Tax cuts won’t grow the economy if Canadians are too scared to spend

The government’s middle-class tax cuts aren’t stoking growth, since heavily indebted consumers use windfalls to save or pay down debt

Shopper pushing a stroller through a Nordstrom department store in Vancouver

Child bonuses from the federal government in 2015 appear to have been saved, not spent. (Ben Nelms/Bloomberg/Getty)

Finally, the Bank of Canada’s forecasting department, which saw bad things coming back in January 2015 before anyone else, got one wrong. The central bank predicted Canada’s economy would stall in the fourth quarter. In fact, gross domestic product increased 0.2% from the third quarter. Hooray.

Statistics Canada closed the books on a lousy year March 1 with its report on fourth-quarter GDP. The economy grew 1.2%—the weakest outside a recession since the early 1990s. The disintegration of investment in nonresidential structures and machinery and equipment subtracted almost a full percentage point from GDP; only 2009 and 1982 were worse in that regard, and neither of those years stand out as high points in Canada’s economic history. Exports of goods and services declined in the fourth quarter, tarnishing somewhat the 2.6% surge in the third quarter that had generated excitement.

Modestly stronger growth than the Bank of Canada had expected should be reason enough for policy makers to leave their benchmark interest rate unchanged when they conclude their latest deliberations next week. Governor Stephen Poloz attended a Group of 20 meeting in Shanghai on the weekend at which he and his counterparts decided the global economy is in better shape than volatile financial markets imply. That suggests Canada’s central bank will look past a rocky start to the year. The drop in exports will be a concern, but probably not enough to prompt an interest-rate cut ahead of Finance Minister Bill Morneau’s first budget on March 22. Prime Minister Justin Trudeau and his top economic official maintain they will go big on infrastructure and sops to the middle class. Poloz made clear at his last policy announcement in January that he wanted to assess the makeup of Trudeau’s deficit-spending program before deciding whether more monetary stimulus is needed.

Morneau was at the G20 meeting too. He was “encouraged” by the support he received from others about his plan for “Canada’s new path to strengthen the middle class and grow the economy,” according to the press release Finance published at the end of the event. The G20 agreed that it was time for the fiscal authorities to take the baton from the central banks. Morneau would have been one of the few at the table who could credibly back up those words. The challenge will be getting the most out of whatever money he and the prime minister decide to borrow. They may confront some difficult choices because their emphasis on the middle class—the focus of virtually every piece of propaganda released by the Trudeau government—may not be the most effective way to “grow” the economy.

One of the first things Morneau did as finance minister was keep Trudeau’s election promise to reduce the 22% tax rate to 20.5%. The government says the change will leave singles who in that tax bracket with an extra $330, while couples will gain an average of $540 every year.

Theoretically, that cash will find its way back into the economy. Unless beneficiaries choose to sit on it. StatsCan’s fourth-quarter figures showed that household disposable income increased 3.9% in 2015, faster than the 3% pace of the previous year. The gain from 2014 was helped by the $3 billion former prime minister Stephen Harper rained on Canadians through his pre-election boost to the universal child benefit. Harper advertised the policy as economic stimulus. Yet Canadians didn’t spend it, or at least not all of it. “We don’t know how much they spent, but we can tell some people saved the money,” Poloz said at a press conference last month. “They certainly didn’t spend it the day they got the cheques.”

As everyone knows by now, Canadian households are carrying record debt burdens. And when households begin to worry about their financial security, they tend to reduce spending and focus on paying off debt. Canada’s savings rate rose to 4.4% from 4.2% in 2014, according to StatsCan, and household spending declined. There’s little reason to think that trend will change as long as the economy is weak and debt is high. That means Morneau must focus his spending on infrastructure, which the International Monetary Fund, the Bank of Canada and others say provides the greatest economic benefit. The best way to “strengthen” the middle class is to create jobs. There’s reason to doubt tax cuts will accomplish that.