For a quarter of a century inflation has been teased with armed conflict, bailouts (bail out), expansionary monetary policies. Nothing seemed able to shake him. But after several decades of dormancy, here it is hitting hard again.
Posted yesterday at 11:00 a.m.
The difficulty with inflation is that most policy experts have no practical experience dealing with it. They manage with often opposing theories, which explains, at least in part, why the public square is awash with conflicting advice on how to deal with it. In order to align theory and practice, I asked the legend Vito Tanzi to collaborate in the publication of this article.
Former head of the fiscal affairs department of the International Monetary Fund (IMF), best-selling author and instigator of the Tanzi Effect, Mr. Tanzi has advised several countries struggling with inflationary crises. He believes that the inflation that is hitting us is likely to stay with us for a while yet and that we must remain vigilant in the face of the possibilities of stagflation, recession or higher inflation.
Currently, the bulk of the job of dealing with inflation rests with the central banks. The latter could favor the brutal approach that Paul Volcker applied in the United States in 1982, which ended inflation, but at the cost of a deep recession. Moreover, Nobel-winning economist Joseph Stiglitz believes that even a more modest increase in interest rates by central banks would slow the investment needed to increase supply, and therefore not reduce inflation.
Faced with the possibility that the work of the central banks is not sufficient, or proves to be excessive, wouldn’t the tax authorities have a role to play in the fight against inflation?
The role of tax
If there is one point on which experts and politicians agree, it is that increasing global supply could help contain inflation. Taxation can play a role in this regard with accelerated depreciation, investment tax credits, tax measures better suited to working from home and to retirees returning to work. However, such measures would only produce a real impact after some time. Consideration should also be given to relaxing certain government rules that require the average business to devote no less than 85 days of work per year to it (CFIB 2022).
Another aspect that most experts also seem to agree on is that expansionary monetary policy contributes to inflation. To counter this, the state must either cut spending, raise taxes, or combine the two.
Higher taxes reduce disposable income and thereby aggregate demand and inflationary pressure. But significantly higher tax rates may also cause some workers to refuse to work overtime, which would contribute to the supply problem.
In addition, the less well-off and the middle class, who are hardest hit by rising food, gas and housing costs, do not have the capacity to withstand a tax hike. You even have to think about granting them a tax reduction or paying them a lump sum. As Vito Tanzi explains, an ever-accelerating rate of inflation can even dramatically reduce a country’s ability to raise revenue from income tax.
For large personal and corporate fortunes, it’s a different story. They have become wealthy during the pandemic and their effective tax rate is often well below statutory rates and society’s tax expectations of them.
For example, the wealthiest 0.01% of taxpayers in the country – those 2,875 Canadians who each had an annual income of $8.9 million in 2019 – had an effective tax rate of 30% (according to Statistics Canada).
There is also the possibility of reducing tax loopholes and unreasonable subsidies. For example, is it really necessary to allow a taxpayer to pay no tax on the gain made on the sale of a multi-million dollar house? These transactions are not negligible. In Toronto, 426 homes over $4 million were sold in 2021, including 19 for over $10 million.
Another example is the $12,000 subsidy (or 100% depreciation) granted for the purchase of an electric car. With the price of gasoline exceeding $2/litre, such a subsidy may no longer be so useful.
Twelve thousand dollars is huge. Four million people live in poverty in Canada, and the social assistance each recipient receives to support themselves for an entire year is less than $12,000. The money saved by reducing this subsidy could be allocated to those less fortunate – and also be used to encourage Canadians to make the environmental choice of abandoning the car for cycling and public transit (like me!).
If Canada is heading for much higher and persistent inflation, consider that the Tanzi effect could begin to manifest itself. This phenomenon is caused by the time lag between the moment when the tax measures are calculated and the moment when they are actually applied. For example, income tax may take several months to be collected. In a significant inflationary environment, this time lag can lead to substantial losses in the real value of government revenue.
In closing, last week at the Empire Club of Canada, Finance Minister Chrystia Freeland said, “I can make no promises to Canadians about how the weeks and months ahead will unfold. She is thus adopting a difficult, but necessary position, in order not to lose the confidence of citizens who have already been confronted with excessive promises and under-achievements in terms of inflation.