Cutting our way into a recession

October 9, 2001

BC's economy has been hit hard in recent months by numerous events outside the province's borders: the US trade actions on softwood lumber; a global economy grinding to a halt; and the economic aftermath of September 11. These factors are affecting BC exporters, weakening consumer confidence, and driving up unemployment rates. Yet the provincial government has committed itself to deep spending cuts that will only make this situation worse, and that could push the BC economy into a full-blown recession.

Having set the stage with dramatic tax cuts earlier this year, the provincial government is now contemplating massive spending cuts on the order of 35% for ministries outside of health care and education. This is a far cry from the mantra that British Columbians heard before and during the election campaign--that tax cuts would pay for themselves.

The tax cuts have had little economic impact so far: retail sales in BC dropped in July (the first month after the tax cuts were announced) for the first time since 1998. Surveys suggest that most British Columbians are more concerned about paying down debt, not spending, with their tax cut.

Even when tax cuts are spent, most of the benefit "leaks" out of BC to other provinces. This is because many of the goods and services that British Columbians consume are produced elsewhere. Our Centre has calculated that Ontario receives a full 31% of the economic benefit from BC's tax cuts, only a bit less than the 35% that stays in BC.

Times have changed a great deal since the new government came to power in a wave of tax-cutting euphoria. The global economic picture is now worse than BC's Finance Minister believed possible only months ago. Even prior to the September 11 tragedy, the US economy was slowing in spite of several interest rate cuts, taking Canada along for the downward ride.

The full consequences of September 11 for BC's economy have yet to be fully understood. But the early signs--long waits at border crossings, the drying up of tourism, an airline industry in shambles--do not look particularly auspicious for BC businesses, especially small ones that are more vulnerable to short-term shocks. With attention diverted to more pressing matters, there also seems to be little likelihood of a new deal with the US on softwood lumber any time soon.

In the face of this economic backdrop, now is the worst possible time to undertake radical spending cuts to the public sector. According to an economic model provided to the CCPA by forecasting firm Informetrica, $1 billion in spending cuts next year would more than offset the mild boost from the tax cuts, leading to decreases in GDP and employment. More radical spending cuts equivalent to the combined personal and corporate tax cuts of $2.1 billion would drop BC's GDP by $870 million, and eliminate over 14,000 jobs, even after accounting for the small boost from the tax cuts. In other words, deep spending cuts could tip the scale from slowdown to recession.

The government's charge to slash spending in order to meet an entirely abitrary target of balancing the budget by 2004 must take a back seat to the realities of the economic situation. It is entirely appropriate that the government run a deficit when facing a weak economy. BC is fortunate to have a low level of provincial debt-to-GDP, which gives the province room to maneuvre in the face of the slowdown.

BC is an outlier in North America--even the Bush administration in the US is planning to increase spending in a bid to boost the economy. Our BC model suggests that if BC were to roll back the planned 2002 tax cuts, and the surprise tax cuts for the affluent in 2001, while putting this same money into new spending, it would have almost double the economic impact of the tax cuts alone. Such an economic stimulus package would create 16,000 jobs and boost GDP by about $1 billion.

Given the reality of global events, no one should fault the government for thoughtfully rethinking its economic strategy. In its short time in office, the government has undertaken a radical experiment. It is time that the government come clean about the results of that experiment and change direction before more people pay the price.