The term “tax fairness” means different things to different people. These days, it is generally employed by progressive politicians and economists who favour increasing taxes on the wealthy, whom they accuse of not contributing their “fair share” of government revenues.
Prime Minister Justin Trudeau and Finance Minister Chrystia Freeland belong to this school of thinking and rarely miss an opportunity to remind us that they intend to make the rich pay. But so far, their rhetoric has not translated into much concrete policy. Mr. Trudeau did raise the top federal personal income tax rate to 33 per cent from 29 per cent shortly after taking office in 2015. But that move was rooted more in politics than tax fairness.
The Parliamentary Budget Officer estimated in 2016 that the increase in the top federal tax rate, combined with a tax cut for lower-income Canadians, would result in less overall tax revenue for Ottawa. While it is difficult to separate the precise impact of those tax measures from others the federal government has introduced in the past five years, it is widely accepted by mainstream economists that raising tax rates on the rich can be counterproductive: The behavioural responses of the wealthy to higher taxes, which include moving income and investment to lower-tax countries, end up reducing governments’ coffers.
It took most governments a long time to admit this. Tax rates soared in the aftermath of the Second World War. But by 1980, when the top U.S. marginal income tax rate stood at 70 per cent, it had become clear that higher tax rates did not always translate into higher revenues.
Under President Ronald Reagan, Congress cut it first to 50 per cent, and then to 28 per cent. While many economists believe Mr. Reagan went too far, his tax cuts fueled the economic boom of the 1980s and radically changed the way governments thought about tax policy.
No economist contributed more to this evolution in economic theory than Robert Mundell, the Canadian-born Nobel laureate who died in Italy this week at 88. “Supply-side economics made the argument that steeply progressive tax rates reduced the size of the pie to be distributed,” Mr. Mundell said in 2006. “The poor might be better off with a smaller share of a larger pie than with a larger share of a small pie.”
Mr. Mundell was best known for his theory of “optimum currency areas,” which served as the basis for the 1999 creation of the euro. After witnessing the harm inflicted by wild currency fluctuations and inflation-inducing devaluations, he also believed that Canada and Mexico would be better off tying their currencies to the U.S. greenback.
“Monetary tinkering in Canada has led, on balance, to this very sharp depreciation of the currency,” Mr. Mundell told the Globe and Mail in 1999, when the loonie was trading below 70 cents (U.S.), not far off its record lows. “If Canada had had a fixed exchange rate since 1949, when it had parity with the [U.S.] dollar, it would have kept that rate and would have had the same inflation rate as the United States, and [Canada] would have had a better monetary policy.”
The iconoclastic Mr. Mundell was hard to pigeonhole, and he was often at odds with both of the dominant late-20th century schools of economic thought, Keynesianism and monetarism. He was no ideologue. Though his name came to be associated with the supply-side economics of the Reagan era, he was largely a political agnostic and called it as he saw it.
“Any tax rate, once it gets above 30 per cent, becomes counterproductive. It inhibits growth and therefore reduces future tax revenues,” Mr. Mundell told CBC Radio in 1999. “When a country has higher tax rates than its neighbours, you suffer from brain drain.”
Governments across the developed world need to keep Mr. Mundell’s wisdom in mind as they seek ways to pay off their COVID-19 debts. So far, however, most remain in denial.
U.S. Treasury Secretary Janet Yellen’s call this week for a global minimum corporate tax rate is nothing more than a political move aimed at distracting attention from the tough fiscal policy choices the Biden administration faces as it seeks to pay for popular spending programs. Governments in high-tax countries, such as France, naturally love the idea, since it would give them cover to tax their citizens even more.
Even if a global minimum corporate income tax rate were possible – a very big “if” – it would inevitably become moot as individual countries moved to create loopholes or cut capital and payroll taxes to gain a competitive advantage. Ms. Yellen, of all people, should know that.
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