John Myles’s review of Alex Himelfarb and Jordan Himelfarb, eds., Tax is Not a Four-Letter Word: A Different Take on Taxes in Canada (Waterloo, ON: Wilfrid Laurier University Press, 2013) appeared in Inroads 35 (Summer/Fall 2014).

In 2014 I wrote a celebratory review of the Alex and Jordan Himelfarb’s edited volume Tax is Not a Four-Letter Word where they and their authors explain why we need more, not less, taxation. Their main target was the highly successful attack on taxation launched in the 1980s and enthusiastically embraced by the Harper regime in power at the time of publication.

Things have changed since then, sort of. The left has reembraced the theme of taxing the rich. They probably always thought taxing the rich was a good idea but were often intimidated by mainstream critiques captured in Prime Minister Harper’s conclusion that there is no such thing as a “good tax.” As a result, the conventional “Robin Hood” agenda was often soft-pedalled. No longer. The outrageous income gains of the top 1 per cent have made the “rich” easy targets once again. Mainstream economists and the OECD have drastically revised their conclusions about the economic Armageddon that would follow higher marginal tax rates for the superrich.

But we are still a long way from the post–World War II view that high taxes for the many are a good idea. Justin Trudeau’s tax cuts for the “middle class” are still widely praised, and no political party is threatening to restore the 2 per cent cut in the GST/HST implemented by Harper. In the short term, historically low interest rates have made debt financing rather than higher taxes an attractive proposition. At 33 per cent of GDP, Canada is a low-tax country by international standards, ranking 21st out of 37 OECD countries in 2018. And low taxes mean low social spending. Since the middle of the last decade, Canadian social spending as a percentage of GDP has actually fallen behind that of the United States.

The upshot is that in both the intermediate and the long term, “progressive” Canadians eager to implement daycare and pharmacare, ensure adequate housing and deal with climate change, among many other good things, will have to embrace “higher taxes for almost everyone” – a bumper sticker to guarantee that you lose the next election. Why so?

The comparative evidence is conclusive. Higher levels of taxation are a necessary, if not sufficient, condition for reducing both inequality and poverty. And getting high levels of taxation probably means we must abandon our fears of so-called “regressive” payroll and sales taxes. Hugh Mackenzie made this point in the Himelfarb volume, where he criticized the left for focusing on the distinction between “progressive” (good) taxes and “regressive” (bad) taxes and failing to look at what those taxes can buy. As he pointed out, regressive taxes (e.g. consumption taxes) can be used for progressive purposes (public health care, education, public transport). I followed up on Mackenzie’s point and have learned a few lessons:

• Raising taxes on the top 1 per cent will raise some big bucks, but it won’t provide the revenues required to do all the good stuff that needs doing with respect to things like global warming, affordable housing, child care and public transit. Lars Osberg estimates that a top marginal rate of 65 per cent would raise $15 to $20 billion, which is not to be sneezed at. But even $30 billion does not represent a fundamental change to a federal tax budget of more than $300 billion. An increase of $15 billion would just offset Harper’s 2 per cent reduction in the GST.
• To move into the big leagues of high tax / high social spending countries such as Denmark and Sweden will require us to emulate their highly “regressive” tax structures that result from high payroll and sales taxes. Ironically, the United States and Canada already have the most “progressive” tax structures in the OECD, mainly because of our reliance on “progressive” income taxes.

There are two reasons we get it wrong.

First, we don’t have good measures of net redistribution – the distribution of taxes minus benefits. Payroll and sales taxes are regressive on the revenue side. But what we want to know is what happens on the expenditure side, and for the most part we simply don’t know how to do that.

As important, in my view, is our capture by the Anglo-Saxon Robin Hood narrative – rob the rich to feed the poor. The narrative underlying Scandinavian social democracy was never a Robin Hood narrative. Rather, it was a narrative of social solidarity – we look after one another.

Alex Himelfarb and Jordan Himelfarb., eds.,
Tax is Not a Four-Letter Word: A Different Take on Taxes in Canada.
Waterloo, ON: Wilfrid Laurier University Press, 2013.
304 pages.

David Stockman, sometime Director of the U.S. Office and Management and Budget under Ronald Reagan, is often credited with articulating the conservative strategy for restraining Leviathan: “Starve the beast.” In other words, cut taxes to create a deficit, thereby forcing program cuts to eliminate the deficits produced by the cuts.

Whatever the origins of the strategy, it is one that, according to the Himelfarbs and numerous contributors to this recent volume, has been strongly embraced by the Harper government. Though there can be many reasons for cutting taxes, the Stockman strategy provides a plausible reading of a Conservative government whose leader has publicly stated that there is no such thing as a “good tax.” It also provides a foretaste of the Conservative platform for the next federal election: more tax cuts.

Across-the-board tax cuts are an effective electoral strategy since, in the short run, they produce only winners; everyone has more money in their pockets. Tax cuts are never introduced alongside a list of the eventual program cuts that will result from the lost revenue, so the “losers” are hidden from view at election time, a point well developed by Hugh Mackenzie and Jim Stanford in their respective contributions to this volume

As the Himelfarbs note, nobody actually likes paying taxes. In the past three decades, however, tax has gone from being an irritant to a four-letter word. In the past, they argue, we accepted taxes as the legitimate price for valued public goods and services, redistribution and new investments in a better future. Now, all political parties construct their platforms so as to avoid being labelled as a “tax-and-spender.” In the 2011 election, the Conservatives promised deep cuts, while the Liberals promised not to raise taxes. The NDP promised tax breaks for families and small business offset by higher corporate taxes. The question the Himelfarbs ask is: What has changed? It didn’t all begin with Harper.

The research literature on the topic typically points to two somewhat different accounts: (1) changes in macroeconomic and taxation theory, ideas eventually adopted even by formerly centre-left parties of the European variety, and (2) organized combat (i.e. politics) led by neoliberal/neoconservative interests.¹ The arguments advanced here provide a mix of both, but with heavy emphasis on the latter.

The Second World War served as the stimulus for the growth of mass taxation and rising state revenues throughout the developed world. In most countries, tax revenues doubled as a share of GDP between 1930 and 1945.² Canada was no exception. The war also centralized power in Ottawa, leaving federal authorities with a highly professionalized bureaucracy and – most importantly – dominance of the primary tax fields. When a federal-provincial conference failed to agree on a new system of revenue sharing in 1941, the federal government simply preempted the provinces, announcing dramatic increases in all tax fields, including fields the provinces had previously occupied.

At the close of the war, there was an expectation that taxes would be rolled back to prewar levels, but that did not happen. As the logic of Keynesian economic management took hold, policy elites saw taxation policy as a tool for enhancing economic efficiency as well as providing revenues for health care, education and income redistribution. All that came to an end with the apparent failure of Keynesianism in the 1970s, opening a political space for Reagan, Thatcher and what might be called “Hayek’s revenge.”

“Tax reform” was not just a right-wing conspiracy, however. A plethora of loopholes, credits and deductions in an increasingly complex tax system led to growing tax expenditures. As Sven Steinmo noted,³ tax policy experts, including many on the left, concluded that tax expenditures as actually institutionalized were often simply “giveaways to the rich and powerful.” Rather than enhancing economic efficiency, they were creating distortions in the economy favouring special interests. In his chapter, Scott Clark, a former deputy minister of finance, suggests that little has changed in this respect.

Robin Boadway discusses the fading of the revenue-raising capacity of the central government and the rise of provincial control over both revenues and spending. Why is this important? The classic finding from comparative cross-national research is that decentralized states constrain social spending, especially if both taxation and spending are highly decentralized. Constitutional structures that generate multiple “veto points” privilege interests that wish to block government intervention in health and social policy.

Canada has always had a federal constitutional structure, of course, and this fact explains in part why Canadian social spending has long been well below the OECD average. Nevertheless, the waxing of federal control over revenues in the postwar decades created the opportunity for Ottawa to construct national social policies, and its subsequent waning has eroded that capacity. Boadway concludes that there is little doubt that revenue decentralization has introduced competitive pressures that have eroded redistribution, and indeed some fans of decentralization see that as an advantage. Ottawa’s declining share of provincial expenditures on health, education and welfare erodes its authority in these fields and its capacity to meet its obligations specified in section 36(1) of the Constitution Act.

In a sharp political history of the evolution of Canadian tax policy, Matt Fodor points to the Reagan-Thatcher revolution as the starting point and then goes on to describe how “neoliberal” ideas spread and then solidified among both political and policy elites, inside and outside of government. Eugene Lang and Phillip DeMont track changes in taxation levels and put paid to the notion that Canada is a high-tax country by international standards. Trish Hennessey puts cognitive linguistics to work to deconstruct the political narratives of the antitax agenda.

Frank Graves reviews Canadian public opinion and concludes that there is support for taxing corporations, the rich, polluters and “vices.” Overall, however, the emotional appeal of lower taxes and less spending trumps less viscerally engaging arguments for progressive taxation or fixing the public plumbing, posing a critical challenge for progressives.

Four concluding chapters discuss reforms that might lead to a fairer and more efficient tax system. Marc Lee and Iglika Ivanova focus on changes that would make the tax system more progressive (e.g. higher rates for high income earners, a wealth tax, rationalizing tax expenditures, implementing a guaranteed income). Stéphane Dion makes the case for carbon taxes and Toby Sanger for a financial transaction tax. Scott Clark advances the now conventional argument among tax economists for a shift away from income to consumption taxes, but also advocates tax simplification (to deal with tax expenditures) and greater progressivity.

The authors are not all at one on the progressivity issue, however. Hugh Mackenzie criticizes the left for focusing on the distinction between “progressive” (good) taxes and “regressive” (bad) taxes and failing to look at what those taxes can buy. As he points out, regressive taxes (e.g. consumption taxes) can be used for progressive purposes (public health care, education, public transport). I increasingly tend to agree.

Most tax experts agree that overall taxation rates (i.e. from all sources) are proportional to income over the income distribution, much like a flat tax. Redistribution occurs almost entirely on the spending side, not only in the form of income transfers but also in public services. On the basis of cross-national comparisons of the effects of taxation systems on inequality, Lane Kenworthy concluded that progressivity in taxation systems matters a little bit but not very much.⁴ What matters most is the quantity of tax revenues rather than the progressivity of the tax mix.

If Kenworthy is right, then Canada is in trouble. According to OECD estimates, total government revenues from all tax and nontax revenues at all levels of government peaked at about 45 per cent of GDP in the late 1990s, slightly above the OECD median. By 2012 the take was about 38 per cent of GDP, a decline of almost seven percentage points, and now well below the OECD median.

There has been much chatter about new “social investments” in early childhood education and, in Toronto, in improved public transportation. But there has been little interest in paying for these investments. In an antitax political culture, tax cuts are easy. Once made, however, they are extremely difficult to restore. Pity the poor party leader who proposes to raise the GST rate back to 7 per cent again.

To my mind, the main claims of the tax-cutters have been largely discredited. Marginal tax rates have been cut without any measurable trickle-down or increases in tax revenues. Corporate tax rates have been slashed without the promised gains in productivity. Yet the antitax agenda remains in place. The question for the Himelfarbs’ next volume should be: Why so?

The chapters are mainly written by progressives for progressives and are unlikely to become required reading for Harper’s cabinet or senior public officials. For the general reader, however, the book provides a lively and accessible introduction to how we got the way we are going in the field of taxation policy. Progressives are typically full of suggestions for more and better spending on new social programs and public investments but pay less attention to the revenue side. Tax Is Not a Four-Letter Word provides a much-needed antidote.

Readers expecting lots of inside dope from a former Clerk of the Privy Council, Alex Himelfarb, will be disappointed. I was. A show-and-tell account, however, would no doubt have violated all sorts of secrecy oaths.

Continue reading “How tax became a four-letter word” →

Up to the late 1990s, a certain smugness was evident in studies of Canadian income inequality. While an upward trend in inequality was evident in the United States and Britain by the 1980s, any signs of rising income inequality in Canada appeared to be offset by the welfare state. Taxes and transfers were doing their job. Canadians might not be as kind and gentle as the Swedes but we were certainly kinder and gentler than those nasty Americans or the increasingly unlovely Brits.

However, it turned out that Canada was not different from the United States and Britain, just a little behind. In the latter half of the 1990s, income inequality in Canada surged upward after four decades of relative stability. This surge in inequality is especially disturbing because it occurred during a period of economic expansion when, if anything, we should expect inequality to decline. A reasonable expectation given its cyclical nature was that by 2003 or so our Gini index of inequality would have fallen back to 1989 levels, just under 0.28. Instead, it was close to 0.32.

When inequality or poverty measures change significantly, there are always three likely suspects to account for the shift: changes in labour markets (e.g. rising earnings inequality), changes in families (e.g. more lone parents) and changes in public policies (cuts to the “welfare state”).

Given the timing of the inequality surge, it is tempting to point the finger at the welfare state. The latter half of the 1990s was the period when Unemployment Insurance (UI) became Employment Insurance (EI) and access to benefits became more restrictive. Social assistance benefits were overhauled in a number of provinces, especially Alberta, British Columbia and Ontario. And federal and provincial surtaxes on high-income earners were abandoned.

As it turns out, however, these efforts at welfare state “retrenchment” constitute a small part of the story. Two recent studies of the effect of taxes and transfers on this trend tell much the same story,¹ and the answer is not as simple as one might suspect.

The redistributive impact of taxes and transfers on income inequality has actually risen, not fallen, over the past two decades. So despite the retrenchment efforts of the 1990s, the welfare state has not been withering away. However, it has not been keeping pace with the changes in labour markets and families that are driving the surge. During the 1980s, the increase in the redistributive effect of taxes and transfers more than offset the increase in inequality due to changes in labour markets and families. By contrast, between 1989 and 2004, the increase in the redistributive effect offset less than a quarter of the increase due to changes in labour markets and families.

The main conclusion from these studies is that politics and policy change matter a little but not very much. The other two suspects, changes in labour markets and especially changes in families, matter much more. However, that leaves open the question: what might have happened had the Canadian welfare state taken a more aggressive stance toward the underlying trends in labour markets and family formation? Fortunately, the experience of the province of Quebec provides some clues. As Pierre Fortin documents in this issue, policy and politics do matter.² Quebec’s more aggressive approach to family well-being has mattered a lot.

Changes in labour markets are important but for most families/households, changes in family formation and the family life course are the big drivers of the surge in inequality. Aggressive policy change was required to keep pace with these developments. Outside Quebec, that didn’t happen.

So what did happen?

Figure 1 illustrates the main story: the surge in market family income inequality that extended from roughly 1980 to 2000. Market family income refers to all income that family members (and unattached persons) bring home from work or receive in the form of dividends, rents and the like. It does not include income transfers from government or take account of taxes paid.

The stunning fact here is that for three decades market incomes in the middle and the bottom of the income scale have been essentially stagnant while incomes at the top have been rising. Canada has been producing more wealth, but the bottom half has not been getting its share. In the early postwar decades in the United States, a rising tide was lifting all boats. While Canada does not have data for those decades, it is likely that trends were similar north of the border. So what accounts for this historic shift?

Changes in labour markets matter. Surging compensation among the top 1 per cent was a key factor.³ Declining unionization rates played an important role, as did the declining earnings of recent immigrants.⁴ Rising inequality in male and female earnings and rising returns to education were also important. But the main conclusion of a recent fine study by Yuqian Lu, René Morissette and Tammy Schirle is that changes in families matter more.⁵ This is a nontrivial result, since family formation and family behaviour are not easily amenable to policy intervention.

Divorce rates have risen and marriage rates have fallen. There are many more lone parents raising children as a result and fewer adults are benefiting from the economies of scale associated with shared living arrangements or the “insurance” provided by an employed spouse during spells of unemployment. The result is a “quantity” problem. Some households have lots of labour to sell (two or more earners) while more families have comparatively little (single-earner households with and without children).

Changes in families can have offsetting effects. Rising education and employment rates among women have had strong equalizing impacts among families. But the relative importance of these changes depends on who marries whom. Educational “homogamy” (the tendency of like to marry like) has risen substantially since the 1970s. Between 1971 and 2001, the proportion of educationally homogamous marriages among young Canadian adults (34 and under) rose from 42 per cent to 55 per cent of all marriages. This was a period when the employment and earnings gap between the more and less educated was also rising. This can be thought of as a “quality” problem: the divide between households with lots of high-quality (educated) labour to sell and those with fewer labour market skills has grown.

To illustrate, consider Figure 2. In 1980, the highest-paid wives were married to men earning between $30,000 and $40,000 per year. Women married to men earning less than $30,000 earned substantially less – and so did women married to men earning more than $40,000. By 2000, in contrast, all this had changed. Women married to men with low earnings (less than $10,000) saw their own relative earnings fall by about 35 per cent, while women married to men with high earnings saw their earnings rise by about 21 per cent. In 1980, the relationship between husbands’ and wives’ earnings looked somewhat like an inverted U: women married to men in the lower middle of the earnings distribution were earning the most. By 2000, the relationship was such that the highest-paid women were married to the highest-paid men, and the lowest-paid women to the lowest-paid men. And over the entire period, rising returns to education favoured families in the top half of the scale.

That well-educated women and men tend to marry each other and subsequently have high earnings and low rates of unemployment is unlikely to change as a result of public policy. A “Lavalife Canada” program aimed at introducing university grads to high-school dropouts is not on anyone’s policy agenda for the near future.

There has also been a steady increase in lone-parent families – from about 6 per cent of all families in 1980 to 11 per cent in 2005 – and a rising number of families without kids. Lu, Morrissette and Schirle estimate that, together, these changes accounted for about 20 per cent of the rise in inequality since 1980.

There were some good news stories over the period. Between 1980 and 2000, employment earnings among lone mothers rose by 39 per cent as a result of rising employment rates. This led some observers to conclude that “tough love” policies in some provincial social assistance schemes, notably B.C., Alberta and Ontario, had been effective. Colleagues and I showed, however, that most of these gains were the result of changes in the demographic composition of lone mothers: by 2000 lone mothers were simply older, better educated and hence more likely to be employed than in 1980.⁶

The outstanding exception was Quebec. Quebec lone mothers had the largest employment gains in the 1990s (9.4 percentage points) and by 2000 their employment levels were four percentage points higher than in the rest of Canada. Demographic changes in Quebec accounted for only 28 per cent of the growth in lone mothers’ employment in the 1990s, results that are consistent with conclusions concerning the effects of liberalized child care provisions in that province.⁷

The interesting puzzle here is that while the surge in income inequality measured after taxes and transfers did not appear until the latter half of the 1990s, the growth in market income inequality had been underway for at least a decade and half by then. In their new study of the impact of taxes and transfers on income inequality, Marc Frenette, David Green and Kevin Milligan show that growth in market income inequality was roughly similar in the 1980s and the 1990s.⁸ The ratio of those at the 90th percentile to those at the 10th percentile grew by 12.8 per cent between 1980 and 1990 and by a further 11.4 per cent between 1990 and 2000. As they demonstrate, this was because income redistribution was rising between 1980 and 1995, offsetting changes in the labour market and families.⁹ These changes did not result in less inequality; rather, the welfare state was running hard to keep inequality levels stable.

Importantly, rising income redistribution through the 1980s and the first half of the 1990s was largely driven by changes at the provincial level, a result of rising transfers under social assistance and surtaxes on top-earning families. As a result, the level of income redistribution peaked in 1995 but then declined because of cuts to social assistance, changes in UI and the elimination of surtaxes on high-income families.

However, the important conclusion is that inequality would have risen even in the absence of these cuts.¹⁰ The big story of the 1990s was not so much one of retrenchment – the tax-transfer system in 2000 was still much more redistributive than that of the 1980s – but rather of the failure of the tax-transfer system to expand and to keep pace with underlying trends toward increasing inequality in labour markets and families. In short, at the national level, the welfare state was “running out of gas.” And most of the action was at the provincial, not the federal, level. As Frenette, Green and Milligan conclude, “The steady after-tax income inequality of the 1980s arose because the tax and transfer system increased its redistributiveness over that decade. In the 1990s, the tax and transfer systems ceased becoming more redistributive, allowing the changes in pre-tax inequality to pass through to increases in after-tax inequality.”¹¹

We still need Robin Hood

So what should we make of all this? Big changes in labour markets and especially families have been driving the inequality surge. As a result, welfare states have had to run fast simply to keep the income distribution standing still. The impact of labour market and family changes, moreover, have been especially severe for young adults (those under 35). Their work careers have been starting later and their earnings relative to older adults have been falling since the 1980s. As a result, we have made relatively little progress in reducing child poverty. While the social and economic life course has changed, the biological life course has not. Because of biology, young adults (under 35) are still the parents of the majority of our young children – 60 per cent of those under six – and no social policy can change this.

If we look at the world from the vantage point of the young adults who are entering the labour market today and who will be supporting our pensions and health care system for the next 30 years, things look a little gloomy for the bottom half.

The world our thirtysomethings of today are entering is very different from the one encountered by the young cohorts of even a quarter century ago. A new high-inequality equilibrium in the distribution of family earnings has emerged and appears to be a relatively permanent feature of our postindustrial world. The cohorts turning 30 this year and those now completing their schooling will make up the core of our prime-age workforce well into the 21st century.

Changing the labour market would help the most. Most people get most of their income from employment for most of their lives. Full employment and decent wages for the employed, not generous welfare states, were the primary objective of social democrats and reformers like John Maynard Keynes and William Beveridge who sought to shape postwar societies in the 1940s. Countries could afford generous welfare states under conditions of high employment and high wages at the bottom of the scale, but not otherwise.

But labour markets change only over the long term. Canada has lots of low-wage jobs by international standards, and that has ever been so. Cross-national differences in wage structures of the current magnitude are the product of longstanding historical differences in wage-bargaining institutions and labour market regulation. Institution building and reform are by definition long-term projects.

Early childhood education programs intended to compensate for the weak cultural capital of many low-income parents have come into favour in many policy circles. Economists like human capital investments of this sort, and so do I. Improving people’s capabilities, as Amartya Sen argues, should always be at the top of our agenda. But the distribution of human capital among those now entering the labour market is unlikely to change very much over their working lives. Early childhood education looks like it could help a lot – but not until the kids who benefit enter the labour market some 25 years in the future.

I value the search for alternatives and complements to the tax-and-transfer welfare state – Robin Hood. And the Quebec experience demonstrates that it’s not just about Robin Hood. While improved transfers were a factor in Quebec’s better performance, Quebec’s child care program is also an “employment” program, enabling single moms and women married to low-wage men to enter the labour market and raise the living standards of their families. Nevertheless, my conclusion is that we are probably going to need more rather than less Robin Hood for some time to come.

Continue reading “The Inequality Surge” →