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Thursday, March 24, 2016

The Radical Status Quo Canadian Federal Budget

The Canadian Federal Liberal Party, led by Justin Trudeau, unleashed its first budget this week (link to information page). Although the Canadian financial media played up the increase in the deficit (one major media outlet ran an article "Welcome back to the age of big government in Canada," which is a more sensationalist headline than even this random blogger uses), I am actually impressed at how radically the budget returns Canada back to the status quo. If you want to do long-term forecasting, this is a sign that projecting current policy settings forward is not particularly naive.

Big Picture Impact

The impact of the announced changes are summarised as (budget, page 49):
The Department of Finance estimates that the measures contained in Budget 2016, along with the middle class tax cut announced in December 2015, will raise the level of real GDP by 0.5 per cent in the first year and by 1.0 per cent by the second year, compared to what would have been the case without these measures. This is expected to translate into 100,000 jobs created or maintained by 2017–18
Although that sounds like a relatively large economic stimulus, their analysis has the embedded "all else equal" assumption. Since we only a vague idea of what the level of the real GDP growth rate will be in 2017-2018 to begin with, we have no way of knowing whether it was raised (or lowered) by 1% by these budgetary changes.

If the Canadian housing market deteriorates, these budget changes will be a drop in the bucket. By contrast, if the Canadian economy continues to muddle through, the "automatic stabilisers" in the public and private sector would probably prevent the economy from growing much faster than what most economists consider the "trend" growth rate. The existence of these stabilisers means that discussions whether the growth rate will increase by 1% versus 0.6% (or whatever) moot.

I cannot claim to have done an exhaustive analysis, but I saw nothing within the plans that indicated that the true impact of the budget plans would be much different from the estimates provided by the Ministry of Finance.

Structural Inertia Wins

Source: Canadian Federal Budget 2016. (Note: does not include effect of tax credits.)

The chart above highlights the incrementalism that is in play. Dropping the second-lowest marginal tax rate to 20.5% from 22%, and creating a new 33% high income bracket (from 29%) is not going to engineer an end to inequality. A steeply progressive income tax system was flattened out in the post-war era, and we are now seeing some incremental re-steepening of the marginal tax rate. The discussion of income tax rates now involve 1% increments, not 10%.

Since most of my readers are not Canadian, it should be noted that this is just the marginal tax rate for Federal income taxes only; there is a provincial income tax which is added on top. Those tax rates vary greatly across Canada; the Texan-wannabes in Alberta face much lower all-in marginal tax rates than those of us semi-Scandinavian Welfare Staters in Qu├ębec (which is reasonable, as we have a fjord). The provincial governments have a big economic footprint, unlike U.S. states, and the divergence in their policy stances tends to limit the policy space for the Federal government.

(Additionally, the marginal tax rate chart is somewhat misleading for foreign readers who are not familiar with the details of the Canadian tax system. It shows the tax rates, but not the effect of tax credits and source deductions, such as for the Employment Insurance -- Canada's rebranded unemployment insurance scheme. Roughly the first $10,000 of income is cancelled out by a tax credit, so there is effectively a 0% marginal tax bracket that is not shown. Meanwhile, the various source deductions are regressive, counter-acting the progressive income tax rates.)

There Goes Harper's Reforms

  • The budget announced the plan to repeal the Federal Balanced Budget Act (page 53). (Repealing that Act in the first budget provides everyone with a lesson in elementary Canadian civics; one parliament cannot bind the hand of future parliaments in that way.)
  • The highly visible payments by cheque to families with children -- "Harper Dollars" -- were folded into a new system of family benefits.
  • The Old Age Supplement eligibility is going back to age 65 (page 173).
The welfare state programmes that have survived to the present day are popular, and highly robust to attempts to reform them out of existence. As a result, we have reason to believe that institutional inertia will predominate over the long term.

Pension Reform

There is some discussion of enhancing the Canada Pension Plan. Since any changes would need to be negotiated with the provinces (quelle surprise...), it is too early to write anything about it. The Federal Government will enhance transfers for the poorest, which was an easy option, as discussed in this article about the Canadian pension system.

Tighter Tax System

The Budget indicates a desire to crack down further on tax avoidance. (Technical note: tax avoidance has a technical meaning in Canadian tax law, defined by the General Anti-Avoidance Rule. Tax evasion is activity that is downright against the tax law. Tax avoidance consists of transactions that are technically legal, but the economic activity only makes sense as a means to avoid paying tax. The transactions are treated by the government as the equivalent transactions that incur a higher tax rate.)

This is not a new trend in Canadian tax policy; how effective the measures can be may depend upon the cooperation of foreign governments. (Most of the various tax dodges that are being exploited now rely upon international transactions.) 

Middle Class And Infrastructure

The Federal Liberal Party knows exactly where the voters are; the budget document was titled: Growing the Middle Class, and the expression "middle class" showed up 113 times within the PDF. 

From 2016 Federal Canadian Budget, page 11.
The Budget starts off with a discussion of inequality, including the chart above. Considering that the Federal Liberal Party was in power for a significant part of this period (particularly during the wage stagnation in the 1990s), this is somewhat ironic. As a result, there are a lot of goodies for the middle class.

However, it is much clear that there is much help for those with incomes below the middle class. (There are programmes for Canada's indigenous population; I am not really in a position to comment on how effective they will be.)

For example, there is a good deal of emphasis on infrastructure spending. Although Canada probably needs to step up its infrastructure spending, I have my doubts about infrastructure spending as a tool of aggregate demand management. We are no longer handing out shovels to gangs of unemployed men; modern infrastructure work is capital-intensive, and the workers are relatively highly paid. This means that infrastructure spending is a poor tool for aggregate demand management, as was argued by Hyman Minsky in the 1960s. This is discussed in articles republished in Ending Poverty: Jobs, not Welfare (link to my review).

It is politically popular to create "good" jobs, and highly paid, skilled infrastructure work creates a handful of such jobs. However, people who are working at a low wage -- or not at all -- need a tightening of the market for unskilled labour (presumably "bad" jobs). No politician wants to say that they want to create "bad" jobs. The end result is widespread underemployment and high inequality amongst workers (without even taking into account the inequality between the top and the bottom of the income distribution).

I fail to see anything in the budget that directly addresses the problems created by the two-tier labour market, and so there is no reason to expect the problems with persistent underemployment going away. This underemployment helps create the economic drag that has been diagnosed as "secular stagnation."

(c) Brian Romanchuk 2015


  1. Thanks this is great. And thanks for the reminder about our fjords!

    About your last point on jobs: there's few things more important in mainstream discourse on the economy than reorienting toward the use of 'net new jobs'.



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