Raising taxes won’t solve budget deficit
When any government has an enormous annual budget deficit, there are three basic options for solving the problem. The options are: raise taxes, reduce spending or borrow. A fourth, unacceptable option would be default. Unfortunately, that would destroy trust and confidence in government.
Most people assume that the third option, borrowing, is acceptable for small debts but a large deficit over a long time is damaging to the economy.
The main budget debate is usually between options one and two — raise taxes or reduce spending. Reduced spending often results in public-sector job loss.
Was the option to increase taxes, chosen by the Newfoundland and Labrador government, the best choice? Do more taxes really increase revenue enough to fix government budget deficits? Undoubtedly there will be an increase in revenue as a result of the tax increase during the first year. However the following years will see a reduction in that increase because of changes in the multiplier effect as a result of that tax increase.
The “multiplier effect” refers to the portion of a dollar of wages or salary that moves around the larger economy, supporting private sector jobs. To understand the multiplier effect, we need to look at the variables used to construct the concept multiplier effect. Three of the variables which help determine the value of the multiplier effect are: the net income employees have to use for discretionary spending, businesses growth and the number of private sector jobs they create.
When governments increase taxes there is a negative impact on these three variables that weakens the multiplier effect. Because government removes more money from the workers, the workers have less disposable income to spend and distribute through the larger economy. They have less money to spend on housing, food, cars, gasoline and other items. Fewer companies can operate when there is less money moving through the economy. Businesses close and there is a reduction in private-sector jobs. Government income from business tax will decrease and the income tax collected by government will decrease because of privatesector job loss. The result is that the increase in government revenue will be less than what was expected because of the reduced value of the multiplier effect. At the same time, government expenses do not decrease.
The wide gap in the provincial government budget cannot be fixed with attempts to increase income by increasing taxes alone. It will damage the local economy and create continuing problems for the provincial budget. Reducing expenses in the budget is necessary. It is the unavoidable solution if we wish to avoid larger loans and option four — default.