Like junior economists, we’re looking at the high level of government spending to fight the pandemic and wondering how it will be paid for without a tax increase. In the financial advice business, there’s already a lot of commentary being issued to help clients prepare for higher taxes.
Before you adjust your finances to deke around future tax hikes, consider one senior economist’s take on the matter.
“I would push back against the assumption that we will see any material tax increases as a result of the government’s COVID-19 spending,” Frances Donald, global chief economist and global head of macroeconomic strategy at Manulife Investment Management, said in an interview. “The idea that we’ve spent a lot of money and therefore taxes need to go up is overly simplistic in a new complicated world with extraordinarily low interest rates for a long period of time.”
Speculation about rising taxes has focused, as has been the case in recent years, on capital gains. Whereas half a capital gain is considered taxable now, the government could move to 75 per cent or even 100 per cent. There’s speculation as well about a tax in some form on the sale of a principal residence. The cult of home ownership in Canada is built on the idea that you can sell a house at a huge profit without paying tax, as long as it’s your principal residence.
It would be naive to dismiss the possibility of taxes such as these, but alarmist to suggest they’re imminent and that savvy operators should take steps now to avoid paying them.
Ms. Donald bases her argument that taxes aren’t about to rise on the fact that the cost of carrying debt is more important right now than the amount of debt. There are parallels to this line of thinking in the housing market. House prices are rising in many communities, but this is affordable for buyers because interest rates have plunged to historic lows.
Ms. Donald said rates are so low now that the cost of carrying federal government debt next year will be lower than this year, even with spending to fight the pandemic and support individuals and business.
The counterargument is that while rates are low for now, they could rise and thereby increase the amount of interest the government has to pay on the bonds it uses to finance its operations. A risky situation would be something like what we saw in the 1990s, when about 35 per cent of government revenue went to pay interest costs on the federal debt. Ms. Donald said the comparable number today is just 7 per cent.
For a few reasons, she sees low rates persisting for years to come. One is that the Bank of Canada is now a major buyer of bonds issued by the federal government. She points out that 80 per cent of Government of Canada bonds issued since March are held by the central bank.
This is significant because it means most of the borrowing by the feds in the pandemic is financed domestically and not by foreign investors who might balk at further buying without higher rates to entice them.
Another reason why rates will stay low is that the economy has been badly hurt by the pandemic. “It took eight years for global interest rates to rise following the 2008 recession, and this is a recession that is multiples worse than that,” Ms. Donald said.
The weak economy itself is another reason to avoid tax increases. Higher taxes leave individuals and businesses with less to spend.
Ms. Donald said a long period of low rates gives the government room to invest in the economy that promotes growth. Other things can be done as well to stimulate the economy, such as introducing policies to promote business investment.
You may recognize this thinking as modern monetary theory (MMT), which holds that large deficits are not necessarily a bad thing and that government spending is a smart way to improve growth. Governments reach their spending limit when there’s a rise in inflation, which seems a distant risk now. In September, the year-over-year inflation rate was just 0.5 per cent.
MMT is a new take on things, but so is everything these days. Remember this if you’re considering major changes in your finances to avoid tax hikes ahead.
“In the post-COVID-19 playbook, higher taxes are very low down the list of measures that any politician would want to enact in order to improve federal finances,” Ms. Donald said.
Editor’s note: About 7 per cent of government revenue goes to paying interest costs on the federal debt, compared to 35 per cent in the 1990s. An incorrect figure was provided in an earlier version.
Rob Carrick