John Lester is an executive fellow at the University of Calgary’s School of Public Policy, and a contributor to the Finances of the Nation project.
Over the course of this year, the COVID-19 pandemic has caused the most severe recession in Canada since the Great Depression. Employment earnings fell sharply as workers lost their jobs or saw their hours reduced. The federal government correctly acted to cushion the impact on household incomes. But in its haste the government set the stage for a massive overcompensation of earnings losses that compromises fairness and limits options for using fiscal policy to strengthen the recovery.
In a recent study for the Finances of the Nation project, I found that earnings fell a cumulative $53-billion below their expected value in the first three quarters of 2020. Federal income replacement transfers – Canada Emergency Response Benefit (CERB), student benefits and continuing EI claims – amounted to $100-billion over the same period, a stunning $47-billion more than the earnings loss, or $1.90 in transfers for each dollar in lost income.
I estimate 20 per cent to 25 per cent of these transfers will be recovered in federal and provincial taxes. But the overcompensation rate won’t change much if both earnings and transfers are measured after taxes.
This massive overcompensation is primarily the result of a CERB design feature. Unlike traditional earnings replacement programs which link the size of benefits to prior earnings, CERB transfers featured a fixed weekly payment of $500 for all recipients. In addition, recipients were able to earn up to $1,000 per four-week claim period without affecting benefits. Finally, pandemic-related job losses hit low-income earners more severely than other workers, which raised the potential for overcompensation.
While there is no indication overcompensation was an intended outcome, the government could have linked CERB payments to prior earnings when it became aware of the issue – possibly as early as April, and certainly by June – but chose not to. Further, the successor programs to CERB – enhanced access to EI, the Canada Recovery Benefit for persons not eligible for EI – both feature a minimum payment of $500 a week, confirming overcompensation is not viewed with concern.
Former finance minister Bill Morneau stated that the three key guiding principles used in setting up the COVID-19 response plan were speed, scale and simplicity. Linking the size of CERB payments to prepandemic earnings would not have compromised these principles. To achieve speed, a “trust but verify” approach was applied to CERB. To qualify for benefits, applicants affirmed that they earned more than $5,000 in 2019, or in the preceding 12 months, with the understanding that verification could follow. Asking for the specific level of prior earnings in a trust-but-verify environment would not have compromised the need for speed.
The fall economic statement implicitly defends overcompensation as a means to bolster the recovery. The generous income support programs contributed to a huge rise in the savings rate, which increased from 2 per cent at the end of 2019 to 27.5 per cent in the second quarter of 2020. The statement describes these additional savings as a “preloaded stimulus.”
Preloading the stimulus is poor income-stabilization policy. Exactly compensating people for income losses runs no risk of overstimulating the economy, but overcompensation does. The contrast with the plan to carefully assess the need for up to $100-billion in targeted stimulus over the next three years is striking. In contrast to the ad hoc acceptance of overcompensation, the government plans to set up “fiscal guardrails” and use “data-driven” triggers to determine when the planned fiscal stimulus can be wound down.
Overcompensation in the first round of income support measures and a similar outcome in the second round will limit the options that can be considered as part of the additional targeted stimulus. The fiscal guardrails may come up sooner than expected, causing overcompensation to squeeze out federal spending that may be more effective and be better targeted to struggling Canadians.
Tilting fiscal stimulus toward low-income individuals can make expansionary fiscal policy more potent since people on low incomes are more likely to spend the transfers – albeit with a lag – than high-income individuals. Providing more support for people with low incomes can also be defended on fairness grounds, if all persons with low income had benefited. But overcompensation only benefited some low-income earners. It did not benefit those individuals who kept working and those who continued to receive EI benefits during the downturn. Fairness is subjective, but few would argue that some members of society – in this case a subset of low-income earners – should be better off because of the recession while others (including some low-income earners) suffer an income loss.
As a form of preloaded stimulus, overcompensation fails a basic fairness tests and consumes resources that could be spent more effectively later. Overcompensation is a major design flaw in Canada’s pandemic response.
Your time is valuable. Have the Top Business Headlines newsletter conveniently delivered to your inbox in the morning or evening. Sign up today.