Archive for the ‘Debt and Taxes’ Category

Debt And Taxes

September 1, 2009

Debt and Taxes

“It is absurd to say that our country can issue $30 million in bonds and not $30 million in currency. Both are promises to pay, but one fattens the usurers and the other helps the people. If the currency issued by the Government was no good, then the bonds would be no good either. It is a terrible situation when the Government, to increase the national wealth, must go into debt and submit to ruinous interest charges at the hands of men who control the fictitious value of gold.”

Thomas Edison


The debt this paper is dealing with is Canada’s accumulated budgetary deficits (ABD).

The absolute debt is rather meaningless unless we have something to compare it with. For example, an absolute debt of $13 billion in 1945 was huge, but an absolute debt of twice that much in 1975 was about as low as Canada’s debt gets.

Although it is by no means perfect a comparison with Canada’s gross domestic product (GDP) is one most often used.

The accumulated budgetary deficit is the debt that is generally used by economists, chief executive officers and governmental officials. Most of the time, these self-appointed pundits sing in three-part harmony. Their refrain is, if we want prosperity we must get everything down. By everything they mean taxes, government spending, debt, inflation and interest rates. In fact, a slow rise in inflation isn’t necessarily a bad thing, and a rise in interest rates may at times be needed to slow inflation. But as we shall see, keeping them low won’t spark a recovery if the government keeps reducing spending, taxes and debt.

Despite the pundits who embrace economic policies of comprehensive reduction (austerity), the free enterprise economy we live in does not respond positively to a diet of reduction.

For the past one hundred years, Canada’s debt, even huge debt, has never been responsible for economic stagnation. It is always the other way around; economic stagnation (and war) causes the debt.

So let’s run this hypnosis’s though the laboratory of history starting with 1913. That year Canada’s debt was as low as it had ever been, and lower than it has ever been since, standing at 12.2% of GDP. A year later World War I broke out and became one of the two causes of Canada’s debt. When the war ended in 1918 the debt was more than double -29.4% of GDP. Immediately depression set in and lasted four years.

At this point the attentive reader might well ask, “Wait a minute, the hypothesis is; debt does not cause economic stagnation, but now a big increase in debt resulted in a depression. How can this be?” Fair enough. The war caused the debt, but not the depression. If the debt caused the depression then surely it would follow that a recovery would have to be sparked to reduce the debt. But that did not happen. By 1921 the wartime debt had doubled to 62.4% of GDP. Only when government, business and consumer demand, delayed during the war, made itself felt after 1921 did Canada experience “the Roaring Twenties”.

Whereupon the government balanced the budget and made faltering steps to pay down the debt. By 1929 the debt in absolute terms was slightly less than it was in 1921 when the post war depression gave way to recovery. But instead of being 62.4% of GDP as it was in 1921, the debt in relation to GDP was close to half that and stood at 34.8%. Economic growth over eight years had reduced the significance of the debt by half.

At that point, the wheels fell of the economic wagon.

It came with a whimper and ended with a bang. The greatest depression history has recorded lasted for ten terrible years. The magic nostrum of lower everything was prescribed in large doses by the government with devastating results. The conservative pundits had all their ducks in a row; low taxes, low government spending, relatively low debt, low interest rates and low inflation. The patient got sicker and sicker and in the end the medicine that worked was high taxes, huge increase in government spending and price controls, (The Wartime Prices and Trade Board).

When World War II broke out, the federal coffers were empty. There is a story, probably true, that C.D. Howe, Canadian minister of munitions and supply, called together all the movers and shakers in industry and government to ask what they could do to contribute to the war effort.

Their response was, the answer depends on how much money he could make available. Howe allegedly replied “You tell me what you can do and I’ll see that you get the money”.

It is not known if that is exactly how it happened but we do know that is what he did. For ten long depression years, under the policy of lower everything, there was no money for anything and then overnight there was money for everything necessary for war.

At the end, after ten years of depression and five years of war Canada’s infrastructure was in a shambles and the national debt stood at 110% of GDP. The debt was higher than it had ever been before or since. If ever there was a recipe for depression his should have been it.

Indeed, like the depression that followed World War I, an incipient depression loomed in1945. But this time the government understood the historical lesson. It knew Canadians would not stand for another depression, so it loosened the purse strings again and set Canada on the road to its greatest recovery. Now everything seemed possible. Thirty years later we had a modern country that Canadians could be proud of. We had built the St. Laurence Seaway and the Trans-Canada Highway and huge hydro dams, for example. We also had social services such as Medicare and Canada Pension Plan. As well, there was huge spending by our provinces and municipalities.

At the beginning of this great recovery the Liberal government balanced the budget and started to pay down the debt. This continued until 1957, the year the Diefenbaker Conservatives government was elected. Under Diefenbaker the debt was allowed to increase and the same policy continued under succeeding Liberal governments.

The most interesting point in this chronology is the year 1976 – thirty years after the Second World War ended. In 1946 the debt was about $13.4 billion (110.3% of GDP). By 1976 the debt was over double what it was in 1946, standing at $28.5 billion, but only 14.4% of GDP. Think of it. Canada had gone through a crippling ten year depression followed by a money-hemorrhaging war and then thirty years of government spending, and in the end the debt had withered. How could this have happened? There are only three possible explanations. One is that it is magic; another is that it is an act of God and the third is what economists call “the velocity of money” or “the multiplier effect”.*

Alas, now the era of stagnation begins under the strategy of neo-liberalism. Under the Trudeau government (with a short interruption by the Clark government) the debt rose from $32.5 billion (15% of GDP) in 1977 to $165.5 billion in 1984 (37% of GDP) – an increase of $133 billion.

Now let’s have a drum role for Brian Mulroney. He came to power in 1984 and when he retired in 1993 he left a debt of $470 billion – a whopping $305 billion increase that now stood at 64.8% of GDP.

How did this happen? Fortunately Brian Mulroney asked the same question and set out to find the answer.

Mulroney asked the Finance Department to study and report to him on the causes of the debt. H. Mimoto and P. Cross were assigned the task. Their 1991 report revealed that 94% of the debt was caused by two things: high interest rates and lower taxes. Only 6% was caused by increased government spending and only 2% of that was social spending.

The debt continued to rise under the Chretien government, peaking at about $560 billion in1996 (69.8% of GDP). True to form, now that the debt was at the highest point since the Second World War, the economy turned around and the Chretien, Marten and Harper governments recorded surplus budgets and started to pay down the debt. By 2007 the debt had been reduced to about $450 billion (32.9% of GDP) and then the wheels fell off again. It was known as a worldwide economic meltdown.

It has been said that capitalism will never fail because socialism will always stand ready to bail it out. The world wide response to the meltdown is testimony to that.

Most banks were broke or teetering on the ledge of insolvency.

World Central Banks responded by printing money like it was going out style.

Canada’s response came in Finance Minister Jim Flaherty’s budget, introduced Oct.14, 2008, just four days before the federal election. It contained a two-part strategy; (a) a bailout for the banks and loans for the automobile industry and (b) an economic stimulus package and vote stimulating tax cuts.

Now, six years later, our debt has risen by $150 billion and the Debt/GDP ratio has remained static at about 33%.

Harper is predicting a balanced budget before the election in 2015.  Will his prescription (Lower everything) lead to prosperity or will debt, as the hypothesis suggest, have to get much bigger before we see a recovery?

It should be acknowledged that even under the rule of capital there is a better way. The wealth of any nation is its natural resources and a population with the skills to exploit them. Canada is rich in both. In a sane world, anything physically possible could easily be made financially possible. We have the power through taxation to keep any one of us from becoming too rich and to keep the rest of us from becoming poor.

Canadians are suffering under the failed neoliberalism of Maggie Thatcher and Ronald Reagan; now embodied in Stephen Harper. The Left should be getting the message out to the sixty percent of voters who haven’t supported Harper, that lower taxes and lower government spending has not led to a fairer, more just society.

* The Multiplier Effect

Let’s suppose the federal government has a surplus of $15 billion. It has about three choices for what it could do with the money. It could pay down the debt, it could reduce taxes or it could spend the money on something. If it paid down the debt it could avoid the annual interest payment. If it reduced the taxes in order to eat up the surplus it would reduce government income for the next year and all the following years unless it raised taxes again. In my opinion the third option is a wiser choice; spend the money on something.

Now let’s suppose that the government spends all of the $15 billion on public housing. This is new money being injected into the economy. All the workers who build the houses now have incomes that they wouldn’t have received if the government had used the money to reduce debt or reduce taxes, as only the government can build public housing or things such as roads, bridges, etc.

Here’s where the multiplier effect comes in. When the government pays the plumber for plumbing the new houses, the money becomes income in his hands and is therefore subject to taxation. The plumber will spend the money in several different directions. If he hires a carpenter to build him a deck, then that money become s income to the carpenter and is also taxed. If the carpenter hires an electrician to do some wiring in her garage then that money becomes income and is taxed. We can see that the original money paid to the plumber can get passed around several times during the year and each time it is taxed by the government.

Some economists say that the money gets passed around on average about seven times within a year. Even if this were so, there is sill some of this money that would not be taxed. Imagine an extreme example of someone taking his wages and going to Las Vegas and blowing it all in a casino. Very little of that money would be available for the Canadian government to tax.

Just to be safe let’s say there is a multiplier effect of four times but all of it is taxable. This means that the original $15 billion of new spending will generate $60 billion ((4 x $15 billion) of economic activity. If, for example, the federal government were to tax the $60 billion at 16 2/3% and the provincial government at 8 1/3%, the total tax would be 25%. Twenty five percent of sixty billion dollars is $15 billion.

Now let’s review. We as taxpayers invested $15 billion in public housing and got all of it back through taxation. Our national debt went down as a percentage of our GDP because of the $60 billion of economic stimulus. As well the new housing will provide permanent jobs for maintenance, administration, etc., which increases the government’s tax base. We also have a new asset worth $15 billion and hundreds of new dwellings for Canadians.

In case you think this is too good to be true; it gets even better. If half of that $60 billion is spent on things that qualify for the Goods and Services Tax, then the government will have additional revenue of $1.5 billion (5% of $30billion). This is enough to pay two years interest on the $15 billion debt that we wisely decided not to pay down in the first place.

Now I’m about to reveal the best kept secret of all. All those billions of dollars that Canada has paid servicing the interest on its national debt could have been easily, painlessly avoided.   That’s right. Canada wouldn’t have to borrow the money from the commercial banks in the first place. We have a bank of our own called the “Bank of Canada” that will lend us money practically interest free.

Political parties are fond of saying; governments are no different than households, deficit financing is the road to ruin. This is not true.

When we go to a bank to borrow money, we can’t ask the bank to give us back part of the profit they make on our loan. The government can. It is called taxes.

When we go to a bank for a loan, we don’t set the interest rate. The governments does, albeit indirectly.

When we go to the bank, we don’t have a bank or our own where we can get a loan for just the cost of writing it up. The government does.

Yes Virginia, there is a Santa Clause. The government really can spend its way out of debt.