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.
by Prof. Jon Kesselman
An earlier version of the following appeared in the Vancouver
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
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
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
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
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
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
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.