28 April 1997
Are Tax Cuts a Good Thing?
Tax cuts or more public spending? This is a question that will be preoccupying a lot of Canadians in the run up to the federal election.
Reform and the Tories are both promising tax relief as a main plank in their platform, while the Liberals are making vague references to possible tax reductions when the deficit is defeated.

In the minds of the public, however, opinion polls show continuing reservations about tax cuts. Many voters seem to want government to spend money on public goods and services. Yet they also continue to show concern about high levels of unemployment and limited economic opportunities. The economic evidence is pretty clear that these problems are linked, in part, to levels of taxation that are too high. So why the ambivalence about tax cuts?

Some voters, in a triumph of hope over experience, still cling to the view that public spending is motivated by the desire to do good, whereas individuals and companies are motivated by self-interest. Governments spend to employ people, to build public goods like roads and bridges, to make people better in our hospitals. The people spending the money do not stand to profit personally from the spending.

But it’s certainly not true that the politicians doing the spending don’t profit from it. On the contrary, politicians are driven by profit and loss. They just measure it differently. Politicians don’t maximize dollars, but rather votes. A successful politician gets more votes than his or her competitors at election time.

That’s why politicians are so poor at making sensible decisions when it comes to spending our money. They need to maximize their electoral benefit in the short term, every four years or so. Well-planned economic investments, however, frequently can and do take many years to bear fruit, just as it can take years for their real costs to become apparent..

That is why, for example, politicians so cavalierly overbuilt our hospital network in the 70s and 80s. Politicians realised no benefit from taking the long view, from assessing carefully whether each community’s claim to a hospital could be properly justified. They glossed over what hospital construction would entail in continuing operating costs over many years. They ignored doctors’ and patients’ clear preference for big city hospitals to the smaller local ones. The real cost of overbuilding those hospitals only became clear years, in some cases decades, after the construction was done.

On the other hand, the politicians who gave the go ahead to build were certainly photographed at the sod breaking ceremonies or handing over cheques to the local communities for construction. Projects like this win votes in local communities in the short run. And when the chickens come home to roost two or three elections later, it’s some other politician who is stuck with a painful problem to solve. Short-termism is the order of the day, no matter how damaging it may be.

Tax cuts mean that more money stays in the hands of the people who earned it in the first place. They are more likely than the politicians to spend that money in a way that produces more value for themselves, and hence for society as a whole.

The question then is, why do voters continue to reward politicians for their economic foolishness? Because public spending gives immediate gratification. Politicians can take taxpayer money and throw it at high profile projects with tangible results. If governments choose to build hospitals or bridges, they quickly rise, shiny, new, concrete. Their existence is entirely due to government’s decision to spend tax dollars. Cut taxes and governments do fewer of these projects.

Consumers who have more money in their pockets, though, do something quite different. After a tax cut, consumers might spend more on a host of small things, a new toaster, a better car, a long delayed trip to visit their folks in another province, etc. The tax cut alone doesn’t cause these choices to be made. It is likely to be the final push that makes a consumer feel well off enough to spend on something new. The money will be split too between savings and immediate consumption. So the stimulative effect of tax cuts, while more powerful for the economy as a whole, doesn’t attract the same kind of direct credit for politicians.

Public spending will beat out tax cuts almost every time, because politicians realise the benefits of spending today, and can put off the costs until tomorrow. Pity