but is a poor short-run stimulus, while tax cuts can generate growth both in the short and long run.

Currently, Canada’s reliance on income taxes impairs incentives for investment, entrepreneurship and the adoption of technology — all critical to growth. Some countries have clearly figured this out. The U.K. and Ireland, with low corporate taxes and some personal tax relief, have recently achieved better growth rates than the U.S., Canada and other European countries.

Canada has been doing the opposite. Federal and provincial governments have pushed up marginal income tax rates, whether at the top end or through higher claw-back rates for income-tested programs. Effective corporate tax rates on new investment have increased by almost 15 per cent through fewer incentives, higher transfer and property taxes, and increased tax rates in some provinces. Small businesses have gotten breaks, but they face a wall of taxes and regulations if they grow. 

If we want to see better economic growth, we need to get back to the productivity agenda — not the Keynesian agenda of deficit-financed public spending.

Jack M. Mintz | September 22, 2016 5:13 PM ET

Jack M. Mintz is the president’s fellow at the University of Calgary’s School of Public Policy.