Interview with Chris Edwards, Director of Tax Policy at the Cato Institute
Posted on July 24th, 2011 by Eleanor Vaughan in Interview
In 1994, Canada was facing the same fiscal situation the U.S. today: fears of debt defaults, credit downgrades, and even I.M.F. intervention. Yet, Canada successfully turned around its economy, and today has lower unemployment and higher growth than the United States. I sat down with Chris Edwards, Director of Tax Policy Studies at the Cato Institute in Washington, D.C., to talk about what the United States could learn from Canadian economic policy.
Vaughan: Americans often stereotype Canada as the socialist North, a land of big government and high taxes. Is this characterization true today?
Edwards: Twenty years ago that was true, but today there’s increasing realization that Canada’s economy has reformed. The Canadian economy fundamentally changed direction in the 1990s under—oddly—a left-of-center Liberal government. They cut spending, privatized a bunch of stuff including air traffic control, cut the corporate tax rate, instituted Canada Tax-Free Savings Accounts, decentralized spending power to the provinces, and partly funded the social security and retirement system. These were all great, extremely successful reforms. Total spending as a share of GDP is now about the same in Canada and the U.S. Canada is no longer the hopeless welfare state that Americans wrote it off as a decade ago.
Chris Edwards advises that the United States has many lessons to learn from Canada in its effort to turn around its economy.
Vaughan: Policymakers here in Washington are very concerned with the high, stagnant unemployment rate. But while American unemployment hovers at a worrying 9.2 per cent, Canadian unemployment is at a healthier 7.4 per cent and falling. What accounts for the difference in these numbers?
Edwards: Keynesian economists say that the big stimulus package prevented the American economy from really losing jobs in the 2008 recession. In reality, the stimulus bill didn’t help the American economy: the U.S. has incurred its biggest deficit since WWII to pay for its stimulus package, while experiencing the worst recovery of its ten economic downturns since WWII.
Most normal people put two and two together and conclude that Keynesian economics simply don’t work. But remarkably, Keynesian economists in the United States—particularly Obama’s advisors—persist, saying the stimulus wasn’t big enough.
But, Canada shows that if you have a sensible budget policy, focus on tax reform, don’t pass invasive regulatory bills, then the economy will grow. You don’t need a stimulus package to ensure recovery. If governments don’t stomp on them, market economies grow by themselves. Policymakers need to learn that the proper response to a recession is to leave the economy alone, let markets adjust, let prices and wages adjust, and then watch economic recovery take off.
Vaughan: In the ongoing U.S. budget talks, there’s been much talk of spending cuts. Could you explain the difference between the way most folks think about a spending cut versus the way Washington defines a spending cut?
Edwards: Most of the U.S. budget is on auto-pilot, increasing automatically every year due to commitments made to programs like Medicare & Medicaid. So, unless a Congress passes a law drastically cutting spending levels, spending just keeps increasing. Washington defines spending “cuts” as trimming increases in spending. Spending is still growing, just at a slightly slower speed. Even with cutting $4 trillion over ten years, federal spending will still continue to rise enormously in the coming decade. What’s being proposed are not real cuts, they’re just modest reductions in spending increases.
Vaughan: Given the size of the U.S. debt, currently about $14.7 trillion, are taxes increases inevitable?
Edwards: Tax increases are looming in the future, unfortunately. Income tax rates are already so high that if you increase them any more, the tax base is going to start disappearing. So, the big battle in the future is likely to be over whether the United States should adopt a V.A.T. (value added tax), as a new way to raise revenue. Every European country—and Canada—has already imposed a V.A.T. Liberals are going to push for a V.A.T. in the future, but I don’t think the public will ever let them do it. This kind of tax would hurt ordinary people too much.
Vaughan: At 15 per cent, the Canadian federal corporate tax rate is almost 25 per cent lower than that of the United States, which is the worst among developed nations. Should the United States cut its corporate tax rates to encourage economic growth?
Edwards: Yeah, in my book “Global Tax Revolution“ I argue exactly that. The U.S. has the highest corporate tax rate in the world, tied with Japan at 40 per cent (if you include state taxes). It’s idiotic: America is shooting itself in the foot. Meanwhile, Canada is phasing in corporate tax cuts. Next year, the average combined federal-provincial rate in Ontario will be 25 per cent. So, if you’re Toyota or Honda or Mercedes-Benz: do you want to invest in Ontario with a 25 per cent tax rate or in Michigan or Ohio where the rate is 40 per cent? It’s a no-brainer.
For international companies who want operations in North America, there’s little reason to go to the United States any more. Canada’s got an excellent immigration policy, high-skilled workers, low corporate taxes, and a sensible and stable government. More and more international investment is going to be moving from the United States into Canada. Canada is going to be a great place to invest.
Vaughan: But it wasn’t always that way. Back in 1994, Canada faced the same kind of fiscal mess that the U.S. faces today: the possibility of default, mounting debts, credit downgrades, and a slowing economy. Canada managed to turn around its economy only through enormous political will. Is it possible for the United States to do the same, given the partisan squabbling that seems to dominate Washington?
Edwards: In the United States, it’s going to be a lot more difficult. The American constitution makes it much more difficult to implement reform than it is under the British parliamentary system. In the parliamentary system, a majority prime minister essentially becomes a dictator. In the American system, power is extremely divided between—but also within—the House, Senate, White House, and courts. When each individual Congressman holds so much power, it’s very difficult to implement meaningful economic reform.
Vaughan: What lessons could the United States learn from Canadian fiscal policy?
Edwards: Politicians need to have spines, the courage to do the right thing. Far too many Republicans want to cut spending, but they simply don’t have the guts to do it because they fear the electoral consequences. Under Prime Minister Jean Chretien, Canada chopped the federal budget by 10 per cent in two years in the mid-1990s. That would be like the United States chopping $400 billion out of its budget in two years, which American politicians regard as impossible. But the Liberal government did it in Canada and went on to win many elections. What Americans should learn from Canada is that cutting spending is not bad politics.
