The Real Cost of the Human Resources Spending Scandal
Elementary economics explains that government spending on job creation does not create more jobs in the economy. The $100,000 paid to a company to hire more people has to be raised through taxes. These taxes cause an equivalent reduction in the ability of the taxed people to buy goods and services and thus indirectly employ those who would have produced them. So there is no net gain in jobs.
As the prime minister keeps on reminding Canadians, in the debacle over waste at Human Resources Development Canada (HRDC), some of the job-creation money went to what may be desirable social causes - such as expenditures on societies to preserve whales and build canoe museums. These expenditures are motivated politically and should be identified as such, as should be spending in depressed regions to create temporary jobs there at the expense of jobs in other regions.
While politicians claim that such spending is for noble goals like creating a "better society," helping the poor, and other good causes spin-doctors can think of, they also have selfish motives. The recipients of the money are expected to vote for their benefactors in the next election. Canadians get justifiably upset when the light shines on obviously ignoble spending projects timed to serve the self-interest of politicians, as it did recently on HRDC's job-creation projects.
However, all of this attention to political matters has diverted interest away from an important, not-so-elementary economic aspect of the matter. Tax collection leads to large economic inefficiencies and the loss of output, which does not appear on any radar screen precisely because it is never produced. The identification and estimation of this loss owes much to the pioneering work in what is known as "optimum taxation" theory by Jim Mirlees of Oxford University; this work recently brought Mirlees a Nobel prize in economics.
The key ideas of optimum taxation can be understood by referring to an everyday occurrence familiar to many Canadians and described in a recent article by William Watson, an economist and columnist with the Financial Post. Last summer Watson used a weekend to paint the porch of his house. He did not like the job and was not very good at it. He would have preferred to write another article for publication and earn $600 doing so. But because the painter had wanted $500 for the job, and after taxes his writing would have left him only with $300, being an economist, Watson reasoned that by painting the porch himself, he was ahead by $200. (All dollar figures are in Canadian currency and are made up by me).
Of course, it does not take an economist to take taxes into account when deciding anything. The painter himself set a price for his work that took taxes into account. The $500 price he quoted Watson included the $200 in taxes he would have had to pay if he had taken on the job. The painter figures he needs at least $300 to use his time in his professional capacity rather than using it to fix his own car, which a mechanic offered to repair for $400. The mechanic's quoted price was, in turn, influenced by his expected tax bill, and so on throughout the economy. Importantly, each of the three people might decide that the after-tax income they are able to earn is not worth sacrificing a weekend to work, and instead take their kids fishing or watch TV.
Because of the "tax wedge" between earnings and real income, the Canadian economy lost Watson's output worth $600, minus the value of his paint job of $300, for a net loss of $300. Similar calculations can be made of the losses incurred all the time by the tax-distorted work decisions of the painter, auto mechanic, and millions of others. The losses in national output are even greater if people choose leisure instead of work. All of the losses are attributable to tax incentives, which prevent people from using their comparative advantage to produce goods and services for sale.
How big is the loss for the economy from the tax wedge? It is very large, according to estimates made by the Department of Finance and recently published by the OECD. Using both sophisticated methods and data, the economists in Finance calculated that for every $1 raised through the personal income tax, the loss in output is 56 cents. So, if the full amount of the $1 billion spent by HRDC on "job-creation" had been raised through the income tax, the loss in output would have been $560 million.
In fact, efficiency losses are different for the different taxes used in Canada. They are lowest per dollar for sales taxes (17 cents), somewhat higher for payroll taxes (27 cents) and highest for taxes on capital ($1.15). In principle, the theory of optimum taxation implies that the higher the output loss, the more options the payer has to use his money.
We all have to spend our money, so it is most difficult to escape the payment of sales and GST-type taxes. Capital, on the other hand, can readily flee from higher-taxing to lower-taxing jurisdictions. Or, the owners of capital can just consume the capital if they do not get the return they want. Human capital formed through education and training is the most mobile of all; in this area the effect of taxation manifests itself in the brain drain.
If we take into account the actual percentage of total revenue raised by the different taxes and apply the official estimates of output losses for each, the $1 billion in spending by HRDC costs Canadian society $520 million in output. This enormous sum of money simply goes unrecorded, like the proverbial puff of wind somewhere in the ocean. But unlike the puff of wind, the loss of output lowers the real living standard of all Canadians. This huge loss represents the most powerful argument against spending on job- creation, which, into the equation, does not create any jobs anyway, and mainly serves the parochial interest of the politicians running the government.
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