Mr. Trudeau, meet Mr. Laffer

The Liberals have sketched two planks of their fiscal platform for the upcoming election. Good. The more specificity about what the different parties would do, the easier for voters to make an informed choice and then, just as important, hold a new government accountable — assuming, that is, voters wish to be informed, and a disturbingly large number appear not to.

Given their self-righteousness about “evidenced-based policy,” it’s surprising the Liberal website provides so little documentation, either for their leader’s claim that higher marginal tax rates for people making more than $200,000 a year will produce $3 billion of new revenue or for their streamlined system of fiscal support for children that, strangely, would return us to the 1990s when smalll liberal lobbyists decried Canada for being the only OECD country without universal support for children: Under the new Liberal plan, if you make more than $150,000 a year and you have a kid, good luck, you’re on your own. A grateful nation thanks you.

The Liberal website does have some beautifully styled bullet points and trendy cartoon graphics showing how much the proposals put in the loot bags of different demographic groups. It’s always fun to check the names the spin-doctors choose for their hypothetical families, in this case: single-mom Anna, and couples with kids Preeti and Jessie, Michelle and Jean, Julie and Andrew, and Darrell and Robert. Vote Liberal and get $1,500 a month! It’s a little obvious and not very catchy but who’ll argue with $1,500? (That’s what Julie and Andrew, who have four kids and family income of $65,000/yr would get.)

But, given the Liberals’ fetish for evidence, it would be nicer to have something a little firmer in the way of an evidentiary base for the proposals, especially the increase in the top marginal rate from 29 to 33 per cent. It’s not that there’s any shortage of good evidence about the effects of taxation on both government revenues and personal incomes. Canadian economists have been working hard on this issue for a long time and if anything at a heightened pace since inequality started to be such a concern — at least among elites.

For instance, last year’s C. D. Howe Institute Benefactors Lecture by University of British Columbia economist Kevin Milligan was in large part about the incentive effects of taxation. It’s of note not just for its quality, which is not surprising since Milligan is one of Canada’s leading research economists, but also because he is often mentioned as one of the economists advising Justin Trudeau. What is surprising, in view of the Liberals’ proposed tax hike, is that the lecture argues that raising taxes on high incomes is far from certain to increase revenues.

Summarizing the recent international literature on the incentive effects of income taxes, Milligan writes: “[T]he responsiveness of high-income earners is much larger than that of low-income earners. The most likely reason is not because higher taxes decrease the work effort of high-income earners but because these individuals find other ways to take their compensation or to shift income across jurisdictions, time or form to avoid some taxation.” And he goes on to highlight the results of work he has done with Michael Smart of the University of Toronto.

Using Statistics Canada tax data the two looked at how differing top marginal rates across provinces affected top incomes between 1988 and 2011. What they found (see chart) is that tax effects can be very big. A ten percentage-point hike in the marginal rate paid by people in the top 1 per cent shrinks their taxable income by about 7 per cent. It would generate new revenue. Their taxable income might be 7 per cent lower but their tax rates would be more than 30 per cent higher. Much higher tax rates on a somewhat lower tax base will get you revenue. And of course the Liberals are proposing a 4-point, not a 10-point increase in the top rate.

But when Smart and Milligan looked at the top one tenth of one per cent, they found the effects are much bigger. The same 10-point increase produces a 30 per cent shrinkage. It’s like dunking the tax system into an ice bath.

Kevin Milligan’s conclusion in his Benefactors Lecture? “These estimates suggest some caution in expecting tax rates of more than 50 per cent to raise much extra revenue.” Or in other words, Mr. Trudeau, meet Mr. Laffer.

That higher taxes don’t generate revenue won’t especially bother you if, one, you don’t mind going into debt to finance your spending plans and, two, taxing rich people more feels good even if there’s no money in it. Some people seem very angry about income gains at the top end of the distribution so maybe retributive taxes will be popular even if they aren’t redistributive.

But even if you do favour resentmentbased policy of this sort, there’s a catch. It may very well hit the 1 in 100 but if Milligan and Smart are right, the 1 in 1000, the super-elite, may escape. True, they’ll suffer the inconvenience of having to rearrange their affairs, possibly by moving some offshore. But you may not get any money out of them.

If you think it’s the 1 in 100 who are causing all the trouble, you can do a Robin Hood on them. But if the real culprits are the 1 in 1000, well, they may escape Sherwood Forest untouched.

So, Canada, who do you really resent? order questions are asked or who it is sent to. Even easily defined concepts like exports can be hard to measure; just this week, Statistics Canada revised down its estimate of energy exports for February by 14% (or $1.2 billion, not an unusually large revision for energy exports). The press goes bonkers over a record monthly trade deficit of $3 billion when Statcan could easily revise that next month to less than $2 billion or more than $4 billion. Given its recent track record for preliminary estimates of energy exports, Statcan might want to start using a dart board for its estimates. A common shortcoming in the use of data in public debates is a failure to inform users of the uncertainty that surrounds estimates.

The uncertainty about estimates increases exponentially when making forecasts. A great deal was made of the Parliamentary Budget Officer’s projection of how much Tax Free Savings Accounts would cost the government in 2080, as if that could be forecast with precision. Imagine all the assumptions and relationships that have to be known, layered on top to a morass of imperfect data about the present, to make a forecast 65 years ahead. Yet journalists ask straight-faced questions based on these forecasts when economists routinely demonstrate they can’t forecast the economy 6.5 months in advance, never mind 65 years. Who saw the slump in oil prices at the start of 2014? Remember former economist Jeff Rubin and his quack forecast of $200 for a barrel of oil? There’s an old joke among economists — we forecast not because we’re good at it, but because we’re asked to. It is the responsibility of the economics profession to provide better guidance on the imprecision and limits of its knowledge. And it is incumbent on users to be skeptical that the world is best understood only with numbers.