EDITORIAL PAGE — A taxing history

We don’t pretend to be economists, but we do feel confident in possessing a rudimentary grasp of the major tenets of modern-day economics.

We know, for example, that the modern government penchant for deficit financing springs from a theory developed by the English economist George Maynard Keynes (1883-1946), who maintained that governments can smooth the sometimes violent swings of the economic cycle.

To crank up flagging activity in a recession, all governments need do is spend more. The money would be funnelled into temporary job creation measures, such as road-building or bridge-mending.

Conversely, in periods of prosperity, governments are advised to reduce spending, thereby liquidating whatever debt had accumulated during the economic trough and bringing the books into balance.

What the theory had going in its favor were two things: simplicity and an elegant symmetry (in good times, do this; in bad times, do the opposite). With only a modicum of head-scratching, even we can follow it. When the econometricians tell you it’s time to open the wallet, you open it; when they say it’s time to close it, you close it.

But as big and sophisticated as governments are nowadays, and as well educated as the bureaucrats (if not the elected representatives) are, they nevertheless managed to mess things up. Or, to be more charitable, they misconceived what old Mr. Keynes meant. They whittled away at his theory, reducing it, in the end, to a single notion — spend.

In Canada, this actually worked for a time. Through the Trudeau years of the late 1960s and the 1970s, the annual deficits kept mounting. But early in the 1980s, concern began growing about the spiralling total debt. Alas, concern did not translate into action. In spite of public pronouncements of increasing concern, successive governments continued to spend more than tax revenues brought in.

In this country, two things have occurred to raise the level of worry even higher, although real action from Ottawa has yet to be seen. First came the discovery of the brutal truth (brutal to government, that is) in economist Arthur Laffer’s theory that rising levels of taxation do not necessarily translate into rising tax revenues. Laffer first postulated the obvious — tax revenues would be zero if the tax rate were zero. What is somewhat less obvious, Laffer notes, is that tax revenues would also be zero (or close to it) if tax rates were 100%. Who would show up at the office or the mine site if every cent earned went to government?

The “Laffer Curve,” as it is now known, suggests that at some point between zero and 100% taxation levels, tax revenues would be maximized. Beyond a certain point, however, people would try to escape paying taxes. The threshold might be 50% or even 75%. But at some level, people will finally seek to avoid (and probably evade) taxes. Such is the case in this country; the underground economy is said to be thriving.

The second problem with deficits is that these monsters must be fed. The only way Ottawa can finance its debt load is to sell bonds. But foreigners are becoming less enthusiastic about buying federal or provincial bonds. Or, rather, they can be enticed — but the price, in the form of higher interest rates or a devalued Canadian dollar, is becoming steeper.

Judging by the Chretien government’s first budget, Ottawa still hasn’t learned these lessons. After the markets had delivered their negative response, it was pathetic to hear Finance Minister Paul Martin promise massive cuts in the next budget.