Bay Street’s Stimulus Manifesto

Yesterday, the chief economists of the chartered banks called on the federal government to permanently cut taxes now and balance the budget after the economic crisis by cutting spending. An obvious but unstated implication is a smaller government when the economy recovers. While this outcome would undoubtedly suit the ideological preferences of bank economists, it would hardly be a sensible response to the economic crisis.

Federal spending currently equals 15% of GDP, its lowest level since 1949. (Because interest payments have fallen faster than this total, program spending has edged back to 13% from the 12% low maintained between 1999 and 2002.) Further reducing the ballast provided by these minimal public expenditures would make Canada’s economy even more vulnerable to the vagaries of private markets.

By what logic do the bank economists reach their conclusion of permanent tax cuts and temporary new spending? First, they assume that stimulus must consist of both tax cuts and spending. They do not consider the possibility of just focussing on government spending, the reliable way to add a given number of dollars to aggregate demand.

Second, having presumed the need for tax cuts, they argue that these cuts must be permanent:

“I would hope that if we do get a tax cut, it’s not just temporary,” said Don Drummond, chief economist at Toronto-Dominion Bank.

He argued that temporary tax cuts only serve to move forward consumers’ purchases that they would have eventually made anyway, without fuelling any lasting increase in spending habits.

“It just shifts around the timing of purchases, and doesn’t accomplish anything.”

One might suggest that the point of stimulus is not to increase consumer spending for all time, but to quickly bolster consumer spending to support the economy in the present. Some eminently mainstream economists, like Dale Orr in Canada and Mark Zandi in the US, point out that temporary tax cuts provide more stimulus precisely because of their effect on the timing of purchases. But the bank economists want permanent tax cuts.

Third, permanent tax cuts and permanent spending increases would create a permanent deficit. Having decided that the tax cuts must be permanent, the only way to avoid a permanent deficit is to make the spending temporary.

None of the steps in this chain have much to do with what would provide the most stimulus in the short term or the most stability in the long term.

UPDATE (Jan. 9): The Globe printed my letter today.

The unstated implication of enacting permanent tax cuts now and balancing the budget with spending cuts later (Economists’ Advice To Flaherty: Cut Taxes Now – Report on Business, Jan. 8 ) is a smaller, weaker government. This outcome would be the wrong response to the crisis.

In the future, Canada’s economy would be even more vulnerable to the vagaries of private markets with less ballast from the relatively stable public sector. The most effective form of economic stimulus would be sustained reinvestment in public infrastructure and programs.

Erin Weir, economist, United Steelworkers

UPDATE (Jan. 13): The Conference Board has my back