Jack M. Mintz: UK budget restores stealth taxation to tackle deficit

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Deindexation has bad economic effects. As inflation drives up incomes, more and more people face higher marginal tax rates, which discourage work, investment and risk taking

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One element of the UK budget last week particularly caught my attention: the deindexing of the tax system. From 2022 to 2026, there will be no adjustment for inflation of income, inheritance and capital gains tax brackets, lifetime retirement allowance or value tax thresholds. added (VAT) for small businesses.

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Stealth taxation was used in the past – in Canada until Finance Minister John Turner indexed the federal income tax system in 1973 – as governments let inflation raise nominal incomes while by freezing the tax brackets. In the UK, de-indexing will generate an additional £ 25 billion in tax revenue over four years, with 1.3 million new taxpayers added to tax rolls by 2026 – all at the bottom of the ladder.

Call it the fiscal price of the extraordinary relief plans used to counter the pandemic recession. Eventually, fiscal discipline sets in as net public debt grows – it now accounts for 94% of UK GDP – and £ 45bn of debt interest crowds out spending on hospitals and education.

Deindexation has bad economic effects. As inflation drives up incomes, more and more people face higher marginal tax rates, which discourage work, investment and risk taking. When benefits are no longer indexed to inflation, people on fixed incomes can no longer afford basic necessities. I will never forget seeing poor people digging through the garbage for recycled materials after the 1997 hyperinflation in Bulgaria.

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Politically, deindexing the tax system is probably the easiest way for governments to raise taxes. At around two percent, the UK’s inflation rate is low enough that most taxpayers don’t notice the tax brackets have been frozen. Still, it’s a powerful tool for generating income, as the numbers show.

Expect more governments around the world to do the same. The Government of Alberta has already solved this problem, freezing its tax brackets last year to deal with its staggering deficits. Other provinces may soon follow suit as they grapple with swelling debts. I suspect the federal government will not hold out indefinitely. Deindexation is unlikely to be part of this pre-election budget but may well become a policy later.

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If inflation rises more than expected, deindexing would be an even bigger revenue drain. As the $ 1.9 trillion Biden plan crosses Congress this week, inflation exceeding two percent becomes more likely in the United States – and may well be imported into Canada if we prevent our exchange rate from rising. .

“Not worried” Federal Reserve Chairman Jerome Powell and other central bankers, including Bank of Canada Governor Tiff Macklem, appear convinced that inflation will not reaffirm itself. However, not everyone agrees, including Larry Summers, former Harvard President and Bill Clinton’s Treasury Secretary. Almost a century ago, economist Irving Fisher recognized that interest rates rise by one point for every point that inflation is expected to rise. The bond market is certainly starting to believe that inflation is on the rise – US long-term bond interest rates have risen by almost a point in the past six months.

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Even though Canada’s inflation rate is currently only 1.4%, this reflects the decline in energy, transportation and mortgage interest costs this year, which have dramatically reversed over the past year. trimester. Some prices increase by up to double the 2% rate: in particular, for food purchases, housing replacement costs and vehicles. And inflation could get worse. With the pandemic disrupting supply chains, fiscal and monetary stimulus in 2021 could cause demand to exceed supply in our extremely weak investment environment.

  1. Nothing

    Jack M. Mintz: We’ll pay all these down payments

  2. Nothing

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  3. Instead of raising taxes, Canada would be better off cutting spending and letting growth reduce the debt burden over time.

    Jack M. Mintz: We don’t need higher taxes to reduce public debt

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Beyond the effects of deindexation, inflation also stimulates other income. With higher nominal interest rates, governments collect more tax on investment income and on withdrawals from RRSPs and pensions. They also collect more taxes on higher nominal capital gains – although there is partial compensation as borrowers deduct higher nominal interest charges.

Revenue from sales and excise taxes is also a boon to government revenue when prices rise more rapidly. With inflation, GST / HST revenues are further increased by the one month delay in claiming input tax credits against sales taxes collected from consumers.

On the other hand, higher inflation spurts widen public deficits by increasing spending. Transfers to individuals represent almost a third of non-pandemic federal spending and are indexed to inflation. Labor compensation and transfers to the provinces also follow inflation. It will be tempting for governments to try to curb indexation on the expenditure side, especially for high incomes or, in the case of the federal government, for transfers to the provinces. Visible spending cuts or tax hikes could be much more difficult politically.

If inflation expectations rise, central banks could potentially intervene to raise interest rates to 2%, where they have been for two decades. This will only slow down the economy and lead to an increase in public deficits. Higher inflation expectations are a dead end.

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