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As we enter the seventh month dealing with this damned pandemic, governments around the world have unleashed unprecedented spending in order to prop up companies, provide wage subsidies for laid off or furloughed workers, or just straight-up handing over cash to its citizens. This has been, to put it mildly, HUGELY expensive. The US government is projecting a deficit of about $3.8 TRILLION dollars, and that’s just this year. In Canada, our deficit is projected to hit $343 billion, with COVID-related subsidy programs costing about $212 billion dollars. To put that in comparison, Canada’s budget for its entire military for 2019 was only $45 billion.
Which of course begs the question: Canada has a military?
For the last time, people, YES. Canada has a military. It’s just mostly composed of moose, and as you can see from that budget, those moose eat a LOT.
But the second question that springs to mind is: How the Hell are we going to pay for all this stimulus money later?
I mean, somebody’s going to have to pay for all this spending eventually, so the question is: Who and how much will it cost them?
Now, I don’t have any special knowledge about what the government’s planning on doing, so we can only speculate, but here are my best guesses.
Taxing Dividends More
Raising taxes on dividends might at first seem like a politically palatable move, since it’s only those rich fat-cats with million-dollar stock portfolios who would even notice, right? Except the favourable dividend tax rates in both US and Canada were never meant as a tax break for the wealthy, they were designed to avoid double-taxation.
Dividends are paid to investors after corporate taxes are already paid, so if the dividend tax rates were increased, it would amount to a form of double-taxation which is inherently unfair. That doesn’t mean the government won’t do it, but I’m betting that they’ll leave dividend taxes alone, considering there are far easier ways to soak rich people, like…
Taxing Capital Gains More
Increasing tax rates on capital gains would also be another way for governments to target rich people. In the US, capital gains held for more than a year can be realized at 0% (if you do it gradually), and in Canada, 50% of realized capital gains get added onto your income. So increasing either of these tax rates could totally be in the realm of possibility.
My issue with this idea is this: What capital gains?
Honestly, with stock markets in turmoil are that many people sitting on huge windfalls in their investment accounts right now? And even if they were, no matter what the capital gains tax rate is, because you choose when to realize capital gains, it’s always possible to delay capital gains indefinitely while you’re still working, and then strategically realize capital gains so that any taxes you’d owe would be offset by your personal exemption amount in retirement.
So they can try messing around with the capital gains rate, but I don’t think that will yield them enough money.
Taxing Capital Gains on Housing More
For Americans reading this, they might be thinking “What are you talking about? Capital gains on houses are already taxed.”
They might be surprised to learn that in Canada, capital gains on your primary residency are tax-free. Yup. That’s one of the reasons our housing market has been so crazy lately.
Removing the tax-free status of primary residences in Canada would affect a huge swath of the population, but I also think it’s fair, especially if paired with an increase in taxes on financial assets. Why should your house be exempt from taxation when every other source of income isn’t?
Of course, the CRA could exempt a portion of your capital gains and make it tax-free like the Americans do. Currently, the IRS allows the first $500k of capital gains to be exempt for a married couple, so if we did something like that up here it would only affect people whose house has appreciated by more than that, and with so much of Canadian’s wealth tied up in their house, this would likely generate enough tax revenue to pay for all this stimulus.
Creating a Wealth Tax
Oh, the far-left would love it if they could do this, wouldn’t they? Here’s the problem with wealth taxes. They don’t work.
That’s not me speculating. That’s based on the experience of Europe in the 90’s. Back then, twelve European countries tried to implement some kind of wealth tax and they kept discovering the same thing over and over again. If you try to tax wealth, the wealth just leaves.
Unlike the middle-class which holds most of their wealth in their home, the truly wealthy (defined as having a net worth greater than $10M USD) keep most of their wealth in financial assets. Stocks, bonds, trust funds, whatever. And unlike real estate, those things can move.
If your government knocks on your door and decides to tax the heck out of your house, well you don’t really have a lot of options. You have to pay it because you can’t move your house. But when all your wealth is in paper (or nowadays, electronic) assets, you’re just one plane ticket (or in the Europe’s case, a train ticket) away from relocating both yourself and your wealth to another country with friendlier tax laws.
Wealthy people, by the way, also tend to be the job creators, so this has a double-whammy effect of negatively impacting your job market. Wealth taxes, to put it simply, are hard to enforce and easy to avoid.
Which is why France abolished its wealth tax in 2017 in an effort to attract talent and money back into the country. French economists estimated the outward flow of wealth cost the French government twice as much revenue as the total ultimately yielded by the tax.
So while governments can try to implement a wealth tax, it’s not going to work and it certainly won’t be enough to offset their deficit.
Taxing Consumption
I’ve heard the argument that taxing consumption, in the form of a national sales tax (or in Canada’s case, a sales tax increase) is an inherently more beneficial tax because it discourages spending and rewards saving. I’ve also heard the argument that it benefits rich people more since it’s a flat tax that applies to everyone regardless of their income.
What I KNOW is that it’s insanely unpopular. When Canada implemented a national sales tax, that government lost power for over a decade. Something about seeing 15% added onto every bill irked people for some reason.
And I’d also argue that given that a lot of people are hurting right now, is deliberately raising the cost of living for everyone a good idea? Especially since it would hurt people without jobs the most.
So while this might work in terms of having the scale necessary to foot this stimulus bill, it would be deeply unpopular and probably turf whatever government is in power.
Raising income taxes
So finally we come to income taxes. It’s the only tax increase on this list that would simultaneously be large enough to pay for this debt, and be able to reliably generate that tax revenue.
How that increase would look is of course up for debate. Targeting only the highest tax brackets would be more politically palatable, but that would need to be balanced with the fact that there are far fewer taxpayers in the top tax bracket. Would that be enough to offset this debt, or would the middle tax brackets also need to be increased?
I do know that there’s only so much you can tax extreme high earners before it stops having an effect. In Ontario, the effective top tax bracket is above 50%, and when you start going too far above 50%, the doctors, lawyers, and business owners who are paying that tax rate simply work less. What’s the point, they argue, if most of my earnings are going towards the government?
So for that reason, I do think that an income tax increase that affects at least part of the middle-class is going to happen.
What Do You Think The Government Should Do?
So that’s my take. While I fully expect governments to try to go after the so-called fat-cats, meaning rich multi-millionaires, when this pandemic is finally over, history has shown that it just doesn’t work. There are just too many ways to avoid those types of taxes for that approach to work at the scale governments need.
Taxing consumption would just be cruel to people who are still unemployed. So that leaves us with either taxing houses, or a middle-class income tax hike.
What do you all think? What do you think is the most fair way to pay for this unprecedented spending it’s taking to fight the pandemic, and what do you think will actually happen? Let’s hear it in the comments!
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In the US, we should let the Trump’s tax cut expires. I think it’s temporary for individual but permanent for corporate. We should raise the corporate tax rate a bit but not back to 39%. That seems high.
No wealth tax. I’m gone if they want to tax wealth.
Corporate taxes are paid for by the consumers at the end of the day. So, all you are doing is increasing the cost of products to everyone.
Corporate taxes cut profitability, which decrease stock prices. A corporate tax increase would be passed onto shareholders, not customers. You’re thinking about tariffs, which increase the cost of source materials.
Yes, there is more nuance then what I said. But raising corporate taxes would be paid for by lower wages, stock holders, and customers of those corporations. In general it also makes the whole country less wealthy overall.
“I’m gone if they want to tax wealth.”
Hey, capital just fled! You all saw it 🙂
Totally agree. Tax my investment portfolio? Bye bye gouvernment. With the click of a button, I can transfer it to another country. Just try to stop me.
And then, what will you have to tax? Immovable real estate. Lol
A wealth tax might be conceivable right at this moment because pretty much every country on the planet is hurting. If there emerged a consensus that this was the thing to do, it’s possible that it could work. For a while anyway. It’s a nice thought.
More likely: higher income taxes, capital gains taxes (fingers crossed it throws some water on the real estate insanity), dividend taxes, maybe even a bump to the sales tax. Who knows.
Or they’ll just keep kicking the can down the road four years at a time.
Yeah but that would require consensus of every major country. If just one country chooses not to implement it, then BAM they’d get all the multi-millionaires (and job creators).
Well written!
Some Military members might take offense to the Moose reference, but you’re not entirely wrong. Lol.
Wife and I sold our house March this year for 26% over asking and we’re happy to be free of the anchor.
Having your assets liquid gives you the freedom of choice as well as not being beholden to any bad government policy decisions.
They’re not just any moose, you know. They’re highly trained and heavily armoured assault moose. You don’t want to mess with one of those.
And CONGRATS on ditching the house! Doesn’t freedom taste sweet?
Canada’s military is hugely important to our freedom and way of life, and they deserve continued funding and respect. Most recently, the military was instrumental in fighting COVID-19 in nursing homes, putting their lives and their families’ lives at risk as they cared for the elderly in long-term-care homes experiencing outbreaks. They even put together a report to the government outlining the terrible conditions in several long-term-care homes. As someone pursuing FIRE, I’m grateful to the military for highlighting these issues in long-term-care homes, as it is a stark reminder that I must save for a safe and comfortable retirement. Also, as a result of the military’s report, the conditions in long-term-care homes will hopefully improve significantly by the time our generation retires. The military is probably doing more for our retirement and FIRE journey than most of us realize.
The biggest part of the solution to bring post COVID19 government debt under control is the same that the USA, Great Britain and others used after WW2.
Inflation
Ramp up inflation by massive spending / inflating the monetary base.
At the same time you could even freeze the value of government bonds like was done in the US after WW2 to avoid increasing costs for servicing the debt (or change those bonds to perpetual bonds with a fixed yearly coupon).
Inflation is the least painful tool to use for politicians or as a better expression its the tool of choice if you want to hide traces of direct responsibility and being voted out of office as a result.
Agreed. Bullish for hard assets and commodities. #GotGold?
100% right. Inflation will be the tax of choice.
Pay attention you people who think your Portfolio should be 100% invested in Vanguard. Or invested in a split of ETFs and Bonds. In an inflation your bonds will really suck.
I suggest buying an INSURANCE POLICY (figuratively speaking) of some hard assets like gold. Some wisely chosen investment real estate wouldn’t hurt either (you CAN do this with an ETF or a direct REIT purchase). So …. portfolio management is important.
I’d start with 5% or 10% of your net worth in gold and other inflation hedges, and increase those percentages as inflation ramps up. And if inflation doesn’t happen, well you’ve bought an insurance policy that you didn’t need. We all do that in life routinely.
We can’t say when the inflation will take place, but it is inevitable.
I also agree inflation will be the way to go.
I believe 10% in precious metals, like gold, is okay in any economic environment – if you so choose. However, re-allocating from equities to commodities isn’t the only way to deal with inflation.
You can choose to invest in value stocks and dividend-paying stocks which are both hedges against inflation. See: https://www.investopedia.com/articles/investing/052913/inflations-impact-stock-returns.asp
I agree. The fancy term for this policy response is “financial repression.” A government keeps interest rates low while increasing the inflation rate to above the interest rates on the debt. Over time, in inflated currency, those fixed-term debts become less onerous to pay off. The risk, of course, is that inflation runs out of control.
I believe strongly that this is definitely what will happen in the coming generation.
Note well: this policy rewards holders of debt and hurts holders of cash. My portfolio is somewhat built on the assumption that this policy is coming to a theater near all of us…..
I do agree that inflation would hurt current bond holders, but I’m not convinced gold is the best place to be. The stock market itself acts as an inflation hedge, as all that extra money sloshing around would increase prices, which would increase profits.
Unless they go too far and screw up the currency of course, but let’s assume these central bankers know what they’re doing.
Central bankers know what they’re doing? Do they though? I’m sure they’ll try their best. You and I both lived and invested through the great recession. I’d say the central banks’ responses were mixed. Just like then, the problem is global and requires some sort of coordinated response. Some of the more crazy ideas being proposed in central bank-land seem… horrible. Negative interest rates? Japan already experimented with those.
The chances they screw up currency is certainly not zero.
When you take money from people at the point of a gun there really isn’t a “fair” way. Also, forcing businesses to shut down isn’t fair either, since those businesses could have come up with a way to slow or stop the spread of the virus themselves which makes since in their personal cirucumstances. Having said that I think taxing the middle class would be the only feasible way to pay for all of this. Or to let inflation happen, which isn’t a very good way either since you are taxing the poor and unemployed that way. Really, the governments screwed themselves (or rather their citizens) over.
Yeah but this wasn’t a choice the government wanted to make. Doing nothing would have been catastrophic, as not supporting the economy would result in no jobs to go back to once this is all over.
While forcing businesses closed isn’t fair, a global pandemic is one thing that the free market isn’t good at tackling. Look at what’s going on in red states right now.
Here in AZ people and businesses started voluntarily closing down before Ducey’s mandate to close down altogether. We are now seeing a big uptick in cases because of Ducey’s lock down. We would be mostly done with this if it wasn’t for government crushing the spread of the disease. Let it spread, except to those that are most vulnerable and it will die out eventually. Other countries did it similar and it worked out OK (like Sweden, except they didn’t protect the most vulnerable). And I believe, Finland or one of those countries said that they wish they had let it spread.
I do think governments have a role in this. Like closing down borders (which they took to long to do) and providing information/recommendations.
And you’re sure that COVID-19 has no long-term health effects for younger or healthy people? And you’re also sure that once you have antibodies you can’t be infected again in a few months? What is your source as I haven’t heard any health expert guarantee that? What if 250 million people got infected in the US (that may be how many would need to be to achieve herd immunity), and next year we found out that we have 250 million people walking (or limping) around with scarred lungs, damaged blood vessels, susceptible to stroke or kidney damage, and they will experience long-term consequences, and haven’t acquired immunity to COVID-19? Who will take care of them? I wouldn’t bet the future of a country that way.
If that is the case then we are all screwed. I don’t care what country you live in. Well, maybe New Zealand will be OK.
The problem with taxing capital gains on primary residences, is that, at least in Canada, home ownership rates are around 67%. Which means that the current government implementing taxes might see themselves losing an election next time around. Home ownership rates also tend to be largest in smaller towns, where peoples’ votes count for more than they do in the big cities (due to voting seat distributions).
1) Many Canadians have been putting money into their homes expecting to use them as a form of retirement – i.e. there is a precedent of investing in one’s home and home repairs with the expectation that one will realize those gains upon retirement. People would lose trust in their government, deteriorating our currency. Note also that unlike the US, interest on your primary residence is not tax deductible precisely because primary residences have tax exemptions. If they were to implement capital gains taxes, and treat primary residences as financial instruments, then the government would also be obligated to provide tax deductions on the interest for said instruments (as is the case for financial instruments). Given that most homeowners pay double for their house in the form of interest payments – I’m not sure that the loss of income from income tax reductions due to mortgage interest payments would net a positive outcome for the country.
2) There is also the argument to be made that similar to stocks – homeowners can simply delay selling their houses for decades until the tax environment is more favorable. I think people are far more likely to sit on their properties for decades than they are likely to sit on company stocks. This may lead to a tighter housing market and more civil unrest.
3) Confidence in the housing market might also deteriorate – which can lead to the bankruptcy of cities like Toronto, which rely heavily on land transfer taxes and property taxes. Toronto is on the verge of bankruptcy already, much of it due to lack of property transfer taxes.
4) There are a number of knock-on economic effects that may see older aged people – close to retirement, lose a large part of their retirement funds, and end up relying on government handouts and OAS to support them in the future. Not sure if the government is going to want to support larger OAS and welfare handouts.
5) Not to mention the fact that pretty much all members of the most prominent political parties would probably not want their own houses taxed.
With 76% of Canada’s wealth wrapped up in real estate, I think we would see general outrage. But who knows!
All true, but the argument that the government can’t politically tax such a large population would be true of a sales tax or a middle class income tax too. The problem is the bill is too big to just go after the 1%. We’re all going to have to pay something. But, I’d argue, if my portfolio is going to get taxed more, your house shouldn’t be exempt.
like it or not, housing sits differently in the eyes of government and average people than an investment portfolio. one is considered an essential good for a decent quality of life while the other is seen more along the lines of speculative profiteering. doesn’t matter it doesn’t fit the reality, it just is and the politics and preferential treatment flows from that.
Sure – but then the government would have to retroactively provide income tax deductions for all interest paid on mortgages, if they are to be treated as a financial instruments currently are. And any capital additions to the houses would have to be accounted for as part of the cost base of the house, as happens with both financial instruments and rental properties. I’m an accountant and implementing this would be a nightmare, if at all possible, retroactively. I would argue the government is not interested in “fair,” they are interested in what brings the least friction to their voter base and may still accomplish their goals. The majority of Canadians hold most of their wealth in their primary residences, which means that the move would be a death blow to their popularity. Far fewer Canadians have most of their assets in equities, which would result in less loss of a voter base. I guess we’ll just have to wait and see!
One point to make for Canada is that interest on investments that *yield dividends* (or are reasonably expected to do so) is tax deductible. This is a really important detail because your primary residence is not paying a dividend, so taxing the capital gain on your house is not an argument in favour of interest deductibility.
In some cases (not all) dividends are tax deductible because taxes have already been paid in Canada by the corporations that issue them. Allowing end recipients to deduct them from taxes prevents double taxation. Dividends are not comparable to capital gains taxes. They are more akin to rent earned from owning property (dividends earned from owning shares), but the taxes have already been paid by the corporations, so no need to pay again when the recipient gets them.
To address your point more clearly. A financial investment does not need to yield dividends in order to have its interest deductible. One can absolutely borrow money to purchase shares of companies that never ever pay dividends and still deduct interest from them. Another very important point is that people tend to sit in their homes for longer than they turnover shares. There is an immediacy argument to be had, where homeowners simply don’t move and never pay capital gains taxes. This is already a problem in cities like Toronto, where aging baby boomers are not selling their houses, preventing younger people from buying into the market. Note that this article explicitly makes the argument that the government is unlikely to tax equities because people can choose to not sell them. This is even more of an argument for primary residences than it is for shares.
Wrong. Money borrowed for for financial assets that do not produce dividend (or interest) income and are never expected to is not tax deductible in Canada.
‘If you borrow to invest only in shares that don’t pay dividends and rely on capital gains to make money, the interest is not deductible.’
https://turbotax.intuit.ca/tips/is-interest-deductible-5459
‘However, if the only earnings your investment can produce are capital gains, you cannot claim the interest you paid ‘
https://www.canada.ca/en/revenue-agency/services/tax/individuals/topics/about-your-tax-return/tax-return/completing-a-tax-return/deductions-credits-expenses/line-22100-carrying-charges-interest-expenses.html
I think it’s an interesting question of how governments will make up in the future for these defecits but I also think this misses out the scenario of if the goverments hadn’t stepped in with stimulus during this crisis. Potentially the long term impact on government budgets would have been worse if we ended up with more businesses collapsing and higher long term unemployment. It’s worth giving them some credit and accepting that this is part of a governments responsibility and some rise in taxes was likely inevitable as a result of COVID. We can hope that we see a quick recovery.
On the subject at hand I think taxing consumption is probably the worst outcome in a period where we need to encourage economic activity.
Totally agree. World governments had to do something, or we’d all be in a much worse situation right now.
Federal Tax on Internet Sales: 5%
Federal Tax on Imported products 5%
Let the Trump Tax Cuts Expire.
The result would be environmentally and economically positive.
Buy local…
The national debts were never meant to be repaid – the govts only need to generate enough revenue to service the interest payments. Every few years there’s a big circus about raising the debt ceiling but it always gets passed and the can gets kicked further down the road until the Debt to GDP ratio rises above a point of no return.
This has happened every few decades throughout history. A debt jubilee is possible but devaluing the currency and inflating the debt away is more likely. That way bonds don’t *technically* default but the original purchasing power is gone. Ray Dalio wrote extensive about this in Great Debt Crises.
Oh and don’t forget there is always the possibility of more climate change / carbon taxes coming from our great virtue signalling PM.
Well, kicking the can down the road is not really a solution. These bills come due eventually…
Just print more money!
Jokes aside, in the US the next president and congress will have the honor tackling this mess. I see implementation of capital gains tax and corporate taxes.
What do you think about the possibility of out of control inflation with all the money being pumped into the economy?
I fear a repeat of the 70’s-early 80’s- very high interest rates/low market return combo.
I think stagflation is the most likely outcome.
They’re printing more money now, and it’s not causing hyper-inflation. There are too many deflationary factors right now.
Well, if you’re a Liberal you don’t have to pay it back. Remember – budgets balance themselves!
No one’s falling for this grant. Conservatives in US regularly rack up more deficits than Liberals.
Well those Predator drones don’t pay for themselves!
You forgot the most popular government strategy of all…print money! No one sees their rates go up at all, and the people on the right side of all these extra circulating dollars get a good deal, but the price of significant inflation gets paid by everyone, especially the consumer and bond holders.
Europe, Japan, & the U.S. had or were currently printing money even before Covid 19. Now, we’re all printing money in huge amounts AND issuing large amounts of debt. I don’t see how this can end well for any of us.
And yet stock markets just turned positive for the year. :shrug:
Hi,
Thanks for your article, I really like your blog and what you have achieved.
However for this post, I disagree with your statement about the French government and the fact that rich people would fly away if they were more taxed and the whole trickle-down theory.
There is a really good book about it called “le mythe de la théorie du ruissellement” (trickle-down theory myth) from A. Parienty (unfortunately I don’t know if it has been translated in English).
In that book the researcher shows that in reality french “rich” people were not leaving France because of taxation, and that even more of them came back to France during the heavy taxation period.
He also demonstrate that in the 80’s the US were having a better growth rate with higher taxes than nowadays which decorrelates the idea that less taxes will lead to more investment and more growth.
The book is really interesting and far much better than my little summary. He also speaks of a lot of other subjects like the tax competition in European countries and why the trickle-down theory has a myth status (despite knowing it doesn’t work in reality, everyone continues to give argument from this theory but in other context)
Thank you for reading me, and thanks for your blog and your workshop 🙂
Antoine
We need to recognize the true problem here. Greed. We are destroying our planet and more and more global catastrophes are going to occur (such as COVID-19) until we all admit what we are doing to this fragile planet we live on. We need to tax fossil fuels more to incentivize more renewables, we need to tax meat and beverages other than water and fast food to shift to a more whole foods plant based diet. Tax gasoline and gasoline based vehicles to lead to a shift to more EVs. Tax consumer products to lead to less waste and consumption. We need to increase the sin tax and other countries should be developing similar taxes on tobacco and alcohol. Everyone wants to bash taxes but taxes are how we can curb our crazy consumption problem and be more aware of how we are destroying our planet.
We wrote a blog post on this if you’re interested in reading
https://modernfimily.com/the-black-elephant/
That would require world governments to take the climate crisis with the seriousness we’re taking the pandemic. Annny day now…
We’re HUGELY good with the environment.
Thanks Wanderer for laying out the situation and options so well. I think in a way you’ve already answered the question. They’re going to print money to inflate the debt away. Inflation is a hidden tax on everyone, and given almost all the options you laid out that are easily doable (ie. increasing the GST back up 2% or increasing income tax) are politically unpalatable, it appears the choice will be inflation. Get ready for $20 Big Macs.
“Get ready for $20 Big Macs.”
Good thing McDonalds is part of VTI!
I honestly think that the most logical option is to start taxing capital gains on primary residences, this is something that should have been done a long time ago, well before the current financial crisis.
Favourable taxation on real estate plays a large role in the ever increasing real estate prices in Canada because the greater population sees their home as a financial investment. “Real estate always goes up” is what you tend to hear, but really this is just a product of decades of lowering interest rates and lower percentage down payment requirements, which just allow new home buyers to take on more debt, transferring wealth from one subset of the population to another. I’m a homeowner myself and I wouldn’t necessarily want to see the value of my home go down, but eventually there needs to be a correction in the housing market which will never happen if housing is treated as a retirement savings plan with a huge tax free payout when you sell. A tax like this is also the most fair option in my opinion, as it’s taxing wealth that people didn’t really earn, this may slightly depress home prices but that’ll help to correct the affordable housing crisis that exists in most Canadian cities. Many younger people have all but written off the idea of home ownership due to the huge increase of prices relative to incomes. Every other form of income is already taxed, why should real estate be exempt?
Exactly! Free-loading home owners…
if they’re as unfairly privileged as you claim, you should’ve just opted to partake. no sense crying foul on something you simply opted out of.
Well I clearly stated that I am a homeowner myself, so I didn’t opt out of anything. I’m simply taking an unbiased view of what I think is the most fair solution, and for some of the younger people in cities like Vancouver and Toronto it’s not a matter of opting out, they never had a chance to opt in.
long time, first time.
I think CRA is going to hire a bunch of auditors and audit the crap out of everyone’s 2019 and 2020 tax filings, and try and make up the money that way.
I think they should go after all the Toronto Airbnb hosts operating ghost hotels first. No WAY those guys are reporting their earnings properly…
The whole premise of this article is wrong. There is no need to repay that debt right now.
The government can borrow at the rate of inflation (a 10 year governement bond is at 1% today https://www.bankofcanada.ca/rates/interest-rates/canadian-bonds/).
At the current time, it is just best to keep the economy in good shape. The debt will also increase if people no longer have jobs and companies close and they no longer pay anything to the government.
Even more, Canada fiscal position was good, and even despite this 100% yearly deficit, the debt load remain incomparable to the one of the United States.
As others have pointed out, the main problem in modern economies is that inflation is too low. It slow the reallocation of ressources in the economy, limit the possibilities of the centrals banks to act and keep debt burdens generally high for everyone.
Sadly, low inflation and low interest rates seem to be here to stay, which ironically mean that governements can still deliver despites high debt load.
Please educate me: the government borrows money from Whom? and the interest of national debt goes to Whom?
I heard about the national finance is far different from finance for family or for business … the current massive government borrowing and spending, in fact, massive income distribution for now, requires massive income redistribution (by tax and inflation) in the future – who would gain? who would lose?
KevinD
“Please educate me: the government borrows money from Whom? and the interest of national debt goes to Whom?”
Each day the governments go on the market and do an auction to sell their new bonds at the best price they think they can get. From the perspective of the government, the lower the interest rate, the better for them.
Anybody can buy government bond, in practice though it is often pension funds, corporates funds (including your etfs) and the country central bank that buy those bonds.
The centrals banks use their bond buying as a way to fix interest rate in the economy at a level needed for the monetary policy they choose.
KevinD
“I heard about the national finance is far different from finance for family or for business …”
There are two main reason why government finance are different from those of a family:
1. Government are more akin to a company than an household. This mean that by borrowing and investing into your operations (or the economy in the case of the governement), you can get more income even if you have more debt. And often that spread between increase in debt and increase in income is really good.
2. Governments are macroeconomic actors. The government is the only actor in the economy that by changing it’s policy, it can change macroeconomic variable like inflation, GDP, unemployement and exchange rate. This mean that government policies can have a lot of impact on the economy and not only directs one, but also indirect one. For example, the current increase in spending aim to keep GDP high, maintain unemployement as low as possible and could possibly result in an increased in inflation.
KevinMD
“the current massive government borrowing and spending, in fact, massive income distribution for now, requires massive income redistribution (by tax and inflation) in the future – who would gain? who would lose?”
This is the big question that everybody would like to have the definitive answer to. And not only that, but the response to this question can be quite political.
What could be said right now, is that usually an inflation of 2-3% is considered good enough by most economists to “grease” an economy. More than that and you will have trouble with price signals to allocate ressources and investment in your economy (i.e. Venezuela). Less than that, your central bank no longer have any room to lower interest rate in case of an economic meltdown and your economy can be stuck in the ditch for years (the Euro during the greek crisis).
The actual problem modern western economies seems to have right now is that inflation seem to be stuck in the 0% range and this despite centrals banks printing truckloads of money. There is still no consensus between economist as to the why , but the consequence are that government need to do deficits to keep the economy going because centrals banks monetary stimulus seems to be ineffective.
Thanks, AP, for the detailed reply.
I have a doubt that the government could borrow that much of money from Bond Market in such a short period of time. The central bank sets the interest rate, which decides the bond yield rate, at the same time, the central bank is buying huge amount of Government Bond – this has two effects: first, keep the interest rate low; second, Government spends the money created by the central bank – owing interest on the book. In this case, the Real Savers are losing in the game.
I also doubt the accuracy of inflation rate, I’d rather look at the cost of living, no doubt it’s rising sharply in the last few years, especially in Vancouver, Toronto – just look at the inflated house prices.
This is a massive wealth transfer and who would and should shoulder this? This blog has some suggestions – I suppose we have to wait and see.
Well just to be sure we are on the same page,
1. The central bank determine for example that a 1% rate is the good one for the economy.
2. The central bank buy government bond until the auction process of the government make the interest rate fall to 1% and use the overnight lending rate between commercial banks to make the private interest rate to follow.
The central bank doesn’t make a rate happens magically, it has to do market movement to get the market to that rate.
But yes your point about interest rate and savers is valid. Now that the bank of Canada is buying bonds of canadian corporations, being a stock holders is more interesting than just being a “saver”. By owning stocks, you are now under “the tap” of the central bank. It is, in my opinion, the reason that the Price to earning ratio seems really high since the 2008 crisis. Earnings hasn’t change that much, but the price have changed since companies have more liquidity than before.
I must admit not living in Vancouver or Toronto, but the inflation told by statisticals agencies seem coherent with what I see in my own expense. And those numbers seem decent enough approximation about the whole country to lead overall policy. But I agree that in these two place, the inflation is probably higher that the average one of the country.
Here is another way to think about government debt, that it isn’t actually debt (from the BBC website): https://www.bbc.com/reel/video/p08jbbry/why-we-need-to-debunk-the-deficit-myth-
Quite an interesting way to look at it, I thought.
Thanks, Tarjei. That’s indeed a highly informative video.
Canada will start warming up more to Modern Monetary Theory (MMT). I’m not an expert, but I started reading Stephanie Kelton’s “The Deficit Myth” and it’s very eye-opening. The basic idea is that debt doesn’t matter as much as debt/GDP ratio, inflation, and the availability of resources to satisfy human needs.
$343+ billion debt sounds huge, but absolute debt isn’t insightful without relating it to GDP. Canada’s net gov debt/GDP was around 40% in Q1 2020. It used to be much higher in Q1 1990…closer to 60%. Of course with GDP suffering from the shutdowns, this ratio will likely shoot higher now.
https://www150.statcan.gc.ca/t1/tbl1/en/tv.action?pid=3810023701
How about Japan’s infamously high net gov debt/GDP? 154% last year, yet it’s inflation rates have practically stayed below 3% for the past 36 years. Seems to refute conventional wisdom, doesn’t it?
https://www.statista.com/statistics/270095/inflation-rate-in-japan
Most developed countries have been struggling with deflation, rather than inflation. Deflation is especially toxic, because it can make debt (both gov and personal) grow uncontrollably bigger. Inflation at least reduces the value of debt over time.
Another interesting point from the book is that society views federal taxation the wrong way. Since Canada can print its own money, the federal government doesn’t need your tax money to fund public programs (provincial/state and municipal govs do because they don’t have money printers). Rather, taxation functions as a deflationary lever to keep inflation in check, and to prevent the over-concentration of wealth (which is bad for the economy because impoverished consumers can’t support businesses, not to mention it’s really bad for mental and physical health). In this model, the government is the provider of currency, not taxpayers.
So accounting for all the deflationary pressures we face (aging population, weak job creation, offshoring of jobs, low wages, etc.), I think the answer will be to keep materializing cheap debt to support people’s basic needs (CERB transforming into UBI anyone?) while increasing inflation, which is something many governments have been struggling to do anyway.
As an aside, if you’re still worried about hyperinflation in the future (possible if governments are incompetent at implementing MMT), I think it’s prudent to hold some gold/precious metals equities and commodities in your portfolio. According to William Bernstein’s “Rational Expectations”, equities tend to suffer initially from unexpected sudden inflation, but quickly pick up the slack thereafter as inflation rates stabilize (even if they stay high). Cash and bonds obviously suffer the most. If you are thinking of using real-return bonds, their ability to compensate enough for high inflation is poor relative to gold/PME and commodities.
https://www.schroders.com/en/sysglobalassets/staticfiles/schroders/sites/americas/canada/documents/investment-perspective-what-are-the-inflation-beating-asset-classes.pdf
In researching this article, I stumbled onto the idea of Modern Monetary Theory. It’s a fascinating idea that I don’t quite understand yet, but thanks for all the resources you’ve linked!
I would suggest making sure to read many of the numerous critics of MMT… because as much as people wish it to be some silver bullet to Ponies4All, it is still very much a fringe (mostly absurd) notion to actual economists of note.
In the U.S. , they can federally legalize cannabis, and enjoy the windfall from legal taxable sales.
In Canada, they merely have to make it easier and more practical for customers to shop legally. Less regulations in pricing, distribution, and availability, etc.
Tax revenue from pot, like the revenue from cigarettes, is trivial and is akin to cutting the Cable TV bill as a financial solution to losing your job. Sure, it’s better than nothing, but not even close as a real solution.
Yes, but then everyone would be smoking pot and no longer worry about their taxes going up.
Sounds like a winning idea to me!
I think the Moose should take offence.
Read an article today where the Nashville, TN area is planning for a 34% increase in property tax.
Moose don’t get offended. They are very professional moose.
And also, the property tax increase is stupid. Property taxes are municipal, yet the debt is federal!
Carbon taxes are the answer for governments. It’s the easiest tax to sell to the gullible masses. Think of the children!!! Works every time.
That’s what I was thinking, too. And it’s the perfect ‘solution’ because they’ll want to implement them globally, so that no one will be able to avoid them.
Hm. As some earlier commenters already pointed out, there’s a crucial bit missing in your article: how the current extra government spending is financed. The Dutch government can currently borrow money at negative interest rates. In other words: my country gets paid money for borrowing. The total interest payments due on our national debt are still falling, even though we are borrowing a lot of extra money, just like Canada and the US are doing. Before COVID-19 hit, political discussion in the Netherlands was about setting up a national investment fund based on borrowing a lot of cheap / free money, in order to do things like upgrade infrastructure or our education system. A lot of commenters seem to think that governments have a lot more of control over their economies than they actually have. Inflation isn’t a policy you can just choose and implement – and doesn’t always happen when you print a lot of money, as the last 10 years have proven in pretty much all Western economies. Also, you shouldn’t just look at the total amount of debt. More relevant is total debt in relation to GNP, i.e. debt as a percentage of national income. By that measure Canada has more to worry about than the USA – or the Netherlands, for that matter. Canada, like the Netherlands, is AAA-rated and can probably also still borrow at low interest rates, but would run into problems sooner if interest rates were to rise, due to the high endebtedness (debt as percentage of GNP). So it would be interesting to check whether and how the Canadian government is hedging against this risk.
You are right that the real measure to look at is federal debt-to-GDP, which right now in Canada is at 34%. That’s not good, but it’s about where we were after WW2.
The US number is 107%, which is…interesting.
Nope. It’s now 49%. And the real measure is Federal plus provincial debt which is close to 100%.
I personnaly like the OECD stats since they add all the public debt of the countries in their numbers.
https://stats.oecd.org/Index.aspx?DataSetCode=QASA_TABLE7PSD
Before the spending binge for Q4-2019
Canada : 108.4%
US : 135.3%
Honestly, I think it’s too little too late for the U.S. I really think our economy, and that of many other countries is going to go to hell in a handbasket and that this will make the Great Depression of the 1930s look like a cakewalk.
When governments run up huge debts while simultaneously running the printing presses at full speed, economic disaster results. Has there even been a time in history when this hasn’t been the result? I don’t think so. This time isn’t different, despite what we’re being told.
Nothing in the article mentions anything about making our economies more competitive again so that they can grow faster. That helps tax revenue more than anything.
In America, if we actually started eating healthy foods again and had policies to promote it, our health care costs would drop by half and people would be healthier, too (not that I’m holding my breath that it will happen).
Yeah, of course this article doesn’t mention anything about eating healthier foods as a way to pay back the stimulus checks. Because that is a…tenuous link at best.
It’s not a tenuous link. 50% of America’s health care costs are publicly funded. 70% of the diseases we have are chronic diseases that can be prevented with diet. 68% of America’s population is overweight or obese. There’s huge cost savings potential there for the government and individuals. Of course, it won’t happen because most people aren’t connecting those dots and think it’s a ‘tenuous link’.
Oh, and I forgot to add America spends about $1 Trillion a year on health care for treating diseases that are largely preventable–and that’s an old statistic from around 2011.
This pandemic proved that no amount of money is too much to be printed out of thin air. Trillion dollar stimulas? No prob! Fed, light up the printer!
I say let’s print our way out of this mess.
I’m obviously joking but unfortunately, the fed is not 😉
I should really find out which company is supplying the ink to the US Fed. They are probably making a KILLING!
How about a very small tax on each sale of stock? It would have the additional benefit of (potentially) reducing high frequency trading.
Finally, an issue we can all agree on. Screw those high frequency traders!
As long as governments can print unlimited amounts of money with no repercussions, I’m just not seeing them doing much of anything. Raising taxes is unpopular and politicians will avoid doing it at all costs. Is it possible that a small token tax increase on the rich could happen? Yes, that’s possible. But, nothing more than that. At some point interest rates will rise and governments will be forced to raise taxes and cut spending at the same time. And that will be an ugly decade for the world’s economies. Now, is that next year or five years from now? Nobody knows.
My comment is for Canada:
1. Definitely cap the principal residence tax exemption to something like $500K like the US. The fact they haven’t is a severe penalty against those who rent and save/invest responsibly as opposed to over-extending upto 10x household income on a single asset as you see often in places like Toronto and Vancouver. Those who don’t have the principal residence tax exemptions have much smaller tax shelters compared with those who do. That’s flat out unfair when you think about how much the government has been pumping residential real estate and bailing out homeowners.
2. Increase property taxes. Larger cities like Toronto have astonishingly low property tax rates compared to their immediate neighbors. On a municipal level this will cover a huge cost of the stimulus.
Unfortunately Wanderer the issue of raising taxes is not so vanilla and way more political. Despite what the government SHOULD do for the financial health of the country, they will not. They will most likely do what will negatively impact their voter demographic the least: create some form of wealth tax to target the top 1% (this usually has no affect) and when that fails, raise income taxes on the upper middle class (the top 20% of income earning individuals who bring in 80% of the tax revenue). Taxing the professional class is the perfect strategy, income taxes on that bracket are basically inescapable, they don’t make up enough of the electorate to be a difference maker during elections, and the government gets it’s “poster boy” for its “eat the rich” policy.
It will have to be a combination of things.
Monetizing the debt with inflation as many have mentioned is one way.
We may have to consider a structured VAT (nothing on necessities like food, most clothing, and shelter) being progressively higher on more luxury goods and assets.
Increase the tax on short-term capital gains (less than a year) somewhat. Add a tiny financial transaction tax that hits companies that make thousands of trades a day.
Decrease tax deductions greatly. This is taken advantage of by wealthy individuals and corporations that influence laws and the tax codes. Possibly go to a progressive flat-tax structure with minimal deductions.
Corporate tax breaks should be more determined by their job creation so they don’t just hoard the tax breaks, move to lower-taxed countries, and do share buybacks. Otherwise pay up!
The headline is slightly misleading – it implies how will the cost of the government debt be paid. However the post talks about possible tax increase.
While related those two things are not the same. First, the disaster relief is working. Second, the government finances and personal finance are similar but not the same. (Because the government literally creates money, and I haven’t figured out how to do that yet).
To cover these cost the first thing to remember is that gov. debt is essentially free money right now. Interest rates are close to zero and negative in some countries. Second is that gov spending can change. However, in most cases the return on investment is such that for the covid 19 disaster relief funds we (us) should print as much money as necessary to overcome the pandemic.
Nytimes reported that defense spending in WWII was 30 percent of gdp. And interest rates were not zero percent then. The equivalent now would be something like spending 10 trillion dollars in the us. So we’ve got room to spend more.
I know as FIRE and aspiring FIRE ppl we are worried about taxes that could affect our financial plans – however living in a world ravaged by covid -19 is untenable and it is very penny wise pound foolish to just worry about having to pay for the remedy.
Put another way – in this cost benefit analysis let’s focus on the benefits — folks having a place to shelter , food on their plates, businesses that can remain open regardless of profit , and the prevention of a Great Depression – with the costs which sound big and scary – trillions of dollars.
What about lowering the RMD age for pre-tax retirement accounts? There are obviously a lot of factors that play into this such as what age do you lower it to, how much do people have saved in pre-tax retirement accounts (likely not too much based on history…), how many people would this lower age capture, how much tax would that generate, and probably others I’m not thinking of, but it could be used to offset other taxes that might need to be implemented.
Maybe I don’t properly understand the nuances of how debt works on the government level. But I think that the US government will most likely just roll it into our total debt and sell it off to China, Japan, and any other countries that want to purchase our debt. Since we are a country that runs on deficit spending whats 3 trillion more dollars in the long run. Fiat currencies suck in my opinion but that’s what we have so we will continue to raise our debt until we restructure it like Mexico did in the mid 90’s so we don’t walk around with 1,000 bills in our pockets like Japan.
Historically, at least within the US, our solution has been to simply grow and inflate out of our deficit spending. I’m not sure how well that’ll work in the very long term, though.
That said, the idea is that over time, as the economy grows to a larger and larger GDP, the debt represents a smaller relative comparison to GDP. That makes it easier for the country to make payments on the debt interest as tax income goes up with GDP growth, generally.
At least right now, interest rates are crazy low, which further incentivizes deficit spending. The interest load on that debt isn’t a big problem, yet.
I don’t know what will happen a decade from now, but I can imagine that one way or another economists will be looking back with strong opinions about our deficit spending today.
Why didn’t you right-wing, trickle downers post when Trump passed his unnecessary tax breaks for the wealthy? We didn’t even need them. We were in the midst of an economic boom.
“Because they were supposed to pay for themselves…” Which they never do and didn’t this time. All they did was give a little bit to the average American and a lot to corporations.
Now that people need the money (to eat, pay their rent, keep their businesses afloat), you become so worried about ‘how are we going to pay for this?”
When you put more money in the hands of the poor and middle class, they spend it. This stimulates the economy.
When you put more money in the hands of the rich, they speculate. This creates crashes like 2008.
What’s my answer? Raise taxes on the wealthy and corporations. Reduce spending on the military. Nationalize healthcare. Raise taxes on dividends and capital gains.
what these kind of ideas lack is an understanding that things don’t remain static and the policy changes themselves alters the amount of money at play. you tax more on the wealthy and corporations, they’ll simply leave for friendlier tax jurisdictions leaving you with even less in the end.
Yep, higher taxes and probably higher levels of inflation. *shrug* I guess it’s better than the world going back to barbarism.
I think it’s time for homeowners to pay their “fair share”.
In the US, homeowners have been subsidized forever… they are generally the wealthiest segment of the population, they terrorize local zoning laws to limit development and protect their “investment” and pushing rents in major cities to the stratosphere for the past two decades, which particularly impacts the poor and people trying to get access to high-productivity jobs. We subsidize wealthy homes far more than renters… see “Dream Hoarders”
It’s also time to take a look at our actual spending. The US budget is out of control and it is immoral for that to be passed on to future generations. We don’t get good ROI on what we are spending. Of the trillions spent on COVID only ~8% is actually being put on the disease – https://www.politico.com/news/agenda/2020/07/10/if-you-want-to-save-the-economy-stop-the-pandemic-355383
Overall, taxing investments are bad. It discourages savings, and inhibits developing the next big things that make our lives better and better overall. We should be getting more people into the stock market, not the even more inflated housing market. We shouldn’t be punishing renters.
We should take a hard look at defense spending, as well as entitlement programs. Maybe replace welfare with UBI and gut a huge administrative apparatus and make government lean again, leaving money more in private hands and crowding out private initiatives less.
I’m sure none of this will come to pass, and we’ll just keep building the debt up and throwing money into an inefficient money fire… our politicians are toothless and captive. One of the few good things that came out of the 2017 tax bill in the US was capping things like SALT and the mortgage interest deduction, and the so called “party of the poor people” mysteriously want to restore it so rich homeowners can be subsidized by the US government while saying they are for taxing the wealthy more: https://www.cnbc.com/2020/05/12/house-democrats-stimulus-bill-rolls-back-10000-salt-cap-for-2-years.html
Both parties in the US have no desire to take any of this seriously because their geriatric butts will be dead and gone by the time it hits the young. 😐
Economic aid packages help people and businesses. The cures & vaccines for the coronavirus will help everyone in the future, so that workers can return to work, students can return to school, and travelers can continue their nomadic lifestyle. Economic aid packages, the cures and vaccines are not free. Everyone will benefit from them directly or indirectly. Everyone must pay for it. If we have our health, then we can make money, work, study, pursue our dreams, etc. It would be a privilege to survive the pandemic and to help pay for the cost of this survival. The worry is not how much we have to pay back, the worry is whether we live through this event. And then, when it’s time to pay back, raising income tax seems a predictable choice. Once our health is out of danger, then we work more and produce more Gross Domestic Products . Increased GDP help reduce debts.
I guess it will be a combination of taxes. Slightly higher sales tax (difficult to avoid), higher income tax (difficult to avoid), payroll tax, higher corporate tax, capital gains tax and dividend tax. Small hikes to all of these will be unpopular but doable. Wealth tax will not happen. Only in Norway where the enviousness of the rich is stronger than the economic sense. This way everyone takes a little hit. But most of all I expect most of it to not be repaid, but just added on to national debt. The young generation sacrificed jobs, their pension and future to save the 1968 generation. They could pay it all back by lowering their current pension benefits. That will not happen. So the 68’ers were saved and their money was saved. Millennials pay for it all — again.
Somebody will always be upset about what gets taxed. Individual states will have to find some sort of tax revenue because their coffers are empty. My idea is to dial back the military, starting with Afghanistan. Next up, religion. No tax deductions for anything religion, basically nothing is tax free. (it’s also a good way to find out who the true believers are). Ok, start the flames.