The road to long term fiscal health doesn’t have to be cobbled with radical policies and painful measures.
Whatever voters and politicians decide government can or must do, government ultimately derives its money from the people, through taxation. If services demands or spending rise, taxes do too, reducing disposable income, and economic growth.
Tax-cutting has been falsely portrayed as not allowing for healthy revenue growth for government to do the things it alone can do. In fact, there is a way to lower the tax burden without any reduction in government services. Both economic growth and tax revenue can increase.
The means is GITaR, Gradual Income Tax Reduction. Since it is difficult to get large personal or corporate income tax cuts enacted, and such cuts cause apprehension of potential curtailing of government spending or servicesGITaR gives substantial, extended tax relief with scant harm to tax revenues.
The government (federal or provincial) would institute a 0.10 per cent to 0.25 per cent annual reduction in the marginal tax rate at each income tax bracket. Government revenue growth tracks the GDP growth rate in nominal (unadjusted for inflation) dollars. In the 4 to 5 per cent range for the past several years, it is likely to continue to remain so.
Taking the mid-point of that range, pre-cut taxable income would still grow at 4 – 5 per cent; each year can see a cut of 0.10- 0.25 per cent, and tax revenues can still grow at 4.24 – 4.4 pe rcent every year.
Given that service outlays only need grow in tandem with population growth and inflation, roughly 2.5 – 3.5 per cent per annum, it leaves room for government to do its tasks, reduce deficits, and, later on, debt. Also, economic growth could increase as consumers, firms and investors have more money to spend and to invest. Foreign investment, plus investor and professional immigration could rise too.
Such low, gradual reductions are not plausibly controversial or ‘extreme’. Thus, they should be viable in most political platforms. Once implemented they also become institutionalized, which makes it hard for politicians to rescind.
This approach is not entirely new. The Canadian federal government gradually dropped the GST rate and also phased in lower corporate marginal income tax rates without harmful effects. Even social democratic Sweden has done the same. GITaR can create a virtuous cycle, where lower tax rates create more growth and continually raise the actual and potential growth rates, creating jobs, and simultaneously raise everyone’s standard of living.
By contrast, raising taxes to ever higher levels in the pursuit of greater revenues induces a vicious cycle where higher tax rates subdue consumer and business spending as well as investment, slowing the economy. In addition, the after-tax return on future investment will decline for businesses, which will reduce further their investment in profitable innovation or expansion.
Lower after-tax personal employee income will also make employment less attractive and require employers to pay more in pre-tax wages to obtain and retain employees. Such conditions will tend to drag on hiring and make unemployment higher than it otherwise would have been. It will also dampen tax revenue growth.
Due to these effects, for any given increase in tax rates, the actual amount of tax revenue governments receive tends to be substantially less. In an extreme form, when rates escalate above a specific high marginal rate, government revenue will fall as rates rise (the Laffer effect).
It is already happening to countries that have implemented austerity to qualify for debt relief from the European Union. Many such countries could start growing again, with revenue loss, entering a virtuous cycle, if they implemented something like the GITaR concept.
Fortunately, it is definitely not too late for Canada, several of its provincial governments, and even for the United States to become more disciplined and adopt some version of GITaR, restoring them to healthier fiscal situations. Let’s see who has the courage, imagination, and conviction to take this GITaR and play a song of ever-increasing prosperity, to a cheering audience of beleaguered taxpayers.