Tax cuts won't increase revenues

February 1, 2001

According to recent polls, approximately half of British Columbians agree with the theory that tax cuts will increase government revenues. It's an appealing notion. After all, it's hard to say no when someone says you can have it all--tax cuts, increased revenues, and thus more money to fund health care and other public programs.

Problem is, the proposition is just plain wrong.

In fact, tax cuts lower what government revenues would otherwise have been. The notion that tax cuts will stimulate so much economic growth that they will pay for themselves is a delusion. Yes, tax cuts do offer a small economic stimulus. But most economists maintain that tax cuts can only recoup 20-50 percent of their cost through the revenues generated by this fiscal boost. Even the BC Business Summit, in its report two years ago, acknowledged that its desired tax cut of $1.5 billion could only recoup one third of its value--the rest would have to be paid for by cuts in government spending.

But will tax cuts result in an actual decrease in government revenues? Well, that depends. It depends on what's happening in the U.S. economy, the Asian economy, and on international prices for BC's key commodity exports like lumber and pulp--a whole host of factors beyond our control.

A few months ago, Liberal finance critic Gary Farrell-Collins challenged opponents of tax cuts to point to a single jurisdiction that cut taxes and lost revenues. So we at the Canadian Centre for Policy Alternatives did. We offered up the example of Ronald Reagan's administration, which cut taxes in the early 1980s--just as the U.S. was heading into a recession--and lost revenues. (This was predicted by George Bush Sr., who dubbed the idea that taxes would pay for themselves "voodoo economics.") We also noted the case of Alberta, which lost revenues in the mid-1980s when oil prices took a dive.

More recently, in response to comments by former Hong Kong Bank economist David Bond, Mr. Farrell-Collins claimed one could not point to a single Canadian jurisdiction in the last five years that cut taxes and lost revenues. True enough, but such cherry-picking of the parameters does the debate no service. No one lost revenues over the last five years--thanks to the booming U.S. economy. The more important question is: what happens during a downturn?

It is fashionable to hold up Ontario and Alberta as models of the virtue of tax cuts. But such examples confuse cause and effect. In the case of Ontario, the last five years have been a free ride, courtesy of U.S. expansion. Interestingly, though, revenues grew only modesty in Ontario over the period--much less than one would expect given their strong economic growth.

As for Alberta, low taxes are not the cause of their prosperity, but the consequence of the real "Alberta Advantage"--oil and gas. The point is not to replicate Alberta--the point is that Alberta is uniquely endowed with natural resources that are not replicable.

It is worth noting that the Clinton government increased taxes on the wealthy early in its mandate. As one might expect, there were plenty of cries from the usual suspects that this would drive the economy into the ground. As we now know, of course, the Clinton tax increases preceded a period of unprecedented economic growth and an exploding budget surplus. This is not to say that the tax increase caused the growth; merely that other things are more important than tax rates.

Even if revenues continue to increase after a tax cut, the question remains: will the increase be sufficient to keep pace with inflation and population growth? Will the increase be enough to maintain existing public services (let alone fund new ones like child care and home care)?

The provincial Liberals are promising to have the lowest bottom two income tax brackets in Canada. That sounds great, but there's a problem. At least two other provinces are promising the same, and they can't all be right. How low will taxes be when the bidding war is over? How much will such a promise cost when the race-to-the-bottom ends? We have no idea.

So remember the old adage, "when something sounds too good to be true, it probably is."

If tax cuts were such a miracle cure, the issue would be a no-brainer--every government in the world would have dramatically reduced taxes long ago. Sadly, tax cuts aren't a wonder drug. They come with a price and mean tough choices.