The economy would be better served by tax relief than more government spending.

(Co-authored by Charles Lammam.)

With Parliament shut down until March 3, the federal government is making noises about "recalibrating" its economic agenda. It's also clear the government plans to "stay the course" and roll out more of its stimulus plan "into early 2011."

The government is also going through the motions of holding pre-budget consultations, soliciting Canadians’ views on how best to fully reinvigorate the economy.

Specifically, Ottawa is asking four questions, almost all of which seem pre-determined to generate answers in support of plowing more tax dollars into a variety of projects in the name of economic "stimulus." Here's our response to its questions:

To what extent has Canada's Economic Action Plan been effective in stimulating activity?

Very little. Canadian GDP estimates for 2009 by Statistics Canada show that government spending at all levels increased by 2.2 per cent compared to 3.7 per cent in 2008. Increases in government capital investments are estimated to have slowed, to 10.1 per cent in 2009 compared to 12.2 per cent in 2008, hardly what one would call stimulus spending.

With 40 per cent of the total federal stimulus package being devoted to infrastructure projects, most of this money will not be spent until well into this year. The risk for 2010 is that a large portion of government stimulus spending (particularly infrastructure spending) will hit the economy as it naturally moves out of recession. As a result, the government will compete with the private sector for scarce resources resulting in increased costs and fewer private sector projects than would otherwise be the case.

The government will of course point to sector-specific spending (auto bailouts) and tax breaks (home renovation tax credit), claiming these had an impact in the targeted areas of the economy. But increased activity in these sectors comes at the expense of decreased activity in others. The end result: increased redistribution, rather than increased economic activity.

What suggestions do you have for improving the effectiveness of the government's stimulus measures or the speed of their delivery?

Stimulus spending fails while tax relief works. A recent study, What are the Effects of Fiscal Policy Shocks?, by economists Andrew Mountford and Harald Uhlig, assessed and compared the economic impact of various cases of deficit-financed spending, deficit-financed tax cuts, and tax-financed spending in the United States from 1955 to 2000. The authors found that deficit-financed tax cuts are the best form of fiscal policy to stimulate the economy. And perhaps more importantly for the Canadian government, Mountford and Uhlig found that both deficit-financed and tax-financed spending do not stimulate the economy; instead they actually discourage private investment.

One of the major problems with the federal government's $47.2-billion Economic Action Plan is that only 13 per cent was dedicated to tax relief.

What steps should the Government take to improve the competitiveness of the Canadian economy and ensure that Canada continues to attract investment and create jobs once the recovery is achieved and the Economic Action Plan is wound down?

First, the current Economic Action Plan needs to be wound down immediately in order to create the fiscal room needed to refocus on improving Canada's ability to attract investment and create jobs.

The key to improving Canada's competitiveness is to focus on tax-relief that improves the incentives for Canadians to work, save, invest and be entrepreneurial. Of particular concern are Canada's high marginal personal income tax rates on middle and upper income Canadians that apply at relatively low levels of income. For instance, Canada maintains among the highest marginal personal income tax rates on middle and upper income earners among the G7 countries.

Over what time period should the government bring the budget back into balance?

The faster, the better. Once the government gets its fiscal house back in order, it can implement a multi-year plan for tax relief. A prudent and realistic plan would eliminate the deficit by 2011/12.

Fortunately, the current government has a precedent. The austerity reforms initiated by former Prime Minister Jean Chretien and then Finance Minister Paul Martin during the 1990s balanced the budget within three years. And the deficit they faced (4.8 per cent of GDP) was larger than the current deficit (3.7 per cent of GDP).

While Finance Minister Jim Flaherty has hinted about the possibility of austere measures, he indicated that some areas of spending, including federal transfers to individuals (i. e. elderly and disabled) and other levels of government, will be protected from cuts. Thankfully, however, tax increases are apparently off the table.

Even if federal transfers are left untouched and taxes are not increased, there is still approximately $117.2-billion in direct program spending a year that could be pared back. Eliminating the scheduled $11.4-billion in EAP spending in 2010/11 and 2011/12 and reducing direct program spending by 8 per cent in each of these years would result in a balanced budget by 2011/12.

The Conservative government claims it's committed to "staying the course" on its original plan. Let's hope Harper reconsiders.