Why lowering taxes can be beneficial... or not?
The taxpayer in me is happy, as well as the businessman, but the economist in me is more worried about the long-term repercussions of the recent tax cut announced by the Quebec government. Although tax cuts can have economic benefits, it is important to consider the potential risks.
We are not in a recession and we do not need to stimulate the economy.
A recession is a time when the economy is in decline and the unemployment rate is high. At the moment we are neither in recession nor our unemployment rate is high. So why cut taxes now?
During the last election campaign, the other opposition parties, knowing full well that they were not going to win the election, took turns promising tax cuts. The CAQ had no choice but to do the same and we are now stuck with a government that "must" keep its promise.
So the government agrees to deprive itself of 1.7 billion dollars in the hope of creating 16,000 jobs annually. That's JUST $110,000 per job. But what job? and why now?
In a full-employment economy like today, is it normal to gamble taxpayers' money on $110,000 jobs?
This type of measure is done in the most difficult periods
During recessions, governments have different ways of stimulating the economy, either through a tax cut or through the Keynes method.
The Keynes method
Named after British economist John Maynard Keynes , involves increasing government spending to stimulate demand. This method rarely works because it requires an increase in public debt.
There are several examples in Canada where the Keynes method has not worked as expected. For example, the federal government launched an economic stimulus package in 2008 to deal with the global financial crisis, spending heavily to stimulate the economy. However, this led to an increase in public debt and did not lead to a significant economic recovery.
Another example is the federal government's attempt to revive the Canadian economy in the 1970s , which led to high inflation and high interest rates. Despite massive government spending, the economy stagnated and public debt rose.
More recently, the Ontario government introduced an economic stimulus package in 2009 , which included massive spending to stimulate the economy. However, this did not lead to a significant economic recovery and led to an increase in public debt.
The tax cut then?
The impact of lower taxes on the economy is also an important factor. Studies have shown that, on average, 1/3 of tax cuts go directly into consumer spending.
Why cutting taxes can be risky
A matter of timing! We are announcing a tax cut, but it will start in the fall. The impact of the announcement will have very little impact because in the end the difference on the money available remains minimal. In order not to put yourself in financial "schnout", a beneficial tax reduction must be made when one of the following 3 conditions is met:
- In a recession (we're not there)
- Taxes too high (it's true! but our needs are too great for our revenue management wants)
- Public funds are well managed (which is not the case)
The medium and long term impact
If the tax cut does not stimulate economic growth, it may increase public debt. Governments may also have little control over how tax cuts are spent. We live in love and hope
Tax cuts can stimulate consumer spending, but it is possible that this spending is spent on imported products rather than local products. Will the tax payer use this new money in Quebec? There is no guarantee. And very likely that a part will go outside the country. I remind you that a dollar spent locally is equivalent to 2.5 dollars.
Let's look elsewhere
Unfortunately, past experience shows us that this method (lowering taxes) is not always effective, as evidenced by the examples of the United States in the 1980s, the United Kingdom in the 1990s and Germany in the 2000s.
In the USA:
Reagan's fiscal policy in the 1980s led to a sharp increase in public debt and a decline in long-term economic growth.
Thatcher's policies in the 1990s led to rising debt and prolonged economic stagnation.
Schröder's tax reform in 2000 led to rising public debt and economic stagnation.
Similarly, the current situation in Japan, characterized by prolonged disinflation since the 1990s, shows the limits of fiscal policy to stimulate the economy.
Beyond these historical examples, it is important to consider the economic mechanisms underlying the tax cut. Studies have shown that only a portion of tax savings is invested in productive projects. A significant portion is spent on consumption, which may temporarily stimulate the economy , but does not create long-term wealth . Moreover, lowering taxes can have negative consequences on the budget deficit and public debt, which can ultimately harm economic growth.
The economy is an ecosystem
Finally, it is important to remember that the economy is a complex ecosystem involving governments, individuals and businesses. Governments have few ways to stimulate the economy directly, but can do so by stimulating demand.
It is businesses that create jobs as long as they are competitive. And these companies create jobs when there is consumer demand. For the newly available dollars to be spent in Quebec, it is important to help businesses remain competitive and create local jobs.
What will be left for the government if our province falls into recession? What will happen if interest rates continue to rise in order to reduce the rate of inflation or give a boost to our dollar? Building bridges? Highways? This measure had to be used when the newspapers would have written in capital letters:
"WE ARE IN RECESSION".
We are not there, but since I have newly available money, should I buy a Chinese Air Fryer or Quebec products? hmmm...I'm going to do my part and choose Quebec products. And you ?