The political appeal of tax hikes rather than spending cuts during an election is clear. Even still, the best way to get out of Canada’s deficit situation is to cut spending, writes Philip Cross in the Financial Post. Below is an excerpt from the article, which can be read in full here.
By Philip Cross, August 20, 2021
No party is irresponsible enough to pretend that the record $354 billion deficit run up in the past year is sustainable. So it is easy to formulate the key economic question of the federal election campaign: how will the main parties distribute lowering the federal deficit between less spending and higher taxes? While popular discussion associates austerity exclusively with spending cuts, tax hikes equally represent fiscal tightening.
Economists know the best way to reduce deficits is to rely primarily on spending cuts and not tax increases. An IMF study in 2018 by Alberto Alesina, Carlo Favero and Francesco Giavazzi followed these two main policy regimes in OECD countries between 1981 and 2014. Their conclusion is that “expenditure-based plans generally were less harmful to growth than tax-based plans.” This clearly contradicts the message permeating retail politics that spending cuts are harsher than tax increases.
Furthermore, during a period when the economy is growing as Canada’s currently is, relying primarily on spending cuts meant “output costs were zero, on average.” In other words, spending restraint did not have the “slash and burn” effect on overall GDP that scare-mongering critics claim when denouncing austerity. Canada’s experience in the 1990s was cited by the IMF as a prime example of what it called “expansionary austerity.” The federal government relied on spending reductions to accomplish over 80 per cent of its deficit reduction in the mid-1990s, very much in line with the IMF’s recommendations.
Conversely, the IMF concluded that “tax-based fiscal corrections were associated with large and long-lasting recessions.” Far from cushioning the effects of austerity, proponents of tax hikes rather than spending cuts are advocating a policy that lowers incomes and raises unemployment. Apparently such a point is too subtle for policy debates during an election.