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Inequality in British Columbia : what role does tax policy play? Wallis, Kimberly Dawn 2006

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INEQUALITY IN BRITISH COLUMBIA: WHAT ROLE DOES TAX POLICY PLAY? by Kimberly Dawn Wallis THESIS SUBMITTED IN PARTIAL FULFILLMENT OF THE REQUIREMENTS FOR THE DEGREE OF MASTER OF LAWS in The Faculty of Graduate Studies UNIVERSITY OF BRITISH COLUMBIA APRIL 2006 ©Kimberly Dawn Wallis,xoo<b A B S T R A C T In 2001 a new provincial government was elected in the province of British Columbia, the BC Liberal party. During their election campaign they promised that lower personal income taxes would stoke the BC economy. Although personal income taxes were lowered after their election, high income earners were given a much higher proportion of the tax cut (when looked at as a dollar value per person) than middle and lower income earners. Further, since government service fees increased in many areas, it is possible that middle and lower income earners may have found themselves paying more to the government in combined taxes and fees than before the advertised tax cuts. It is thus more realistic to suggest that the burden of taxes has shifted rather than to say that taxes were cut. Social services were also cut dramatically. It is suggested that inequality is likely to increase in the province as a result of these changes. The question of whether the changes to the personal income tax rates will have a positive effect on the BC economy, both in the short, medium and long term is considered. In the short term, it is questionable whether reducing personal income taxes will provide any stimulus to such component parts of the economy as the supply of labour and the supply of capital. It is noted that productivity, a key indicator that the BC Liberals sought to alter through changes to personal income taxes, has not improved. In the long term, a decreased investment in such social services as health and education may have a negative effect on the rate of economic growth in the province. ii TABLE OF CONTENTS Abstract " Table of Contents iii List of Tables iv Acknowledgements v Dedication vi 1 Introduction 1 2 Efficiency vs Equality: The Law and Economics Position 4 2.1 The Neoclassical Tradition: The Importance of Efficiency 4 2.2 The Dissenting View: Institutional Economists 11 2.2.1 The Rational Actor 13 2.2.2 Methodological Individualism 16 2.2.3 The Efficient Use of Scarce Resources 23 2.3 Conclusion: Distributional Concerns Do Matter 26 3 Inequality in British Columbia, Canada and Internationally 29 3.1 Inequality in Canada 29 3.2 Inequality in British Columbia 37 3.3 Cross-Country Comparisons of Inequality 45 4 Equality and Fairness in Taxes: The Canadian Tax Mix 52 4.1 Progressivity in Taxes 52 4.2 Clawback of Benefits 53 4.3 Reduction in the Number of Brackets 54 4.4 Assessing the Progressive System 56 4.5 Alternative Bases and Their Implications for Progressivity 60 4.5.1 Consumption Taxes 60 4.5.2 Wealth Taxes 62 4.5.3 Capital Gains. 63 4.5.4 Payroll taxes 64 4.6 British Columbia: The Attack on Progressivity 65 5 Tax Policy and Economic Growth 78 5.1 Introduction 78 5.2 Inequality and Economic Growth 78 5.3 Theoretical Models 81 5.4 Empirical Studies 91 5.5 Economic Growth in British Columbia 93 5.5.1 Introduction 93 5.5.2 Health and Education Spending 99 5.5.3 Capital Spending 102 5.5.4 Government Spending Transfers, Defense and Public Order 103 5.6 Government Spending on Research and Development 105 5.6.1 Fiscal Policy and the Cost of Labour 106 5.6.2 Fiscal Policy and the Cost of Capital 108 5.6.3 Conclusion 112 6 Conclusion 114 Bibliography 123 i i i LIST OF TABLES Table 3.1 All Individual Returns by Income Group - 1993, 1997, 2001 - British Columbia 38 Table 3.2 Shares of Family Income Going to Various Groups, 1947-95 47 Table 3.3 Taxes and Inequality, Selected OECD Member Countries 50 Table 4.1 Tax Rates in British Columbia Before and After BC Liberals Victory 68 Table 4.2 Number Returns Per Income Band 69 Table 4.3 Breakdown of Those Earning $50,000 or more 70 Table 4.4 Revenue by Source 73 Table 5.1 GDP Per Year in BC 1998-2003 95 Table 6.1 Total Taxes Paid per Person in BC 2000/1-2004/5 114 A C K N O W L E D G E M E N T S I offer my gratitude and appreciation to all those who helped me to write this thesis. I owe particular thanks to Claire Young who has never failed to support me, to Kim Brooks whose detailed feedback has improved the work immeasurably, and to Janis Sarra and Stephen Wexler, whose classes in Law and Economics and Philosophy of Law were enormously inspirational. DEDICATION To My 'Husband'^im and"My (Daughter Natasha 1 Introduction The year was 2081, and everybody was finally equal. They weren't only equal before God and the law. They were equal every which way. Nobody was smarter than anybody else. Nobody was better looking than anybody else. All this equality was due to the 211 t h, 212 th, and 213 t h Amendments to the Constitution, and to the unceasing vigilance of agents of the United States Handicapper General. -Kurt Vonnegut, "Harrison Bergeron" The passage by Kurt Vonnegut cited above reveals a human fear of too much equality. Today, we associate such enforced sameness with totalitarian regimes that aim to stamp out individual differences in favour of a homogeneous population in which individual abilities, aims and desires have been forcibly subsumed into collective needs. George Orwell's 1984 is another good example of a piece of literature that warns us of the dangers of ignoring the human needs of individual men and women. One senses the writers of these works inciting us to cry in response to such imaginary draconian regimes, is there not a legitimate space in human society for rewarding the talented, the intelligent, even the extravagantly beautiful? Are our differences not good, are they not what make us fully human? Why should we aim for such a drab sameness? However, another way to look at inequality between people is through the lens of the economist, for whom a straightforward calculation of the gap between the wealthiest and poorest members of a given society gives a numerical figure that represents the level of inequality in that society. Both the literary and the economic views may offer us something of value when we decide the extent to which our laws should promote equality, however, only the economic definition of inequality will be looked at in this thesis. 1 In this thesis I am primarily interested in assessing the economic reasoning behind the BC Liberal government's tax policies, instituted in this province since it came to power in 2001. It is my thesis that the tax policies chosen by the Liberal government are likely to have a direct and significant impact on the level of inequality (as defined by economists) in British Columbia, and will provide at best a weak stimulus for economic growth. Chapter 2 shows that the traditional law and economics movement derived its tools from the neoclassical economic tradition. This tradition was very strict about ignoring distributional concerns when analyzing economic behavior, on the assumption that efficiency was a much more significant marker for good economic policy, and further, that more efficiency would lead to more goods and services for everybody. Today, there are schools of economic thought other than the neoclassical, and in many distributional concerns are paramount. Thus, traditional law and economics analysis may be somewhat dated where it seeks to create the illusion that distributional concerns are, or should be, irrelevant. In fact, as will be discussed in detail in Chapter 5.2, the distribution of wealth in a given society provides an important indicator for many indicia of the quality of life, such as low infant birthweight. The notion that greater efficiency will in and of itself lead to greater amounts of goods and services for all members of a given population appears to be untrue, because we see in the world today very advanced, efficient economies in which inequality is increasing quite dramatically. In Chapter 3, the extent of inequality in the Canadian and British Columbian economies today and over the last several decades is examined. It is clear that inequality has been increasing in Canada over the last several decades. However, the data necessary to draw such conclusions takes time to emerge from Census reports and other sources; therefore, it is not absolutely possible to say exactly what has happened to inequality in 2 British Columbia since 2001. In order to gain some perspective on inequality and on what the changes in inequality mean in an increasingly globalized world, Chapter 3 provides a look at inequality trends in other jurisdictions. Chapter 4 contains a discussion on the impact that tax policy can and should have in the area of inequality. Considerations include the optimum degree of progressivity of an income tax and the impact that shifts in the tax base can have on inequality. Again, I look specifically at British Columbia as a case study and analysing the likely impact on inequality of the BC Liberals' changes to tax policy. Chapter 5 considers the argument that there is an inherent tradeoff between enhanced efficiency and greater distributional equality. The neoclassical model in which this tradeoff is thought to exist will be described, followed by a discussion of the competing models, which suggest the opposite - that efficiency will be hampered by inequality. The BC Liberals fiscal policy will then be analysed in reference to a comprehensive study commissioned by the IMF in which the various component parts of fiscal policy are analysed for their impact on economic growth. Finally, this information is used to assess the likely impact of the BC Liberals' fiscal policy on economic growth in the province of British Columbia. The thesis concludes with a summary of the dangers of driving the British Columbia and Canadian economies towards greater inequality. Tax policy is shown to play an important role in alleviating inequality. 3 2 Efficiency vs Equality: The Law and Economics Position 2.1 The Neoclassical Tradition: The Importance of Efficiency Ronald Coase and Guido Calabresi1 are almost universally cited2 as having created law and economics as a distinct discipline in the early 1960s. Richard Posner, the discipline's most famous exponent, suggests that Coase and Calabresi represent the "first attempts to apply economic analysis in a systematic way to areas of the law that did not purport to regulate economic relationships."3 Gregory Crespi, however, is more specific: Calabresi and Coase represent "a sustained effort to apply the techniques of neoclassical economic theory to the analysis of legal questions" [emphasis added].4 It is important to keep in mind that economic theory encompasses many more variants than the neoclassical model used by Coase and Calabresi, and that Posner ignores this, eliding all conflicts within the discipline of economics into one unanimous "economic analysis". Posner's lack of any reference to alternatives to the neoclassical tradition is understandable given that he was writing in 1973, but today some reference to the lack of any unanimity within the field of economics would be more appropriate. 1 Ronald Coase, "The Problem of Social Cost" (1960) 3 J. L. & Econ. 1; Guido Calabresi, "Some Thoughts on Risk Distribution and the Law of Torts" (1961) 70 Yale L.J. 499. 2 For example, Jacob Ziegel states: "The modern law and economics movement is usually traced to the publication of Ronald Coase's classic article on The Problem of Social Cost' in 1960 and the publication of two books: Guido Calabresi's The Cost of Accidents: A Legal and Economic Analysis, published in 1970, and Richard Posner's evangelical textbook, The Economic Analysis of Law, the first edition of which appeared in 1973." Jacob Ziegel, "What Can the Economic Analysis of Law Teach Commercial and Consumer Scholars?" in Commercial and Consumer Law: National and International Dimensions, Ross Cranston and Roy Goode, eds. (Oxford: Clarendon Press, 1993) at 249. 3 Richard Posner, "The Economic Approach to Law" (1975) 53 Tex. L. Rev. 757 at 759 [Posner, "Economic Approach to Law"]. 4 Gregory Crespi, "The Mid4Jfe Crisis of the Law and Economics Movement: Confronting the Problems of Nonfalsifiability and Normative Bias" (1991) Notre Dame L. Rev. 231 at 231. 4 Neoclassical economic theory rests on certain assumptions that have implications both on the microeconomic and the macroeconomic level. The most basic of these assumptions is that we live in a world of finite resources5 and that therefore not all human needs and/or wants can be met. Hence the traditional emphasis upon efficiency: the more efficient we are at allocating scarce resources, the more we will be able to increase the sum total of human satisfaction.6 Individuals are constructed within this theory as self-interested rational maximisers7 who seek to increase their own satisfaction in encounters with others. The ultimate place to increase satisfaction is in the market, constructed by neoclassical economists as "'natural' and 'private' where atomistic, selfish individuals and profit-maximizing firms interact."8 In keeping with the notion that the individuals meeting in the markets have no relevant life history, "[t]he imagery of these private markets is of Robinson Crusoe autonomy and self-sufficiency."9 The problem with constructing individuals as self-interested rational maximisers is that this construction ignores all the societal and familial supports that the individual required to reach adulthood and to be self-sufficient; humans, after all, are born spectacularly ill equipped to be self-sufficient in comparison to all other species. Further it ignores the communal aspects of most labour in today's marketplace. Who "makes" a Toyota or a 5 "...every human action requires the use of scarce resources, making competition for these resources unavoidable - competition among different human beings but also among the different ends that any single person may pursue (for which the same resources are often needed.)" Anthony Kronman, The Lost Lawyer (Harvard: Belknap Press, 1993) at 227. 6 Jacob S. Ziegel puts it thus: "...since resources, all resources, are limited in supply, they should be exploited in such a way that human satisfactions as measured by aggregate consumer willingness to pay for goods and services are maximised. This is the principle of allocative efficiency." Ziegel, supra note 2 at 253. 7 "The basis of an economic approach to law is the assumption that the people involved with the legal system act as rational maximizers of their satisfactions." Posner, "Economic Approach to Law", supra note 3 at 761. 8 Lynne L. Dallas, "Law and Socioeconomics in Legal Education" (2003) 55:4 Rutgers L. Rev. 855 at 857. 9 Dallas, ibid., citing Ulla Grapard, "Robinson Crusoe: The Quintessential Economic Man?" (1995) 1 Feminist Economics 33. 5 Pentium word processor, or, for that matter, a Barbie? The answer here is clearly that one individual is not responsible. Most goods and services are in fact the result of communal effort. Thus one interacts in a marketplace often not as an individual but as a member of a classifiable group, whether as consumers or producers. Even the classic independent self-employed individual does not really work totally alone: what would it mean to be a sole practitioner of law in the absence of a legal regime that states members of the bar have a monopoly on representation in the higher courts? As this example shows, it is nonsensical to ignore the contributions of others, no matter how indirect, to any modern exchange of goods or services. For the early exponents of law and economics, the excitement of the new discipline was its seeming ability to find a pattern where none had existed before. Was the intellectual backdrop to the common law an instinctive response on the part of judges to maximize human satisfaction by eliminating waste? Could the desire for efficiency provide an explanation not just of how the law was, but indeed, how it should be? This excitement led Posner to claim in 1975 that Coase and Calabresi discovered that the law has an implicit economic logic and that "[l]ater writers have generalized this insight and argued that many of the doctrines and institutions of the legal system are best understood and explained as efforts to promote the efficient allocation of resources."10 As late as 1993, Kronman describes the argument thus: "...proponents of law and economics...seek to show that the law has a greater intelligibility as it appears to, and that the historical accidents to which it seems to owe its shape are in reality the product of actions that conform to certain timeless laws of human behavior."11 Such characterizations cannot Posner, "Economic Approach to Law", supra note 3 at 759. 1 1 Kronman, supra note 5 at 227-8. 6 help but add legitimacy to the neoclassical economic analysis of law, making it appear to be a manifestation of nature rather than a product of human design. The final step, for the neoclassical law and economics scholar, was to move the model from one that has explanatory power to one that dictates policy: not only does the common law promote the efficient allocation of scarce resources, it should do so, and legal decision making should become an explicitly efficiency enhancing mechanism.12 In essence, this point of view promotes the idea that the law should allow markets to function with as little intervention as possible, because harmonious and efficiency-maximizing outcomes will naturally emerge at the points where supply and demand reach equilibrium. So much for the theory; in practice, law and economics scholars rely on two related tests in order to assess the proper allocation of scarce resources between competing individuals. These are popularly known as Pareto and Kaldor-Hicks, after their respective creators.13 The Pareto test states that a change (or ruling in a legal dispute if one is interested in the application to law) is desirable if it makes at least one person "So long as there remain important areas of the legal system that are not organized in accordance with the requirements of efficiency, the economist can play an important role in suggesting changes designed to increase the efficiency of the system." Posner, "Economic Approach to Law", supra note 3 at 764. See also, generally, Richard A. Posner, The Ethical and Political Basis of the Efficiency Norm in Common Law Adjudication, (1979-80) 8 Hofstra L, Rev. 487 at 504-5 [Posner, "Efficiency Norm"]. 1 3 "The social welfare analysis of neoclassical economics rests on two concepts of efficiency: Pareto optimality and Kaldor-Hicks efficiency" Dallas, supra note 8 at 874. "Two criteria of efficiency are commonly applied [by the lawyer-economist] to answer [the question of allocation efficiency]...the Pareto superior efficiency test...[is] very partial to market economics and equally congenial to liberal democratic values...the Kaldor-Hicks test... comes into play when it is impractical or impossible to secure ex ante the consent of every individual likely to be affected..." Ziegel, supra note 2 at 253; "The evaluative standard almost universally used by law and economics writers is that of 'efficiency'. Legal rules and institutions are given a stamp of approval if they enhance the efficiency with which scare resources are allocated and are criticized if it can be demonstrated that they foster inefficient practices. Two generally accepted and related definitions of efficiency exist: Pareto efficiency and Kaldor-Hicks efficiency." Crespi, supra note 4 at 234. 7 better off and makes no-one worse off. The Kaldor-Hicks rule states that a legal judgment is desirable if it makes at least one person better off, even if it does make some other person(s) worse off, if the gains are so large that the "losers" could be completely compensated for their loss and there would still be an advantage for the winner. Pareto is clearly an abstraction not suited to the world of litigants, as by definition if two people have a legal dispute, the outcome will involve a loser and a winner. For all practical purposes, then, law and economics scholars ultimately refer to the Kaldor-Hicks test to pronounce a solution to a legal problem as efficiency enhancing. It is generally understood that, if in theory the winner could compensate the loser and still come out ahead, a decision will be efficiency-enhancing even if no such compensation is paid. Indeed, such a point is inarguable, although one may feel somewhat shortchanged to learn that one is the "loser" who need not be compensated - and, selfish human beings being what they are (at least according to neoclassical economic theory) that feeling, of being shortchanged by the system, can lead to frustrations that find an outlet in antisocial (violent) behavior.14 If this is true, the argument that efficiency has been enhanced must take into account the losses incurred by such antisocial behavior. However, no such analysis of the costs of having angry uncompensated losers forms part of the neoclassical model. Traditionally, economists have divided their field of inquiry into two distinct realms: microeconomics, or the study of the behavior of individual agents (constructed variously as either individuals, households or firms) and macroeconomics, or the study of the aggregate economy - which seeks to know how and why the economy as a whole will grow, go through cycles and interact with various other economies. However, since the 1970s, the notion that economic study can be so divided has been criticized, and the 1 4 See Chapter 5.2 for more on inequality and increased crime. 8 view has been taken that individuals are actually the starting point for what was traditionally defined as macroeconomics as well as microeconomics. The rise of the individual to pre-eminence in economic theory is explained by Sonja Amadae in her analysis of the rise of "rational choice theory" following the end of the Cold War. 1 5 In keeping with the neoclassical economic theory sketched out above, Amadae posits that the "rational actor" now reigns supreme in a world believed by the expounders of neoclassical economics to be freed from the bondage of regimes that rested on a collectivized notion of human welfare. The threat of "authoritarian socialism" having been vanquished, believers in rational choice theory felt confident that they had pushed the evolution of human progression as afar as it could go. We had reached, in the famous phrase of Francis Fukuyama, the "end of history": ...the self-interested, strategic rational actor became the central figure around which the reexamination of traditional Enlightenment themes and problems of government was based. The set-theoretic and axiomatic treatment of human rationality came to serve as the new standard for describing the zenith of human consciousness, and could be used as a virtual litmus test to determine if one were a liberal individualist or an irrational collectivist: rational choice theory holds that rational individuals do not cooperate to achieve common goals unless coerced, in direct contradiction to the precepts of Marxism and communism.16 In effect, Amadae is saying that in no circumstances are the selfish goals of individuals furthered through cooperative behaviour. Further, as Amadae also points out, this veneration of the individual has led to a growing skepticism concerning traditional ideas of 'public goods' or 'general welfare.' By always taking the self-interested individual as the starting point for analysis, it becomes difficult to imagine how one could construct a state-governing apparatus that had any interests transcending those of the individuals 1 5 Sonja Amadae, Rationalizing Capitalist Democracy: The Cold War Origins of Rational Choice Liberalism (Chicago and London: The University of Chicago Press, 2004). 16/b/d at 3. 9 who constitute it. By extension, government or state action becomes simply "interference" with individual freedoms. Two major proponents of rational choice theory are James M. Buchanan and Gordon Tullock,17 who articulated a vision of western liberalism designed to oppose collectivist ideology - "whether communist, socialist or Keynesian - by stressing the significance of the individual over the group, thereby undermining any notion of the 'public'."18 The popularity of these ideas led to Buchanan being awarded the Nobel prize for economics in 1986; as late as 1997 he was still warning of the "normative delusion, stemming from Hegelian idealism: [that] the state was, somehow, a benevolent entity and those who made decisions on behalf of the state were guided by consideration of the general or public interest."19 However, where does this argument actually lead? If all rules created by the state represent the personal selfishness of the lawmakers themselves, then this must surely include a rule that implements a legal regime to force Kaldor-Hicks style efficiency enhancing dispute mechanisms on the general public. In fact, if one takes the argument that all governmental intervention represents unwarranted interference, then surely the only legal regime left to make a positive argument for is total anarchy. Thus we arrive at the nucleus of the neoclassical economic world-view: atomized individuals seeking their own gratification in encounters that take place in an abstract plane devoid of any distinct features of a recognizable place and time, suffused with a 1 7 Their ideas were first expressed in James M. Buchanan and Gordon Tullock, The Calculus of Consent: Logical Foundations of Constitutional Democracy (Michigan: University of Michigan Press, 1962). 1 8 Amadae, supra note 15 at 134. 1 9 James M. Buchanan, "Socialism is Dead But The Leviathan Lives On", in James M. Buchanan, ed., Post-Socialist Political Economy (Lyme, Conn.: Edward Elgar, 1997) at 85, cited in Amadae supra note 15 at 133. 10 winner take all mentality that precludes cooperative effort to achieve common goals. This portrait has not gone unchallenged. In the next Chapter, criticisms of the neoclassical economic theory, especially as it has been used as a tool for the analysis of law, will be canvassed. 2.2 The Dissenting View: Institutional Economists Virtually all aspects of the neoclassical economic model have come under attack from the various other schools of economic thought that have sprung up since Coase and Calabresi's time. Lynne Dallas lists these other schools as "behavioral, neo-institutional, feminist, binary, traditional institutional, and post-Keynesian", and, by implication, her own field, that of socioeconomics.20 They offer a fresh perspective on such time-worn themes as, what is the study of economics really all about? Not even the seemingly incontrovertible suggestion that we live in a world of finite resources and must strive to make the most efficient use of them escapes criticism. Although Dallas reluctantly accepts that this analysis may be useful in some contexts, she insists that it is the wrong starting point. The many other possible starting points from which to analyse economic activity are usefully summarized by her as follows: ...socioeconomists offer a more complex, inclusive view. To institutional economists, economics is the study of changing patterns of social relations dealing with the creation of material goods and services to meet social (private and public) needs and wants. Similarly, many feminist economists and institutional economists describe economics as the study of provisioning or how society provides for the well-being of its members. They analyze the 'social goals and values that give rise to...economic activity,' and, along with neo-institutional economists, analyze 'institutional frameworks in society.' To socioeconomists, the units of analysis include the individual, group, organization, community, Dallas, supra note 8 at 855. 11 society and also the transaction. Under the socioeconomic umbrella, institutional economists study economies in real time and in relation to culture and history...21 As this quote shows, it is crucial to those who would dispute the validity of the neoclassical model that reference be made to real people making real decisions in real places and real times. Where the neoclassical economist eliminates context and strives to describe universal human behavior, those with alternative views always aim to situate their analysis of economic behaviour in the real world. Another criticism of neoclassical economics is that "value" cannot be inferred without reference to the real world. For something to have "value" it must exist within a cultural context that ascribes value to it. For example, Anne Mayhew, the feminist-institutional economist, insists that value is not natural, nor is it simply the result of supply and demand, but rather, "[v]alue is socially constructed through an ongoing process, and prices and distributional consequences are always a consequence of the current play of interests, policies and customs."22 In essence, such arguments rely on the notion that what is "valuable" to human beings is malleable. This question has generated a fair amount of controversy, but will not be examined in detail in this thesis. The argument of this thesis, that inequality has negative implications for the health of an economy, follows equally well from an acceptance of the neoclassical point of view, that there are universally desired "values" that human beings strive for. 21 Ibid., at 860 [citations omitted]. 2 2 Dallas, supra note 8 at 861. 12 2.2.1 The Rational Actor The concept of the "rational actor" who seeks to maximize pleasure on an individual basis without regard for others is one of the fundamental beliefs of neoclassical economics and by extension the traditional law and economics approach to legal reasoning. Gregory Crespi 2 3 has made a powerful critique of the "rational actor" concept. He argues that in stating all people make rational choices to maximize their own satisfactions, neoclassical economists are simply creating a tautology. It is axiomatic to a neoclassical economist that the only way to determine a person's choice is through the actual transactions that they undertake in the marketplace, known as "revealed preferences."24 The problem is that one begins by defining the choices that people make as rational - then one looks at what those choices are for proof of what "rational" decisions are. The argument would work equally well if one decided that the very definition of irrational was "that which people actually decide to do" - all human behavior would then be irrational. The following is Crespi's assessment of the reasoning involved: Unfortunately, economic analysis as now conducted by mainstream practitioners rules out of bounds any attempts to empirically measure preferences through observations of the conduct of the actors apart from the behavior through which their preferences are expressed in binding form. Stated differently, the only generally accepted evidence of persons' preferences is their "revealed preference" behavior at the moment of actual binding choice. Given this evidentiary constraint, their preferences can only be indirectly inferred by working backwards from this behavior under the assumption of rationality. In this tautological universe, the assumption of rationality is nonfalsifiable. No matter how people behave, their behavior can be irrebutably argued to be completely rational, given the freedom of the analyst to infer exactly the necessary preference structures and changes in those structures over time needed to Crespi, supra note 4 at 240. 2 4 As opposed to an analysis that would take into account psychological factors that influence people's decision making. 13 support this conclusion. This degree of freedom reduces virtually the entire structure of neoclassical economic analysis to metaphysics rather than science.25 This perhaps goes some way to explaining why Posner complained that "the logic of rational maximization is subtle, frequently complex, and very often counterintuitive."26 The inherent elasticity of the rational actor model as explained by Crespi may also explain Becker's delight with its scope: I have come to the position that the economic approach is a comprehensive one that is applicable to all human behavior, be it behavior involving money prices or imputed shadow prices, repeated or infrequent decisions, large or minor decisions, emotional or mechanical ends, rich or poor persons, men or women, adults or children, brilliant or stupid persons, patients or therapists, businessmen or politicians, teachers or students.27 In other words, Becker could find no situation in which the rational actor model broke down. This is predictable enough if one accepts Crespi's analysis of it as a tautological definition: once the expression of a preference is itself the definition of rational, one hardly help but to see nothing but the rational expression of preferences all around. It should also be pointed out that in using people's actual behavior in the marketplace as the only indicia of true preferences, we can only ever know what preferences people demonstrate given the options currently available to them at a given place and time. In other words, Swedish mothers may opt to stay at home with their children for the first two years of their children's lives and then return, without penalty of any kind, to the jobs they left behind. The fact that women in other European countries, Canada and the United States, and developed countries do not "choose" this option is unintelligible unless the framework within which such choices are made is clarified. Here we see once again why 2 5 Crespi, supra note 4 at 240 [citations omitted]. 2 6 Posner, "Economic Approach to Law", supra note 3 at 761. 2 7 Gary Becker, The Economic Approach to Human Behavior (Chicago: University of Chicago Press, 1976) at 35. 14 so many take issue with the abstraction of the neoclassical economist - any serious discussion of appropriate maternity benefits would have to take into account how women behave when faced with different options. One of the problems with excluding preferences for options that are not currently on offer to the individual is the well-known "prisoner's dilemma". The prisoner's dilemma problem refers to situations in which the rational pursuit of self-interest generates harm for the many, but beneficial results for the few. For example, in the workplace, people may work hard to get to the top, or even just to keep their jobs, working longer hours, spending less time with their families and communities. As each employee strives to outdo the other, "a rat race develops in which each tries to outwork the other."28 Only one can be promoted to the position of authority, "yet, all have an incentive to participate in a rat race that makes all but one worse off."29 At the end of the day, many workers will be made worse off by this rat race, but any individual who chooses not to participate will, as an individual, be even worse off than those competing; "consequently, there is no opting out."30 For each individual competing in the "rat race", they express their preference by working hard in order to survive. If collective bargaining is not available, an economist could conclude that "revealed preferences" show that the individuals wish to compete aggressively, constantly outdoing each other in competing for jobs or positions of authority. However, if collective bargaining is available, it may be that the individuals involved would reveal a different preference, that of collectively negotiating a higher 2 8 Thomas I. Palley, Plenty of Nothing: The Downsizing of the American Dream and the Case for Structural Keynesianism (Princeton: Princeton University Press, 1998) at 9. 29 Ibid. 15 wage for fewer hours of work. Thus, revealed preferences can only tell us what the individual chooses from amongst the array of choices currently before them. It follows that preferences are actually highly contingent and depend very much on the specifics of a particular culture and legal infrastructure at a particular point in time. This is why institutional economists insist on studying economics in relation to culture and history, and criticize neoclassical economists for using models that are abstract, universal and not specifically situated.31 It also seems clear that, taking the actual behavior of people as evidence of their choice will always work to preserve the status quo. This is because the status quo does not form part of the analysis according to a neoclassical scholar, rather, it remains safely outside the scope of analysis. To continue with the example used earlier, an analysis of women's choices of when to return to work after having a child that took the current legal regime of maternity leave as a given would be of little or no use in helping to formulate a new, and potentially more popular, policy. To conclude, the rational actor model is vulnerable to the attack that the "revealed preferences" methodology for determining rationality uses a particular choice as evidence to confirm that the choice is rational, an unacceptable tautology that will always work simply to endorse the status quo. 2.2.2 Methodological Individualism As has been mentioned briefly, the concept that economic study can be divided into microeconomics and macroeconomics has been attacked on the basis that all economic activity originates with the individual, and thus the individual is the correct starting point 3 1 Dallas refers to such universal economic theories as "arm-chair economics." Dallas, supra note 8 at 891. 16 for all economic inquiry. This is known as "methodological individualism". Methodological individualism shares very close ties with the "rational actor" model, and they both figure strongly in game theory, which has grown slowly in the public consciousness since John Von Neumann and Oskar Morgenstern introduced the concepts to an academic audience with the publication of Theory of Games and Economic Behavior in 1944.32 As Amadae puts it, they sought to "study the interactions between strategic actors by mathematically defining what it means to be 'rational' in all conceivable decision contexts involving payoffs against the actions of other similar actors."33 Game theory has brought various tools and concepts to the debate about individual versus collective decision making that are very helpful. The prisoner's dilemma, described above, is one of these. The prisoner's dilemma derives its name from a game in which two players decide whether to cooperate or defect: if both cooperate they both get 3 points, if one cooperates but the other defects, the defector gets 5 points while the cooperator gets zero, and finally, if both defect, they both get 1 point. The idea is to play with the concept of individual rational decision making: as much as each player might strive for 5 points, it is clear that the other player will also do so, and thus the temptation is to mutual defection, whereas mutual cooperation will lead to a higher score. Hence the dilemma. In an attempt to find the best "solution" to the Prisoner's Dilemma, Robert Axelrod invited specialists from a range of different disciplines to submit computer programs that would 3 2 John Von Neumann and Oskar Morgenstern, Theory of Games and Economic Behavior (Princeton: Princeton University Press, 1947). Amadae, supra note 15 at 6-7. Von Neumann took his theories and worked them into a set of precepts that could supposedly be used to best the Soviets if nuclear war broke out, rather disturbing in the context of the comments made by Pinker above on the tendency for human beings to be limited in their ability to think rationally when it comes to assessing their own likelihood of future success. 17 play the game, much as artificial intelligence programs can now play chess. He received fourteen entries from five disciplines: psychology, economics, political science, mathematics and sociology. As Axelrod reports, "[s]urprisingly, there is a single property which distinguishes the relatively high-scoring entries from the relatively low-scoring entries. This is the property of being nice, which is to say never being the first to defect...there is even a substantial gap in the score between the nice entries and the others."34 The computer program game results suggested that the highest scores could only be achieved by adopting the most cooperative strategies. Methodological individualism posits that self-interested rational actors make choices that maximize their own payoffs, the crucial point being that self-interest is always narrowly constructed down to the one individual human being making the decision and is accompanied by a skepticism regarding the existence of truly altruistic behavior. At first glance, this seems to have negative implications for the possibility of collective, rational decision making, or, as Amadae puts it, "one profound consequence of the scrupulous individualism of rational choice...has been a growing skepticism over the inherent meaningfulness of 'the public', 'public interest', or 'general welfare.'"35 In person,36 she has been more explicit, stating that the endpoint of rational choice theory is the conclusion that it is irrational to cooperate. Incidentally, Gordon Tullock is referred to above for his work on public goods theory, and Amadae suggests that he and Buchanan were explicitly influenced by von Neumann and Morgenstern's game theory work. Nonetheless, Tullock's submission to Axelrod's game came in 13 th out of 14 submissions, besting only one submitted by an anonymous donor, and doing only marginally better than one designed to play a purely random game designed by Axelrod as a control. This is hardly an endorsement of his interpretation of von Neumann. 3 5 Amadae, supra note 15 at 4. 3 6 Law & Economics Seminar, Friday March 19 th 2004, Faculty of Law, University of British Columbia (unpublished). 18 Amadae suggests further that other fields of inquiry have been influenced by game theory and methodological individualism, including the field of genetics: "Beginning in the late 1960s and 1970s, evolutionary biologists began to incorporate the results of game theory in the concept of the 'selfish gene' and in biological studies of altruism and cooperation."37 The suggestion here is that methodological individualism can be taken beyond (or below?) the level of the individual human being to the level of the genes that make up one person, which, by this analysis, would be equally engaged in a "selfish" attempt to maximize their own payoffs, in contest with the other genes that make up an individual human. In the passage cited above Amadae is blurring of the concepts of altruism and cooperation. What evolutionary biologists such as Dawkins38 and Trivers39 have sought to prove is not that cooperation is irrational, but rather, that it is often motivated by self-interest rather than altruism. In fact, it is clear that, far from being a rare and generally ill advised strategy for evolving organisms, cooperation may be the most payoff enhancing strategy of all: "many of the benefits sought by living things are disproportionately available to cooperating groups."40 Simply put, if there were no benefits to cooperation in the natural world, there would be no reason for cells to group together to form multi-celled organisms. It is like saying that Paramecium, who "choose" to go it alone, are more rational than the cells that comprise a human being, who have "chosen" to band together and specialize. This is very much the opposite of what evolutionary biologists teach. 3 7 Amadae, supra note 15 at 8. 3 8 Richard Dawkins, The Selfish Gene (Oxford: Oxford University Press, 1976). 3 9 R. Trivers, Social Evolution (Reading, Mass: Benjamin/Cummings, 1985). 4 0 Robert Axelrod, The Evolution of Cooperation (London: Penguin Books, 1984) at 92. 19 Thus, it is wrong to assert that cooperation is never rational - clearly it is, if only because cooperation can involve much larger rewards for the individual than refusing to cooperate. For example, a cartel is by definition an example of cooperation, which clearly boosts the payoffs for those involved more than unfettered competition would in the same circumstances. However, it would be equally wrong to assert that cooperation is always rational, in the sense of payoff enhancing. What game theorists and evolutionary biologists have concluded is that reciprocal altruism does provide a basis for rational cooperation. "Reciprocators who help others who have helped them, and who shun or punish others who have failed to help them, will enjoy the benefits of gains in trade and outcompete individualists, cheaters, and pure altruists."41 In the language of the biologists, reciprocal altruism is an evolutionary stable strategy - a strategy that is not vulnerable to infiltration by individuals who use a more aggressive, selfish strategy for generating payoffs. Ultimately, the importance of this discussion lies in its rejection of the supposed problem that methodological individualism poses for the possibility of collective action. As Pinker puts it: "[a]n ethos of reciprocity can pilot not just one-on-one exchanges but contributions to the public good, such as hunting animals that are too large for the hunter to eat himself, building a lighthouse that keeps everyone's ships off the rocks, or banding together to invade neighbors or to repel their invasions...people are neither the amoral egoists of classical economic theory nor the all-for-one-and-one-for-all communalists of Utopian fantasies."42 In other words, there is no conflict between believing that human 4 1 Stephen Pinker, The Blank Slate: The Modern Denial of Human Nature (New York: Penguin Books, 2002) at 255. 4 2 Pinker, supra note 41 at 256. 20 beings are motivated by self-interest and simultaneously believing that each individuals' self-interest is best served by cooperating with others. Another powerful criticism of methodological individualism comes from some feminist economists.43 They have shown that the abstracted model of human interaction of neoclassical economics as being between two independent, able-bodied, self-sufficient individuals ignores some fundamental biological facts about the human condition: the experience of pregnancy, for example, in which two people inhabit the same body, that of parenthood, in which one human being relies entirely on others for all of his or her needs for many years, and even the decline of faculties in old age, in which human beings once again may reach a completely child-like dependent state. One must exclude the universal44 experience of the completely helpless and dependent state of childhood in order to characterize all human interaction as being in some way "independent." Another flaw with the neoclassical economic model pointed out by feminist economists is that it fails completely to provide a satisfactory explanation for the phenomenon of marriage. The conservative view, most associated with Gary Becker, is that, unlike the model for human behaviour outside the family, which assumes complete selfishness, behaviour within the family can be described as complete altruism. This model assumes that each family acts as a single economic unit 4 5 It is further assumed that one rational 4 3 See generally Frances Wooley, "The Feminist Challenge to Neoclassical Economics," (1993) 17 Cambridge Journal of Economics 487. 4 4 Becoming a parent may not be universal, but all human beings nonetheless participate in this dynamic by virtue of the fact that we were all babies and then small children, completely dependent on others for survival. 4 5 Hence the colloquial term "black box." The metaphor suggests that as an economist one does not peer inside the box, i.e. into the family, to see how choices were formed and how they emerge out of it, rather, one treats such intra-family negotiations as invisible and one only analyses the choices made by the family as a unit. 21 decision-maker (implicitly, the male breadwinner), optimally distributes resources amongst family members 4 6 As feminists have pointed out, this ignores power relations and bargaining within the marriage and does not correspond to many women's experience of the state of marriage.47 Actually, the latter half of the previous sentence is a gross understatement: "evidence on domestic violence is a rather horrible reminder that it is not always appropriate to assume that individuals within families are equally well-off."48 The feminist critique of the black box theory also illustrates in a convincing manner the limits of the purely self-interested rational actor model as an explanation for all human interaction. To conclude, methodological individualism is vulnerable to the criticism that it ignores basic biological facts concerning the creation and maintenance of human life. It is also vulnerable to the clear evidence emerging from the fields of evolutionary biology and game theory, fields which supposedly provide support for it, that cooperation based on reciprocal altruism is a more successful strategy in generating payoffs, than a purely individualist one. Nevertheless there are those who still endorse the neoclassical approach to economic policy. The BC Liberals fall into this camp. If higher taxes can be used to pay for more public services, and a society that provides for all its members more public services can be described as more "cooperative", then one could say that the BC Liberals have intentionally been making BC fiscal policy one that is more individualistic and less cooperative. 4 6 See generally Gary Becker, "A Theory of Marriage" in T.W. Schultz, ed., Economics of the Family (Chicago: University of Chicago Press, 1994) and Gary Becker, A Treatise on the Family (Cambridge MA: Harvard University Press, 1981). Wooley, supra note 43. 4 8 Shelley Phipps and Peter Burton, "Collective Models of Family Behaviour: Implications for Economic Policy" (1996) 22 Canadian Public Policy 129 at 135. 22 2.2.3 The Efficient Use of Scarce Resources Another problem with the notion that an efficient use of scarce resources is the way to maximize aggregate human happiness is the difficulty that arises the moment one tries to actually assess which result amongst a possible array does in fact most enhance efficiency. The first conundrum is that one must be more specific and answer the question, what, exactly, is it that we are trying to increase? So far in this paper I have used the terms "pleasure", "happiness", and "satisfactions", interchangeably and uncritically; other contenders found in the literature are "utiles", "wealth", and simply "payoffs". Not only is choosing one of these very difficult and fraught with political considerations, one is then faced with the Herculean task of measuring it in order to make comparisons and declare an outcome the winner in increasing the sum total of "happiness" in the world. Perhaps not only due to these conceptual difficulties, Posner, as my iconic neoclassical law and economics scholar, unambiguously chose wealth49 as the thing we are trying to increase, which seems at first glance to preclude at least any difficulties with measurement. Even Bentham, the most famous exponent of utilitarianism, came up against this problem and devoted some considerable energy to explaining how utiles were to be measured. To give Pareto his due, he came up with his famous formula precisely in order to deal with the longstanding recognition that it is extremely difficult to make interpersonal welfare comparisons. As Posner puts it, this was an answer to the "traditional problem of practical utilitarianism, that of measuring happiness across persons for purposes of determining the effect of a policy on total utility."50 Despite Bentham's cheery belief that See generally, Posner, "Efficiency Norm", supra note 12. Ibid at 488. 23 there was no real difficulty in doing such measuring, it has proven a thorny problem for all those who seek to promote utilitarianism. Both the Pareto and Kaldor-Hicks principles rely on some means to measure the sum total of payoffs in order to work. Both of these principles have attracted a fair amount of criticism because of this. First, as has been discussed at length by Calabresi himself, if there are changes that could be made that have benefits and no losses, why have they not already been made?51 Crespi acknowledges the same problem when he says the "...unanimity requirement...makes the Pareto criterion almost completely useless as a practical evaluative standard...there are few if any significant measures that can be taken that do not adversely affect someone, somewhere, if only in a non-pecuniary, psychological sense."52 Again, as will be discussed later in this thesis, a method of dispute resolution that results in losers "only in a non-pecuniary, psychological sense" may be seen as a precursor to a higher crime rate as the "losers" assert their anger with a system that discounts their losses to a zero value. The Kaldor-Hicks criterion is less of an abstraction than Pareto, because it acknowledges that in any dispute there will be losers as well as winners. However, because of its implicit reliance on a "one dollar-one vote" mechanism, it is now widely recognized by many economists and law and economics scholars to "affirm the status quo arrangement of resources and, hence despite its lack of coercive force, tacitly legitimizes the status quo."53 The one dollar-one vote weighting for assessing utility also violates a commonly 5 1 Guido Calabresi, "The Pointlessness of Pareto: Carrying Coase Further" (1991) 100 Yale L.J. 1211 at 1227. 5 2 Crespi, supra note 4 at 235. 5 3 "Rawls made this point in a paper presented to the Committee for Non-Market Decision-Making, and explicitly tries to deal with the limitations of Pareto in his concept of the "difference principle" in which he states his belief that if individuals were to hammer out a constitution without 24 held principle that in fact forms the underpinning of our progressive tax rates: that of the declining marginal utility of a dollar as wealth increases. As Crespi puts it, "the implicit social welfare function underlying this criterion is one that accords equal marginal utility to each dollar of impact, regardless of the financial condition or other circumstances of the particular person affected...[this is] certainly a nonneutral, politically controversial choice."54 One-dollar, one vote accords much more weight to the decisions of those with more dollars to start with, again leaving the "losers" out in the cold. Finally, there is the suggestion that the whole conception of wealth (or happiness, or utiles) as having a value that is not relative to the amounts that other people have is inherently nonsensical. Wealth is essentially power - the more I have, by definition, the less you have and vice versa. To say that for one person to increase their endowment may have no effect on others if they have not lost any part of their endowment ignores this fundamental truth. Warren J. Samuels, an institutional economist, gives here a convincing, although somewhat lengthy, explanation of this concept, one that is difficult to neatly summarize: Individual decision making is a function of one's opportunity set, which "consists of the available alternatives for action or choice, each with a relative opportunity cost, which are open to the individual." However, these opportunity sets are not without limit in their scope; rather, reflecting human interdependence and scarcity, each individual's opportunity set is constrained, and indeed shaped, by the opportunity sets of others in society. Each individual desires to make choices from a set that is as unconstrained as possible, which, in turn, means that individuals will wish to control the choices, and hence opportunity sets, of others who may constrain their choices. The extent of each individual's ability to determine his or her own choices and to influence the opportunity sets, and hence choices, of others is the outcome of a process of mutual coercion, where the ability to coerce is simply the ability of A to impact B's opportunity set without B's consent. An individual's capacity to exercise coercion is, in turn, a function of any knowledge of their station in life, they would be most concerned to benefit the least well-off person." Amadae, supra note 15 at 150. Crespi, supra note 4 at 236. 25 that individual's power, defined as "the means or capacity with which to exercise choice" and this power is relative to the power of others. Thus, "[t]he opportunity set of the individual, within which he attempts a constrained maximizing equilibrium, is a function of the total structure of mutual coercion, grounded upon relative power."55 Similarly, Thorstein Veblen, cited by Lynne Dallas as one of the originators of institutional economics, sees the situation thus: "[i]f...the incentive to accumulation were the want of subsistence or of physical comfort, then the aggregate economic wants of a community might conceivably be satisfied at some point in the advance of industrial efficiency; but since the struggle is substantially a race for reputability on the basis of an invidious comparison, no approach to a definitive attainment is possible."56 Veblen is asserting that the desire for more - more goods, more assets, more power, more whatever - can never be satisfied, that it is, in fact the exact opposite of rational. In other words, driving a Mercedes is only meaningful precisely because there are not many who can afford to do so. The forgoing leads me directly into the main economic effect that I am interested in analyzing in this paper, that of inequality. To say that the increase in wealth of one person has no effect on another unless their own position deteriorates is to say that inequality is irrelevant. The argument made in this paper is that quite the reverse is true, and that the distribution of wealth in a given economy does have significance for a number of important indicators. 2.3 Conclusion: Distributional Concerns Do Matter Cited by Dallas, supra note 8 at 858 [citations omitted]. Thorstein Veblen, The Theory of the Leisure Class, (New York: Mentor Book, 1899) at 39. 26 One of the generalizations made by Dallas in her paper on socioeconomics is that what is really happening in markets is that actors are competing to impose their own choices in zero-sum situations such as those described by Samuels. Inevitably, these are going to involve power struggles. It is no surprise, then, that "while neoclassical economists focus on how harmonious outcomes are reached in the economy as supply and demand intersect at equilibrium points, socioeconomists are more likely to emphasize conflict and power struggles...whose resolution is often antecedent to individual market exchanges."57 To the neoclassical law and economics scholar, the proper role of law is to facilitate efficiency by using Kaldor-Hicks type criteria; to the law and socioeconomics scholar, what is more interesting and more urgent is to explicate the ways in which the law creates those resolutions before the individual market exchanges described by Dallas. To use an illustration already alluded to, the Swedish mother choosing to spend two years at home with her new baby and then return to work is not the point: the system that allowed her to make that choice is what we must examine. Otherwise we run the risk of looking at mothers who return to work weeks or months after their children are born and conclude that mothers prefer to leave their young children in the care of others, without asking what penalties they will pay in the marketplace for taking time out from their jobs. Crespi refers to neoclassical law and economics writing as a literary genre, in order to "emphasize [his] theme that law and economics writing is more appropriately regarded as a subjective, impressionistic, rhetorical, polemical form of literature than as a form of scientific explication."58 Calabresi himself finally came to the conclusion that "[t]he great attempt to avoid interpersonal comparisons and to make economics . . . a science 5 7 Dallas, supra note 8 at 859. 5 8 Crespi, supra note 4 at fn 6. 27 immune from distributional contaminants-must be recognized once and for all as a total failure."59 In fact, much of the above analysis obliquely skirts around the central dispute between adherents of neoclassical economic theory and its critics: that of the significance to be accorded to distributional concerns. In this thesis, far from ignoring distributional concerns, I am making them the focus of my investigation, using indicia of inequality as my primary data to assess the results of the changes to British Columbia's tax policy brought in by the BC Liberal government. It is my thesis that a fairly direct link can be drawn between the tax policy of a state and the level of inequality that results, and that the policies of the BC Liberal government have resulted and will continue to result in increased inequality in the province. Calabresi, supra note 51 at 1232. 28 3 Inequality in British Columbia, Canada and Internationally 3.1 Inequality in Canada Popular opinion holds that the distribution of income and wealth60 is becoming increasingly inequitable in Canada.61 For an economist, the truth of this statement can be assessed using mathematical formulae, but before the calculations can be performed, decisions must be made about what factors are relevant when assessing relative inequality. For example, when calculating the gender gap in wages, is the relevant point of comparison total yearly wages or wage per hour? Since the first does not distinguish between part-time and full-time work, it provides a ratio of 63.8% 6 2 whereas a calculation based on an hourly wage and accounting for human capital, productivity related, and industrial and occupational characteristics provides a ratio of 89%.63 One can immediately see from this example alone that political considerations make the exercise of assessing inequality one that cannot be reduced to numbers. 6 0 It is very important to distinguish between the two terms. Income is that which one earns in a year - wealth is the accumulation of property and assets already held. Entitlement to many components of the Canadian tax and spending schemes are based on income - which leaves open the possibility that the wealthy may be eligible for schemes designed to help the poor. Furthermore, an assessment of income inequalities may ignore important changes in the distribution of wealth. For an assessment of wealth inequality in Canada and changes to it see page 33 and following 1 See Statistics Canada, Winners and Losers in the Labour Market of the 1990's by A. Heisz, A. Jackson, G. Picot (Ottawa: Statistics Canada, Business and Labour Market Analysis Division, 2002) [Heisz, "Winners and Losers"]; Statistics Canada, What is Happening to and Earnings Inequality and Youth Wages in the 1990s? by G. Picot (Ottawa: Statistics Canada, 1998) [Picot, "Youth Wages"]; Statistics Canada, Minorities, Cognitive Skills and the Income of Canadians by Ross Finnie and Ronald Meng (Ottawa: Statistics Canada, 2003) [Minorities]; Canadian Centre for Policy Alternatives, A Report Card on Women and Poverty by Monica Townson (Ottawa: CCPA, 2000) [Townson, "Women and Poverty"]; Statistics Canada, The Evolution of Wealth Inequality in Canada, 1984-1999 by Rene Morissette, Xuelin Zhang, and Marie Drolet (Ottawa: Analytical Studies Branch, 2002) [Morisette, "Wealth Inequality"]. 6 2 Townson, "Women and Poverty", supra note 61 at 5. 6 3 Statistics Canada, The Persistent Gap: New Evidence on the Canadian Gender Wage Gap by Marie Drolet (Ottawa: Analytical Studies Branch, 2000). 29 Another political consideration is the question whether the correct unit for comparing levels of inequality is the individual or the family, just as the same question must be answered when choosing a tax unit. If low income women are working far more hours in a year in order to compensate for the declining male wage at the lower end of the income scale, but those same women are also experiencing declining hourly wages, an assessment of their total yearly income alone would make them appear better off (see indented quote on page 32 for more detail on this subject). As families, the wife's increase in income may cancel out the husband's decrease: the fact that she has had to double or triple her workweek in order for the family to "stand still" disappears. This example reveals that the choice between the different units will produce profoundly different conclusions regarding the levels of inequality in a society, and the changes to those levels. One must also choose whether to compare employment income or disposable income. Since the latter takes into account the redistributionary effects of transfers and taxes, again the resulting analysis of inequality can be profoundly different depending on one's choices. It is necessary to consider also whether to include those with no income when dividing the population into percentiles of relative income: if only working people are included, an increase in the numbers of people who have fallen off the income scale (perhaps permanently giving up the search for paid employment) disappears from the analysis. Two standard tools are used by economists to measure inequality: one is the gini co-efficient, the other is polarization. The gini coefficient is a number between 0 and 1, where 0 means perfect equality (everyone has the same income) and 1 means perfect inequality (one person has all the income, everyone else earns nothing). While the Gini 30 coefficient is most often used to measure income inequality, it can be used to measure wealth inequality as well. Polarization, on the other hand, measures the number of people in each decile rather than changes to income. By choosing an arbitrary point in time, dividing the population into deciles by income, and then projecting forward (accounting for inflation) one can see whether the number of people in each decile has changed. However, as demonstrated above, before these formulas can be used, one must make political decisions that will alter the results, sometimes profoundly. Having acknowledged some ideological problems with assessing levels of inequality, what do the statistics tell us about levels of inequality in Canada? Beginning with a disaggregated look at men and women, economists looking at changes during the 1980s and the first half of the 1990s have concluded that there has been no increase in women's earnings inequality (the wage gap between low and high wage female workers) overall, but, as alluded to above, this is largely due to substantial increases in earnings for women at the bottom end of the earnings scale, and this in itself is largely caused by an increasing number of weeks worked by such lower-income women.64 On the other hand, there has been a significant increase in men's inequality: the incomes of lower paid males fell 13% over the 1980s and another 9% between the mid-80s and mid-90s, while earnings of higher paid males rose 4.3% and 5% respectively over the same period.65 On average, the earnings of women across all deciles rose in the period 1986-1995, whereas men's earnings declined in all deciles except for the top two, where gains did not nearly match those of women.66 Note that these figures refer to average yearly incomes, so they are not a reflection of what may be happening to hourly wages. Picot, "Youth Wages", supra note 61 at 21. Ibid, at 7. Ibid, at 16. 31 Looking beyond earned income to disposable income (which, as mentioned above, takes into account the impact of the tax and government transfer systems) we see that, interestingly, despite the potential for greater inequality in the 1980s due to increasing wage inequality, government transfers more than offset the earnings decline and the low-income rate actually fell. During the 1990s, we see the beginnings of an era in which social transfers no longer offset earning losses.67 Prior to 1993, low after tax income and unemployment show trends that track each other, which makes sense: the harder it is to find a job, the more people will be found under Statistics Canada's Low Income Cut-offs (LICO) 6 8 However, after 1993, there is a stark jump in LICO despite steadily decreasing unemployment. Research has established that all of this trend "was due to transfers (e.g. IE benefits, social assistance, child tax benefits, etc.) received by low income families."69 If unemployment and LICO are not tracking each other, but rather are diverging, then what must be happening is that having a job does not necessarily provide the same insurance against LICO as it did in the past. This is the first indication we have that a new social class may be emerging in Canada: that of the working poor. This jump in the numbers of low-income families is also reflected in the data on inequality. Data now arriving from the late 1990s confirms that, when looking at all families (including those with no income), government transfers and tax policies failed to offset the effects of rising pre-tax earnings inequality in the second half of the decade. 67 Ibid, at 21. 6 8 Low Income Cut-offs have been the leading poverty line indicator in Canada for over 30 years. Empirical research has shown that the most serious negative impacts of low income start to abate when family income approaches the income levels that correspond with the low income cut-offs.: The Canadian Council on Social Development, Canadian Fact Book on Poverty 2000 (Ottawa: The Canadian Council on Social Development, 2000). 6 9 Heisz, "Winners and Losers", supra note 61 at 21 32 Marc Frenette reports that, after careful consideration of the relative merits of data supplied by three imperfect sources, it can be said that "[b]ased on Census and tax data, there appears to have been higher levels of inequality and much stronger increases in market income inequality in the 1990s than has been previously acknowledged. Further, in contrast to the 1980s, the tax and transfer system did not offset these inequality increases."70 Ultimately, Frenette concludes that the tax and transfer system may have actually exacerbated pre-tax market income inequalities beginning with 1993: "the tax data point to much stronger increases in equality and no mediating role for the tax and transfer system in the period following 1993. In fact, changes in taxes paid and transfer benefits received tended to increase (not reduce) inequality over this period."71 Since we normally conceive of the tax and transfer schemes as existing to redistribute income downwards, that is from the relatively wealthy to the relatively poor, any movement towards the opposite should be carefully analyzed. In speculating on the causes of this sea change, Frenette lists the overhaul of the Unemployment Insurance system in 1996, the tightening of eligibility for social assistance programs at the provincial level and, most interesting for my purposes, the federal and provincial reductions in tax rates, which have as their most dramatic impact increasing incomes at the top end of the income spectrum. Possibly the shifting of the tax base towards consumption and income taxes and away from capital gains also contributed, but Frenette does not discuss these elements.72 7 0 Statistics Canada, Rising Income Inequality Amid the Economic Recovery of the 1990s: An Exploration of Three Data Sources by Marc Frenette, David Green and Garnett Picot (Ottawa: Statistics Canada Business and Labour Market Analysis Division, 2003) [Frenette, "Rising Income Inequality"]. 71 Ibid, at 19. 7 2 See section 3.5 for an analysis of the way that changes to the tax base impact inequality. 33 Amartya Sen, a Nobel prize-winning economist, has pointed out that one of the dangers of using the LICO to generate meaningful data is that one could perversely reduce the number of people under the LICO by transferring money from the very poor to those living just under the cut-off point. This reveals the importance of measuring the depth of low income, calculated as the difference between the LICO and the average income of low-income people. As was noted above, the mid to late 90s have registered a shift in these trends. The depth of low income is increasing, and has continued to increase despite improvements to the economy: "the low-income gap deteriorated during the recession years 1991-1992 as one might expect, but surprisingly continued to deteriorate in 1997, in spite of substantial economic growth later in the decade"73 The Canadian Council on Social Development reports that the depth of low income almost doubled between 1981 and 1997.74 The low-income gap is particularly sensitive to changes in the transfer system, because "transfers are often targeted at families well below the low-income cut-off. The benefits received may improve a family's financial position, but not necessarily move them over the low-income threshold."75 Alberta's adoption of flat taxes and commensurate cuts in transfer payments meant that "[t]he rise in the low-income gap during the 1990s was most evident in Alberta".76 To conclude, it seems that changes to the market income of Canadian men and women up to the mid-90s were largely cancelling each other out at the family level. The reduced incomes of lower wage Canadian men were being made up for by their wives working for 7 3 Heisz, "Winners and Losers", supra note 61 at 22 74 The Canadian Fact Book on Poverty 2000, supra note 68 at 4. 7 5 Heisz, "Winners and Losers", supra note 61 at 22. 76 Ibid. 34 equally low wages but dramatically increasing the hours spent in paid employment per year. As Brenda Cossman and Judy Fudge put it, for an earlier decade: By the 1980s, however, despite its nostalgic appeal, the male breadwinner norm was no longer an empirical reality for the majority of people in Canada: it took between sixty-five and eighty hours of work each week for a family to earn what it took a single breadwinner, typically a man, to earn in a forty-five hour week in the mid-1970s77 The story of declining male wages at the lower end of the income spectrum is thus one that clearly impacts both men and women, especially given the increasing tendency for lower-income people to marry each other and higher income people to marry each other.78 For the lower income woman, badly paid, part-time, low benefit work has clearly become an ever more inescapable reality given that she is likely to be married to a man earning ever less. As some commentators have pointed out, the white male backlash against perceived special interest groups "has only served to obscure the real cause of middle-class decline, which is a shift in the balance of power of capital over labour."79 Further, it seems from the available data that the reductions in market incomes seen during the eighties and nineties have, since the mid-nineties, no longer been effectively dealt with by the tax and transfer system, such that disposable incomes increasingly reflect the growing inequality in market incomes. Inequality has also been increasing when measures of wealth rather than income are used, concludes a 2002 Statistics Canada study titled "The Evolution of Wealth Inequality in Canada, 1984-1999." The average share of wealth of all bottom nine deciles of the Canadian population have decreased during the last fifteen years; only the top 10% have increased their net worth. Changes were also seen in median wealth; for 7 7 B r e n d a C o s s m a n and J u d y Fudge , eds. , Privatization, Law and the Challenge to Feminism (Toronto: University of Toronto P r e s s , 2002) . S e e genera l ly Picot , "Youth W a g e s " , supra note 61 . 7 9 Pal ley , supra note 28 at 27 . 35 example, between 1984 and 1999 median wealth fell in the bottom three deciles of population, but rose 27% or more in the top three deciles. Changes to median wealth can reveal increases in inequality in subgroups: for example, "among families whose major income recipient is aged 25-34, real median wealth fell 36% while real average wealth fell only 4%."80 What this tells us is that within the subgroups being studied inequality increased dramatically. The percentage of families with zero or negative net worth also increased, from 11% to 13% over the same period.81 The average wealth of the bottom 50% remained essentially unchanged between 1984 and 1999, decreasing very slightly from $13,808 to $13,722 or 0.6%. However, the average wealth of those located between the 60th and 95th percentile rose a dramatic 32.8% (from $188,469 to $250,223).82 In seeking an explanation for these changes, the authors conclude that income, like "education, lone-parent family status, family size, province and urban-rural status,"83 explains very little. In combination, they account for only 8% of the increase in the wealth gap.84 On the other hand, while differences across groups in the growth of inheritances, inter vivos transfers, rates of return on savings and the number of years spent working full-time are likely to have contributed85 it is ownership of assets that is crucial: stock, bonds and mutual funds are the three most unequally distributed wealth components, therefore, "when we consider all family units, the growth of wealth inequality can be explained...mainly by the growing contribution of RRSPs and stocks, Morisette, "Wealth Inequality" supra note 61 at 1. Ibid, at 4. Ibid, at 15. Ibid, at 14. Ibid, at 17. Ibid at 2. 36 bonds and mutual funds to overall inequality."86 RRSPs, stocks, bonds and mutual funds all represent the same thing: the ownership of capital. As discussed in s. 2.3, the allocation of profits between labour and the ownership of capital has changed dramatically since the 1970s, so it is not surprising that this factor has led to increased inequality. In conclusion, it is clear that there have been enormous changes in rates of inequality of both income and wealth registered across Canada over the last two decades. As quoted in the next Chapter, there is ample evidence to assert that there has in fact been a redistribution of wealth, from the poor and middle class to the rich. The next chapter will examine whether these country-wide trends can be seen in the census data available regarding British Columbia. 3.2 Inequality in British Columbia Unfortunately, it is too soon to find definitive figures on the state of inequality in British Columbia since the BC Liberals came to power in 2001.. The Census figures used to do the kind of number crunching that is available for Canada throughout the 1980s and 1990s are only available after a significant delay. Further, there is no concerted effort to track inequality and publish the results in an easily accessible format, unlike, for example, the unemployment rate or the GDP which are constantly updated and available almost immediately. A comparable tracking of inequality could be a monthly update on the gini coefficient, for example. Between 1993 and 2001, years for which census figures are available, incomes in British Columbia were becoming more unequal, but, as the following table demonstrates, the 86/b/dat19. 37 increase in the number of low-income British Columbians was small. Rather, the greater inequality was caused by the numbers of high-income people increasing. The following table illustrates changes to the polarization of incomes in British Columbia since 1993: Table 3.1 All Individual Returns by Income Group - 1993, 1997, 2001 - British Columbia U n d e r $ 1 , 0 0 0 $ 1 , 0 0 0 -$ 5 , 0 0 0 $ 5 , 0 0 0 -$ 1 0 , 0 0 0 $ 1 0 , 0 0 0 -$ 1 5 , 0 0 0 $ 1 5 , 0 0 0 -$ 2 0 , 0 0 0 $ 2 0 , 0 0 0 -$ 3 0 , 0 0 0 $ 3 0 , 0 0 0 -$ 4 0 , 0 0 0 $ 4 0 , 0 0 0 -$ 5 0 , 0 0 0 $ 5 0 , 0 0 0 a n d o v e r 2 0 0 1 184,110 195,230 348,940 370990 274,860 218,960 + 197,570 358,780 258,800 503,310 % 6.32 6.7 11.98 12.7 9.44 14.3 12.32 8.88 17.28 13.02 1 9 9 7 174,080 195,170 356,450 385,000 256,970 410,590 338,080 229,950 394,490 % 6.35 7.12 13.00 14.04 9.37 14.98 12.33 8.38 14.39 13.47 1 9 9 3 311,480 333,660 381,250 259,620 212,820 + 193,990 170,430 + 142,590 211,520 311,500 % 12.31 13.19 15.07 10.26 16.08 12.36 8.36 12.31 These figures show that there have not been dramatic changes to the proportion of British Columbians living on low- and middle-incomes since 1993. In fact, there was 8 7 BC Stats, British Columbia Taxation Statistics, (N.p.: Canada Revenue Agency, 1993), online: Government of British Columbia Website <http://www. bcstats. gov, be. ca/data/dd/handout/93txhand. pdf >; URL for 1997 data: <http://www.bcstats.qov.bc.ca/data/dd/handout/97txhand.pdf>: URL for 2001 data: <http://www.bcstats.qov.bc.ca/data/dd/handout/01txhand.pdf>. 38 some reduction in the percentage of the population living on $15,000 or less between 1997 and 2001, from a total of 40.51% in 1993 to 37.7% in 2001. Similarly, there was no increase in the depth of low income between 1997 and 2001, as the percentage of those living off less than $5,000 per year also decreased slightly. However, a significant change can be seen in the numbers making $50,000 or more, which jumped from 12.31% in 1993 to 17.28% less than a decade later. Thus, increasing inequality in British Columbia has largely occurred due to increases in the number of those with high incomes. A corresponding decrease in those with low-incomes, which would have exacerbated increases in those making high incomes, had not occurred as of 2001. Admittedly, some of the increase in those making $50,000 or more can be attributed to inflation, but this does not change the analysis that inequality has increased, as there would need to be a corresponding decrease of those making lower incomes to come to the conclusion that the increase in those making $50,000 or more is simply a case of all boats rising with the tide. As will be argued in the next Chapter, the tax cuts and tax increases chosen by the BC Liberals are likely to lead to a net increase in taxes paid for all but a wealthy minority, who will see a large decrease in the amount of tax dollars they will be paying. This is not the end of the story of inequality in BC, because, as pointed out repeatedly by commentators such as the CCPA, the one third reduction in all government services other than health and education is likely to have a disproportionate impact on lower income British Columbians, who have a lesser ability to pay for services privately. The most prominent and controversial example of this is the threat to put a general time limit on the length of time for which BC Employment Assistance can be collected. Initially, the BC Liberals brought in legislation stating that, out of every 60 month period 39 commencing on April 1, 2002, employable individuals would be limited to one cumulative 24 month period during which they could receive benefits.88 For the other 36 out of 60 months, no assistance would be given. The accompanying regulations contained some exceptions to this rule, covering such persons as those over 65, those with persistent multiple barriers to employment, children under the age of 19, and pregnant women.89 Social activists rallied to prevent the time limit being imposed, many by asking the Federal Liberal party to prevent it. The Toronto Star reported on February 23, 2004 that "[m]ore than 125 organizations - food banks, churches, women's shelters, city councils, human rights associations, health-care groups and First Nations - have appealed to Martin to intervene in B.C."90 There were claims in the media that a leaked government document showed a total of 29,000 people due to have their benefits cut off on April 1, 2004 (the two year anniversary of the start date for the new legislation).91 Finally, the provincial Liberals backed down and added another exemption. Those with an employment plan who are actively seeking work but have not been successful in finding employment are also excluded from the time limit provision.92 In a press release confirming the new rule, the Ministry of Human Resources claimed that the total number of clients who would be actually cut off from benefits totaled only an estimated 339. 9 3 Nonetheless, the number of people receiving income assistance (including both those receiving Temporary Income Assistance and those receiving Disability Assistance) in 88 Employment and Assistance Act, S.B.C. 2002, c.40, s 27(1 )(a). 89 Employment and Assistance Regulations, B.C. Reg 263/2002, s. 18(3). 9 0 Carol Goar "Giving the Family a Bad Name: Paul Martin Might Want to Have a Quiet Word with his Liberal friends in British Columbia" Toronto Star (February 23, 2004). 9 1 Gordon Laird "The Politics of Homelessness" The Georgia Straigh (February 5-12th, 2004) 19. 9 2 Government of British Columbia, News Release, "BC Employment and Assistance Time Limits Update" (6 February 2004). 93 Ibid. 40 British Columbia has fallen significantly since 2001, the year that the BC Liberals came to power. The Ministry of Human Resources-BCEA Summary Reports show a total number of 191,938 clients receiving benefits in 2001, and only 78,471 as of October of 2004.94 The reduction of the number of people receiving income assistance between 2001 and 2004 reflects a long term trend in British Columbia: in 1995, 340,679 clients were receiving income assistance, and the number has fallen consistently every year since then.95 As long as those no longer receiving income assistance have found a better alternative, lower numbers are a good thing for inequality. Since the tax return figures96 do not show increases in the depth of low income from 1997 to 2001, it can be assumed that the decrease in those receiving income assistance in those years was achieved without forcing people into lower-income alternatives. Whether the same will be true for the years after 2001 remains to be seen. One thing that we do know is that in comparison to the rest of Canada, which has seen a significant drop in LICO from an average of above 15% in 1998/9 to below 13% in 2001/2, the situation in BC is deteriorating: the rate of LICO in BC in 2002 was 16.5% versus a Canadian average of only 12.7%.97 Another very significant non-tax change that is likely to have an impact on inequality in British Columbia is the introduction of a "training wage" which allows employers to pay new employees $2 less per hour than the minimum wage.98 If the lower minimum wage 94 British Columbia, Ministry of Human Resources - BCEA Summary Reports, (N.p.:Ministry of Human Resources, 2004), online: Government of British Columbia website, <http://www.mhr.qov.bc.ca/research/archive/04/12 Oct2004.pdf>. 95 Ibid. 9 6 See above p. 35-6. 9 7 BC Progress Board, Leadership and Vision - Benchmarking for North Star 2010: Volume I -External Performance Review: Inter-Provincial and International, (Vancouver: BC Progress Board, December 2004) at 150, online: BC Progress Board website, http://www.bcproqressboard.com/index.php , "BC Progress Board December 2004". aB Employment Standards Regulation, B.C. Reg. 396/95 s. 15. Minimum hourly wage 41 was designed to increase the number of jobs available to young people, it is not working. Statistics Canada reports that as of late 2003, the unemployment rate of British Columbia's full-time students, age 15-19, was, at 19.3%, higher in BC than in any other province." Youth unemployment is more typically tracked using the 15-24 age group as a marker. In the second quarter of 2001, when the BC Liberals came into power, youth unemployment was at 12% in British Columbia.100 Since then, it has averaged 14.9% 2002,1 0 1 and 14.4% in 2003. 1 0 2 Furthermore, the average weekly wage rate for all employees rose only 0.4% in British Columbia between 2003 and 2004, less than in any other province other than Newfoundland which did not see an increase. All other provinces achieved more than 2 percentage points in growth.103 This trend continues to date: for the last six months for which data is available, September 2005 to February 2006, average weekly wages grew only 1.53% per month on average in BC, against an average Canadian growth of 3.8%. In concert, higher or stagnant youth unemployment figures and declining wages are likely to worsen the inequality profile of young people in British Columbia. 15 (1) Subject to sections 16 to 18, the minimum wage is $8.00 an hour. (2) Despite subsection (1), the minimum wage is $6.00 an hour for an employee who (a) has no paid employment experience before November 15, 2001, and (b) has 500 or fewer hours of cumulative paid employment experience with one or more employers. [en. B.C. Reg. 307/2000, s. 2; am. B.C. Reg. 261/2001.] 9 9 Statistics Canada, Labour Force Survey, Year-to-date averages for months when youth are in school: Jan-April and Sep-Oct, 2003 (N.p.: 2003). 1 0 0 The youth unemployment rate was below 14% in British Columbia for all quarters between 3Q 1999 and 3Q 2001 except for 3Q 2000 and 4Q 2000 , when it went up to 15.1% and 14.3%, respectively. BC Stats, Labour Force Statistics September 2001 (N.p.: Ministry of Management Services, 2001) at 5, online: Government of British Columbia website, <http://www.bcstats.qov.bc.ca/pubs/lfs/lfs0109.pdf>. 1 0 1 BC Stats, Labour Force Statistics December 2003, (N.p.: Ministry of Management Services, 2003) at 3, online: Government of British Columbia website, <http://www.bcstats.gov.bc.ca/pubs/lfs/lfs0312.pdf>. wTlbid: 1 0 3 BC Stats, Earnings and Employment Trends Monthly Publications, One Page Summary Extract of Earnings by Province (N.p.: Ministry of Management Services), online: Government of British Columbia website, <http://www.bcstats.qov.bc.ca/data/lss/empern/eet21.pdf>. 42 The suggestion that inequality is increasing for young people is borne out by statistics reflecting that the demographic profile of the homeless in Greater Vancouver has been found to include a "sharp increase in the number of young adults, age 19 to 29" since 2001. 1 0 4 The homeless are also increasingly likely to be employed: The most startling change to report is the increase in the number of employed persons, usually male, ages about 24 to late 40s who are working, but who live outside or try to find shelter in mat programs a night at a time'sic]. Much of the work available is part time, and pays at minimum wage or little more. Many of the employed shelterless do heavy physical work through labour pools, some work in restaurants or as house painters and dry wallers for contractors. They are often laid off when it rains, or business is slow and may not be able to secure employment every day. Even working full time, their pay is so low that they are unable to save the security deposit and first month's rent for a room while they are living outside.105 The program manager at Hyland House, Surrey's only full-time homeless shelter, states that "quite a few of our people here are already working, consistently working."106 As mentioned in Chapter 3.1 above, we are seeing in British Columbia the emergence of a new social class, the working homeless. Overall, it is believed that homelessness in Vancouver has approximately doubled since 2001. 1 0 7 Other changes reported are increases in the number of both Aboriginal and Asian people living in the streets.108 Approximately half cite the difficulties involved with accessing the new welfare system as a reason for their homelessness: Before assistance is received, the system now involves several appointments, delays and tasks they find overly challenging. This seems to have been a particular problem for people with head injury, mental illness, severe depression, 1 0 4 J. Graves, "Shelterless in Vancouver, 2004" Administrative Report of Vancouver City Council, February 10, 2004 RTS No. 03962, CC file NO. 4659. 105 Ibid. 1 0 6 Laird, supra note 91. 1 0 7 Graves, supra note 104. 43 young people who are trying to find work, prisoners following their release from incarceration, those raised in foster care in BC, and immigrants and refugees.109 Other legislative changes have added to the downward pressure on average weekly wages. The Employment Standards Act was changed to allow employers to enter into "averaging agreements" with employees. Under such agreements, the standard 8 hour day or 40 hour work week can be altered without giving rise to an obligation on the employer's part to pay overtime rates.110 Statutory holiday pay was also eliminated for a number of part-time workers.111 Declines in the number of British Columbians receiving social assistance cannot be attributed to corresponding declines in the unemployment rate because the unemployment rate in British Columbia has not, on average, decreased in the three years that the BC Liberals have been in power; nor has it improved relative to the rest of Canada. In July 2004, the unemployment rate in BC was 7.3%, almost the same as the 7.2% it averaged in 2000, the year before the BC Liberals took over from the NDP. 1 1 2 However, BC has had an unemployment rate higher than the Canadian average on a monthly basis for every month since June 2001, (other than for approximately two months in December 2003 - January 2004) and in some months the rate has spiked up to over 9%. 1 1 3 To put these rates into some historical context, the three years prior to the election of the BC Liberals (1998-2000) were also years in which BC had an unemployment rate that 109 Ibid. 110 Employment Standards Act, R.S.B.C. 1996 c. 113, s. 37. 111 Employment Standards Act, R.S.B.C. 1996 c. 113, ss. 44-49. 1 1 2 BC Stats, Labour Force Statistics, December 2001, issue 2001-12 (N.p.: Ministry of Management Services, 2001), online: Government of British Columbia website <http://www.bcstats.qov.bc.ca/pubs/lfs/lfs0112.pdf>. 1 1 3 BC Stats, Current Statistics, June 2004 and July 2004, Data Services Issues: 04-06 and 04-07 (N.p.: Ministry of Management Services, 2004). 44 was higher than the Canadian average; prior to that, BC's yearly unemployment rate was lower than the Canadian average (from 1991 to 1997).114 Taken together, these figures show dramatic declines in the number of British Columbians receiving social assistance but no corresponding increase in wages. It seems likely, therefore, that inequality has been increasing in British Columbia since the election of the BC Liberal government. In the next Chapter I take a step back and place the Canadian experience within a global context. This is important because, in seeing the choices that other countries are making and the results obtained, we can see alternative visions of social policy that could be implemented in Canada, and even in British Columbia. We can also see the future: that is, what do societies look like that are much more unequal than our own?. 3.3 Cross-Country Comparisons of Inequality Not surprisingly, given the much greater commitment to methodological individualism and small government south of the border, much of the rhetoric surrounding lower and flatter taxes emerges from the United States. Recent events show that far from being over, this trend continues most aggressively in the administration of George W. Bush Jr., who appears to be more of a tax cutter than any previous US president. The scope of the tax cuts that his administration has brought into law are truly breathtaking. In a study analyzing the impact of the Bush tax cuts from 2001 through to 2010, Citizens for Tax Justice concluded that the wealthiest 1 % of Americans will receive $477 billion in tax breaks over the decade, which amounts to $342,000 each. The tax cuts are structured in such a way that the share of the wealthiest one percent increases 1 1 4 BC Stats, Labour Force Data for British Columbia and Canada (N.p.: 2004), online: Government of British Columbia website <http://www.bcstats.qov.bc.ca/data/lss/lfs/bccanlfs.pdf>. 45 dramatically as the years go by: although they receive less than ten percent of the benefit in 2001, by 2010 this group will be receiving a staggering 51.8% of the value of the tax cuts. 1 1 5 At the other end of the scale, the four out of five families and individuals who make less than $73,000 per year, already received three quarters of the value of the tax cuts, about $350 each. The total amount to be cut from government revenue over the course of the decade amounts to $1,323 billion, with just 1.2% of the dollar value of the cuts going to the lowest quintile of Americans. The second quintile will receive 6.2%, the third quintile 9.6%, and the fourth quintile 13.2%, leaving over 69% of the value of the cuts to be enjoyed by the top quintile, (but remember, even within the top quintile, 51.8% of the value goes to the top 1%).116 As suggested above, data on median family incomes can reveal increases in inequality that are concealed by averages. It is thus illuminating that the median family incomes of all American families grew in all decades from 1947 to 1989, but from 1989 to 1995 they have shrunk.117 The share of family income going to various groups is equally indicative of dramatic increases in inequality. 1 1 5 Citizens for Tax Justice, "Year-by-Year Analysis of the Bush Tax Cuts Shows Growing Tilt to the Very Rich" Washington DC, (June 12, 2002). 1 1 6 Ibid. 1 1 7 Palley, supra note 28 at 25. 46 T a b l e 3.2 S h a r e s o f F a m i l y I n c o m e G o i n g to V a r i o u s G r o u p s , 1947 -95 S h a r e s o f F a m i l y I n c o m e G o i n g t o V a r i o u s G r o u p s , 1947 -95 ( p e r c e n t ) 1 1 8 1947 1973 1989 1995 P e r c e n t C h a n g e , 1973 -1995 L o w e s t f i f th 5.0 5.5 4.6 4.4 -20.0 S e c o n d f i f th 11.9 11.9 10.6 10.1 -15.1 T h i r d F i f th 17.0 17.5 16.5 15.8 -9.7 F o u r t h F i f th 23.1 24.0 23.7 23.2 -3.3 T o p F i f th 43.0 41.1 44.6 46.5 +13.1 T o p 5 % 17.5 15.5 17.9 20.0 +29.0 Perhaps the most telling statistics on inequality in the US relate to rates of CEO pay, which have reached astronomical levels. In 1960, the average factory worker earned $4,665 while the average CEO earned $190,383, a multiple of 41; by 1992 the average worker had increased their income six times to $24,411, while the average CEO was earning a whopping 20 times more than in 1960, averaging $3,842,247, a multiple of 157 times the worker salary.119 Analysts using data compiled by the Luxembourg Income Study have established three main patterns in inequality trends in developed countries from 1980 to 2000: the "Continental", the "Anglo" and the "Scandinavian". Continental countries, such as France and Germany, have inequality rates that have remained essentially the same over the period 1980-2000, and are in the middle of the normal range for developed countries. Canada is included in this pattern by the researchers, but they acknowledge an "observed uptick" in inequality at the end of the 1990s, which they speculate "may be attributed in part to survey inconsistencies", however, their data set ends in 1998. The 118 Ibid. 119 Ibid, at 58. 47 Continental pattern gini co-efficient group average in 1984 was .284, by 2000 it had actually declined to .276.120 The "Anglo" pattern, best characterized by the United States, is one in which the country starts the 1980s with average inequality, but it then begins to steadily increase throughout the period. The United Kingdom and Australia fit this pattern. Like the Continental countries, they had an average gini co-efficient of .284 in 1980, but by 2000 this had increased to .341. Finally, the Scandinavian pattern is one in which the countries begin with very low inequality but have seen rates of inequality rise, approaching convergence with Continental levels of inequality. Norway, Sweden and Finland are exemplars of the Scandinavian Pattern. They began with a group average of .210, which increased to .250 by 2000.121 Initially, it was thought that such rising rates of inequality were an inevitable consequence of "'globalization', de-industrialization and the rise of the technological, skill based economy in the 1980s and 1990s."122 However, Timothy Smeeding points out that the data do not support this interpretation, given that some countries (those in the "Continental" pattern) have not experienced rising inequality. France, for example, reports a decrease in inequality during the period 1984-2000 (but no change when measured from 1979 to 2000).123 He concludes: 1 2 0 All information in this paragraph: Timothy Patrick Moran, "Bootstrapping the LIS: Statistical Inference and Patterns of Inequality in the Global North" Luxembourg Income Study Working Paper No. 378 at 20, online: LIS website <http://www.lisproiect.org/publications/liswps/378.pdf>. 121 Ibid. 1 2 2 //b/'d. at 19. 123 Ibid, at 20. 48 The explanations for rising inequality in rich countries are many, and no one single set of explanations is ultimately convincing. In particular, there is no evidence that we know of that trade and globalization is bad for rich countries. This suggests that rising economic inequality is not inevitable, or that it necessarily hurts low skill-low income families. Rather it suggests that globalization does not force any single outcome on any country. Domestic policies and institutions still have large effects on the level and trend of inequality within rich and middle-income nations, even in a globalizing world economy.124 What this data set tells us is that it is wrong to lump together the rising inequality rates of the Anglo and Scandinavian countries into one "inevitable" progression. The greater integration of Europe through EU initiatives may be leading to a convergence of inequality rates there, but that is no reason to think that the Scandinavian countries will continue to increase in inequality once they have converged with the Continental countries, or that Continental countries will depart from their long term stability and begin to experience rising inequality rates. The "inevitability" of rising inequality is thus challenged by the data, which do not support such a thesis. In fact, globalization does not dictate policy within any country, whether rich or poor, according to this data. Finally, what do we know of the link between measures of inequality and the amount of revenue generated through taxation? The following table provides a snapshot of the relationship between taxes as a percentage of national income, the gini coefficient125 and the decile ratio126 for various developed countries in 1994: 1 2 4 Timothy M. Smeeding, "Globalization, Inequality and the Rich Countries of the G-20: Evidence from the Luxembourg Income Study (LIS)"Luxembourg Income Study Working Paper No. 320, online: LIS website <http://www.lisproiect.org/publications/liswps/320.pdf>. 1 2 5 See above, page 28. 1 2 6 The decile ratio is the ratio between the top of the bottom decile and the bottom of the top decile, and thus slightly understates the gap between the top and the bottom of the income distribution. 49 Table 3.3 Taxes and Inequality, Selected OECD Member Countries Taxes and Inequality, Selected OECD Member Countries1 2 7 Gini Coefficient Taxes Decile ratio United States 0.368 28.4 6.44 United Kingdom 0.346 34.5 4.56 France 0.324 43.7 4.11 Japan 0.316 27.8 4.17 Germany 0.3 38.4 3.84 Canada 0.287 35.1 3.93 Italy 0.255 41.4 3.14 Netherlands 0.249 44.7 3.05 Denmark 0.239 49.9 2.86 Norway 0.242 41.3 2.85 Belgium 0.23 45.9 2.79 Sweden 0.229 49.0 2.78 In general, the chart supports the theory that lower taxes are associated with greater levels of inequality. Note that Japan, an aberration in the chart, has chosen a path of extremely high deficits as a means to keep taxes low without sacrificing public expenditures such as transfer payments. It is also widely acknowledged that Japanese corporations voluntarily take on some of the responsibilities assumed by governments in Western economies, and thus that it is likely to throw off comparisons such as this 1 2 7 Andrew Jackson, "Tax Cuts: Implications for Growth and Productivity" (2000) 48:2 Can. Tax J. (2000) 298. Jackson used information found in the Luxembourg Income Study and from the OECD. 1 2 8 Neil Brooks suggests that the inclusion of Japan in studies such as this can be extremely misleading. He recounts the story of a newly elected Conservative Government in Ontario using a chart which purportedly showed a link between lower taxes and higher economic growth to support its 30 percent income tax reductions. According to Brooks "Japan was the clear outlier in the chart...if Japan was removed from the analysis, the trend line actually reversed, showing just the opposite of what the government wanted to show." Neil Brooks, "Flattening the Claims of the Flat Taxers" (1998) 21:2 Dal. L. J. 287 at 338. Similarly, Anthony Atkinson points out that attempts to reconcile conflicting data on the impact of social transfer payments on growth have identified the "inclusion or exclusion of Japan" as one of the reasons for discrepancies in result: Anthony Atkinson, "The Welfare State and Economic Performance" 48 National Tax Journal 171 at 178. 50 T h e t a b l e a b o v e w a s c o m p i l e d b y A n d r e w J a c k s o n , w h o a r g u e s , u s i n g s t a t i s t i c a l d a t a , t ha t w h a t t h e f i g u r e s s h o w is a " s t r o n g a n d s i g n i f i c a n t " r e l a t i o n s h i p b e t w e e n t a x e s a s a s h a r e o f G D P a n d i n e q u a l i t y , bu t a " w e a k a n d i n s i g n i f i c a n t " r e l a t i o n s h i p b e t w e e n t a x e s a n d g r o w t h a n d p r o d u c t i v i t y . 1 2 9 T h e p o s s i b l e n e g a t i v e l ink b e t w e e n h i g h e r t a x r a t e s a n d e c o n o m i c g r o w t h is o n e o f t h e m o r e d i s p u t e d o n e s in t h e a r e a o f p u b l i c p o l i c y . C e r t a i n l y , it is t h i s c o r e b e l i e f that f o r m e d t h e b a c k b o n e o f t h e B C L i b e r a l s a r g u m e n t s in f a v o u r o f l o w e r t a x r a t e s , l o w e r g o v e r n m e n t r e v e n u e a n d u l t i m a t e l y s m a l l e r g o v e r n m e n t . Jackson, supra note 127 at 294. 51 4 Equality and Fairness in Taxes: The Canadian Tax Mix 4.1 Progressivity in Taxes To what extent can the increases in inequality across Canada and within British Columbia be laid at the door of tax policy? This Chapter of the paper examines how different taxes affect inequality and assess the likely impact that tax policy can have on inequality. Discussions regarding the role of tax policy in achieving equality and fairness often centre on theories regarding the appropriate degree of progression in personal income tax rates. A progressive tax system is one in which income tax rates increase, in bands, as levels of income increase. However, the higher rate is only charged on the amount of income earned above the cut-off for the band below. The rate of tax paid on the last dollar earned by a tax-payer is referred to as their marginal rate. The Canadian system has seen a reduction in the number of brackets in recent years, and this, along with clawbacks and "tax on income changes" tend to reduce the progressivity of the income tax system. There have been changes to taxes other than income taxes that must also be looked at in order to assess the progressivity of the tax system as a whole. For example, an increase in the amount of revenue collected as a consumption tax (in Canada, the GST) will tend to lead to a flatter rate of taxation because all taxpayers pay consumption taxes at the same rate. Thus, it is not only the progressivity of income tax rates that should be assessed in order to describe the progressivity of the tax system as a whole; rather, all taxes collected must be analyzed for their impact on progressivity, and, by extension, inequality. 52 Neil Brooks does not mince words when describing the trend in tax policy in Canada over the last two decades. He sees the desire to reduce the progressivity of the tax system as part of a "sustained and deliberate redistribution of income from the poor and the middle-class to the rich".130 He believes that strategies other than tax policy are implicated in the shift: ...every policy instrument that citizens use to achieve their collective goals through democratic institutions has been maligned and stunted: state enterprises and even social services have been privatized, industrial and financial sectors have been deregulated; environmental and consumer regulations abandoned, social security programs have been reduced, and union power has been curbed.131 4.2 Clawback of Benefits Marginal income tax rates for middle and lower income Canadians are heavily affected by the clawback of benefits. For example, prior to the election of the BC Liberals, welfare recipients in BC could keep up to $100 of earnings ($200 for families) and 25 percent of their earnings in excess of $200. 1 3 2 The elimination of this provision means that the money given in the form of welfare is "clawed back" at a rate of 100%. The welfare recipient's marginal rate could thus be 100%. For example, if a lone parent received $600 per month in benefits and found a part time job, which paid her $150 per month, she would lose $150 of her welfare benefit and end up with a net income that was identical to what she made before getting the job. Other clawbacks are phased in at various levels of income, such that one loses a percentage of the benefit initially, then, at higher incomes, all of it is clawed back. 1 3 0 Brooks, supra note 128 at 292. 131 Ibid. 1 3 2 Caledon Institute of Social Policy, A New Era in British Columbia: A Profile of Budget Cuts Across Social Programs (Vancouver: Caledon Institute of Social Policy, 2002). 53 Clawbacks have been identified by some commentators as a major problem with the Canadian system: [o]ver the years the lack of indexing and the accumulation of refundable credits that have to be recovered as income rises have caused the marginal rate structure to spike to more than 60 percent (and, in some extreme cases, more than 100 percent) around income levels slightly above $30,000. As Robert Brown recently quipped, this is the equivalent of chaos theory applied to tax policy.133 Other examples of benefits that are clawed back are the Old Age Supplement (for 2004, clawbacks begin when net income before adjustments reaches $59,790134), the Goods and Services Tax credit (the clawback for married couples, with or without children, begins at $30,000 net family income per year for the year 2004-5135), and the child tax benefit (clawbacks begin with a net family income of $35,000 for the July 2004-June 2005 payments136). High clawback rates are particularly detrimental to middle and low income Canadians.137 Clearly, because they will significantly reduce the amount of after-tax income enjoyed by a low-income earner, clawbacks are likely to increase inequality. 4.3 Reduction in the Number of Brackets In 1987, Canada reduced the number of income tax brackets at the federal level from 10 to 3, and reduced the federal maximum marginal tax rate from 34 to 29 percent.138 The choice to reduce the number of brackets was made as part of a strategic plan to derive Pierre Fortin, "Less Taxes and Better Taxes: Principles for Tax Cuts and Tax Reform" (2000) 48:1 Can. Tax J. 92 at 97; see generally Robert D. Brown, "Tax Reform and Tax Reduction: Let's Do the Job Right" (1999) 47 Can. Tax J. 182. 1 3 4 Canada Revenue Agency, General Income Tax and Benefit Guide - 2004, (N.p.: 2004). 1 3 5 Canada Revenue Agency, GST/HST credit, (N.p.: 2004). 1 3 6 Canada Revenue Agency, CCTB calculation sheet, (N.p.: 2004/2005.). 1 3 7 "...among OECD countries only Canada has experienced an increase in marginal rates since 1985. When combined with the clawback rates on child tax benefits and goods and services tax (GST) credits, marginal tax rates hurt low- to middle-income families the most." Jean-Yves Duclos and Julie Gingras, "A Roadmap for Federal Tax Reform" (2000) 48:2 Can. Tax J. 303 at 305. 138 Ibid. 54 more tax revenue from firms and consumption and less from direct personal income taxes; thus, in 1991, a value-added tax, the GST, was also created. For the year 2004, federal income tax rates are 16% on income up to $35,000, 22% on the next $35,000, 26% on the next $43,804 and 29% on income over $113,804.139 For the year 2004, personal income taxes comprise approximately 31% of all taxes collected in Canada, while corporation income taxes comprise only 8.5%.140 Until 2001, all provinces inherited the degree of progressivity embodied in the federal system due to their tax-on-tax approach, which was required in order for the provinces to stay within the tax collection agreements. A tax-on-tax approach is one in which the amount of provincial tax payable is expressed as a percentage of the federal tax payable. As of 2001 the provinces have the option of using a tax-on-income approach, in which they impose taxes directly on income.141 Since then Alberta has taken the radical step of instituting a flat provincial tax of 10 percent on all income. Note, however, that this is coupled with a very high basic personal and spousal deduction of over $14,000.142 In comparison, most other provinces have at least three different rates and personal exemptions averaging only half that of Alberta. Both of these changes - the reduction in the number of brackets and the trend towards collecting less revenue in the form of Personal Income Taxes - exacerbate inequality. Canada Revenue Agency, What are the tax rates in Canada for 2004?, (N.p.: 2004), online: Canada Revenue Agency website <http://www.relocatecanada.com/pdfdocuments/provtaxrates.pdf>. 1 4 0 Statistics Canada, Consolidated federal, provincial, territorial and local government revenue and expenditures (Revenue)" (N.p.:2004), online: Statistics Canada website <http://www.statcan.ca/enqlish/Pqdb/qovt01a.htm>. 1 4 1 Kenneth J. McKenzie, Provincial Tax Priorities in a Global and National Economy: What's Good for the Goose is Good for the Gander" (2000) 48:2 Can. Tax J. 356 at 363. 1 4 2 Online: Government of Alberta website, <http://www.qov.ab.ca/home/index.cfm?Paqe=678> 55 4.4 Assessing the Progressive System Two common tools used to assess the fairness of a tax system are horizontal and vertical equity. Horizontal equity dictates that those who have an identical standard of living before a tax is imposed should have an identical standard of living afterwards while vertical equity relates to the use of tax to level standards of living across all taxpayers. The tool used to achieve this is progressivity of the personal income tax. Political considerations cannot be ignored when assessing who has an identical standard of living before a tax is imposed. For example, the question of the correct tax unit comes into play - should it be the individual or the family? Ultimately the question boils down to the role played by spouses and children: should a single person, a two earner family and a one earner family with the same net income pay the same in taxes? This depends on whether one characterizes a non-working spouse as a benefit or a liability. A taxpayer without a spouse at home may have to pay for childcare, which is received free by the taxpayer with a spouse. On the other hand, the needs of two (or more) people must be met out of one income. Monies earmarked for a daycare subsidy have recently been attacked as unfair to families with a stay at home parent, again highlighting that within Canada there is little agreement as to who is "the same" prior to a tax subsidy and should therefore be included within the bounds of its largesse. As mentioned above, in Alberta, a taxpayer with a non-income generating spouse can claim the basic personal exemption twice, once for themselves and once to cover the costs of having a spouse, whereas a single parent could only claim it once. It seems clear that agreement on who has an identical standard of living before a tax is imposed, a necessary step to implementing horizontal equity, will be difficult to achieve. 56 Those arguing in favour of flat or lump-sum taxes use many of the same building blocks of neoclassical economic theory outlined in the second Chapter, and this is true even where conceptions of justice rather than economic theory are claimed to be the motivating force behind their ideas. 1 4 3 Those in favour of flat rate taxes tend to prioritize equalities of opportunity when defining "fairness." On the other hand, those in favour of steeper progression in tax rates are essentially swayed by the economic theory identified as "institutional economics" in the introductory Chapter, seeing power struggles antecedent to market exchanges as of crucial importance, and those in this camp perceive equality of result as important to "fairness." In general, discussions of the "fair" degree of progressivity in the tax rates will stumble at the first hurdle, when it must be acknowledged that there is no universally accepted definition of "fairness" when it comes to tax law. Nonetheless, claims to fairness are commonly made by all those debating the correct degree of progression in tax rates. As Maureen Cavanagh insists, "[bjecause of the malleability of 'fairness' and 'equality', it is important to ask 'equality of what?'"144 The answer, for those writing in the neoclassical law and economics tradition, is equality of burden. As Jeffrey Schoenblum states unequivocally, "[t]he starting point for determining a person's fair share must be the proposition that, as equals before the state, each of us ought to be required to pay the same absolute amount of tax to it."145 I am referring here to Jeffrey Schoenblum's article, in which, despite using neo-classical economic theory to back up his arguments, he claims that "[t]there are several relevant subjects this Article does not address. One is the issue of the most effective structure of income taxation from an economic standpoint." See Jeffrey Schoenblum, "Tax Fairness or Unfairness? A Consideration of the Philosophical Bases for Unequal Taxation of Individuals" (1995) 12:2 Am. J. Tax Pol'y 221 at 223. 1 4 4 Maureen B. Cavanagh, "Democracy, Equality and Taxes" (2003) 54:2 Ala. L. Rev. 415 at 428. 1 4 5 Schoenblum, supra note 143 at 270. 57 The philosophical bases for such a position accord completely with those of the neoclassical tradition sketched out above: the "primacy of the individual and his property";146 the freedom of the individual to make choices in markets that result in a fair allocation of wealth ("[t]he ultimate income position for an individual is largely one of his own responsibility"147); and a rejection of the notion that the production of wealth is an inherently communal exercise: ("[e]ven if all income were inextricably associated with more than one person's efforts, this would only justify claims inter se between the parties, which is precisely what contract law regulates. Recognition of more tangential claims simply cannot be proven...").148 Certainly, Schoenblum does exactly what was complained of by the institutional economists: divorces actual transactions from the context in which they occur. Schoenblum likens progressive taxation to theft in a scenario in which one is "[sjitting in your home and a stranger breaks in and removes, under threat, valuable assets belonging to you or your family."149 His metaphor makes Dallas' criticism of the neoclassical tradition, that in its level of abstraction it eliminates considerations of a particular place and time and becomes "armchair" economics, very apt. An analogy more removed from the reality of the complexity of the modern industrial state can hardly be imagined. If Crespi is right and one of the things that law and economics scholars are doing is telling stories, it is clear that the question of when the story starts is crucial. Those power struggles that took place antecedent to you sitting in your living room with a stash of valuables have disappeared, whereas for an institutional economist they would be a major element of any tax narrative and certainly its starting point. 146 Ibid, at 245. Ibid, at 267. Ibid. Schoenblum, supra note 143 at 259. 147 148 149 58 What Neil Brooks has referred to as the "attack"150 on progressive taxation began with the publication in 1952 of Blum and Kalven's classic article, "The Uneasy Case for Progressive Taxation".151 They object to progressive taxation, inter alia, because it conflicts with democracy in that a large majority could theoretically vote for onerously high tax rates on a wealthy minority, and democracy requires that the minority be protected from the majority. In fact, it does not appear that this has ever happened, and Barbara Cavanagh convincingly argues that "[gjreater equality of tax burdens is uniformly associated with governments little concerned with political rights."152 She asserts that "political regimes from the Persian to the Roman Empires shared...flat rates of tax (often a tithe) on agricultural production ... taxes were levied ... without consideration of political status or economic ability ... [hjowever these various political systems are described, none can be characterized as democracies, or governments concerned with political equality."153 This discussion is outside the scope of this paper, but it is worth noting that increased inequality arguably has an impact not just on economic prosperity but on questions of what it means to live in a democracy as opposed to a totalitarian regime. Note that Amadae equated collective endeavours with totalitarianism; Cavanagh argues for the opposite, that a lack of collective responsibility can be more accurately described as despotic. The alternatives to a progressive system of rates on personal income include a proportionate or flat tax, which would tax all earned income at the same rate, a regressive system in which rates decline as incomes rise, and a lump-sum, poll or head 1 5 0 See generally Brooks, supra note 128. 1 5 1 Walter J. Blum and Harry Kalven Jr., "The Uneasy Case for Progressive Taxation" (1952) 19 Chi. L. Rev. 417. 1 5 2 Cavanagh, supra note 144 at 478. 153 Ibid, at 479. 5 9 tax in which all taxpayers pay not the same rate of tax on income earned but rather exactly the same dollar amount. Any of these can be coupled with a minimum income requirement to deal with those who have very low (or, indeed, no) income. In addition to factors that affect the real progressivity rates of income taxes, it is important to look at other tax bases and assess these for their impact on progressivity. This is necessary in order to get an accurate picture of the impact that taxes have on inequality. These alternative bases will be examined in the next Chapter. 4.5 Alternative Bases and Their Implications for Progressivity Another way to frame alternatives is to look not at rates of income tax but rather at alternatives to a tax on income; that is, to look at changes to the composition of the tax base. As noted above, Canada has recently chosen to decrease the amount of revenue collected from personal income taxes and increase the amount collected as consumption and corporate taxes. 4.5.1 Consumption Taxes One alternative to taxing income is to tax consumption. As discussed above, part of the federal government's goal since the late 80s and early 90s has been to reduce the proportion of the tax base that is made up of income taxes. Under a consumption tax system it would only be when income is spent that tax is paid - one could earn income and increase net worth tax free. Consumption taxes are inherently anti-progressive; first, because everybody pays at the same rate, and second because "a consumption tax 60 exempts income from capital from tax; most income from capital is earned disproportionately by the wealthy."154 It should be noted, however, that it is also possible to eliminate the tax on income from capital even if other sources of income are taxed; that is, it is not necessary to switch to a consumption tax in order to avoid taxing income earned on capital. For the 2003-2004 tax year, approximately 21% of government revenue was collected through consumption taxes.1 5 5 Lisa Phillips has commented on the reduced role that personal income taxes are playing in revenue collection in Canada, emphasizing that when the tax base shifts away from income taxes towards revenue generated from other sources, the role of the state changes: Governments in Canada and elsewhere are presently under intense pressure to cut taxes and especially to reduce the level of personal income tax — the most progressive element of the Canadian tax system and by far the biggest revenue raiser. Other levies, such as sales taxes and property taxes, are not geared to ability to pay and tend to be regressive because they take a larger proportion of lower incomes than of higher incomes. The personal income tax is really the only component of the Canadian tax system that gives it significant redistributive potential. Thus, the attack on progressive income taxes can be understood as a direct challenge to the redistributive role of the liberal state.156 1 5 4 Brooks, supra note 128 at 296. One analyst has suggested that a consumption tax of only 0.3 percent could replace all federal taxes in the US and still be revenue neutral: the trick would be to include financial dealings such as sales of stocks and bonds, currency trading and the like. Clearly this would be quite progressive, because most financial dealings are, of course, conducted by the wealthy. This is interesting in that the basic assumption that consumption taxes are anti-progressive accepts without comment the fact that these transactions attract no tax: see "Dreaming Out Loud: One Tiny Little Tax" The New York Times (2 February 2003) reporting on the ideas of Edgar L. Feige. 1 5 5 Statistics Canada, Consolidated federal, provincial, territorial and local government revenue and expenditures (Revenue), (N.p.: last updated 2006), online: Statistics Canada website <http://www.statcan.ca/enqlish/Pqdb/qovt01a.htm>. The figure holds true whether looking only at federal revenues or consolidated federal, provincial, territorial and local government revenue and expenditure. 1 5 6 Lisa Phillips, "Taxing the Market Citizen: Fiscal Policy and Inequality in an Age of Privatisation" (2000) 63 Law & Contemp. Probs. 111 at 118. 61 Thus we can see that, in moving towards sales and property taxes and away from personal income taxes, Canada is moving away from redistribution and towards a flatter tax regime. Research performed by Jonathan Kesselman also demonstrates that only the personal income tax is demonstrably progressive: ...based on lifetime income groups in the long-run equilibrium, only the personal income tax is found to be strongly progressive. Payroll taxes are strongly regressive; sales excise and property taxes are significantly regressive except for the top two deciles of lifetime incomes; and even the corporate income tax is somewhat regressive over lifetime income groups except for the top decile. All taxes taken together are found to be roughly proportional for the bottom nine deciles and highly progressive for the top decile. 4.5.2 W e a l t h T a x e s One possible tax base is wealth. A true wealth tax, as seen in some European jurisdictions, is usually a small percentage (1 or 2%) payable on the taxpayer's net worth. In this sense, Canada does not have a wealth tax. However, municipalities do collect property tax. The deemed disposition rules also act as a form of tax on wealth when assets are transferred between generations or sold, although, as a tax on the capital gain, this can be seen "as a form of income taxation since it taxes changes in wealth."158 As a percentage of all taxes collected at the federal; provincial, territorial and local government level, property taxes comprise approximately 10%. 1 5 9 Jonathan Kesselman, "Tax Incidence, Progressivity and Inequality in Canada" (2004) 52:3 Can. Tax J. 709 at 711 [Kesselman, "Incidence, Progressivity and Inequality"]. 1 5 8 Duclos, supra note 137 at 316 159 Consolidated federal, provincial, territorial and local government revenue and expenditures (Revenue), supra note 155. 62 It is clear that taxing wealth would, on the face of it, lead to greater equality as this would be a tax paid predominately by the wealthy. Considerations such as asset hiding would, however, have to be taken into account. Although it seems like a weak argument to say that a law is bad because people will not want to follow it, some recognition of the resources that the wealthy have to hide their wealth would have to be acknowledged. 4.5.3 Capital Gains Only 50% of the value of a capital gain need be included in income.160 A very small percentage of Canadians report more than half of the capital gains declared in this country. Lisa Phillips reports that "[d]ata from 1996 show that 57.3% of capital gains on corporate shares, and 63.2% of capital gains on all types of property, were reported by 1.6% of taxpayers...".161 Thus most capital gains are earned by only a tiny minority of Canadians, who enjoy the benefit of only paying tax on half the amount that they have earned. Including 100% of capital gains in taxable income would at first glance increase equality in Canada as it would be a tax paid mostly by the wealthy, especially assuming a continuing exemption for the primary residence of each taxpayer. However, as described in detail in Chapter 5.6.2, it is a more effective way to increase investment in an economy to tax dividend earnings highly and provide some relief for stockholder capital gains, as this encourages retained earnings. Canada Revenue Agency, Capital Gains 2005, Form T4037E (Ottawa: Canada Revenue Agency, 2005). 1 6 Y Phillips, supra note 156 at 121. 63 Thus the real scope for both improving equality measures and ensuring a positive impact on economic growth would be to tax shareholder dividend income and personal income much more aggressively than corporate profits and capital gains. 4.5.4 Payroll taxes Canadians also pay what are known as "payroll" taxes, which are "often levied on a limited range of wages (those between a specified floor and ceiling)."162 Payroll taxes are, at least in theory, used to fund "social programs, such as El and the CPP/QPP at the federal level and worker's compensation, health care and education at the provincial level."163 Because of the ceiling on contributions, payroll taxes are highly regressive, that is, those earning higher incomes pay less than those with lower incomes. Arguably, they are also a source of inequity because they "are not raised on a broad base of earnings and income (the El base excludes, for example, self-employment income, non-wage benefits, and returns from business, property and financial investments)."164 Clearly, those sources of income excluded from the obligation to pay payroll tax are those overwhelmingly earned by the wealthy, which makes it a tax that is not only regressive in that those who earn more employment income pay less tax, but also in that those who earn other types of income are exempt completely. The importance of payroll taxes as a percentage of government revenue has increased dramatically over time. Zhengxi Lin writes: Revenues raised from payroll taxes levied on employers and employees reached $48 billion in 1997, amounting to 14% of total federal and provincial government revenues. This represents an increase of over 70% from 1980 (at 8.2%). Over the same period, total payroll tax revenues rose from 2.8% of GDP to 5.7%; the 1 6 2 Duclos, supra note 137 at 315. 1 6 3 Ibid. 1 6 4 Ibid, at 307. 64 effective total payroll tax rate more than doubled from $5.61 per $100 of wages and salaries to $12.23; and average annual total payroll taxes increased from $1,650 per employee to over $4,200 (in 1997 constant dollars).165 It is now widely recognized that the amounts collected exceed what is required to fund the social programs listed above. For example, El surpluses have been in the region of $5 billion per year since 1995. 1 6 6 The excess is added to general government revenue, which is significant given the fact that someone making $39,000 will pay the same amount as someone making $300,000, making this a profoundly regressive tax. Payroll taxes thus exacerbate inequality. They are regressive and levied primarily on those with lower incomes. Income taxes, on the other hand, are progressive and are levied on a wider base. Any movement towards generating a larger portion of revenue from payroll taxes and less from personal income taxes decreases the progressivity of the system as a whole. 4.6 British Columbia: The Attack on Progressivity The current BC Liberal government, headed by Gordon Campbell, was sworn into power on June 5, 2001, elected on a platform of reduced taxes and increased "fiscal responsibility". It has implemented a tax policy regime that represents a shift in priorities away from those of the New Democratic Party (NDP) government that preceded them. In many ways, it is following in the footsteps of Ontario and Alberta, two provinces that have also recently pursued aggressive restructuring policies aimed at reducing the size of government and tackling public debt. However, these two provinces adopted tax-1 6 5 Zhengxi Lin, "Payroll Taxes in Canada Revisited: Structure, Statutory Parameters, and Recent Trends" (2000) 48:3 Can. Tax J. 577 at 579. 1 6 6 Duclos, supra note 137 at 308. 65 cutting policies at a time when they "enjoyed strong external demand for their major industries - energy for Alberta and manufacturing for Ontario."167 BC, on the other hand, began its policy of tax cuts and public spending reduction "in an environment of depressed external demand for and prices of some of its major sectors, including forest products, tourism and base metals."168 The philosophy of the BC Liberals is essentially that of the neoclassical economic theory outlined in Chapter 1. A belief in the superiority of market transactions, and ergo a preference for smaller government, can be seen as the fundamental guiding force behind much of their thinking on tax policy. In a nutshell, their plan to curb government spending entailed leaving spending on health and education static and cutting the rest of government spending by one third. It is clear that the BC Liberals believe that less revenue and smaller government will lead to an invigorated private sector. In an address on December 13, 2001, Gordon Campbell told the Coalition of BC Businesses "in our first complete budget, individual British Columbians are paying over a billion dollars less in taxes today than they were before the election, and corporate British Columbia is paying $390 million less. Every single one of those dollars goes back into our economy to encourage economic activity, to encourage investment, and to encourage job creation."169 Jonathan R. Kesselman, "Fixing BC's Structural Deficit: What, Why, When, How? And For Whom?" (2002) 50:3 Can. Tax J . 884 at 922 [Kesselman, "BC's Structural Deficit"]. 1 6 8 Ibid, at 923. 1 6 9 Gordon Campbell "Address to the Coalition of BC Businesses" (December 13, 2001), Government of British Columbia: http://www.qov.bc.ca/bvprd/bc/channel.do7channellD— 8397&navld=NAV ID premier. 66 There is no doubt that the BC Liberals government was truthful when it made tax cutting part of its election platform; however, some commentators feel that the rhetoric prior to the election suggested that the cut would be directed to low- and middle-income British Columbians.170 In fact, the marginal rates for high-income British Columbians were the major focus of the cuts. The following table is copied directly from the provincial government's own website, under the heading Questions and Answers about the June 6, 2001 Reduction to Personal Income Tax Rates:171 "During the election campaign, British Columbians were led to believe that tax cuts would be concentrated on the bottom two tax brackets..." says the Canadian Centre for Policy Alternatives, News Release, "BC Government's Tax Cuts Give Biggest Benefit to Top 10%" (6 June 2001), online: CCPA website, <http.7/www.policvalternatives.ca/bc/nr24.html>. 1 7 1 British Columbia, Ministry of Provincial Revenue, Income Taxation Branch, Questions and Answers about the June 6 2001 Reduction to Personal Income Tax, (N.p.: 2001), online: Government of British Columbia website <http://www.rev.qov.bc.ca/itb/itapit/Taxcut-QA.htm> 67 Table 4.1 Tax Rates in British Columbia Before and After BC Liberals Victory T a x a b l e I n c o m e * B e f o r e A n n o u n c e m e n t 2001 2002 $0 to $30,484 8.4% 7.3% 6.05% $30,484.01 to $60,969 11.9% 10.5% 9.15% $60,969.01 to $70,000 16.7% 13.7% 11.7% $70,000.01 to $85,000 18.7% 15.7% 13.7% Over $85,000 19.7% 16.7% 14.7% Tax brackets for 2002 are indexed. See 2002 Tax Brackets and Rates. Here we can clearly see that, while all those earning $60,969.01 or more received a 5% cut in their top marginal rate(s) by 2002, those earning less than $30,484 received less than half of this cut when expressed as a percentage, 2.35%. Middle income earners received slightly more, with a 2.75% tax cut. According to the Canada Revenue Agency, in 2001, the most recent year for which such statistics are currently available, the average income in BC was $30,981.173 Below is a table showing the number of British Columbians in each income group for that year: 1 7 2 The indexing of brackets means that, by 2004, the first bracket ended at $32,476, the second ended at $64,954, the third at $74,575, the fourth at $90,555 and the fifth went from applying to all income over the amount of $85,000 to all income over the amount of $90,555 in 2004. See British Columbia, Ministry of Provincial Revenue, Personal Income Tax TONI in 2004, (N.p.: 2004), online: Government of British Columbia website: <http://www.rev.qov.bc.ca/itb/itapit/toni 2004.htm>. The Provincial Government states that indexing is based on the Consumer Price Index for British Columbia. Between 2001 and 2004 all brackets were increased by 6.53%. 1 7 3 BC Stats, British Columbia Taxation Statistics 2001, (N.p.: 2001), online: Government of British Columbia website, <http://www.bcstats.qov.bc.ca/data/dd/handout/01txhand.pdf> at 1. 68 Table 4.2 Number Returns Per Income Band Locality Code Statistics 1 For all return fields 2001 tax year 1 ' ' 4 Total Returns Under $1,000 $1,000-$5,000 $5,000-$10,000 $10,000-$15,000 $15,000-$20,000 $20,000-$25,000 2,911,540 1 / b 184,110 195,230 348,940 370,990 274,860 218,960 $25,000 $30,000 $30,000-$40,000 $40,000-$50,000 $50,000 and over 197,570 358,780 258,800 503,310 Here we can see that the majority of British Columbians filing income tax returns, approximately 1,786,000 or 61%, will fall into the category of those who received only a 2.35% cut. This table, provided by BC Stats, does not go into detail regarding the 503,310 British Columbians earning over $50,000. According to David Schreck, a former MLA for North Vancouver Lonsdale and former Special Advisor to the Premier of British Columbia during the reign of the NDP, using figures that he has obtained from the province through freedom of information laws, the breakdown of the number of people earning $50,000 or more in 1997 was as follows: BC Stats, Locality Code Statistics for all return fields, 2001 tax year, (N.p.: 2001), online: Government of British Columbia website, <http://www.bcstats.gov.bc.ca/data/dd/handout/01b(hand.pdf> at 6. 1 7 5 BC Stats, British Columbia Taxation Statistics 2001, (N.p.: 2001), online: Government of British Columbia website, <http://www.bcstats.gov.bc.ca/data/dd/handout/01 txhand.pdf> at 1. 69 Table 4.3 Breakdown of Those Earning $50,000 or more Income Level $50,000-$60,000 $60,000-$70,000 $70,000-$80,000 $80,000-$90,000 $90,000-$100,000 $100,000-$150,000 $150,000-$250,000 $250,000 and over Number of Taxpayers 159,860 97,730 48,880 27,590 16,660 29,450 12,400 7,920 1' b When looked at as dollars saved rather than percentage reduction in income tax rates, the differences between what low-income earners have saved in tax cuts compared to what high-income earners have saved is more dramatic. Using these 1997 returns as a baseline and applying the new rates declared by the BC Liberals in 2001, David Schreck calculates that those taxpayers earning $10,000 or less will have saved on average $6, yet they represent 23.7% of the population. As a percentage of the dollar value of the tax cuts they will receive 0.3%. On the other hand, the approximately 8,000 British Columbians who earn $250,000 or more will receive 13.7% of the tax cut pie, or approximately $23,848 each. 1 7 7 Similarly, the CCPA calculates for the tax year 2002 that those earning under $30,000 will make up 48.8% of the population, but will receive only 13.4% of the tax cut pie, while those earning $30,000 to $60,000 - 38.3% of taxpayers, will receive 33.9% of the cut. The remaining 13% of taxpayers who earn $60,000 or above will receive 52.8% of the value of the cut. In fact, if one disaggregates that top sector into the 1.5% of British Columbians who earn more than $150,000, it is startling to realize that they will receive 20% of the value of the tax cuts, representing $269 million out of a total cut of $1,348 million.178 therefore, in keeping with the comments on progressivity made at the 1 7 6 Schreck, David, The Real Story Behind BC's Dramatic Tax Cuts, (2002)[Unpublished], online: Strategic Thoughts website, http://www.strateqicthouqhts.com/record2001/taxcuttable.html. 177 Ibid. 1 7 8 Marc Lee, "The Great BC Tax Cut Giveway" (2001) 4:3 CCPA: BC Commentary, A Quarterly Review of Provincial Social and Economic Trends, online: CCPA website, 70 s beginning of this Chapter, the reduction in progressivity of income tax rates chosen by the BC Liberals is very likely to increase inequality in British Columbia. Taxes on the income earned by corporations have also been reduced in British Columbia. From 1993 to January 1, 2002, the rate of income tax payable on taxable corporate income earned in the province was 16.5%. From January 1, 2002 to the present the rate has been reduced to 13.5%.179 The Small Business Rate, applicable to Canadian controlled private corporations with active business income has gone from 9.0% in 1998 to 4.5% starting January 1, 2001. Note, however, that this tax was already on the decline before the BC Liberals came to power: in the first half of 1999 it was 8.5%, which declined to 5.5% until mid-2000, at which point it dropped to 4.75%. The Corporation Capital Tax, a tax payable on "net paid up capital" in excess of certain threshold amounts180 has been eliminated as from August 31, 2002, other than for financial corporations (banks, trust companies and credit unions). The threshold for becoming liable to pay the small business income tax was raised by 50% to $300,000 on April 1, 2002.1 8 1 As with the reduction in personal income tax rates, it seems likely that a reduction in corporate taxes will be of disproportionate benefit to the wealthier community of British Columbia, because investment and property income is disproportionately earned by the <http://www.policyalternatives.ca/documents/BC_Office_Pubs/bc_commentary/bccsummer01.pdf >. 1 7 9 British Columbia, Ministry of Provincial Revenue, Income Taxation Branch Corporate Income Tax, (N.p.: 2002), online: Government of British Columbia website, <http://www.rev.gov.bc.ca/itb/itacit/itacit.htm>. 1 8 0 Ranging from $1.5 million in 1998 to $5.0 million in 2000 for non-financial corporations and from $1.5 million in 1998 to $10.0 million in 2003 for financial corporations. British Columbia, Ministry of Provincial Revenue, Income Taxation Branch, Corporation Capital Tax, (N.p.:2003), online: Government of British Columbia website, <http ://www. re v. gov. be. ca/itb/cct/cct. htm >. 1 8 1 British Columbia, 2001/2 Annual Report: A New Era Update (Victoria: Ministry of Finance, 2002) at 8. 71 wealthy. Another tax that has been reduced by the BC Liberals is the surtax on passenger vehicles. Effect July 31, 2001, the surtax has only applied to vehicles costing over $47,000 rather than vehicles costing over $32,000.182 Clearly it is only those who can afford relatively expensive vehicles, i.e. those with higher incomes, who will benefit from this tax cut. Another dimension to the tax cut strategy of the BC Liberals is that the reductions in personal and corporate income tax rates were accompanied by increases in service charges and increases in other taxes. In this sense, the BC Liberals made changes to the tax base as well as rates. One of the questions to be answered regarding the BC Liberals tax cuts is whether, when all increased charges are taken into account, there will be a change to the long term trend of very gradual increases in government revenues. In Table 4.4 (A7 of the Government of British Columbia Budget 2004), revenue by source is detailed:183 182 Ibid. 1 8 3 British Columbia, Budget and Fiscal Plan 2004/5 -2006/7 (Victoria: Minister of Finance, 2004) at 144, online: Government of British Columbia website, < http://www.bcbudget.gov.bc.ca/bgt2004/bfp/BudgetFiscalPlan.pdf> 72 Table 4.4 Revenue by Source $ millions Actual 2000/1 Actual 2001/2 Actual 2002/3 Updated Forecast 2003/4 Budget Estimate 2004/5 Plan 2005/6 Plan 2006/7 Taxation Revenue Personal Income 5,963 5,366 4,150 4,895 5,005 5,302 5,606 Corporate Income 1,054 1,522 612 771 893 776 959 Social Service 3,625 3,552 3,795 3,945 4,156 4,353 4,546 Fuel 715 659 684 870 891 910 939 Tobacco 460 499 606 645 676 676 676 Property 1,452 1,481 1,541 1,584 1,655 1,716 1,782 Property transfer 262 303 407 505 432 400 400 Other 772 728 557 454 477 487 490 Total 14,303 14,110 12,352 13,669 14,185 14,620 15,398 Other Revenue Medical Service Plan Premiums 894 954 1,355 1,387 1,398 1,413 1,429 Post secondary fees 440 452 580 662 713 779 837 Other health care related fees 411 383 445 437 421 423 425 Motor vehicle licences and permits 339 342 351 362 370 378 387 Other fees and licences 1,068 1,071 1,074 673 852 686 708 Investment Earnings 1,438 1,257 1,009 908 826 873 916 Sales of Goods and Services 916 890 875 699 681 700 719 Miscellaneous 966 960 976 1,137 1,133 1,097 1,067 Total 6,472 6,309 6,665 6,265 6,394 6,349 6,488 This table plainly shows that, while revenue from personal and corporation income taxation has indeed declined since the BC Liberals came to power, revenue from social services (the PST), fuel, tobacco, property and the PTT (Property Transfer Tax) all increased. As mentioned above, consumption taxes such as PST, fuel, and tobacco taxes are inherently anti-progressive because everybody pays at the same rate. Effective February 20, 2002, the PST (Provincial Sales Tax) went from 7.0% to 7.5%. Tobacco has been creeping up steadily: from $22 to $30 per carton in 2002; in February 2003 this was raised again to $32; 1 8 4 less than a year later a further increase, from $32 to $35.80 per carton, was announced.185 When consumption taxes increase to make up for losses to revenue in progressive taxes such as income tax, the result is once again increased inequality. Similarly, revenue provided by Medical Services Plan premiums, (listed under "Other Revenue"), and post-secondary fees has also increased dramatically. Effective May 1, 2002, the BC Liberals increased premiums for MSP by 50%. However, low-income people qualify for a rebate, from a 100% rebate for those earning $16,000 or less to a 20% subsidy for those earning $24,000 or less. It is apropos here to mention Neil Brooks' warning about the necessary squeezing of the middle class that will occur when the urge for lower taxes meets the need to provide some sort of rebate system for the very poor: 1 8 4 Deborah L. Ort and David B. Perry "Provincial Budget Roundup 2003" (2003) 51:3 Can. Tax J. 1159 at 1197. 1 8 5 British Columbia, Ministry of Provincial Revenue, Bulletin TTA 005, revised December 2003. 74 If tax rates are to be reduced for high-income individuals, and low-income individuals are to be exempt from tax by a large basic exemption, how is it possible that middle-income individuals will not get soaked? 1 8 6 The MSP premium changes are a good example of the possibility that it is middle-income earners who will bear a disproportionate burden of the tax cuts. In fact, the CCPA (Canadian Center for Policy Alternatives) has calculated "that a family of four with a household income of $35,000 loses more than the value of the tax cut just due to the MSP premium increase (net loss $359)."187 In fact, one can actually challenge the terminology of the BC Liberal government: is it really talking about "tax cuts" at all? Or is the issue more one of shifting the burden from some taxpayers and onto others, leaving the amount collected roughly the same? If that is the case, for whom will the burden increase? BC Family Bonus benefits are clawed back when net family incomes reach $20,500, the BC Earned Income Benefit is phased out for individuals with family net income greater than $20,921 and the Sales Tax Rebate is reduced when net individual incomes reach $15,000 and net family incomes reach $18,000.188 By making special allowances for those with extremely low incomes, and giving large tax cuts to high-income individuals, it is middle-income families who seem poised to end up bearing an increased burden for the cost of government. As can be seen in Table 4.4, reproduced on page 66, "Other healthcare-related fees", and motor vehicle licenses and permits are also generating increasing levels of revenue. 1 8 6 Brooks, supra note 128 at 329. 187 Canadian Centre for Policy Alternatives, Press Release, "New CCPA study calculates British Columbians "Cost Shift": Study details how British Columbians fare after one year of tax and spending cuts..." (July 4 2004) [CCPA, "Cost shift"]. 1 8 British Columbia, Ministry of Provincial Revenue, Income Taxation Branch, Sales Tax, Political Contributions, and ESOP, EVCC and VCC Tax Credits (N.p.:2001), online: Government of British Columbia website, http://www.rev.gov.bc.ca/itb/itapit/other-credits.htm. 75 Like the increases in consumption taxes referred to above, these increases are likely to increase inequality in British Columbia as they are levied at the same rate for everyone. Some of the more common health care related services that must now be paid for include physiotherapy and eye exams. Most of the increased costs under discussion (fuel, sales, tobacco, MSP premiums) involve payments of either less than a hundred dollars or a few hundred at most. It is not possible to detail every possible permutation of combined income tax reduction or consumption tax increase for all British Columbians, but, one can generally say that in order for the changing mix of tax rates and tax base to be of benefit to an individual British Columbian, it is likely that they must have saved thousands, rather than hundreds, in the income tax cut. Therefore, while high-income earners are likely to come out ahead, low- and especially middle-income earners will quite possibly see the gains that they have made in income tax cuts wiped out by increases in costs for other services. Sylvia Fuller of the CCPA has generated some hypothetical individual scenarios that illustrate the point that for many individuals, there will be no net increase in disposable income after the income tax cut and corresponding service increases are implemented: ...a single individual earning $30,000 loses more than she gains if she requires a course of physiotherapy and an eye exam (net loss $31). A family of four with a household income of $35,000 loses more than the value of their tax cut just with the MSP premium increase (net loss $359) - if they have daycare expenses and a course of physiotherapy they are deep in the hole (net loss $780). A family of four with a combined income of $60,000 remains ahead even after the addition of MSP, eye exams, and a course of chiropractic treatment, but not by very much (net gain $130). A single individual earning $150,000 remains well ahead after the MSP increase, an eye exam, and a course of physiotherapy (net gain $4,529).189 1 8 9 CCPA, "Cost Shift", supra note 187. 76 Although it is outside the scope of this paper to review regional inequality in detail, it should be noted that of those earning $50,000, and therefore falling into the highest income bracket recorded by the Canada Revenue Agency, more than half (270,380), live in Greater Vancouver.190 Therefore, it may be that regional inequality as well as income inequality will increase due to the new tax policies implemented by the BC Liberals. To conclude, it seems clear that at first glance inequality is set to increase in British Columbia due to the policies of the BC Liberal party. However, what of the arguments that the party itself has promoted, that by freeing up monies to spend and invest, and making the cost of doing business cheaper, that the economy will grow faster and that the benefits of this will ultimately accrue to all British Columbians? In the next Chapter, this argument will be examined, and the component parts of the BC Liberals fiscal policy will be examined for their likely and actual impact on economic growth in this province. 1 9 0 BC Stats, British Columbia Taxation Statistics 2001 (N.p.: 2001), online: Government of British Columbia website, <http://www.bcstats.gov.bc.ca/data/dd/handout/01txhand.pdf> at 8. 77 5 Tax Policy and Economic Growth 5.1 Introduction Within the paradigm of neoclassical economics it is axiomatic that there is a tradeoff between enhanced efficiency, which requires lower taxes for the wealthy, and redistributive tax policies that could create more equal societies. However, as will be examined in detail in this Chapter, there is now a growing body of empirical work that suggests the exact opposite. Models to explain why distributional concerns should be abandoned if one seeks strong economic growth have proved inaccurate at forecasting economic growth patterns, and new models have appeared that offer potential explanations for why inequality may itself be a drag on economies. In this Chapter the original neoclassical model that was relied upon to bolster claims of a tradeoff will be examined, as well as the more contemporary challenges to this model. The exact manner in which various elements of tax policy can effect an economy will then be looked, at and the results applied to the changes to taxation in British Columbia made by the BC Liberal party. 5.2 Inequality and Economic Growth The link between inequality and economic performance is generating more and more interest191 as rates of inequality have increased, especially in the "Anglo" pattern countries described in Chapter 3.3. Some economists are even shifting perspective, 1 9 1 Christopher J. Niggle, "Equality, Democracy and Economic Growth" (1998) 32 Journal of Economic Issues 523, states that his interest in this "emerging field" was stimulated by attendance at the Luxembourg Income Study's Advanced Workshop held in Differdange, Luxembourg, during July 1996. 78 and, rather than assessing the cost of redistributive policies, are calculating the cost of inequality. For example, in an article that asks the question whether inequality is the Achilles heel of the new American economy, Richard Freeman states that "...the clearest consequence of increased disparity is that lower income people are poorer than they otherwise would be.... [the] poor are more likely...to live in crime-prone neighborhoods and to be victims of crime; their children are more likely to have health problems and trouble in school" 1 9 2 and the very poor risk homelessness. All of these generate costs to an economy. Other researchers have found that with high inequality people fight over distribution rather than focus on increasing the national output: ... The potential link between income inequality and poor health seems to be declining social cohesion and lack of shared social goals. Declining social cohesion has many correlates: declining investment in human capital (such as in education and health care) in low income areas; increasing social distrust manifested by declining confidence in government and in one another; increased rates of property crime and violence in low income areas; and impaired functioning of democracy, as seen by voting patterns and related evidence.193 The link between inequality and crime is captured in the phrase "[wjhatever makes legitimate work less attractive makes crime more attractive."194 Thus it may be not only absolute poverty that can increase crime rates, but also the perception that inequality exists to an unfair degree, making participation in the legitimate workforce feel like exploitation. The cost of higher crime rates is more spending on "police, judges, prosecuting attorneys, defense lawyers, guards, parole officers, executioners, municipal 1 9 2 Richard B. Freeman, "Is the New Income Inequality the Achilles' Heel of the American Economy?" in James A. Auerbach and Richard S. Belous, eds., The Inequality Paradox: Growth of Income Disparity (Washington: National Policy Association, 1998) 219 at 222. 1 9 3 Timothy S. Smeeding, "U.S. Income Inequality in a Cross-National Perspective: Why Are We So Different?" in Auerbach and Belous, supra note 192, 194 at 196. 1 9 4 Freeman, supra note 192 at 225. 79 jails, state prisons and federal penitentiaries."195 According to one commentator, it costs "as much" to incarcerate someone for a year as to send them to Harvard,196 and the state of California, for example, budgeted more on prisons than higher education in 1995. 1 9 7 A comprehensive study of the economic effects of inequality would have to take into account the long term effects of such under-investment in human capital. However, precisely because the effects of high inequality can take decades to appear in economic indicators, and the "Anglo" pattern of high and increasing inequality in developed countries is a new trend, there are no studies that can definitively tell us what the long-term economic implications of high inequality are going to be for these countries. For example, a higher rate of crime is not commonly accounted for in economic theories that champion lower tax rates; much work remains to be done in this area in order to make all the costs associated with inequality quantifiable. The costs of inequality are one side of the equation: the other is the question of whether a positive relationship exists between inequality and rates of economic growth. The next Chapter of this paper challenges the thesis that there must be a trade-off between high rates of growth and greater equality of distribution. Increasingly, it seems, the data do not support such an interpretation. 1 9 5 William M. Dugger, "Against Inequality" (1998) 32 Journal of Economic Issues 297. See generally Jim Homer "The War on Drugs: A Legitimate Battle or Another Mode of Inequality?" in William M. Dugger, ed., Inequality: Radical Institutionalist Views on Race, Gender, Class and Nation (Westport, Conn.: Greenwood Press, 1996) 225. 1 9 6 Freeman, supra note 192 at 225. 80 5.3 Theoretical Models The role played by the distribution of wealth in economic growth was raised by the classical economist David Ricardo. Ricardo considered the distribution of income across the social classes as a relevant factor for predicting the growth of an economy. 1 9 8 Ricardo theorized that since landowners used their revenue for luxurious consumption whereas capitalists used it to invest in new productive capital, a shift in the ratio of land rents to profits would improve the rate of economic growth. Ricardo's theories have also been adopted in the twentieth century: [Ricardo's] approach reappeared in the work of twentieth century heterodox economists such as Michael Kalecki, Nicholas Kaldor, and Luigi Pasinetti; all saw the distribution of income across social classes (factor shares) as an important influence over capital accumulation and growth because profits finance accumulation. Keynes argued that distribution also influenced accumulation indirectly through its influence over aggregate demand for final goods and ultimately over profit expectations.199 However, in a departure from these theories, orthodox neoclassical economists such as Robert Solow 2 0 0 and T. Swan 2 0 1 created a model in which it was assumed that all savings were invested and all social classes had the same savings rate.202 Once these two assumptions are made, changes to the distribution of income between classes will clearly have no effect on economic growth within the model. The Solow/Swan model featured an assumption of decreasing marginal returns to both capital203 and labour.204 They concluded that long-run per capita output growth would thus be determined by the David Ricardo, Principles of Political Economy and Taxation 1817 Reprint (London: Gonner, Bell and Sons, 1891) cited in Niggle, supra note 191 at 525. 1 9 9 Niggle, supra note 191. 2 0 0 Robert H. A. Solow, "Contribution to the Theory of Economic Growth" (1956) 70 Quarterly Journal of Economics 65. 2 0 1 T. Swan "Economic Growth and Capital Accumulation" (1956) 32 Economic Record 334. 2 0 2 Niggle, supra note 191 at 525. 2 0 3 In this case, the return from additional investment in capital will just equal its cost. 2 0 4 Labour here is measured in terms of productivity. 81 rate of exogenous technological change. It is assumed in this model that economies will always tend towards a steady state. The notion that the rate of growth is controlled by exogenous factors is crucial, and provides a sharp contrast to the work of the "endogenous growth" school described below. In mathematical terms, Swan and Solow argued that at any particular time (f) output would be a function of the stocks of physical capital and labour available (K and L respectively), as well as two other functions, one measuring the quality of the stock of labor (this will depend on the educational level of the workforce, as well as on its health or nutritional status) and similarly one measuring the quality of the physical capital (respectively, 6 and A).206 The fact that B and A, the quality of the stock of labour and the quality of the stock of capital, are by this theory deemed to be outside of the control of a state is what makes them "exogenous" i.e. "without". Another neoclassical economist, Arthur Okun, finessed the Snow/Solow model with the assumption that those with lower incomes would probably save (and hence invest) less. 2 0 7 This is the standard formulation of the tradeoff between growth and equality. Okun made his case using a metaphor that continues to haunt those who would argue in favour of greater equality: "Any insistence on carving the pie into equal slices would shrink the size of the pie. That fact poses the tradeoff between economic equality and economic efficiency."208 Okun also created the infamous leaky bucket analogy, used 2 0 5 See generally Philip Gerson, "The Impact of Fiscal Policy Variables on Output Growth" International Monetary Fund, Fiscal Affairs Department, Working Paper No. 98/1, online: International Monetary Fund website <http://www.imf.org> at 5. 206 Y(t)=F[A(t)K(t),B(t)L(t)]. This formula is used by Philip Gerson to describe the Snow/Solow model. The formula is significant because it will be used to illustrate the difference between exogenous and endogenous models of economic growth, see below at 77. 2 0 7 Arthur Okun, Equality and Efficiency: The Big Trade-Off (Washington D.C.: Brookings Institution, 1975). 208 Ibid, at 48. 82 frequently in the mainstream media to condemn redistributive governmental policies. In this analogy, as the government carries money from the rich to the poor, some will leak out, and what leaks out represents inefficiency. "The leaks include such things as administrative costs, reduced and misdirected work effort, and changed motivation. It follows that, if government would just abstain from responding to the pleas of the underdogs, inefficiency would be reduced, and the economic pie would grow faster for all groups - rich and poor alike."209 In Okun's metaphors we can see some of the strains of neoclassical economic thought described in the Introduction, and of the critiques of neoclassical economic thought presented by institutional economists. Okun starts with a particular point in time in which wealth is, presumably, in his view, justly distributed by a market that is controlled not by government regulation but rather by the egalitarian laws of supply and demand. Institutional economists, on the other hand, question how we arrived at that point. Dugger asks whether, if the bucket leaks when Robin Hood carries water to the poor, does it not also leak when the Sheriff of Nottingham carries water from the poor to the rich. 2 1 0 The fact that the government is constantly engaged in "allocating and reallocating rights and obligations, powers and exposures, limitations and protections"211 is ignored in Okun's metaphors. The real game, according to Dugger, is not the minor readjustments that can be made at the margins of inequality, but rather, "the original 2 0 9 Dugger, supra note 195 at 230. 2 1 0 It has also been suggested that the leaky bucket metaphor is mistakenly used even by those who argue that lower taxes boost growth. Anthony Atkinson states that there are two possible growth effects of cutting taxes assumed by the models: in the first, a cut in social spending induces a temporary rise in the growth rate, but there is no permanent increase in the rate of growth (known as a levels equation). Alternatively, one could predict that a cut in transfers would raise the growth rate permanently (known as a growth-rate equation). Atkinson states: "Most of the empirical studies are concerned with the growth-rate version but the frequent references to "leaky buckets" (loss of efficiency) appear to have in mind a levels equation." Atkinson, supra note 128 at 179. 2 1 1 Dugger, supra note 195 at 231. 83 creation of the systems of inequality that are based on race, gender, class, nation/ethnicity, and religion."212 Okun, on the other hand, is clearly using the concepts of scarcity of resources and efficiency to make the classic Pareto-type argument that the right way to settle disputes is the one that leads to the most efficiency, regardless of the distributive consequences. The possibility that economic inefficiencies are part and parcel of the initial allocation of rights and resources is explored by some contemporary economists. For example, Edward Glaeser and Andrea Shleifer have suggested that the operation of legal, political and regulatory institutions may be subverted by the wealthy and powerful for their own benefit. 2 1 3 The final step in the Swan/Solow/Okun model, most associated with Simon Kuznets, is the infamous notion that the benefits of stronger growth would eventually "trickle down" to the poor, which would ultimately cause less inequality.214 As Andrew Jackson has said, this element is necessary, because it would be difficult otherwise for the already affluent to argue that they should get more for themselves while "poor people and insecure and average Canadians sit on the sidelines."215 2 1 3 Edward Glaeser and Andrei Shleifer, The Injustice of Inequality (Massachusetts: National Bureau for Economic Research, 2002), online: NBER website, <http://www.nber.org/papers/w9150>. 2 1 4 Simon Kuznets, "Economic Growth and Income Inequality" (1955) 45 American Economic Review 128 cited in Niggle, supra note 191 at 524. Note however, that the "Kuznets curve" which predicts that inequality will first increase and then decrease as an economy progresses, was meant to explain the shift from a rural/agricultural economy to an urban/industrial one. Its relevance to early 21 s t century increasing inequality in "Anglo" pattern countries may thus be limited. See generally Robert Barro, "Inequality, Growth and Investment" NBER Working Paper No. 7038. 2 1 5 Jackson, supra note 127 at 278. 84 The views of these neoclassical economists are being challenged by economists who endorse the "new political economy of growth" which looks at endogenous growth factors.216 While the institutional economists tend to focus on the distribution side of economic activity, endogenous growth theorists are interested in identifying those elements that cause economies to grow. In contrast to the neoclassical model, the endogenous growth theorists have created models in which perpetual growth is possible, due to endogenously determined increases in both capital and labour. The endogenous growth model posits that advances in "knowledge" are the most crucial elements for economic growth in an economy. These models "typically rely on mechanisms such as learning by doing on the 2 1 6 Paul Romer, a professor at the Stanford University School of Business, is credited with being the first to start writing about the New Growth Theory (in American texts, the term is capitalized), in works such as: Paul Romer, "Increasing Returns and Long Run Growth," (October 1986) 94 Journal of Political Economy 1002. Here is his explanation for the term endogenous (offered to the CBC host Ian Brown on CBC Radio, April 27, 1997): BROWN: Has technological change and new ideas, have they not been part of standard economic thought for a long time? ROMER: Well, economists have recognized for a very long time that technological change was the force which kept growth going. What's new in this kind of theory is that instead of treating technology as just something that comes into the economy from the outside, a bit the way the weather impinges on the economy, we're now thinking of technology as something that springs from the inside of the economy, and so that incentives, choices, policies, matter, and shape, the direction and the rate of change of the technology. Essentially, Romer came up with mathematical formulae that could be used to quantify the impact of technology (and other forms of knowledge) on economic growth. As an aside, it is interesting to note that economists themselves, while excited by the potential for this work to inform real world policies, are sanguine regarding at least one of the reasons why sometimes it does not: ...while endogenous growth theory has had a considerable impact on economics, the impact of the insights to emerge from this work in other social sciences is at present somewhat limited. One reason for this is that the debate amongst economists has often been technically arcane, precluding ready access to non-initiates in the relevant mathematical technique. Fedderke, Johannes, "Technology, Human Capital, Growth and Institutional Development: lessons from Endogenous growth theory?" Niggle also optimistically suggests that "the theory has exciting potential to inform policy. Perhaps we could describe an optimal distribution within a given institutional context..." (Niggle, supra note 198 at 532). 85 part of the labour force, or increasing social returns to scale in physical or human capital."217 Using the mathematical formula described above, endogenous growth models posit that changes to both A and B are within the control of an economy rather than being imposed by outside events. Therefore, the term "endogenous" i.e. "within", is used to describe this model. Because advances in knowledge will never accrue only to those who discover them but will always "spill over," the private sector will tend to under-invest in this area. One example of the knowledge spill-over effect is that we "know" the information in patents even if we are excluded from using them, so the insights in them can be used by others to further the body of knowledge.218 However, as this example makes clear, intellectual property law may be an important factor in new growth theory because of the temporary monopoly that can be granted over the use of knowledge. The idea that rates of growth are endogenous and impacted particularly by those investments for which a market failure is likely, leads inexorably to the conclusion that intervention by the state will be required in order to optimize economic progress. As Niggle suggests, this idea has very concrete implications for inequality: "th[e] literature produced a consensus that under reasonable and plausible assumptions both inequality and increases in inequality can reduce growth, while greater equality encourages Gerson, supra note 205 at 5. 2 1 8 The implications for poorer countries, while outside the scope of this paper, are interesting. It is suggested in these models that, if knowledge is the single most important factor to determine long-term growth, and in some economies human capital simply cannot be spared from production in order to be used developing knowledge, a vicious cycle develops and may explain the continuing divergence in growth rates between wealthy and poor economies. This is exacerbated by the fact that if poor countries attempt to combat the problem by increasing their investment in human capital, the resulting highly educated individuals will tend to emigrate, simply because the rewards of doing so are so large, thus further draining the resources of the poor country which will have lost its investment. This helps to explain divergence in growth rates between poor and wealthy nations. 86 growth."219 A very clear example would be primary school education: it would be difficult to conceive of a means for the private sector to finance this, because it would be impossible for any one firm to predict how much of a benefit they will enjoy by employing workers from a literate workforce. But endogenous growth models suggest that just this type of investment in human capital can have a permanent effect on the long-run rate of output growth. Therefore, government intervention to increase school enrollment may boost growth permanently.220 One of the reasons that the "new growth theories" have excited interest is that the standard Solow/Snow model predicted a convergence of growth rates among wealthy nations, based on the assumption of diminishing returns to physical capital, and an exogenous rate of technological progress.221 However, empirical studies have established that this does not appear to happen: growth rates both amongst wealthy nations and between poor and rich nations have diverged.222 Romer himself states that this finding motivated his work. He writes, "[b]oth Robert Lucas (1988) and I (Romer, 1986) cited the failure of cross-country convergence to motivate models of growth that drop the two central assumptions of the neoclassical model: that technological change is exogenous and that the same technological opportunities are available in all countries of the world."223 In other words, the assumption that the level of innovation within a particular economy is outside of its control has been abandoned in endogeneous models - it is this that in fact makes them "endogeneous" i.e. within rather than without. If one assumes that the level of innovation can be controlled, it then becomes necessary to 2 1 9 Niggle supra note 191 at 530 2 2 0 Gerson, supra note 205 at 6. 2 2 1 Niggle, supra note 191 at 530. 2 2 2 Robert Barro "Economic Growth in a Cross Section of Countries" (May 1991) 106:2 Quarterly Journal of Economics 407. 2 2 3 Paul Romer "The Origins of Endogenous Growth" (Winter 1994) 8:1 The Journal of Economic Perspectives 3. 87 identify those factors that lead to a high level of innovation in order to make policy recommendations that lead to a higher growth. In response to the empirical evidence that certain endogenous factors do influence the rate of economic growth within a given economy, some economists have created models trying to explain the relationship and what factors influence it. In many of these models, the distribution of wealth amongst social classes plays a role, as it did in Ricardian theories. For example, Persson and Tabellini2 2 4 have created a model which predicts that, if the median voter's income is less than the average wealth of the population, then redistributive tax policies will be voted in and tax revenues will be transferred to low income individuals for consumption. This reduces investment and results in lower economic growth. This sounds much like the Kuznets trickle down hypothesis, in that higher taxes lead to less investment and thus lower growth. Within this model, it is believed that only if one changes the political component of the model to a rightwing dictatorship that prevents redistribution (rather than a democracy) can growth increase. However, Said-Paul and Verbier looked at likely results if government expenditures are spent on public education and investment subsidies. Their model predicts that inequality must cause redistribution in order for growth to occur, because redistribution has positive rather than negative effects on growth. Unlike the previous model, in this model, "a rightwing dictatorship might perpetuate inequality at the expense of accumulation and growth."225 Alternatively, Benabou 2 2 6 assumes that if inequality grows to high enough 2 2 4 Torsten Persson and Guido Tabellini, "Is Inequality Harmful for Growth? (June 1994) 84:3 American Economic Review 60. 2 2 5 G. Said-Paul and T. Verdier. "Education, Democracy, and Growth." (1993) 42 Journal of Development Economics 406. 2 2 6 Roland Benabou, "Inequality and Growth" Luxembourg Income Study Working Paper no. 142 (Syracuse N.Y.: Syracuse University Maxwell School, 1996). 88 levels, it will lead to political and social instability, which will in themselves negatively influence accumulation and growth. His model suggests that some level of redistribution is positive and will enhance both growth and the security of property rights. The variation in the models described above is due to the fact that there is no consensus regarding the impact of inequality on economic growth, let alone the impact that tax policy has on each of these. It is significant that no model yet created has resulted in a consensus amongst economists regarding the interplay between inequality and economic growth, because without such a consensus, the confidence expressed by Paul Martin and Gordon Campbell in a fiscal strategy that relies on lower taxes to stimulate growth may be misplaced. In July 2001, just after being sworn in as the new provincial government, the BC Liberals published an "Economic and Fiscal Update" which outlined its plans for the rejuvenation of the provincial economy. In this document, it is stated that investment "foundered" under the previous administration, that economic growth had not kept pace with the rest of Canada and that real incomes per capita had fallen. The key to reversing this trend was identified as higher productivity growth, and the necessary ingredients for greater productivity were identified as an improved education system, and a smaller regulatory burden. However, the "fundamental element" to higher productivity was identified as a "tax system that is competitive and that encourages investment and innovation".227 The centerpiece of such increased competitiveness in the BC tax system is the reduction of personal income taxes by 25%. Gordon Campbell has expressed the belief that the money released from tax revenue will be re-injected into the local economy via either 227 Economic and Fiscal Update, July 31 2001, Part 3 "Revenue Measures", British Columbia, Ministry of Provincial Revenue, Income Taxation Branch. 89 increased investment or increased consumption. In an address to the San Francisco Bankers Club on November 14, 2002, he stated: Within a day of being elected there was a dramatic cut in personal income taxes so everyone in British Columbia regardless of their wage bracket had a benefit: they kept more dollars in their pocket. 25% across the board. $1.2 billion more in your pockets in British Columbia for you to spend, for you to invest, for you to do what you decide to do." 2 2 8 The BC Liberals have also stated that another side effect of a lower top marginal rate is that it will "encourage more highly skilled knowledge workers and entrepreneurs to live and work in the province."229 It is not surprising, then, that the BC Liberal government has repeatedly claimed that its tax cuts would "pay for themselves" through increased economic growth.230 Distributional concerns, whether from a humanitarian or economic perspective, have not been addressed. In giving the largest tax cuts to those with the highest incomes, the BC Liberals would also appear to be adhering to the belief that those with higher incomes save, and thus invest, more than those with lower incomes. Although there appears to be no explicit reference to such a belief in their public announcements, it is difficult to see any other justification for lowering the taxes of higher income British Columbians more than middle and lower income British Columbians. As Andrew Jackson has pointed out, in order to be sold to lower and middle income earners, tax cuts for the higher must surely include a promise that the end result will be a bigger pie for everybody.231 Gordon Campbell "Address to San Francisco Bankers Club" (November 14, 2002), online: Government of British Columbia website, <http://www.gov.bc.ca/prem/popt/speech/>. 229 Economic and Fiscal Update, supra note 227. 2 3 0 Kesselman, "BC's Structural Deficit", supra note 167. 2 3 1 Jackson, supra note 127. 90 5.4 Empirical Studies The final testing ground for the models described above is whether they can successfully predict the results of empirical studies. However, the interaction between the models and the studies is complex: the studies may confirm or disprove the model's predictions due to factors that have yet to be discovered. For example, Persson and Tabellini,232 include as part of their model the assumption that inequality will lead to pressure from voters to redistribute and this redistribution will take money away from productive ends, such as investment in capital stock, and give it to non-productive ends, such as transfer payments to the poor. The first step in the analysis is that greater rates of inequality in a democracy will lead to voters choosing more redistributive policies. This is very much the opposite of what the studies reveal. In the following citation we see that in fact, more unequal democracies have less redistributive policies than ones that are less unequal: ...redistribution is often correlated with income inequality in just the opposite way than predicted by standard politico-economic theory: among industrial democracies the more unequal ones tend to redistribute less, not more. The archetypal case is that of the United States versus Western Europe, but the observation holds within the latter group as well; thus Scandinavian countries are both the most equal and the most redistributive. In the developing world a similar contrast is found in the incidence of public education and health services, which is much more egalitarian in East Asia than in Latin America (e.g., South Korea versus Brazil). Turning finally to time trends, it is rather striking that the welfare state is being cut back in most industrial democracies at the same time that an unprecedented rise in inequality is occurring.233 So the assumed correlation, between more voters experiencing the negative effects of inequality and increased votes for more redistributive policies, does not happen. In an effort to explain this, some economists have looked at social mobility and "imperfections Persson and Tabellini, supra, note 224. 2 3 3 Roland Benabou, "Unequal Societies: Income Distribution and the Social Contract" (March 2000) 90:1 American Economic Review 96 at 102. 91 of information."234 In the language of economists, voters express "preferences for redistribution" in voting patterns. What studies of voting patterns reveal is that if the poor believe that they are quite likely to better their economic situation, they are less likely to "prefer" redistributive policies. However, these findings have been fine-tuned,235 in the American context, with the additional finding that those who believe that greater social mobility exists have less of a preference for redistributionary policies than those who believe that discrimination interferes with equality of opportunity. Groups that have historically suffered discrimination, such as African-Americans and women, are found to be the groups who are most likely to prefer redistributionary policies. Subtleties such as these findings regarding beliefs about equality of opportunity and the possibility of betterment are clearly left out of the basic theory that self-interested voters with median incomes below the mean will prefer, and vote for, redistribution. The Persson/Tabellini model thus fails when confronted with empirical results. The empirical results make clear the fact that voters cannot be grouped together without reference to gender, or race, or beliefs about social mobility for that matter, for the purposes of predicting preferences for or against redistribution. The model thus requires more elaboration. In 1998 the IMF published a comprehensive report on the relationship between growth and tax policy. "The Impact of Fiscal Policy Variables on Output Growth"236 was authored by Philip Gerson, and it surveyed virtually all the available theoretical and empirical literature on this topic. Gerson admits to being inspired by the endogenous growth models described above, however, he seeks to identify amongst the various possible endogenous factors which ones affect growth. Gerson states that most studies 2 3 4 Alberto Alesina, Rafael Di Telia, Robert MacCulloch, Inequality and Happiness: Are Europeans and Americans Different? (Massachusetts: National Bureau for Economic Research, 2001). 2 3 5 Alberto Alesina and Eliana La Ferrera, Preferences for Redistribution in the Land of Opportunities (Massachusetts: National Bureau for Economic Research, 2001). 2 Gerson, supra note 205. 92 have looked at "total expenditure or government revenues" whereas he wants to disaggregate these elements and examine their component parts and identify the specific channels through which fiscal policy can affect growth. One question to ask when looking at his results is, if endogenous growth models suggest advances in "knowledge" are the most crucial elements for economic growth, what is meant by "knowledge" in this context? Gerson looks at both the revenue side, and analyzes the impact of changes to the tax rate and base, and the expenditure side, where he looks at the relationship between spending and achievement in the crucial areas of public education, public health, infrastructure, defense and public order. The next Chapter of this thesis will begin with an overall assessment of British Columbia's economic growth during the first three years of the BC Liberal's administration. The final Chapter will examine each of the component elements of Gerson's study individually and assess the decisions made by the BC Liberals with regard to each of these elements of fiscal policy, in order to assess the likely efficacy of each element of the fiscal stimulus package. 5.5 Economic Growth in British Columbia 5.5.1 Introduction At the federal level, former Finance Minister of the federal Liberal party and then former Prime Minister of Canada Paul Martin is a firm believer in the tradeoff between efficiency and redistribution. In these roles he has chosen to reduce taxes and public spending in order to enhance Canada's competitiveness, particularly in relation to the United States. His belief in a link between lower taxes and higher economic growth is illustrated in the following statement, made to the International Monetary Fund (IMF): 93 Together, federal and provincial tax reductions in 2001 amount to 2.3 per cent of GDP, providing timely stimulus to the Canadian economy. These measures will also help to improve Canadian competitiveness and foster innovation and entrepreneurship going forward. When the tax cuts are fully implemented, corporate tax rates in Canada will be below those in the U.S. In addition, the capital gains inclusion rate has been reduced, putting the average tax rate on capital gains in Canada below the U.S. As well, Canada has introduced a more generous treatment of stock options than has the U.S.237 Here, Paul Martin is clearly articulating a belief that Canada ought to emulate the US in order to have a stronger economy. Paul Martin has a fellow believer in the efficacy of lower taxes at the provincial level in British Columbia. Gordon Campbell, the Premier of British Columbia since the election of his BC Liberals party in 2001, has, along with his Minister of Finance, Gary Collins, instituted a set of very high cuts to the rates of both personal income tax and corporate tax. In this Chapter I am canvassing the changes made to tax policies in British Columbia and their actual (or predicted, if no statistics are yet available) effect on BC's economy. There has been no obvious jump in GDP in British Columbia as a result of the economic policies pursued by the BC Liberals, neither when looked at as an absolute figure (GDP per capita in $1997) nor when looked at in terms of growth rate per year (percent). The BC Progress Board, created by the BC Liberals to track the progress of BC's economy during their tenure, reports as follows: International Monetary and Financial Committee Statements, Washington, April 29 2001, online: International Monetary Fund website, <http://www.imf.org/external/sprinq/2001/imfc/can.htm>. 94 Table 5.1 GDP Per Year in BC 1998-2003 GDP Per Year23" 1998 1999 2000 2001 2002 2003 $1997 Per Capita 29,094 29,816 30,983 30,950 31,684 32,175 Growth Rate per capita (annual percentage change 0.4 2.5 3.9 (0.1) 2.4 1.6 Where BC Ranks, by Province (annual percentage change) 10th 7th 4th 8th 6th 5th However, even at 1.6%, BC's economy grew faster in 2003 than the Canadian average for the first time since 1996.239 BC ranked 5 t h in terms of provinces in 2003, an improvement on the 2001 and 2002 rates. Statistics Canada, in a brief review of the economic situation of the provinces last April, suggests that the increase in GDP in British Columbia can largely be accounted for by the 15% increase in housing starts.240 Housing starts have been increasing at a rate of 4,000 - 5,000 per year for the last two years. For an example of how this affects statistics, the BC Business Gross Fixed Capital Formation as a Percent of GDP figure for 2004 is 19.4, which puts it fourth among provinces and sounds impressive. However, because such a high percent of this spending is related to residential structures in BC, examining the same data but excluding residential structures give a very different 2 3 8 BC Progress Board 2004, supra note 97 at 141. 2 3 9 Ibid 2 4 0 Statistics Canada, The Daily, Wednesday April 28, 2003, Hot Housing Market Pushes British Columbia Economy (N.p.: 2003), online: Statistics Canada website <http://www.statcan.ca/Daily/English/040428/d040428a.htm>. 95 picture: now BC spends only 11.1 percent of GDP and ranks seventh among provinces.241 BC's hot housing market and historically high housing costs also have knock-on effects: namely, high personal debt levels. In the current environment of low interest rates, BC residents have been increasing personal consumer borrowing as well as dealing with the burden of the largest mortgages in Canada. This has led to a situation in BC where "the savings rate has been negative for seven years, hitting a low of -8.2% in 2003, which means that BC residents were drawing on their savings and accrued wealth to support their spending."242 The news with respect to other leading indicators is no more positive. In absolute dollars, exports of goods and services (international and interprovincial) per capita are lower in 2003 than they were in 2000. 2 4 3 In comparison to other provinces, BC ranked 7 t h between 2002 and 2003 in rate of growth of this indicator. Business gross fixed capital formation as a percent of GDP has hovered around 16 to 17% since 1995: in 2003 it was 17.3%., recovering from a fall to 16.4% in 2002, but still falling short of the 17.4% invested in 2001. 2 4 4 While BC's real per capita disposable income has in absolute terms remained unchanged at 3 r d in Canada during the years 2000, 2001, 2002 and 2003, the one year 2 4 1 BC Progress Board, Comparing BC's Performance - Reaching Our Potential, Fifth Annual BC Progress Board Benchmarking Repod, Volume I - External Performance Review: Inter-Provincial and International, (Vancouver. BC Progress Board, December 2005) at 163, online: BC Progress Board website, http://www.bcprogressboard.eom/2005Report/AnnualA/l Final 2005.pdf ,"BC Progress Board 2005". 2 4 2 Marlyn Chisholm & Associates, British Columbia Check Up 2004 (Vancouver: Institute of Chartered Accountants of British Columbia, 2004) at 14; 2 4 3 BC Progress Board 2004, supra note 97 at 144 244 Ibid, at 147 96 progress check that compares the rate of change between provinces places BC 6 t h out of 10 provinces for the last two years recorded, 2003 and 2004. 2 4 5 From 2001 to 2002 BC went from having the 6 t h worst employment rate in Canada to the 7 t h worst; from 2002 to 2003 that loss was recovered and BC returned to 6 t h worst.246 According to BC Stats, the average unemployment rate in BC over 2004 was 7.3%,247 almost the same as the 7.2% it averaged in 2000, the year before the BC Liberals took over from the NDP. 2 4 8 However, BC has had an unemployment rate higher than the Canadian average on a monthly basis for every month since June 2001, (other than for approximately two months in December 2003 - January 2004) and in some months the rate has spiked up to over 9%. 2 4 9 As for real average hourly wages, BC ranked 2 n d in Canada in 2003 in absolute terms.250 However, between 2000 and 2001 BC's rate of progress in this indicator was the third best in Canada; this momentum was lost with the BC Liberal victory and between 2001 and 2002 BC's rate of progress was 9 t h worst in Canada. Between 2002 and 2003 BC was still in the bottom half with a rate of progress that was 6 t h worst,251 and the situation again deteriorated in 2004 when BC ranked 8 t h worst.252 2 4 5 BC Progress Board 2005. supra note 241 at 158. 246 Ibid, at 10. 2 4 7 British Columbia, Ministry of Management Services, Labour Force Statistics, December 2004, (N.p.: 2004), online: Government of British Columbia website, <http://www.bcstats.qov.bc.ca/pubs/lfs/lfs0412.pdf> 2 British Columbia, Ministry of Management Services, Labour Force Statistics, December 2001, issue 2001-12, (N.p.: 2001), online: Government of British Columbia website, <http://www.bcstats.qov.bc.ca/pubs/lfs/lfs0112.pdf> 2 British Columbia, Ministry of Management Services, Current Statistics, June 2004 and July 2004, Data Services Issues: 04-06 and 04-07(N.p.\2004). 2 5 0 BC Progress Board 2004, supra note 97 at 143 251 Ibid. 2 5 2 BC Progress Board 2005, supra note 241 at 159. 97 However, of all the financial indicators used by the BC Progress Board to assess BC's prospects, the one that has declined most dramatically in relation to other Canadian provinces since the year 2000 is productivity. This is ironic given the emphasis placed on enhancing productivity in the BC Liberal's fiscal policies.253 BC was the only province to experience a decline in productivity between 2002 and 2003, 2 5 4 leaving it with 10 t h place in BC Progress Board's 1 Year Progress Check. The average Canadian growth rate in productivity has increased at a very consistent rate year upon year for every year between 1996 and 2003. Between 2001 and 2003 productivity in BC increased in absolute terms, but by less than any of the other Canadian provinces.255 Some improvement was made in 2004, but BC was still 7 t h out of the ten provinces in improving labour productivity between 2003 and 2004. 2 5 6 It thus appears that to date there is no apparent boost to the BC economy as a result of the tax cuts implemented by the BC Liberals. The question then arises, how quickly ought the results of lower taxes to impact upon economic growth? And would they have a one-time impact, or would the impact continue to affect the annual growth rate of GDP year after year? Anthony Atkinson points out that while most empirical studies are concerned with the former (a one-time impact that changes the level of GDP immediately but has no impact on future rates of growth), "the frequent references to 'leaky buckets' (loss of efficiency) appear to have in mind" the latter interpretation.257 It seems reasonable to expect that the amounts saved in tax cuts would appear as investments in the economy relatively quickly. Therefore, if, by 2003 there is no sign of growth in See above, page 74 BC Progress Board 2004, supra note 97 at 38. Ibid. BC Progress Board 2005, supra note 241 at 159. Atkinson, supra note 128 at 180. 98 investments or in the rate of GDP, it is difficult to conceive of a model that would allow for increases in these in later years to be attributed back to the 2001 tax cuts. Gerson, in his comprehensive review of the impact of fiscal policy on economic growth, isolates various factors that affect both the productivity and growth of capital and labour and assesses the likely impact of a given tax policy on each of these factors. Each of these factors will now be looked at in turn, comparing Gerson's findings with the policies put in place by the BC Liberal government. 5.5.2 Health and Education Spending Government spending on health and education is the first element of fiscal policy examined by Philip Gerson in his comprehensive study of the impact of fiscal policy on economic growth. He begins with an assumption that such spending will be growth enhancing if it corrects for a market failure, that is, if it does not simply replace private expenditure that would have occurred anyway.258 In the area of education, he concludes that it is clear a market failure exists, and furthermore that the private returns to education on the individual level may well be smaller than the social returns, thus making it a classic public good. 2 5 9 Similarly, in the case of health, primary health care may involve significant externalities, as in the case of immunization, where much of the benefit is enjoyed by those around the individual who will have less likelihood of contracting a disease. A healthy population translates directly into the economy in the form of reduced illness and absenteeism. Gerson, supra note 205 at 8. Ibid, at 10. 99 Gerson concludes that while it seems clear that high achievement in either of these areas correlates to better economic performance, it is more difficult to see the relationship when looking at spending. This is because some of the spending may not be well targeted, and because the lag between the spending and any economic effects could take well over a decade to manifest, making measurement difficult260 It has been a much vaunted element of the BC Liberal's fiscal policy to leave spending on health and education intact for the first three years of their administration, while cutting all other government ministries combined by approximately 25-30%.261 Due to a growing population, simply leaving the spending on health and education in stasis translates into spending cuts. The population of BC increased from 4,055 in January of 2001 to 4,168 in January of 2004 (expressed in thousands), a percentage increase of 2.8% 2 6 2 The current Budget forecasts spending increases for both health and education for coming years: a 1.6% increase in health in 2005/6 and a 3.8% increase in 2006/7.263 As pointed out by Gerson, the economic effects of spending increases or decreases in both health and education both depend on proper targeting and can take decades to manifest fully. It should be noted that while there are modest spending increases planned for these two Ministries in the next two years, the government is simultaneously planning deep cuts to capital spending in both areas. Capital spending on education will drop from $658 in 2003/4 to $488 in 2006/7 (expressed in millions), a 35% drop. Similarly, while spending 260 Ibid, at 13. 2 6 1 Outlined in numerous Government of British Columbia reports, this was a key element of the "New Era" vision for the future of British Columbia created by the BC Liberals. 2 6 2 BC Stats, B.C. Quarteriy Population 1971-2003, (N.p.: 2003), online: Government of British Columbia website, <http://www.bcstats.gov.bc.ca/data/pop/pop/BCQrtPop.htm>. 2 6 3 British Columbia, Ministry of Finance, Budget and Fiscal Plan 2004/5 - 2006/7, (Victoria: Government of British Columbia, 2004). 100 on health will increase by 1.2% in 2005/6 and 3.4% in 2006/7, capital spending on health will decrease by 23% over the same time period.264 When the BC Liberals came to power, BC had the second lowest rate of completion in the country.265 However, after seeing steady increases for the six years spanning 1994 to 2000, the percentage of secondary school students graduating declined in 2001, from 76.1% for the 2000/1 school year to 74.7% for the 2001/2 school year. 2 6 6 A recovery was made in 2002/3 to 77.1%, the most recent year for which figures are available.267 University Completion saw a similar rather dramatic slump in 2001. In the year 2000, BC ranked 2 n d in Canada for this indicator, which measures the percentage of the population aged 25-44 with a university education. In 2000/2001, BC reported the worst progress on a one year basis in Canada and slipped to 4 t h place overall. Like the reduction in Secondary School Graduates, this sharp decline was a departure from a long-term trend, which had seen figures increase every year since 1994. A strong recovery was made in 2002 and 2003, and BC was back in 2 n d place, with a graduation rate almost identical to the Canadian average,268 however, problems again became apparent in 2004 when the rate again declined dramatically, putting BC in 9 t h place. Although it is difficult to assess the long-term impact that the spending cuts will have on health, one indicator that is likely to produce immediate results is low birth weights and infant mortality rates, things that can serve "as a proxy for a jurisdiction's overall social 2 6 5 BC Progress Board 2004, supra note 97 at 74 2 6 6 Statistics Canada, The Daily Wed Feb 2, 2005 Secondary School Graduates, online: Statistics Canada website, <http://www.statcan.ca/Dailv/Enqlish/050202/d050202b.htm>. 267 Ibid. 2 6 8 All information in this paragraph taken from: BC Progress Board 2004, supra note 97 at 78 101 condition."269 Between 2001 and 2002, the percentage of babies born with low birth weight in BC increased from 5.1 to 5.3, placing BC 8 t h in Canada for one year progress on this indicator.270 Alberta (with the flattest taxes in Canada) has by far the highest rate of low birth weight babies born in Canada, at 6.5%, and has seen steady increases since 1999.271 Similarly dismal statistics on infant mortality rates exist in BC, here, we have seen the percentage of these climb from 3.7 in 2001 to 4.6 in 2002. As of early 2006, no data was available for either of these indicators more current than the year 2002. Given the importance of this indicator for assessing both the current health of a population and the long-term prospects, it is very unfortunate that more of an effort is not made to keep the data on low-birth weights and infant mortality current. 5.5.3 Capital Spending Government spending on capital productivity such as transport and communications can also be positively related to growth, and, as in the areas of health and education, these represent clear areas in which market failures are predictable due to their inherently shared nature. However, again as with spending on education and health, the definitive link between spending and performance is difficult to make due to the fact that the quality of infrastructure investments can differ dramatically.272 A simple example is the one used by Gerson himself: one sewage plant will undoubtedly lead to gains for the local community; three may well not. Such seemingly irrational spending decisions can often be explained by way of corruption. 269 Ibid, at 114 270 Ibid. 271 Ibid. 272 Gerson, supra note 205 at 19. 102 An important element of the BC Liberal's economic stimulus package is the winning of the 2010 Winter Olympic bid. It seems questionable whether spending on extremely expensive and highly specialized winter sports infrastructure (such as a new luge round) will have the same positive economic effect as spending on transportation and communications infrastructure. However, it is outside the scope of this paper to make a thorough analysis of the impact of holding an Olympic Games to the local economy. To conclude, it remains to be seen whether spending on Olympic games will fall into the category of infrastructure spending that boosts economic growth. The impact of the cuts in capital spending in the areas of health and education will similarly take time to manifest. 5.5.4 Government Spending Transfers, Defense and Public Order The final areas of spending considered by Gerson are spending on transfers, defense and public order. The data on transfers in these areas is conflicting, and much of it predates the modern era in which, as described in the Chapter above, we are seeing unprecedented levels of inequality in the "Anglo" pattern countries, thus it makes sense to be reluctant to draw any conclusions until the role of transfers in increasingly unequal developed societies has been definitively assessed. However, with regards to the prevalence of families and unattached individuals living below the LICO, it is very clear already that BC has departed from long term trends, beginning even before the election of the BC Liberals and continuing with increasing force since its coming to power. For the years 2002 and 2003, the most recent years for 103 which data is available, BC had the highest rates of LICO in Canada. From 1988 to 1998, the percentage of people living below the LICO in BC mirrored almost exactly that of the Canadian average.273 However, since 1998, BC has never been less than 2 percentage points above the rest of the country in LICO rates. In 2002, with a Canadian average of 15.5%, BC reported a full 4.5% higher figure at 20.0%, and in 2003 BC was again ranked 10 , h in Canada for LICO prevalence, with 3.3% more of the population living below LICO than the Canadian average. Spending on public order is considered by Gerson but all the studies that he cites have looked at public disorder that involve such significant measures of political unrest as assassinations, violent revolutions and coups, or at least, a propensity for governmental collapse. No studies are assessed that look at the long-term links between inequality, crime and the cost of incarcerating the criminal element of the general public. Thus it is difficult to draw any conclusions with confidence when it comes to assessing the link between spending on public order and economic growth in a relatively peaceful location such as British Columbia. If the ideas of those cited in the introduction to this Chapter are correct then inequality itself increases crime, which in turn increases spending on public order, a cumulative relationship that leads to snowballing inequality. Personal and property crime rates in BC, although consistently the highest in Canada since the mid-90's, were declining from 1996 to 2000. In that year they flattened out, only increasing slightly in 2001 and 2002, but a noticeable increase has been registered for the year 2003, and BC ranked 9 t h in Canada for personal and property crime as of 2003. As suggested by the BC Progress Board, "crime is costly to society, both from BC Progress Board 2004, supra note 97 at 150 104 individual and community perspectives. This increase is unlikely to bode well for economic growth in the province. 5.6 Government Spending on Research and Development The impact of government spending on research and development are also difficult to assess due to mixed results in the empirical studies. This probably reflects once again the point made above; that spending must be appropriately targeted to have the desired effect, and must not simply replace private spending that would have occurred anyway. Statistically, significant positive results have been found only for G7 countries.275 Less developed countries are clearly better off copying and implementing innovations discovered elsewhere until they have reached a certain level of affluence. Between 1999 and 2000 there was a fairly dramatic rise in total R & D spending in British Columbia, from 1.07% of GDP to 1.23% of GDP 2 7 6 or from $1,290 to $1,614 (expressed in million of dollars).277 However, the increase in the subsequent two years, 2001 and 2002, was marginal.278 The amount spent by the business sector between 2001 and 2002 actually declined significantly, with the shortfall being slightly more than made up for by increases in the amount spent by the provincial and federal governments, institutes of higher education, and private non-profit organizations.279 2 7 4 All information found in: BC Progress Board 2004, supra note 97 at 118. 2 7 5 Gerson, supra note 205 at 25. 2 7 6 BC Progress Board 2004, supra note 97 at 148. 2 7 7 Statistics Canada, Estimates of Canadian Research and Development Expenditures (GERD), Canada, 1993 to 2004, and by province 1993 to 2002, by Janet Thompson, (Ottawa: Science, Innovation and Electronic Information Division, 2004) at 32. 278 Ibid. 2 7 9 Ibid. 105 It is ironic that the private sector should cut back on R & D spending in the time span immediately following the BC Liberals tax cuts. Clearly, R & D is not one of the things that the money freed up by lower tax personal income tax rates was spent on. 5.6.1 Fiscal Policy and the Cost of Labour Is the supply of labour in an economy affected by marginal personal income tax rates? Theory offers two opposing models: on the one hand, a "substitution effect" suggests that as the marginal cost of an hour of foregone leisure increases, the marginal benefit of working an extra hour decreases, and thus higher marginal rates will encourage people to work less; on the other hand, if leisure is a '"normal good' (i.e. if people tend to consume more of it as their incomes rise, and less as their incomes fall)"280 then people will tend to increase their hours worked as the marginal rate increases. The latter is known as the "income effect". Studies have shown that the elasticity of primary wage earners is in fact close to zero. 2 8 1 Thus, marginal tax rates do not have a strong effect on the supply of primary wage earners in an economy. On the other hand, there is also a consensus that for secondary wage earners, primarily married women, there is a much larger elasticity. However, many countries tax the family unit; when this happens, the "marginal tax rate applying to the first dollar earned by a secondary worker is equal to the marginal tax rate on the last Gerson, supra note 205 at 27. 2 8 1 "Labor-supply elasticity ...estimates...are typically less than 0.5%", Yongsung Chang and Sun-Bim Kim, "On the Aggregate Labor Supply" (2005) Economic Quarterly Winter 2005 Vol. 91 No. 1; R. Blundell and T. MaCurdy, "Labor Supply: A Review of Alternative Approaches", in O. Ashenfelter and D. Card, eds., Handbook of Labor Economics, vol. 3A, (Amsterdam: Elsevier Science B.V., 1999). 106 dollar earned by the primary worker". In Canada, the tax unit is the individual, not the family unit, so this effect will not apply. In summary, there is no clear proof that the overall supply of labour will be significantly altered by changes in the marginal tax rates. However, changes to the tax unit may alter the composition of the labour market, in that secondary earners who would be taxed at a significantly higher rate in a family unit tax system will be more encouraged to work in an individual unit based system. Wages in BC are mirroring those in the rest of Canada by declining steadily for every year that goes by in the new millennium. The most dramatic decline in BC occurred from 2002 to 2003, when real average hourly earnings fell (in $1997) from $16.02 to $15.67, a rate that is on an absolute basis much lower than in any other year since and including 1994.283 In 2004, BC made the 8 t h worst progress in Canada on this indicator, as wages increased nominally from $15.67 to $15.88. Not a single province in Canada has seen wages in 2003 that are higher than those earned in 2000; only four have higher wages in 2003 than in 1994.284 These average hourly wages may also conceal a story of proportionately greater losses at the low end of the earning spectrum. This may be particularly true in British Columbia since the introduction of the "training wage" allows businesses to pay young people $2/hr less than the minimum wage. The wage decline may go some way to explain both the increase in the percentage of people living below LICO in BC and the emergence of the working homeless. On the other hand, lower wages may signify a more flexible workforce and this may be good for business. If so, 2 8 2 Gerson, supra note 205 at 35. 2 8 3 BC Progress Board 2004, supra note 9 7 at 143. 284 Ibid. 107 BC has yet to register any benefits in such leading indicators as growth in GDP or increases in exports. Further, productivity (defined as real GDP per hour worked in the business sector in $1997) grew in every province in Canada between 2002 and 2003 with the glaring exception of British Columbia.285 A further decline in productivity was realized between 2003 and 2004. 2 8 6 If the changes to the tax structure initiated by the BC Liberals were in some measure designed to improve productivity, there is little evidence to date that this strategy will be a success. In direct contrast, productivity grew in this province every year since 1995, up to 2002 when the current decline began. 2 8 7 5.6.2 Fiscal Policy and the Cost of Capital One of the central claims made about the effect of taxes on economic growth is the claim that lower marginal personal income tax rates increase savings, and higher savings result in higher investment.288 However, if we begin with an analysis of the definition of savings, we shall find, somewhat surprisingly, that the data suggests the exact opposite. As one commentator puts it, one could say that increased savings leads to increased investments in plants and equipment; however, "the empirical evidence suggests that investment causes savings. Thus, firms first undertake spending on plant and equipment, and, once this spending takes place, it gets counted as saving in the form of 2 8 6 BC Progress Board 2005, supra note 241 at 159. 2 8 7 BC Progress Board 2005, supra note 241 at 159. 2 8 8 As Gerson points out, while it is the impact on investment that is of interest, most empirical studies have used savings as the dependent variable. In theory, with the free flow of capital between markets, domestic savings rates would not necessarily impact on domestic investment rates; in reality, many studies have shown that individual investors are much more likely to hold domestic investments and the changes in the rate of savings do lead, almost dollar for dollar, to changes in the rate of investment. See Gerson, supra note 205 at 37. 108 capital accumulation."289 Looked at in this way, policies that aim to encourage savings by reducing consumption and government spending actually can reduce the level of savings because they reduce the level of consumer demand, hence reducing the likelihood that firms will invest in greater productive capacity. The theory that increased savings will lead to increased investment (referred to as the "savings-shortage hypothesis" by Thomas Palley) lead to policy recommendations that are designed to increase the after-tax income of individuals, who can then "invest" the amounts they have saved on taxes. Thus, "the claimed saving shortage has ...prompted calls for exempting dividend and interest income from taxation...[a]nother policy suggestion that follows ...is reduction of the capital gains tax rate."290 It should be clear from the previous Chapter that both of these suggestions would reduce taxes payable by the wealthiest individuals within an economy, thereby increasing inequality. A Canadian example of this call for lower personal income taxes for high- and middle- income earners can be found in the Business Council on National Issues (BCNI) presentation to the House of Commons Standing Committee on Finance in 1999. Tom DAquino, president of the BCNI, argued that even regressive tax measures would be better than redistributive policies, because they will "lead to faster growth of personal incomes and of national income and thus 'expand the size of the pie.'"291 The policy recommendations made by the BCNI offered no relief at all to those in the bottom tax bracket and provided maximum benefits to those in the top tax bracket.292 2 8 9 Palley, supra note 28 at 133. 2 9 0 Ibid. 2 9 1 Jackson, supra note 128 at 278. 2 9 2 Ibid. 109 In British Columbia, the amount spent on Business Gross Fixed Capital Formation (as a percent of GDP) declined in 2002 from 2001 levels,293 and 2002 would be the year that one would presumably expect to see the amounts saved by those who enjoyed the benefits of the tax cuts reinvested in the local economy. The amount increased in 2003, but still fell short of the figure recorded in 2001. Another important point to consider is the question of whether savings decisions are affected by the distribution of corporate income between dividends and retained earnings. The answer is yes: "Feldstein...finds that an increase of one dollar in corporate retained earnings (at the expense of dividend payments) led on average to a decrease of only 75 cents in personal savings."294 What this means is that incentives to reduce dividend payments in favour of retained earnings are likely to increase real savings. Tax policy can clearly play a role here, and Gerson concludes as much: "...changes in tax policy that induce increases in corporate savings - for example, decreases in corporate profit taxes with offsetting increases in personal income taxes, the adoption of preferential treatment for shareholder capital gains, or the removal of any preferential treatment for shareholder dividend income - could have positive effects on savings, investment and output growth."295 In contrast to such advice, the BC Liberals adopted aggressive cuts to ""personal income taxes, rather than offsetting cuts to corporate profit taxes with increases in personal income taxes to encourage retained earnings. 2 9 3 From 17.4% to 16.4%. BC Progress Board 2004, supra note 97 at 147. 2 9 4 Gerson, supra note 205 at 41-42. 2 9 5 This is particularly interesting given Canada's decision to increase the proportion of revenue collected from consumption and corporate taxes and reduce personal income taxes (see page 50 above). 110 The final question in the analysis of the effect of tax policy on savings and investment is whether reducing the cost of capital, in the form of tax incentives, can positively effect growth. Here we must consider again the point made earlier in the context of spending on health and education: in order to have an effect, the tax incentive must lead to investment where none would have occurred, if it does not, then all that results is a windfall for the company who received the incentive. Two studies, looking at very different economies, suggest that the latter is the case. First, Boadway and Shah looked at a number of studies that examined the impact of tax incentives in developing countries. These studies find that "nontargeted tax incentives typically result in more lost revenue than additional investment, and that the elimination of nontax disincentives to investment - for example, a lack of adequate infrastructure - would do more to stimulate investment than would tax incentives."296 In other words, if the goal of the tax cut is to stimulate economic growth, there are more effective means of doing this that involve targeted spending of revenue rather than a reduction in the amount of tax collected. The second study looked at the impact of state taxes on corporate investment in American states. Due to the American states similarity in other factors likely to influence a choice of location, like language, or political and legal systems, the conclusions of this study are likely to be particularly significant. Ultimately, after surveying a number of studies on this topic, Wasylenko concluded "state taxes have little impact on the location of investment in the United States."297 Robin Boadway and Anwar Shah, (1992) "How Tax Incentives Affect Decisions to Invest in Developing Countries," World Bank Policy Research Working Paper WPS 1011, cited in Gerson, supra note 205 at 43. Michael Wasylenko, "Empirical Evidence on Interregional Business Location and the Role of Fiscal Incentives in Economic Development," in H.W. Herzog, Jr., and A.M. Schlottmann, eds., Industry and Location in Public Policy, (Knoxville: University of Tennessee Press, 1991) cited in Gerson, supra note 205 at 44. I l l 5.6.3 C o n c l u s i o n Gerson himself concludes that, since tax rates have a very limited or zero effect on the supply of labour or capital in an economy, "the growth effects of most taxes are likely to be relatively small."298 Empirical studies trying to prove or disprove this thesis on the aggregate level have produced conflicting results. At any rate, in the absence of a robust model of economic growth, these studies are necessarily somewhat ad hoc, and should thus be treated with some suspicion.299 Anthony Atkinson also feels that the lack of a satisfactory model compromises any attempt to assess the economic impact of spending on social transfer payments. The results of the studies are mixed, he argues, and "provide no overwhelming evidence that high spending on social transfers leads to lower growth rates."300 Joel Slemrod, after conducting what Neil Brooks described as one of the most thorough reviews of the available literature, concluded that his "review of the existing cross-country literature suggests that there is no persuasive evidence that the extent of government has either a positive or negative impact on either the level or the growth-rate of per capita To conclude, the empirical evidence simply does not exist to satisfactorily support the thesis that lowering personal income tax rates is likely, all other things being equal, to promote economic growth. Rather, it appears that economists cannot ignore what may appear to be issues of detail. In other words, the effect of fiscal policy on growth will only be understood when each component of it is treated separately. It will never be possible 2 9 8 Gerson, supra note 205 at 46 299 Ibid. 3 0 0 Atkinson, supra note 128 at 196. 3 0 1 Brooks, supra note 128 at 339. 112 to come up with general rules about rates of tax and rates of growth, because the specific elements that compose each of these need to be treated individually. An appropriate model would thus differentiate between quality spending on infrastructure, and wasteful spending on infrastructure; between tax policies designed to encourage retained earnings and tax policies designed to encourage the distribution of profits to shareholders; between "targeted" benefits and universally available transfers. 113 6 Conclusion It seems clear that equality needs to be recognized as an important evaluative criterion for a good tax system, both for the strength of the economy and for reasons of morality. Nonetheless, any discussion about the importance of income and/or wealth inequality is absent from the public debate surrounding fiscal policy. Instead, there is much talk about reducing taxes. However, as has been discussed briefly above, are taxes really being reduced, or are they being shifted from one group to another? According to statistics compiled by the BC Progress Board, the per capita consolidated provincial and local government tax burden declined in the tax year 2002/3, but made a full recovery the following year to slightly more than the amount collected by the NDP government in 2000/1. From 1994/95 to 1999/00 there was a gradual increase from $4,744 per person to $4,994 per person - an increase of $250 per person over five years. 3 0 2 The last four years saw the total tax burden fall very slightly and then recover, for a total increase of $320 per person over four years:3 0 3 T a b l e 6.1 T o t a l T a x e s P a i d p e r P e r s o n in B C 2000 /1 -2004 /5 Year 2000/01 2001/02 2002/03 2003/04 2004/5 Per Capita Tax Burden $5,142 $5,155 $4,818 $5,201 $5,462 3 0 2 BC Progress Board 2004, supra note 97 at 145. 3 0 3 BC Progress Board 2005, supra note 241 at 161. 114 It seems then, that the BC Liberals promised "tax cuts" were more a shift in burden than an outright reduction in taxes collected and there is virtually no change from the long term trend towards a slightly increasing total tax burden in BC. It is thus more accurate to talk about a tax shift rather than a tax cut. This is the same phenomenon that Lisa Phillips has identified in Ontario, where tax cuts were also advertised by an opposition government keen to win over voters. In this excerpt, she summarizes the shift in burden from more progressive sources of revenue to those that are less progressive and even in some cases regressive: Notably, the tax cuts in Ontario have not translated into smaller government. On the contrary, the government's own statistics show that total revenue as a share of Gross Domestic Product ("GDP") is set to increase slightly from fifteen percent in 1995, the year the Conservatives were first elected, to 15.3% in 1999-2000. What has changed, however, is the composition of the revenue stream. Whereas personal income taxes comprised 31.6% of provincial revenues in the 1995-96 fiscal year, that figure was projected to fall to twenty-seven percent in 1999-2000. The province now draws a larger share of its revenue from sources that have a less progressive or even regressive incidence, such as retail sales taxes (up from 19.1%> to 20.8% of total revenue), corporations tax (10.5 to 13.4%), and casino revenues (.85% to 1.71%). It has also relied more heavily on sales and rentals of government assets, a category that represented one percent of total revenue in 1995-96 and was projected to rise to 3.83% in 1999-2000. Thus, Ontario has undercut the redistributive capacity of its tax system both by giving the biggest income tax cuts to higher income earners and by changing the fiscal mix so that government relies more heavily on non-progressive sources of revenue.304 The same process has been at work in British Columbia. There have certainly been "tax cuts" in that the top marginal personal income tax rate is a full 5 percentage points lower than it was before the election of the BC Liberals, but the size of government has not correspondingly been reduced. The inescapable conclusion is that the amount of taxes paid by those on middle and/or lower incomes must have increased. Phillips, supra note 93 at 123 [citations omitted]. 115 As in Ontario, the tax mix between personal income taxes and other sources of revenue has been altered in British Columbia such that non-progressive sources of revenue (revenue from social services (the PST), fuel, tobacco, property and the PPT (Property Transfer Tax)) have increased while personal income tax rates, identified as the only progressive taxes in Canada by Jonathan Kesselman, have decreased.305 It seems clear, then, that the overall tax mix currently in place in BC must be less progressive due to the changes brought in by the BC Liberals, given that the constituent elements have been altered in the manner described above. The rationale for reducing the burden on the province's wealthiest residents, only to increase it for those in the middle and lower-income classes, can be found in the reasoning of the neoclassical economists described in Chapter 2. For example, self-reliance is emphasized over inter-dependence. In a provincial government document entitled "Bringing Out the Best for Families and Children"306 one of the few major headings under which information is grouped is titled "Helping People Achieve Self-Sufficiency." Under this heading we learn of the measures taken by the government to assist those with disabilities, or who have suffered violence or abuse, to find employment. In theory, this is a laudable goal; in reality, in the context of declining wages at the lower end of the earning spectrum and provincial legislation reducing worker's rights to paid overtime and introducing a new, lower minimum wage, it seems much more likely that the vulnerable are simply being told that they ought to be relying exclusively on their own dwindling resources. It is then but a short jump to see that they have been characterized as individuals who ought to go out into the marketplace and strike bargains, exchanging labour for remuneration. Implicitly, the market will value their 3 0 5 Kesselman, "Incidence, Progressivity and Inequality" supra note 94. 3 0 6 British Columbia, Bringing Out the Best for Families and Children, (N.p.: 2004), online: http.7/www.qov.bc.ca/bcqov/content/docs/@235G1 QYQtuW/children families.pdf 116 labour appropriately, and their "independence" will have been achieved. Adam Smith himself, so long ago, famously saw a problem with this line of reasoning, in that, while the owner of capital and the labourer may equally need each other, the need of the owner is not so immediate. There can be no free bargaining where subsistence levels of survival are at stake, and it must be true that part of the BC workforce falls into this category because, as we have seen, increasingly there are those who work regularly yet are still homeless. The fact that the homeless are more likely to be "people with head injury, mental illness, severe depression, young people who are trying to find work, prisoners following their release from incarceration, those raised in foster care in BC, and immigrants and refugees" (as quoted above on page 40) completes the circle. In other words, those who are being "assisted to be independent" end up living on the streets in greater numbers when the emphasis is on self-reliance rather than inter-dependence. In his comprehensive study of tax incidence, progressivity and inequality in Canada, Jonathan Kesselman laments the fact that most data available is quite out of date. Even the flattening of the personal income tax at the federal level, from 10 brackets to 3, in 1988, is not caught by most of the studies he used, writing in 2004: "most of the Canadian studies reviewed here are already quite dated in their periods covered and would benefit by updating to include the important tax policy changes since 1988."307 Similarly, just as the provincial government publishes data on the size of the GDP, employment rate, etc., if data regarding the extent of inequality in British Columbia were published regularly it would be possible to assess more quickly the impact of changes to the tax base and personal income tax rates on inequality in the province. Kesselman, "Incidence, Progressivity and Inequality", supra note 157 at 712. 117 In the absence of such published reports, this paper has tried to assemble evidence from a variety of sources. Much of the evidence points to an increase in inequality in British Columbia as the likely outcome of the tax shift instituted by the BC Liberals after their election victory in 2001. However, it may be that the very poor have been hit less than the middle-income earners, due to the exemptions that very low earners receive for things like MSP premiums. Neil Brooks warns that the combination of reduced rates for the wealthy and exemptions for the poor will lead to an increase in the tax burden on middle-income earners.308 Jonathan Kesselman also sees this phenomenon at work in Canada, particularly after: ...Canada's 1988 conversion of all allowances and some major deductions into tax credits. Since those provisions were converted into credits at the bottom bracket tax rate, this change should have increased effective progressivity. However, the 1988 Canadian reforms also flattened the tax rate schedule and lowered the top rate, thus offsetting the increase in progressivity.309 He points out that, while personal income taxes are in the final analysis the only progressive taxes collected in Canada, the extent of their progressivity may be exaggerated. This is because recent research has suggested that the incidence of high personal income tax rates on high earners may be shifted to other parties. If so, Kesselman warns, "even these mildly progressive findings might be overturned."310 The impact of the tax shift on British Columbia's economy is more difficult to establish with certainty. In the very long run, inequality will itself impact the economy if it leads to lower health and education outcomes. Along with the emergence of the young, working homeless person, the increase in babies born with low birth weights in British Columbia 3 0 8 See above, page 67. 3 0 9 Kesselman, "Incidence, Progressivity and Inequality", supra note 94 at 756. ™ Ibid, at 712. 118 in 2002 is perhaps a troubling indicator of what may be happening to those at the lower end of the income scale. It remains to be seen if this is the beginning of a trend or whether subsequent years will see a return to lower levels of low-birth weight babies. At any rate, the economic impact of a cohort of less healthy children entering the workforce would only make itself felt a good 15 to 20 years after the policy that caused it, and would thus be impossible to measure today. Similarly, what of the change in the numbers of students completing secondary school, from a steady increase to a sudden decline? This change, along with the decline in the percentage of the population with university graduation, may take a very long time to register in terms of an actual effect on GDP. Eventually, however, as reported by Philip Gerson, reduced achievement in the areas of health and education will impact the financial bottom line. The fact that the year to year growth rate of BC's GDP rose above the national average in 2003 is a cause for celebration; the fact that it sank from 2.4% in 2002 to 1.6% in 2003 is not.311 Similarly, the fact that BC was the only province to experience a drop in productivity between 2002 and 20 03 3 1 2 and the fact that BC was one of five provinces to experience a drop in exports of goods and services between 2002 and 2003 are not good, given that the need to improve productivity in order to increase competitiveness and exports was one of the major reasons given by the BC Liberals for its changes to tax policy.313 In the final analysis, if I am correct in saying that the changes to the tax mix will produce an increase in inequality, the trade off must be a larger economic pie that eventually gets distributed such that everybody in the economy benefits from the change. If not, then, as 3 1 1 BC Progress Board 2004, supra note 97 at 141. 3 1 2 Ibid, at 143. 3 1 3 See above, page 74. 119 Andrew Jackson 3 1 4 points out, it is really a question of asking lower and middle income earners to tighten their belts while the more affluent see their net incomes rise. The more pessimistic view is the one espoused by Lisa Phillips, who sees a decrease in the progressivity of tax rates as a straightfonward abdication on the part of the welfare state of its traditional role of redistribution.315 In order to assess whether or not this is true, reliable data on inequality would have to be published regularly by BC Stats or Canada Statistics. Unfortunately, BC Stats do not have anything like an inequality report amongst the various indicators that they track, and there is a very significant lag between changes to tax policy and the census data necessary to track the effect of such changes at the federal level. The quote from Kurt Vonnegut that began this paper is a warning to human beings not to impose too much equality on each other, lest the innate differences that make us unique are squelched. Unfortunately, when the fear of too much equality gets translated into less redistributive economic policies, the end result is not a colourful explosion of diverse individuals but rather the entrenchment of a "different" underclass, for whom educational and career aspirations become more and more challenging. Much of the rhetoric used by those who advocate a world in which individuals are left to fend for themselves is essentially a discussion of "equality of opportunity." Why should the diligent support the lazy, in their view, when both had the opportunity to strive for success? The problem with this analysis, as low birth weight statistics so poignantly attest, is that the interconnectedness of human beings means that there can be no "equality of opportunity" without some semblance of "equality of result." Nobody enters the world as a self-sufficient individual. Institutional economists try to deal with this flaw by looking at 3 1 4 S e e above , page 70. 3 1 5 Phillips, supra note 93. 120 the circumstances antecedent to the moment a bargain is struck, between employee and employer, landlord and tenant, voter and aspiring politician. There can be no more solid vindication of the need for this larger view of human bargaining than the change to BC's iabour law that makes it possible for employers not to pay workers for overtime and hire young people for a rate $2/hr below the minimum wage for older workers. Clearly, the institutional framework (here, the BC Employment Standards Act) is the most relevant factor in the bargain struck on overtime between employer and employee. The armchair economist who would ignore such an element of the environment and see only a bargain struck between free, rational, self-motivated individuals working out the equilibrium point on a supply and demand curve for labour is surely missing a crucial element of the picture. Ultimately, it is the argument of this thesis that the benefits of cooperation outweigh the costs. On the most abstract of levels, the fact that multi-celled organisms evolved at all is proof that going it alone is not always the most successful strategy. A high and progressive rate of tax is linked to better outcomes for those at the bottom of the income scale. But those better outcomes, in health, education and resistance to criminal activities, lead to benefits for all members of a society. These benefits are not only economic: as Henry Simons pointed out in the 1930s, it may be that a more progressive rate of tax and a redistributive role for the state is desired simply because there is something "unlovely"316 or aesthetically distasteful to the unnecessary creation of an underclass that lack access to basic standards of food and shelter. However, the 3 1 6 "The case for drastic progression in taxation must be rested on the case against inequality -on the ethical or aesthetic judgment that the prevailing distribution of wealth and income reveals a degree (and/or kind) of inequality which is distinctly evil or unlovely." Henry Simons, Personal Income Taxation, (Chicago: University of Chicago press, 1938) at 17. 121 argument in favour of lower taxes and a less redistributive role for the state has most often been cast in terms of economic efficiency. As pointed out in the introduction, efficiency has reigned as the uncontested touchstone of good policy in the law and economics movement since its inception, but is now being contested by those who see a different and broader role for the law and economics scholar to play. Thus, I have tried to take on the arguments about economic efficiency and demonstrate that even those arguments have many flaws. Ultimately, however, I agree with Henry Simons, and even if demonstrable economic benefits could be shown to inure to lower tax jurisdictions with higher rates of LICO and more homelessness, more low-birth weight infants, more jailing of young people, I would still perceive these things to be undesirable. Fortunately, as pointed out by Andrew Niggle, it would appear from recent work done analysing the interaction between tax rates and economic growth, "we can now have a bit more confidence in the desirability of policies that reduce relative poverty through transfers, that enhance access to education and entrepreneurial finance capital for the poor and middle classes, and that enhance democracy in the full sense of the word: evidently, they are likely to be wealth enhancing."317 Thus the "trade-off, between less economic growth and productivity and a more redistributionary state that alleviates the worst excesses of poverty created under a capitalist system, may well be an illusion, and the true trade-off will prove to be simply one between greater economic prosperity for the majority and higher after-tax incomes for a small number of already very wealthy people. 7 Niggle, supra note 191 at 530. 122 BIBLIOGRAPHY LEGISLATION Employment and Assistance Act, S.B.C. 2002, c.40 Employment and Assistance Regulations, B.C. 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