Why Ontario's Personal Income Tax Cuts                               are the Best Way to Stimulate Growth and                    Employment

The Honourable Ernie Eves, Q.C.

On January 1, 1997, the second phase of Ontario's plan to cut the provincial personal income tax by 30 percent came into effect. However, some critics of the Ontario government's plan say that the government should cut its spending less instead of cutting taxes, while others say that there should be no tax cuts until the deficit is eliminated. The crucial issue these critics ignore is the powerful positive effect of lower taxes on economic growth. This has been documented in recent economic research, especially by economists studying the effects of tax cuts in the United States.

The Canadian economy has performed very poorly over the past decade. Real disposable income for the average Canadian worker is no higher today than it was in 1984. This key measure of progress had stopped growing well before the 1990-92 recession. One of the main reasons for this was rising taxes. Over a period of just 9 years, from 1982 to 1991, the share of income absorbed by personal direct taxes rose by 27 percent. The Fraser Institute is most prominent among those who have highlighted the economic burden of rising taxes. The Institute's "Tax Freedom Day," which occurs so late in the year, shows just how deeply governments have encroached on the economic freedom of Canadians.

Higher taxes reduce personal disposable income in two ways. One-the most obvious-is the deduction that is taken from the individual's pay cheque. The second and more insidious way is through the long-term reduction in economic growth that results from weaker incentives to work and invest.

Why cut taxes while there is still a deficit?

Ontario's economic performance has suffered from excessive increases in both government spending and taxation. Ontario's basic income tax rate rose 7 percentage points between 1988 and 1993, compared to an average of only 2.8 percentage points for the other provinces. Provincial government spending rose to 18.5 percent of GDP in 1994-95, compared to 15 percent 10 years earlier. That is why the Ontario government has decided that it is necessary to reduce both taxes and spending immediately.

International evidence shows that those jurisdictions that have quickly and decisively restructured government spending, as we are doing in Ontario, are the ones most likely to succeed in restoring fiscal soundness after a period of large deficits. A recent National Bureau of Economic Research study of the OECD countries' performance emphasized that the way in which fiscal adjustment is carried out is of vital importance for success. They found, in particular, that countries which attempt fiscal adjustments through personal tax increases usually fail to achieve a lasting deficit reduction.

This point is especially relevant given the recent history of tax increases in Ontario. The Ontario economy, even more than economies in the rest of the country, has suffered from a loss of jobs-the legacy of past policy mistakes. Cutting spending to the required degree, without also cutting taxes, would produce an excessive economic drag and much higher unemployment. Weak economic growth performance is counterproductive for deficit reduction.

Suppose that a government waits until its budget is balanced and government spending is reduced to its optimal level before it cuts taxes. At this point that government may decide that taxes should be cut because of the long-term positive impact on productivity growth. However, tax cuts also stimulate demand. That is clearly something the economy needs in the current environment, and that is why it makes sense to cut taxes now. If we wait several years, it may turn out that a tax cut would be poor macroeconomic policy, since it would overstimulate demand and lead to inflationary pressures.

The Canadian and Ontario economies' improved fundamentals are becoming widely recognized, and this has led to much lower interest rates. There has been disappointment that this reduction in interest rates has not translated into a stronger recovery in consumer spending, which has been a very weak element in our economic recovery. Part of the reason for this is the lack of growth in consumers' disposable incomes. Growth in disposable income, through tax cuts, would make lower interest rates more effective at boosting demand in an economy which continues to suffer from a large output gap due to insufficient demand.

Lower taxes are an essential element, along with deficit reduction and less intrusive regulation, in restoring an environment that supports growth and job creation. In addition, lower tax rates reduce the temptation to avoid taxes by participating in the underground economy. There is a rare degree of consensus among Canadian economists that the underground economy has grown considerably in recent years, and many point to rising taxes as a primary cause. Keeping taxes high, therefore, is not the best way to fight the deficit.

Cutting taxes and government spending will create jobs

The Ontario government's spending reductions will total about $8 billion, representing a reduction of about 15 percent in provincial government spending. These cuts will return provincial government spending to about the same share of GDP as it was in 1985. The spending cuts are not designed to pay for the tax cuts. We have cut government spending because government has grown unnecessarily large and inefficient. It has been doing many things that are best done by the private sector. It is this government's view that the best way to stimulate the economy is to leave more money in the hands of Ontarians to spend as they see fit.

Some critics claim that tax cuts will do little to offset the economic drag from spending cuts. They base this view on macroeconometric models which predict that government spending has a larger multiplier effect than tax cuts. They suggest that, dollar for dollar, more jobs will be lost from the spending cuts than will be gained from the tax cuts.

These models, although they are often labelled "Keynesian," are not very good at taking into account some of the key insights of that famous economist. Keynes wrote that it is "characteristic of human nature that a large proportion of our positive activities depend on spontaneous optimism." Carefully documented case studies from OECD countries (some including G-7 countries), have found instances of countries growing faster after sharp reductions in government spending and deficits. The loss in public sector demand in these countries was quickly replaced by increased private sector spending due to increased consumer and investor optimism about the future.

Optimism is not something that can be created by turning on a switch, and we cannot necessarily count on achieving fiscal balance in Canada without some temporary economic drag. Nevertheless, it is likely that the economic drag from government spending cuts would be considerably less than what is predicted by a mechanical model that ignores the effect of fiscal policy on private sector confidence.

The fiscal policy being pursued in Ontario has succeeded in improving business confidence. The Conference Board's surveys in 1996 found that 53 percent of respondents rated Ontario as the province in which they were most likely to invest, compared to only 46 percent at the beginning of 1995.

Experience in the industrial countries over the past two decades has shown that high government spending financed by deficits does not create jobs on a sustainable basis. As deficits and government spending have grown, so have unemployment rates. Nothing is as effective at destroying the optimism of the private sector as the spectre of ever-increasing government deficits and the rising taxes needed to pay for them.

The incentive effect of tax cuts

One of the key factors that is ignored in most macroecono-metric models is the positive incentives to work that result from lower income taxes. People work harder when they are allowed to keep more of what they produce. Income taxes are also an important consideration for the most mobile people in today's global economy, who also tend to be the most highly skilled. Therefore, employers in a jurisdiction with high income taxes are forced to pay higher salaries to compensate. Tax cuts translate into a lower cost of doing business.

The boost to economic incentives given by lower taxes has particularly positive effects on investment and productivity growth. One might ask, though, does this matter for short-run job creation? The answer is yes. The increase in the economy's production potential and labour force participation rate are key indicators that the Bank of Canada watches as it sets its monetary policy. Higher productivity growth and higher labour force growth both mean that the economy can grow faster without raising inflation, and this prompts the Bank of Canada to cut interest rates.

Lower taxes also make it easier for Canadian companies to export because lower taxes reduce business costs. Canada has a highly open economy, and there is no limit to what we can sell the rest of the world if our prices are competitive. Increased production capacity resulting from tax cuts will translate into increased output growth.

What kind of tax cut is best?

While most people would agree that the overall tax burden is too high, there is no consensus about which taxes should be cut first. In Ontario, we have focused on the personal income tax, supplemented by cuts in payroll taxes, especially for small business.

Some have argued that a sales tax cut would have a more stimulative effect on consumer demand. They point to the fact that a sales tax cut is received directly as a consequence of spending, whereas people getting an income tax cut might save their higher disposable income rather than spend it. In fact, there is very little difference in how much spending is increased in response to a sales tax cut versus an income tax cut.

Remember that consumers do not have to spend more in order to receive the benefit of a sales tax cut. Even with a constant level of spending, they would save money on all the things they were already buying before the tax was cut; they could then just bank the savings if they wished.

Economists such as Michael Manford of ScotiaMcLeod and Jeff Rubin of Wood Gundy, who have studied the problem of the weakness in consumer spending, point to low income growth as the reason. The personal savings rate dipped to just 5.1 percent of income in the third quarter of 1996, its lowest level since 1970. This shows that consumers would be eager to spend more if they had the financial means to do so. There is no reason to suppose that they will suddenly start saving all or most of the increase in their disposable income just because it was created by a tax cut. If some individuals, in the first instance, use a tax cut to pay down their debts, this will put them in a position to spend more shortly thereafter.

Whatever differences exist between income and sales taxes in the area of stimulating consumer spending are relatively minor. The greatest difference is that cuts to the former create a stronger incentive for work and investment.

Making the tax cut fair

Among those who recognize the benefits of income tax cuts, the distribution of the cuts is a contentious issue. Ontario has accompanied its income tax cuts with a Fair Share Health Care Levy, which results in a smaller percentage income tax reduction for higher income people. The health care levy will not apply to individuals with taxable incomes of $51,000 or less. People earning more than $250,000 per year will end up with a 17.9 percent reduction in their provincial personal income tax, while individuals with less than $15,000 per year will get a 41 percent reduction. As the name implies, this tax design was aimed at achieving the goal of fairness in the distribution of the tax cut.

One columnist who supports tax cuts suggested that this levy "claws back much of the tax cut's incentives to work, save and invest," while another claimed that because the Ontario government "designed the tax cut on the basis of political rather than economic analysis, they have missed the opportunity to repair the damage done by Ontario's very high marginal rates."

These critics are missing the point that the marginal tax rate is important for everybody in the economy, not just those at the top end of the income distribution. Ontario's personal income tax cuts reduce the provincial marginal income tax rate by 30 percent or more for 90 percent of the tax-paying population.

Tax cuts helpful to small business

Since the average operator of an unincorporated business in Ontario has an income of $31,000 (well below the $51,000 limit), the vast majority of small business operators will not pay the health care levy. Their increased after-tax earnings will give them additional funds to reinvest in their enterprises.

This is especially important for small businesses, which usually have limited access to outside financing. The small business sector has been the most dynamic part of our economy in the past decade, creating the most jobs. Technological change will continue to favour the dynamism of this sector, as computerization and microelectronics now make a much smaller scale of operation efficient. These businesses will benefit additionally from the elimination of the of the Employer Health Tax (EHT) starting this year. Once the phase-in is complete, 88 percent of Ontario businesses will no longer be subject to this tax. Self-employed individuals will also be exempt from this tax, and for them it will represent an additional cut in their effective marginal tax rate.

Tax cuts will spur investment

The worst aspect of a deficit is the negative expectations it creates of a worsening spiral of debt. This discourages investment not so much because of a fear of defaults, but rather because of the inevitability of higher future taxes. Nobody wants to invest in a province in which taxes are expected to rise to excessive levels. In Ontario, we have developed a credible plan for eliminating the deficit by the end of our first term in office.

Analysis in the June 1996 issue of the International Monetary Fund's Economic Outlook contrasted the effects of deficit reduction achieved via government spending cuts versus tax increases. The IMF found that cutting government deficits through spending cuts resulted in a real GDP improvement of 0.6 percent compared to only 0.2 percent when the same deficit reduction was achieved through higher taxes. This is because higher taxes lead to reduced capital investment.

There is growing evidence that tax rates have a permanent effect on the rate of economic growth. Countries with lower taxation levels have higher rates of investment, both in physical and intellectual capital, and their economies grow faster. Credible international studies show that, for each percent of GDP that the government raises in taxes, real GDP growth is permanently lowered by at least 0.1 percent per year. Applying this estimate to Canada, one finds that just the tax increases since 1980 have robbed the Canadian economy of about half a percent of growth per year.

Conclusions

The past decade has been a period of economic malaise in Canada. Living standards have been stagnant or, by some measures, have actually fallen. There is no need for our economy to perform so poorly. Canada is endowed with natural and human resources at levels unsurpassed by any other country, and yet many other countries have outperformed us. A look at these countries reveals that they are ones in which governments have not hampered individual initiative and enterprise.

Through our balanced approach to cutting spending and taxes, we are rebuilding optimism about Ontario's future, creating incentives for hard work and investment, and reducing the incentive to participate in the underground economy. Canadian tax rates have risen to levels that are clearly counter-productive, and reducing tax rates should be among the top priorities of all levels of government.

References

Alesina, Alberto, and Roberto Perotti, "Fiscal Adjustment in OECD Countries," Cambridge, Mass: National Bureau of Economic Research (NBER), Working Paper No. 5730, August 1996.

_____, "Fiscal Expansions and Adjustments in OECD Countries," Economic Policy, Oct. 1995.

Becsi, Zsolt, "Do State and Local Taxes Affect Relative State Growth?" Federal Reserve Bank of Atlanta Economic Review, March-April 1996.

Engen, Eric, and Jonathan Skinner, "Taxation and Economic Growth," NBER Working Paper, Nol 5826, November 1996.

Feldstein, Martin, and Marian Vaillant, "Can State Taxes Redistribute Income?" NBER Working Paper No. 4758, 1994.

Giavazzi, Francesco, and Marco Pagano, "Non-Keynesian Effects of Fiscal Policy Changes: International Evidence and the Swedish Experience," NBER Working Paper No. 5332, Nov. 1995.

_____, "Can Severe Fiscal Contractions be Expansionary? Tales of Two Small European Countries," NBER Macroeconomics Annual, 1990, pp. 75-116.

Habermeier, Karl, and Steven Symansky, "Fiscal Policy and Economic Growth," International Monetary Fund Occasional Paper No. 125, 1995.

IMF Economic Outlook, June 1996, p. 96.

Mullen, John K., and Martin Williams, "Marginal Tax Rates and State Economic Growth," Regional Science and Urban Economics 24 (November 1994), pp. 687-705.

Tanzi, Vito, and Ludger Schuknecht, "The Growth of Government and the Reform of the State in Industrial Countries," IMF Working Paper, Dec. 1995.



Debt or Democracy?

Filip Palda

How much is your vote worth? These days, the answer is probably "not much." Canada has never had a strong democratic tradition. The Westminster style of government holds the people in mild disdain. But the real enemy to democracy in Canada is government debt. Debt has put politicians on a leash. In theory, voters are supposed to be yanking the leash. In practice, bond rating agencies, traders and creditors are taking politicians for a walk. Canadians are right to be frustrated by unresponsive government. Government is no longer in their hands.

The hands now guiding government are sensible, but such sensibility comes painfully late. Lenders are forcing politicians to cut spending, privatize money-sucking state companies, and whip efficiency into hospitals and schools. Why did politicians not do these good things earlier? Because voters did not have politicians under proper control. It has taken the demands of lenders, protected by laws that guarantee interest payments, to impose reality on our leaders.

The discipline of public debt is similar to the discipline of private debt that swept Wall Street in the 1980s. Scattered shareholders had lost control over the executives who managed their companies. Executives were flying to resorts in corporate jets while neglecting basic company business. Clever outside investors spotted the neglected potential of these companies. They borrowed money, bought a controlling share of stocks, and put managers to the oar. Sometimes managers defended themselves by being the first to borrow and buy out the shareholders. In either case the reformed company had to answer to the regular demands of its lenders. The result was a jump in company efficiency. The same story can be told of government efficiency in Canada. No matter what party our political managers come from, small government is where they are heading.

The tragedy of Wall Street is that discipline slipped so far that takeovers became a major industry. The tragedy of Canadian government is that our democratic instruments did not restrain politicians from pulling us down into the fantasy world of playing without paying. The result is that voters have mortgaged much of their power to lenders. If voters want their power back they need to pay down the debt. To keep that power they will need to shackle their leaders.

Direct democracy, such as the voter initiative and the referendum, make particularly fine restraining devices for wayward politicians. Researchers from Switzerland have found that government is a third smaller in communities with direct democracy than in similar communities that rely on politicians to make all the decisions.

Professor John Matsusaka of the University of Southern California has found that U.S. states with voter initiatives manage their affairs along sound economic principles. States with voter initiatives spend up to 12 percent less than similar states without such initiatives. Initiative states shift expenditure toward local government and away from state government. These states also make users of government services pay for them directly. What this boils down to is that states with initiatives restrain politicians from redistributing income against the wishes of the majority. Voters use initiatives to bypass politicians and shut the door on special interest groups who quietly lobby government for the public's money. U.S. voters enjoy the privileges of direct democracy in nearly half their states. Perhaps this is why U.S. government debt as a fraction of national income is half that of Canada. Perhaps this is why U.S. citizens frequently rank first among western countries in surveys of voter enthusiasm. Direct democracy will not make Canadian politicians perfect servants of the people, but it may keep government in check. For without proper restraints, politicians will be tempted to write IOUs on our ballots.

References

John G. Matsusaka (1995), "Fiscal Effects of the Voter Initiative: Evidence from the Last 30 Years," Journal of Political Economy 103, pp. 587-623.

Wehrner W. Pommerehne and F. Schneider (1983), "Does Government in a Representative Democracy Follow a Majority of Voters' Preferences?" in Horst Hanusch, ed., Anatomy of Government Deficiencies, Berlin: Springer Verlag, pp. 61-84.

Raymond E. Wolfinger, David P. Glass, and Peverill Squire (1990), "Predictors of Electoral Turnout: An International Comparison," Policy Studies Review 9, pp. 551-74.

When Government Gets Too Big

Michael Walker

The way things are shaping up, the next federal election campaign is going to evolve around a central philosophical issue, namely, how big should the government sector be? This question will emerge because of the different positions taken by the Liberal Party and the Reform Party over the issue of tax cuts versus spending increases when the fiscal dividend becomes available.

Let us set aside the question of whether it is sensible in 1996 to be talking about a fiscal dividend. While I have great reservations about even considering such a concept, the presumption that the federal government's deficit targets will be met earlier than planned is going to give rise to more discussion along these lines. So, we have to be prepared to understand the implications of tax cuts and/or spending increases.

The Reform Party suggests that there should be further cuts to federal spending and commensurate tax reductions, thus leaving the deficit to decline even though tax cuts are implemented. This is a different strategy than that being pursued by the Conservative government of Ontario, which has opted for tax cuts not matched by spending cuts and therefore a more gradual reduction in the deficit. The federal finance minister has indicated that he will not reduce taxes but rather will increase spending to absorb any fiscal dividend which may arise. His argument is that the cuts in spending which have occurred may be rescinded as a result of the fiscal dividend.

Apart from the obvious fact that a tax cut strategy produces a reduction in tax cost for Canadians, the central difference between the Reform policy and that suggested by the finance minister is the effect on the size of government. At the moment, the government of Canada and the other levels of government together spend 45.2 percent of Canada's GDP. A combined strategy of reducing taxes and spending would reduce the fraction of the total national economy absorbed by the public sector. A policy of reinstating spending programs would cause the ratio to stay the same, or at least decline less quickly.

Why should we care about the size of the government sector? In 1995 two economists at the World Bank published a study which examined the effect of larger government. Starting their analysis from 1870, they were able to establish that the share of the government sector in the economy, in industrialized nations, had grown on average from 8 cents on the dollar in 1870, to 15 cents by 1920, 21 cents by 1937, 43 cents in 1980 and 47 cents by 1994 (all measured as government spending as a percentage of the GDP). These economists then asked what the benefits have been from the growth of the government sector. Specifically, they asked whether there were diminishing returns from further public spending. In most human endeavours, adding more of a resource to accomplish a particular goal is usually subject to diminishing returns. So, for example, the last pound of fertilizer added to a field is much less productive per pound than the first pound. Is this also true of government?

Vito Tanzi and Ludger Schuk-necht, the study's authors, found that indeed there are diminishing returns to government spending. They found that beyond 30 percent of GDP, government spending produced fewer and fewer benefits. They also found that countries with relatively small government sectors nevertheless had comparable outcomes with respect to life expectancy, infant mortality, number of children in school, etc. Not only did they discover that in those econo-

Do Lower Taxes Help Stimulate Economic Growth?

Fazil Mihlar

The first volley in the next general election campaign has been fired. The Reform Party and the Progressive Conservative Party, along with many business groups, argue that income taxes and payroll taxes need to be reduced if we are to have higher levels of economic growth and job creation. The governing Liberal Party disagrees, claiming that the economy is doing fine, and that the emphasis should be on deficit reduction and perhaps a reinvestment into social programs after the budget is balanced. Given these competing claims, the pertinent question is: will tax cuts help stimulate the Canadian economy? The answer is a resounding "yes."

There is a way to evaluate the impact of lower taxes on the economy. Recent experience sheds some light on whether tax cuts spur economic growth by reducing the disincentive to work, save, and invest. The U.S. experience with tax cuts in the 1920s, 1960s, and the 1980s is instructive in this regard.

According to a Heritage Foundation study, in the 1920s under Presidents Harding and Coolidge, consecutive tax cuts reduced the top income tax rate from 73 percent to 25 percent. Lower rates of taxation helped expand the economy dramatically. The U.S. economy experienced an average annual real economic growth rate of more than 6 percent between 1921 and 1929. In spite of, or perhaps because of the dramatic reductions in personal income tax rates, revenues increased from $719 million in 1921 to $1,160 million by 1928, an increase of more than 61 percent. (Unfortunately, this period of sustained economic growth could not be maintained due to the adoption of ill-conceived trade protection policies which eventually led to the Depression.)

In the 1960s, President Kennedy initiated a series of tax cuts which resulted in the top income tax rate being reduced from 91 percent to 70 percent. These cuts, in part, helped increase economic growth by 42 percent between 1961 and 1968, a real average annual rate of more than 5 percent. In real terms, income tax revenues rose by one-third during the same period.

In the 1980s, President Reagan phased in tax cuts and reduced the top rate from 70 percent in 1980 to 28 percent by 1988. The effects of these tax cuts were significant. During the Reagan years, economic growth averaged around 4 percent per year, and personal income tax revenues increased by 28 percent in real terms.

According to a World Bank study, economies with lower taxes experience more rapid economic growth, invest more, and experience more productivity gains. Recent studies estimate that a 10 percent increase in the tax burden reduces a country's annual growth rate by 2 percent. Thus, there appears to be a negative association between growth and high marginal tax rates.

The economics behind these conclusions is straightforward. Lower taxes encourage work effort, innovation, and higher savings rates. Since these activities are instrumental in the growth process, economies that encourage them are likely to grow faster and create more jobs.

Critics claim that Canada cannot afford a tax cut because of its budget deficit and debt problems. But taxes have to be looked upon as the price we pay for engaging in productive activities (creating wealth). If the price of creating wealth and jobs is high, we get less of them. If we lower the price, we will get more prosperity. Tax cuts, however, should be matched by equivalent spending cuts to ensure that budget deficits do not recur. That is, tax cuts should be implemented within a balanced budget framework.

If the current Liberal government wants to create more jobs, then it must engage in fundamental tax reform by shifting the tax burden to consumption activities, rather than to income-generating activities. In order to encourage job creation, the government should also reduce job-killing payroll and income taxes.

Evidence from the U.S. and other parts of the world suggests that tax cuts are a necessary condition for economic growth. The federal government would be well-advised to consider the positive impact tax cuts would have on the Canadian economy, or risk facing a tax-battered electorate ready to fire its own volley at the Liberals, under cover of the ballot box.

References

Antonelli, Angela M., and Christianna L. Shortridge, eds., "Why America Needs a Tax Cut," Washington, D.C.: Heritage Foundation, Sept., 1996.

King, Robert, and Sergio Rebelo, "Public Policy and Economic Growth: Developing Neoclassical Implications," Journal of Political Economy, vol. 89, 1990, pp. S126-S150.

Marsden, Keith, "Links Between Taxes and Economic Growth: Some Empirical Evidence," World Bank Staff Working Paper No. 605, 1983.

GST-The Goods and Software Tax

Mark Weller

It seems that Revenue Canada is mad at Bill Gates. Why? It appears that his plan to allow people to purchase software directly from Microsoft over the Internet has them running scared. The process would go something like this: I log in to the Microsoft web site; I choose a product I would like to purchase; the server posts a message asking me for my credit card number; I type in the number, and the charge is processed. Ideally, the computer informs me that my card has been approved, and the transaction is complete. Now that I have paid, I am given access to a secure site from which I can download the software I purchased.

No middle-man. No Canada Post. Sounds great.

The problem is, where does the transaction take place? Is it on the Microsoft server? Is it at my geographic location where I have typed in my credit card number? Is it at the location where the purchase is approved? All of this matters when one attempts to charge sales tax.

Revenue Canada is concerned that Internet transactions are a way for increasing numbers of Canadians to beat the GST. Already dozens of organizations provide this kind of service, and when the credit card bill comes in the mail, no GST is charged. Of course, for American companies, the charges are made in U.S. equivalents, which tends to lend credence to the notion that the transaction is happening outside of Canada.

This problem is similar to the one that the government faced a few years back with catalogue sales and the GST. People were ordering products from the U.S., but in many cases were not paying the GST when the parcels crossed the border. The government's "solution" was to impose a special Canada Post processing fee on companies shipping into Canada.

However, with the Internet there are no real borders. In fact, transactions happen in cyber-space. So how do you patrol a virtual border?

Microsoft is not interested in collecting taxes for foreign jurisdictions. The cost of implementing a computer system that could process all the various tax requirements of hundreds of jurisdictions worldwide would be prohibitive. For instance, in the case of British Columbia, one would have to charge both PST and GST, whereas in Alberta's case, one would charge only the GST.

Another solution would be to have national servers. So Canada would have a Microsoft Internet store in Toronto, and Germany would have one in Bonn. At the moment, however, this is not in the works.

So, will Revenue Canada sue Bill Gates? Probably not. More likely, the tax department will develop a way to tax transactions that are made by Canadians in cyberspace. For instance, Microsoft could report all the Canadian transactions to Revenue Canada every few hours, and then the government could run through all of the tax charges. So your bill would indicate a charge for a piece of software, and then a few lines down there would be a taxation charge.

Thus begins the era of virtual taxation. One can imagine that sometime in the not so distant future, Revenue Canada might see fit to debit your bank account directly via Interac.

Of course, the one thing the government may wish to consider is how many of these transactions would cease to be reported. And it thinks the underground economy is big now . . . .


The Government's Distorted Version of                                   Robin Hood

Jason Clemens                                                                                                                                                                   [This article is reprinted from the November/December 1996 issue of the Canadian Student Review]

In the classic fable Robin Hood, the hero "robs" wealth from the nobility in order to return it to the peasants from whom it was first stolen. The fable is commonly viewed as a moral story; Robin Hood stole property in order to provide the peasants with the means for their subsistence.

The Canada Pension Plan (CPP), the modern version of the Robin Hood fable, was established to provide a moderate level of income for retiring seniors who were facing a substantial decline in income levels when they were no longer working and collecting a paycheque. The plan was based on the notion of transferring a small amount of money from a large group of workers to a small group of retirees. However, deductions from working Canadians were not placed in personal funds in order to finance their own individual retirements, but rather transferred immediately to those persons already retired (called the "pay-as-you-go" system).

As it turns out, the plan was built on false assumptions. Canada, like most industrialized countries, has an aging population and a declining rate of disposable income growth. In 1966, when the plan was implemented, there were 5.5 persons under the age of 20 for each person over the age of 65. By 1995, this ratio had declined to 2.3, and is expected to further decrease to 1.1 by 2030 according to a report by the Canadian Institute of Actuaries. The change in demographics and the poor funding structure has resulted in a system where an ever-increasing level of current income is being transferred from a shrinking group with stagnant incomes to an expanding group of seniors.

The principal injustice associated with CPP is the inequitable transfer of wealth. David Walker, Chair of the House Committee on CPP reform, has stated his impression that there is a "preponderance of opinion . . . willing to accept an increase [in contribution rates]-if it truly fixes the CPP." This acceptance is in response to the rumoured policy of accelerating CPP contribution rates to 10 percent of earnings from the current 5.6 percent with no change in the benefit level. (In 1966, the contribution rate was up to 3.6 percent of the average industrial wage (AIW) with a commensurate benefit of up to 25 percent of the AIW.)

In order to illustrate the injustice and the size of the wealth transfer, consider the results of assuming the proposed contribution rate of 10 percent and a 4.5 percent growth in the AIW (based on standard actuarial assumptions). If an individual aged 25 works for 40 years and receives the average industrial wage, the difference between what the individual will receive in CPP benefits and what they could receive from a privately funded plan is staggering. By opting out of the CPP at age 25 and investing the funds privately, one would have a large surplus at age 80 that could be left to one's children. For instance, if the fund gener-ated an average return of 6.5 percent, the resulting surplus would be approximately $1.3 million; at 10 percent it would generate a surplus of over $8 million. (These rates are not unrealistic since equity market returns have averaged anywhere between 10 and 18 percent depending on the particular market and time.) This surplus is after paying out the same benefit stream as the CPP from age 65 to age 80. This foregone surplus amounts to an intergenerational transfer because today's youth do not have the option of investing privately instead of contributing to the CPP.

The youth of this country, regardless of political affiliation or ideology, must unite against the current system of retirement income support. The state must encourage individuals to save for their own retirements rather than continue on the path of inter-generational wealth transfers. A small deduction or allocation from general tax revenues could be established to finance a moderate income support for truly needy seniors. This type of means-tested system of retirement income would limit the inequitable transfer of wealth.)



January Questions and Answers

Joel Emes

Q: How have the top spending priorities of the federal government changed over the past 30 years?

A: Table 1 shows how federal expenditure priorities have changed from 1966 to 1996. The largest change is for debt charges, which account for more than twice as much of total spending as they did in 1966 (from 12.5% to 26.9%). Except for social services, spending in all of the other main categories, i.e., health, education, and protection of persons and property, have decreased. Taken together, these three areas have dropped from 28.5 percent of total spending to 15.8 percent, a drop of 12.7 percentage points. Meanwhile, debt charges have increased by 14.4 percentage points.

The categories in table 1 are those defined by Statistics Canada's Financial Management System (FMS). Social services includes programs that support the socio-economic well being of individuals and families. It includes Old Age Security (OAS), the Guaranteed Income Supplement (GIS), Employment Insurance, Workers' Compensation, Family Allowances, Veterans' Benefits and other social assistance services. Protection of persons and property includes the costs of policing, law courts, correction and rehabilitation, and national defence. Health includes all expenditures related to hospital and medical insurance programs, disease control and prevention, and laboratory services. Education includes all outlays for elementary, secondary, and post-secondary education as well as skills retraining and upgrading.

Q: What is the average Canadian's share of the public debt?

A: The Fraser Institute recently released its annual compilation of Canada's total liabilities, including direct debt, indirect debt, and obligations. The main results are summarized in Table 2. Federal, provincial, and local governments have accumulated $795,878,000,000 ($796 billion) in direct debt and $3,463,675,000,000 ($3.5 trillion) in total liabilities. Each Canadian owes $26,656 in direct debt. Direct debt is what most people and governments refer to as "the debt." If indirect debt, unfunded liabilities, and all other obligations are counted, each Canadian owes $116,009. Direct debt includes the accumulated net debt incurred by a government and all its agencies while indirect debt is the net debt of quasi-government entities, such as government business enterprises and hospitals, that government is ultimately responsible for. Obligations include programs and benefits that a government has committed to provide in perpetuity. They include the Canada and Quebec Pension Plans, the Old Age Security program, and the health care system.

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Last Modified: Wednesday, October 20, 1999.