Don’t tax our way out of pandemic debt

The COVID-19N pandemic has created a huge government debt. There are traditional ways of dealing with debt: by slashing spending, raising taxes, or a combination of both.

Image: BMG DIY Investor

Canadian Taxpayers Federation has raised alarm of a possible tax on the sale of homes. They point to a study by the Canadian Mortgage and Housing Corporation which spent $250,000 to investigate such a tax.

Fear not. Such a tax is not going to happen any time soon, if at all.

Canada’s finance minister, Chrystia Freeland, recently outlined her approach to debt and it will not be to raise taxes or cut programs. In fact, spending on programs to help Canadians get through the pandemic will increase. She said: “To ensure that our recovery is as broad, robust and complete as possible, we will need to build our way out of it.”

The new way of thinking of debt is called “modern monetary theory,” which posits that large deficits are not a bad thing as long as inflation and borrowing rates are low.

I can remember the disastrous “bloodbath budgets” of Liberal Finance Minister Paul Martin in 1997. Martin warned that we were about to become a Third World country unless something drastic was done.

Drastic cuts to government programs were made. Sure, we reduced debt but cuts to medicare left us less prepared for the current COVID-19 pandemic.

And Martin’s cuts were not what saved us. Rather, we rode on the coattails of a strong U.S. economy. The U.S. economy was strengthened, not by austerity, but by President Clinton’s stimulus spending and by his application of monetary policy such as lowering interest rates.

These are not the nineties and economy-strangling austerity won’t work. Lowering interest rates is not an option when rates are virtually zero. “With interest rates approaching zero,” said Freeland, “monetary policy is running out of bullets. That puts the onus squarely on fiscal policy to grow our way out of this recession.”

A number of factors make a new response essential. The first is that in the nineties, interest rates were so high that 35 per cent of government revenue went to pay interest on the federal debt. Now, even with the government heavily in debt, only one per cent of government revenue goes to servicing the debt.

Raising taxes now would be a mistake says Frances Donald, global chief economist at Manulife Investment Management: “The idea that we’ve spent a lot of money and therefore taxes need to go up is overly simplistic in a new complicated world with extraordinarily low interest rates for a long period of time.”

We don’t have to offer high interest rates to attract foreign purchase of government debt: 80 per cent of Government of Canada bonds are held by the Bank of Canada. We hold the debt.

Debt only becomes a problem when inflation rises, and inflation only rises when the economy strengthens which is not going to happen anytime soon. In September, the year-over-year inflation rate was just 0.5 per cent.

The weak economy itself is another reason to avoid tax increases. Higher taxes leave individuals and businesses with less to spend.

The way out of this economic slump is investment in people and businesses, not by raising taxes.


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