UBC Reports | Vol. 47 | No. 17 | November 1 , 2001

A way out of B.C.'s fiscal quandary

A UBC economist suggests taxing more efficiently is more vital to economic performance than taxing less.

An earlier version of the following appeared in the Vancouver Sun.

Based on a misunderstanding of the economics of taxation, the British Columbia government is about to embark on sharp cuts to public spending and public services.

The B.C. Liberals gave personal tax cuts a key role in their election campaign and they assured voters that these tax cuts would "pay for themselves" through faster economic growth.

They argued that revenues would be maintained through this growth, so that major public services, especially health care and education, could be sustained.

The BC government now concedes that its tax rate cuts will not be self-financing.

As a result of the lost revenues, provincial public services aside from health care and education will be slashed by almost half in real per capita terms over the next three years.

Even health-care and education services will be significantly reduced, as the government will maintain only nominal rather than real spending levels; high inflation of health-care costs will quickly devour dollars so that real service levels must decline.

These severe consequences for public services in BC result in part from a slowing economy. However, the government also failed to heed the warnings of economists that broadly based tax cuts cannot finance themselves except perhaps in a very depressed economy or when beginning with very high tax rates.

Upbeat references to Alberta's and Ontario's tax-cutting experiences were unfounded, as they ignored the economic booms those provinces enjoyed in recent years due to external demand for their products.

The personal tax cuts promised for individuals with incomes below $60,000 were extended to all higher earners, for a total cost of $1.5 billion per year.

Major business tax cuts have also been put into play, which will cost an additional $0.8 billion per year when fully implemented.

The extension of tax cuts to higher earners and businesses will aid the longer-run growth and competitiveness of the BC economy, but over the next few years they will cut deeply into provincial revenues.

Given the government's commitment to return the BC budget to balance by 2004/05, the large revenue loss will tightly constrain almost all areas of spending. Spending cuts of this magnitude will be very difficult and painful to achieve.

For example, social services and income support for our most disadvantaged citizens, the third largest area of provincial spending, will be significantly affected.

It is unfortunate that the groups who derived the least benefits from the BC tax cuts -- low and moderate income households -- are also the ones most at risk from large spending cuts.

Some budgetary pressure to contain public costs and find more effective ways of delivering public services is undoubtedly salutary.

But the order of magnitude dictated by BC's new fiscal program goes well beyond what voters could have imagined at election time -- much more than just avoiding expenses like the fast ferries, the Skeena Cellulose bailout, the Forest Renewal program, and the "fair wages" policy.

A way out of BC's fiscal quandary can be found if the government will now heed another lesson from the economics of taxation. Namely, taxing more efficiently is more vital to economic performance than taxing less.

It is well established in economic research that taxes on consumption and labour income or payrolls are much less harmful to economic efficiency and growth than taxes on savings, capital income, and investment.

European countries have exploited these insights to achieve better long-run economic performance than Canada or the United States, even with much higher overall tax burdens, by relying heavily on sales and payroll taxes.

British Columbia, too, could benefit by instituting efficient tax changes to recoup a substantial portion of the revenues lost through the already announced personal and business tax cuts.

Although BC could restore part of its lost revenues in an efficient manner by raising the sales tax rate, this is not the best remedy.

Sales taxes are regressive, imposing a disproportionate burden on lower income persons and younger families. BC's total federal plus provincial sales tax rate of 14 per cent is well above that in adjoining Alberta and Washington, thus raising issues of enforcement and public acceptance.

And, despite recent initiatives by the BC government, the sales tax imposes a burden not only on consumers but also on business competitiveness and investment.

The best candidate for recouping a substantial portion of BC's lost revenues is an employer payroll tax.

By instituting such a tax, BC would follow in the footsteps of four other Canadian provinces, which have had employer payroll taxes for many years to help finance health care and post-secondary education.

And these are large taxes elsewhere; in 2001/02 they are forecast to raise $3.6 billion for Ontario and $4.4 billion for Quebec.

A two per cent tax on all BC employers with annual payrolls exceeding $400,000 would generate about $1.1 billion per year, almost half of the $2.3 billion revenues lost to tax cuts.

The tax would exempt nearly 90 per cent of all private businesses, and it would obtain revenues from the federal government as employer of workers in BC

A two per cent rate is just above the 1.95 per cent rate for Ontario's Employer Health Tax.

Applying a payroll tax at four per cent in BC (the rate of Quebec's payroll tax for the Health Services Fund) would generate $2.2 billion per year, enough to offset more than half of BC's lost revenues plus abolish the $900 million of BC's medicare premiums.

Such premiums are a highly regressive head tax, serve no useful rationing purpose for Medicare usage, and have been abandoned by all other provinces except Alberta.

A general payroll tax applied to all wages, salaries, and fringe benefits is one of the most neutral forms of taxation.

While this tax is applied nominally to employers, over several years its burden is shifted to labour through slower growth of wages and salaries.

If restricted to larger employers, this is the simplest form of tax for both public administration and business compliance.

Based on Newfoundland's experience, such a tax could be put into operation in BC within just a few months of legislative approval.

An employer payroll tax could relieve the insuperable strains on BC's public services.

It could do so in a way that retains the efficiency gains from the other tax cuts, the budget-balancing target, and effective pressures for restructuring public programs.

Levies of this kind are popular in other provinces.

They appear to be a tax on business rather than workers, they raise large revenues at low rates of tax, and their linkage to spending on education and health care further enhances public support.

Still early in its mandate, the BC government is at a crossroads in its tax and spending policies.

It could forge ahead with the current course, which involves sharp cuts to public services that threaten the well-being of citizens, tear at the social fabric, and may eventually sap voter support.

Or it could escape this fiscal quandary by drawing a lesson from the economics of taxation -- that the mix of taxes matters more for an economy's performance than the level of its taxes.

Economics Prof. Jonathan Kesselman is the director of the UBC Centre for Research on Economic and Social Policy and its Equality/Security/Community project, and author of the award-winning monograph, General Payroll Taxes. His study of BC tax policy is online at www.arts.ubc.ca/cresp.