Q&A | Spend away on infrastructure, but be wary of spiralling deficits: Sauder prof

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Now that Bill Morneau has been chosen as Canada’s minister of finance, he has a lot of promises to live up to, centred on a plan for building infrastructure, financed with deficit spending, plus a rebalancing of the taxation system.

Professor James Brander of UBC’s Sauder School of Business says there are some promising things in the works, but we need to find other ways to finance the plans to avoid going down the dangerous road of never-ending deficits.

Brander JamesDoes a big spend on infrastructure make sense?

Yes, now is an excellent time to spend more on Canada’s infrastructure – we’ve reached a point where it needs improvement. And spending on infrastructure yields a high rate of return as it generates more benefits to the economy, to individuals and to businesses, than it costs the government. But one word of caution: infrastructure spending is often distorted by politics, as MPs try to get their pet projects in their own ridings pushed through, and that’s a terrible way to make decisions. So as long as projects are chosen based on merits, and from objective assessments, then it will be very beneficial.

The Liberal government wants to run a deficit to pay for it. Is that justified?

While I’m happy to hear about infrastructure plans, I’m less enthusiastic about deficit spending. We’ve had a long period of responsible fiscal management, so we’ve forgotten to be concerned about deficits. But once you entrench deficit spending, it’s very hard to undo it. I’m not saying we’re going to become Greece anytime soon, but it’s a cautionary tale that’s worth keeping in mind.

The Liberals have been selling their deficit spending plan on the idea that spending money now will generate more economic activity so that eventually, the deficit will pay for itself with increased government revenues. That’s a traditional Keynesian economic analysis, which has merit, but I don’t think it’s the best approach for Canada. We are too small to carry out such a macroeconomic plan by ourselves; a lot of the increased demand for goods and services will go to those produced outside of Canada, so although the net effect within Canada will be positive, it will be fairly weak.  

So how can we finance infrastructure spending then?

A carbon tax. A big issue with infrastructure is the transportation network is too congested, especially in the big cities, and the costs of congestion are enormous, in terms of time, environmental damage, wear and tear and so on. The benefits of new infrastructure will be compounded if we pay for it with a carbon tax – or other carbon-based taxes like a gasoline tax – which will further reduce pollution. So we should pay for infrastructure with a carbon tax, supported by appropriate user fees such as road pricing.

Another pillar of the Liberal plan has been the middle class tax cut and tax increase for the rich. What will that do?

In a few ways, the Liberals are seeking to make the tax system more progressive, in order to level out the balance of wealth. That’s partly a value judgement, but a good one considering the extreme increase in high incomes and stagnation of living standards of the middle class in the past couple of decades. But as for the economic effect of raising taxes on the wealthy, there are three negative outcomes to that: the rich will have less incentive to generate economic activity, there will be more tax avoidance and evasion, and some people with successful businesses will leave the country. The downsides often get exaggerated, but they do happen. Now, this particular increase in taxes for the wealthy is not huge, but marginal tax rates will go over 50 per cent in some parts of the country, and 50 seems to be a key threshold. Basically, I think the Liberals are overestimating the increase in revenues that the tax changes will bring about, so I don’t believe their tax plan will be revenue neutral. Rather, it will further contribute to a deficit. I don’t want them to make the same mistakes Canada made in the 70s and 80s, and that many other countries have made about deficits, fooling themselves into thinking it will bring about such windfalls that the deficit will just disappear – that doesn’t usually happen and I don’t think it will this time.

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