Canadian Commentary: Economics

An Embarassment of Riches: How to Spend the Surplus

September 1997

As the federal government's deficit steadily shrinks, the business press has been engaging in the old game of counting chickens before they hatch. Assuming continued unending growth (which seems to be a rather reckless assumption given the length of the current period of growth and the probability of another referendum), the media have been having visions of huge surpluses, and have promptly started spending them. Naturally, they are advocating allocating the surplus in a manner that suits the interests of their business readers. This takes the form of two (contradictory) policies: reducing the debt, and cutting taxes. It is time to examine these policies more closely, and provide a different perspective on the situation.

The idea of using the surplus to reduce the debt is, to put it simply, pointless. It is a waste of the taxpayer's money. There are three reasons for this:
1) The last thing Canada needs is to have yet more money sucked out of its economy. The unemployment rate is still far higher than it should be, and the government already holds back growth by taking tens of billions of dollars out of the economy every year to pay interest on the debt.
2) The inevitably small amounts of surplus (a few billion at most) will have minimal impact on a debt of close to $600 billion. By contrast, the combined effect of inflation and growth will reduce the significance of this debt fairly rapidly (as long as the budget remains balanced). As Bruce Little has shown in his "Amazing Facts" columns in the Globe, repaying a few billion dollars of the debt every year would have little impact on reducing the overall debt burden.
3) It would be politically impossible for a government to run significant surpluses while taxes remain high and government programs remain desperately underfunded.

The second proposed use of the surplus is tax reduction. Naturally, the business press advocates tax cuts that benefit business: cuts in corporate taxes, in payroll taxes, and in the upper brackets of income taxes.

In fact, corporate taxes in Canada are not all that much higher than those in the U.S., and lower than in most other industrial nations. Corporations now pay a much smaller portion of the tax burden than they have for decades, and they are obviously doing very well for themselves despite the present taxation rate. They hardly need a break. It would be ridiculous to cut corporate taxes.

Despite what one hears in the press, Canada's payroll taxes are also very low compared to other nations, and are comparable to those in the U.S. On the other hand, it is true that the surplus in the Employment Insurance fund is becoming excessive, and that the increases in the CPP payment will start making payroll taxes more burdensome. The EI payroll tax should be reduced - but in a manner that contributes to public policy [see my proposals for Employment Insurance].

As for income taxes, it would be a good idea to target some of the surplus towards reducing them. But this should not go towards the upper brackets. Rather, the federal government should gradually increase the basic income tax deduction to at least $10,000 (which was the only sensible proposal in the Conservative Party's election platform). This would benefit all taxpayers by the same amount - but the benefit would be more significant for low-income earners. It is by far the fairest way to reduce taxation. Furthermore, it is ridiculous that individuals earning $10,000 a year - well below the poverty line - should have to pay any income tax at all.

Finally, the option that is ignored in the business press is that of increasing spending. The right wing is overjoyed that the deficit forced a serious reduction in the role of government in Canadian society, and it is doing its best to keep things that way. But the argument that the government should not increase its spending again is absurd. Canada's federal government program spending is now at its lowest level (in real terms) since the early 1950's, although it does far more now than it did in the middle of the century. The government has been starved of funds for a decade, and the negative effects of this are manifesting themselves in numerous ways - including many ways that undermine the work of business in Canada. No-one is advocating a return to the inefficient spending practices of the 1970's, but the Canadian government needs to return to normality after its long fast - to hire new blood, to give its most efficient employees a raise in order to keep them, to provide sufficient funding to the programs it has retained in order to make them function effectively. This is in everyone's interest, even business'.

What is important is that the government not fritter away the surplus on new programs that have no useful effect - that simply look impressive or subsidize groups of voters, as many old programs used to do. The government should introduce new programs, but they should be targeted and have a measurable impact. Here follow two proposals for effective ways to spend the government surplus.

A) A well-educated population will be vital if Canada wants to maintain its standard of living in the next century. However, tuition fees are skyrocketing across Canada, restricting access to higher education for a significant proportion of the population. The federal government should establish a loan fund of a significant size (billions of dollars), available to all students, that would be repayable based on post-graduation income (this could be administered through the tax system). Rather than the administrative hassle of working through banks and having them pay the students, the loans could be applied directly against the student's tuition fees (i.e. the money goes from the federal fund to the university). As repayment money began to come in, the fund would begin to be self-sustaining. Thus, post-secondary education would become permanently more accessible to Canadians, as the amount of tuition that they had to pay up front was reduced.

B) Canada's economy will undoubtedly go into recession again at some point. The government's infrastructure program was a popular measure to reduce the impact of the last recession. The problem, however, was that it was applied too late, and that the money was being spent when the government could least afford it, because its revenues were plummeting.

It would make sense, in the future, for the government to set up a "rainy day" fund while the economy was growing and the budget was in surplus. Money would be set aside in an independently administered fund (like the Heritage Fund in Alberta). When the economy went into recession, this fund would automatically be activated, to be spent on useful infrastructure projects which would add to the economy (ideally, chosen by independent fund administrators according to set criteria). While this would obviously not defeat a recession, it would at least alleviate its impact, and it would save the government from the paradox of needing to spend money the most when it can least afford it.

A further advantage of this fund would be that the government could adjust its contribution depending on how much surplus it ended up with each year. A wise way of proceeding would be for the finance minister to continue to set aside a contingency fund in order to ensure that no unexpected events moved the budget from surplus to deficit, and pledge to direct whatever money is left over from the contingency fund (i.e. the surplus at the end of the year) into the "rainy day" infrastructure fund.

(Sure, this is Keynesian - but as far as I know, no-one has ever tried the first part of the Keynesian equation, putting money aside when the economy is growing. So far, governments have generally spent all the money they have in good times, and then tried to spend their way out of recessions through debt. It is hardly surprising that didn't work very well, but it could work if done properly).

Of course, all of this speculation about the surplus may be premature. The reason the deficit is plummeting so quickly is that interest rates are low and growth is high. This could be reversed at any time. For instance, the last time Quebec held a referendum, growth stalled suddenly and interest rates went way up. This is likely to happen again in two years. If it does, the government will be lucky if it does not have to reduce spending again and raise taxes even higher.

September 1, 1997

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