Wheat from the Chaff Blog

Here’s a recent rant that I had with a friend of mine over the imprudence of lowering taxes in a time of recession:

“…individual citizen or corporation, want good value for their dollar.”

I certainly agree… except if “good value for their dollar” means the government must cut back during a time of a recession. If a government tries to act like a household or company in this situation, then it commits the fallacy of composition: the government – which acts for the whole – erroneously tries to act like an individual unit such as a household or small business. This adds (massively) to the contraction, and sends the entire country into a much faster tailspin. This is exactly what happened to Canada and the USA from 1929 to 1933, and it made a bad situation into a disaster. This is why Hoover and RB Bennett were so reviled: they didn’t understand the difference between micro-economic business planning and macro-economic government policy. I saw some corporate-toadying homily from the Fraser Institute in today’s Sun, and it repeated almost verbatim Hoover’s speeches at the beginning of the Depression. It’s like they’ve never read a book on economic history.

In our current case, simply lowering business taxes won’t be enough. The prime consideration in any business model (and when a business applies for a loan) is expectation of profit. If nobody is going to buy the goods or services that your investment will offer, lower taxes or lower interest rates will be of little help. That’s exactly what they found in the Great Depression. In Canada, where 56% of our GDP is generated by consumer spending (67% in the USA), the key is consumer spending. It’s that spending that will (re-)pay the vast majority of one’s investment. And if it’s not there, corporate tax cuts will simply lead to a gutting of the treasury. [Tax cuts, and especially targeted tax cuts, can certainly work, but usually when consumer confidence – aka consumer spending – is already strong.]

Some continue to believe that personal tax cuts will boost consumer spending. But again, that doesn’t work in a recession. When times are tough, people tend to use their tax cuts for savings or paying off debt. (This is the logic of the household I mentioned earlier.) Savings and paying down debt are good things during a boom, but useless when the country as a whole is looking for stimulus. And if you’re unemployed, tax cuts won’t matter anyway.

By the way, lower corporate income taxes for the largest companies – courtesy of Chretien, Martin and Harper – have not improved productivity or investment in Canada. In fact, machinery investment has dropped since 2000. But CEO bonuses and shareholder dividends haven’t hurt!

Cheers,
Colin