Canadians right to worry about ‘big government’ agenda (and a high tax regime is one of Canada's problems)

By Matthew D. Mitchell & Jake Fuss of The Fraser Institute.

"In his latest piece for the Globe and Mail (“Canada has 99 problems but a high tax regime ain’t one”), columnist Claude Lavoie begins with the observation that most Canadians are unhappy with the country’s “bigger government agenda” and high taxes. They believe that Canada’s large and intrusive government throttles the country’s economy and leaves the average citizen with less. But, he says, “Maybe we are looking at the issue the wrong way.”

Channeling an argument made famous by American economist Thorstein Veblen 125 years ago, Lavoie says it’s not absolute prosperity but relative prosperity that makes us happy. We like getting new cars, he says, but we really like getting cars that are better than our neighbour’s car. And since we can’t all win this sort of relative arms race, we shouldn’t enter it. In fact, we should welcome higher taxes because they discourage this self-defeating arms race.

Lavoie isn’t all wrong. He has certainly picked up on a salient—and perhaps unfortunate—aspect of human nature. But in four key respects, it’s Lavoie, not the average Canadian, who’s looking at the issue in the wrong way. First, there’s more to “big government” than taxing and spending. From the perspective of the average Canadian, the big government agenda is worrisome because it limits their economic freedom. Economic freedom refers to a citizen’s ability to make his or her own economic choices, free of constraints imposed by others. When governments limit economic freedom, citizens find it harder to buy and sell what they want. They find it more difficult to start and run businesses. And they are more limited in their ability to acquire and use property, including productive property like machines and tools.

Economic freedom has been exhaustively studied. And the results overwhelmingly suggest that economically freer people are more prosperous than less-free people. Those who live in the freest countries in the world earn about 7.7 times as much as those who live in the least free countries. And their greater prosperity doesn’t just buy them nicer cars. It also buys them longer life spans, better literacy rates, higher levels of self-reported life satisfaction, cleaner environments, less poverty, lower infant mortality and less violence.

Lavoie and others who favour higher taxation often point approvingly to the Scandinavian countries. The irony is that, with the exception of their large governments, these are some of the most economically free countries in the world. They generally have fewer regulations, lower tariffs, sound monetary policies and exceptional legal systems.

Canadians have historically enjoyed high levels of economic freedom and this explains their relative prosperity compared with other countries. But, bit by bit, Canadian economic freedom has been falling for nearly a quarter century. Not since the late-1970s has Canadian economic freedom been as low as it is today.

Second, while larger governments and higher taxes are not everything, they are important. Especially among industrialized countries, larger government sectors correlate with slower economic growth. Higher taxes on capital gains inhibit economic growth by discouraging entrepreneurship and business investment. When you reduce the return that entrepreneurs and investors can expect from starting a business or investing in the Canadian economy, potential entrepreneurs and investors are more likely to take their ideas and money elsewhere. Higher business taxes have similar effects by chasing away capital and the businesses that are essential for improving productivity, increasing worker wages and creating jobs.

The empirical economic literature shows that high tax rates hinder economic growth and prosperity. Canada’s high rates have put it at a competitive disadvantage for attracting and retaining professionals, businessowners and entrepreneurs—all of whom are critical for job creation and innovation. With high tax rates, Canada is experiencing a “brain drain” in which our best and brightest are leaving for greener pastures in lower tax jurisdictions.

Third, there’s more to tax policy than the rates. Another important question is how broadly these burdens are shared. Lavoie lauds “high progressive taxes”—that is, those that impose higher rates on higher income individuals. And again he points approvingly to Scandinavia. But despite the common perception, Scandinavian countries such as Sweden and Denmark do not stick the ultra-rich with the burden of paying for their extensive social programs. Instead, their tax burdens are widely shared. In 2023, Sweden’s top marginal income tax rate of 55.5 per cent kicked in at just 10 per cent above the average wage, meaning many Swedes with modest incomes paid the highest marginal tax rates. A Swede making C$81,000, for example, pays a marginal tax rate of 52.4 per cent.

Sales taxes—which are paid by everyone regardless of income—are another important source of revenue in these countries. Sweden’s 25 per cent value added tax on most goods and services is the second-highest among advanced economies. Because of its widely-shared tax burden, Sweden has one of the least progressive tax systems in the OECD.

Finally, economic freedom isn’t just valuable as an instrument to achieve higher living standards. Those who live in economically freer societies report that they feel greater autonomy and control over their lives. And this, in turn, permits them greater life satisfaction. Maybe Canadians are right to think that the big government agenda is holding them back."