Ten Tax Myths

 T hose calling for major tax cuts have anticipated that public support for social programs translate into public resistance to cuts — so they claim we can have both. This seemingly contradictory argument promises the sky: lower taxes (appealing to tax-cutters) and more revenue (appealing to those concerned about funding for social programs.) It is an attractive idea, except that it’s a promise that can’t be kept. In times of high economic growth rates, revenue can increase in spite of tax cuts. But there is simply no evidence that revenue increases because of tax cuts.

This argument is part of the ideological arsenal of what in the 1980s were called economic “supply-siders.” Until the advent of these neo-liberal economic theorists, it was widely accepted that it was the level of demand in an economy that determined whether or not economic growth took place. Up until the late 1970s, governments were concerned about the level of unemployment because people who weren’t working weren’t spending money in the economy (or were spending less) and that meant “demand” was down.

It also meant that tax revenue was down because unemployed workers paid less in taxes, as did companies selling fewer goods and services and making lower profits. Policies to lower unemployment were seen by “demand-siders” as the way to increase tax revenue.

Supply-siders, on the other hand, argued that, if you freed up money by lowering taxes on the wealthy, they would invest that money (to make more money) and in the process create new productive capacity. In other words, if you stimulated the supply side of the economic equation (create more goods and services and people will buy them), the economy would grow and so would tax revenue (as well as jobs and investment).

In this scenario, the stimulation of demand was much less important, and in fact the whole question of unemployment became less important. Controlling inflation was seen as paramount because inflation ate into the value of assets, which were the key to supply-side stimulation.

When the numbers were in, particularly in the U.S. where this economic experiment was conducted with the greatest enthusiasm, the supply-siders were simply proven wrong. President Ronald Reagan made major tax cuts, claiming they would stimulate growth and increase government revenues. Instead, over Reagan’s two terms, revenues fell and annual federal deficits and resulting debt soared to record levels. The wealthy did not go on an investment spree. Far from it. Gross investment in relation to total GDP actually fell. Supply-side policies were subsequently ridiculed as “voodoo economics” by pro-business U.S. President George Bush.

A recent study conducted by the B.C. office of the CCPA came up with similar conclusions about tax cuts and revenue growth. In A Tale of Two Provinces: A Comparative Study of Economic and Social Conditions in British Columbia and Alberta, Seth Klein and Catherine Walshe show that government revenues grew faster in B.C., where tax cuts were minimal, than they did in Alberta, where tax cuts were deep and extensive.

The study revealed that, while revenue in both provinces grew between 1993-94 and 1996-97, it actually grew faster in B.C. than it did in Alberta. This was the case even though Alberta enjoyed faster economic growth, and growth in corporate profits. Both corporate and personal income tax revenues increased at a slower pace. Given that the Alberta economy was growing due to other factors (the ideal situation for the supply-side theory to prove itself), the fact that revenue grew relatively slowly suggests that supply-siders have it completely wrong. The evidence suggests that tax cuts had exactly the effect one would expect: they slowed revenue growth well below the pace it would have achieved without the cuts.

The decline of revenue from general tax reductions is paralleled in the record of selected tax breaks for corporations. Here, too, tax breaks failed to encourage new investment. Responsible CEOs don’t invest in new plant and equipment unless they know there is potential new demand for their goods. But, of course, corporations and the wealthy will happily take advantage of tax loopholes and tax cuts if governments are misguided enough to offer them.

The evidence over the years suggests that revenue increases as population increases (increased demand) and as real economic growth occurs. The latter is determined by domestic demand and by the demand for exports, and by where we are in the business cycle. Tax cuts can do nothing to change the lowered demand for Canada’s natural resources caused by the Asian economic crisis. Lowering high-end taxes in this situation has a completely predictable effect: lower government revenue.

Ten Tax Myths