Government financial support for the economy in the pandemic is essential, but it’s going to cost us all.
Higher taxes seem inevitable. It’s hard to see how the economy will grow its way out of the huge deficits that governments are racking up, which means spending cuts and tax increases have to be considered by all levels of government.
Near term, pandemic personal finance is a story of those who have a job and steady income and those who do not. Years from now, both groups may find themselves united in dealing with the cost of the pandemic through some degree of higher taxes.
Stay calm, now. If governments apply a heavy hand to taxation, they’ll smother the economy and worsen their revenue shortfalls.
“Any net increase in taxes is going to withdraw from the economy and stand in the way of getting the economy back on track,” said Don Drummond, an adjunct professor at the School of Policy Studies at Queen’s University and a senior bureaucrat in the Department of Finance when the deficit-busting budget of 1995 was drafted.
Mr. Drummond said the most harmful form of taxation for the economy is a tax on capital, which applies to corporate wealth rather than income. Next, come corporate income taxes and personal income taxes. “A properly designed sales tax is always the least harmful,” he said.
While he considers it flawed, Mr. Drummond sees the GST as being a better option for increasing tax revenue than personal or corporate tax increases. The federal government lowered the GST to 5 per cent from 7 per cent starting in 2006. Kicking it back up to 7 per cent, with increases in GST rebates for low-income people, is an obvious option for the federal government at some point.
Another avenue for raising revenue is to increase taxes on the wealthy. So expect frantic speculation about an increase in the capital gains tax in the run-up to the next federal budget. You must pay taxes on half the gain when you sell an asset for more than the purchase cost. Nudging the inclusion rate to two-thirds or three-quarters is certainly possible, even if the benefit to government revenue would be minimal.
“You don’t get much money out of doing that,” Mr. Drummond said. “The money just disappears – it gets booked somewhere else.”
The government of Canada’s most recent annual financial report, for 2018-19, shows that the GST accounted for 11.5 per cent of revenue, while corporate taxes were 15.2 per cent and personal income taxes were 49.3 per cent (the rest was mostly a mix of other taxes, duties and revenues). However the federal government chooses to increase revenue through taxation, expect a take-it-slow approach to deficit reduction.
“I don’t think this is getting paid back any time soon,” Mr. Drummond said. “I think it would be a disaster to attempt to do that.”
In fact, Mr. Drummond believes a second round of government support for individuals and business will likely be needed before the economy stabilizes. The government’s mission from there is to do what it can to get the economy back on track, a process that could take as long as five years.
Back in the mid-1990s, the federal government’s drive to beat the deficit was helped by strong economic growth that came in around 3.5 per cent. Today, Mr. Drummond said the economy’s potential growth rate is closer to 1.5 per cent. The potential growth rate is a sustainable maximum level of output where inflation is contained and employment levels are high.
The mid-1990s deficit was also beaten down through spending cuts and downloading costs to the provinces, Mr. Drummond said. There’s less room for cost downloading now because provincial spending to fight the pandemic has soared, too.
Falling interest rates further helped improve government finances in the later 1990s. Here, we finally arrive at one advantage the current government has. The extensive borrowing needed to fund support programs for individuals and business can be done at rates very close to zero.
Whatever choices governments make to get their finances in order, expect it to drag on and on. Every federal and provincial budget for years to come will demand attention to see whether it contains tax measures that affect our personal finances. “We could be well over a decade dealing with something that basically hit us over a five-month period,” Mr. Drummond said.
Stay informed about your money. We have a newsletter from personal finance columnist Rob Carrick. Sign up today.