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Time for a Paradigm Shift
Dateline: October 2006
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Tax and spend! Tax and spend! That has been the mantra for governments since time immemorial. Even the Bible mentions taxes - render unto Caesar! Caesar taxes. Caesar spends. No wonder then that today we continue to look on government as an agency that taxes and spends. Most people even think this is normal and can't conceive of any other way of financing government.
True, some have revolted against taxes. Lady Godiva. The noblemen who fought for the Magna Carta. The Boston Tea Party. But these revolts have been against oppressive taxation, unfair taxation, or taxation without representation. None were revolts against the idea of taxes themselves. Heck, we need government. Government needs to be financed. Ergo, we need taxes.
Although the anarchists among us might dispute whether we even need government, let's take as a given that we do, in fact, need it. And let's take as a given that government needs to be financed. Does it follow that we need taxes? The old paradigm says yes! But what if we looked at it a different way? What if we approached the financing of government the way an individual looks at financing his retirement?
Ah! Now there's a paradigm shift! An individual does not continue working throughout his whole life. He plans for a time when he will leave the workforce to enjoy his senior years in leisure. He still needs to eat. He still needs shelter. He still needs to get around. He still needs to spend. That does not change although seniors often have lower expenditures.
All during his working life, the individual's mantra was earn and spend, earn and spend just as the government's is tax and spend, tax and spend. But the individual knows he must plan for retirement, so along with earn and spend, he takes a portion of his earnings to save and invest. After 40-50 years of working, if he has been wise and frugal and followed a well thought out savings and investment plan, he will have built up a nest egg that will generate an income to live on. And if he has been very wise, he will be able to live out his senior years in great comfort, enjoying trips, dinners out, evenings at the theatre and so on.
Right now Canada is blessed in that our government is running a substantial surplus. What if government followed the same plan as an individual? What if government saved that money and invested it? What if the government built up a nest egg over time large enough to generate enough income to cover the cost of the government itself?
By my calculations, the government could achieve that goal in under fifty years. In just two generations the government of Canada could abolish the personal income tax forever! From there it could move to eventually eliminate all taxes.
Here are the facts:
Canada has run a surplus since 1998 after years of profligate spending. These surpluses have varied year to year but for fiscal 2006, Canada ran its largest surplus ever, over $13 billion. The government is directing the entire sum to retiring the accumulated debt, which is not a bad thing. But here is a better idea.
Why not take some of the surplus and put it into savings and invest it? Why not build up a nest egg large enough that the entire cost of government can be funded out of investment income?
Government funding out of investment income? Not as outlandish an idea as it may seem. Since 1989 (the earliest year for which Statistics Canada has downloadable government fiscal information), investment income has been prominent in the government's accounts. The lowest figure is $4,536 million in 1997. The highest has been $7,485 million in 2003. The average has been $6,001 million and change.
The $5,523 million of investment income in 1989 accounted for 4.94% of all government revenues. The $6,613 million of investment income for 2006 accounted for just 2.88% of all government revenues as the total revenues more than doubled in those 18 years while the investment income remained relatively unchanged.
If the government commits to re-investing just the approximately $6 billion of investment income into further investments, compounding growth over time, the government will eventually be able to be self-financing. This is especially so since the government doesn't eventually cease to exist so its time horizon for saving and investing is unlimited whereas individuals have a time horizon of 45 to 50 years.
The table below shows the government's revenues, revenue from all income taxes, revenue from personal income taxes, revenue from investment income, expenditures and surpluses since 1998. Click to link to see the data for all the years from 1989 to 2006.
The growth in government expenditures from 1989 to 2006 averaged 2.72% a year. From 1989 to 2006 it grew at an average of 3.55% a year. The longer time period included years where the government actually managed to cut expenditures - 1994, 1997 and 1998.
Let's assume that the average increase in government expenditure since 1998 represents a correct assessment of the likely future growth of government expenditures from both inflation and organic growth due to population growth and net immigration.
Let's consider several goals starting with the elimination of the personal income tax. The personal income tax as a percentage of government revenue in 2006 was 46.04%. Let's assume that personal income taxes will continue to contribute the same percentage to revenues until our nest egg is able to take over fully as a replacement for this revenue.
The table below shows how long it would take to build up a nest egg sufficient to do that for various parameters. Explanation of the columns is as follows:
This table has been truncated. Click for a complete 75 year version.
As our parameters, we are considering four different rates of return on our investment while the nest egg is growing and three different lower rates of return once the target nest egg has been achieved (assuming the government, like retiring seniors, moves into more conservative investments at this point.)
The rates of return for the growing nest egg are 10%, 12%, 15% and 20%. The rates of return after switching to a more conservative style is varied between 6%, 8% and 10%.
In the table above, the yellow bars represent the 10% return after switching to a conservative style option. The green bars represent the 8% return and the blue bar represents the 6% return.
With a 20% growth portfolio, the required nest egg to eliminate personal income tax based on a 10% return after target is reached is 24 years. With the 15% portfolio, the target is reached at 31 years. With the 12% growth portfolio it's reached after 38 years and with the 10% growth portfolio, the target is reached after 47 years.
Assuming the worst scenario...the 10% growth portfolio to achieve the target and a reversion to a conservative 6% growth after the target is reached, it would take 55 years to reach the point where the government of Canada could effectively eliminate personal income tax.
A possible and perhaps probable outcome is somewhere between the best and worst scenarios here, namely a return of 12% while growing and a reversion to 8% growth once the target is achieved. That would take 41 years.
Eliminating personal income tax within two generations is achievable.
What would this nest egg be invested in?
Lest these rates be considered unrealistic, consider the following:
Of Canada's 6769 mutual funds, only two had a 15 year track record average of 20% or better. There was only one that did better than 20% average over a ten year period. But there were 84 over a five year period. Looking at the other parameters, the table below tells the story:
Although the number of funds that manage to deliver the returns we are looking for is small, the closer in the time frame, the larger the number of funds meeting those targets. For example, the number of mutual funds making 10% or better returns in the last year is 1544, just under a quarter of all funds. Remember too that the funds in our table weathered the severe market downturn of 2000-2002 and still showed these solid results.
If the government chooses to invest in funds with an average of 15% return in each of the one year, three year and five year time frames, switching as the qualifying funds change, they could easily average between 15% and 20% a year return. By showing such returns in each of those time frames, the respective fund managers show, not only talent, but consistency.
Perhaps an even better route would be for the government to form an administrative board for its nest egg comprised of the lead investment managers for each of the qualifying funds. Or it could form a panel of expert advisors based on the longer term best performing funds.
And there is no need to stay invested in Canada. The nest egg fund could invest globally...and let the success of businesses in other countries pay for our government.
While I believe 15% a year return is achievable, 10% a year certainly is. And an annual return fluctuating between 10% and higher is the most likely scenario.
There is a caveat here. There should be limits on how much of a particular company the nest egg fund could buy, probably the same limits as apply to any other mutual fund. Also, the nest egg fund's involvement with companies it has an interest in should be arm's length. The fund should not be involved in the day to day management and operations of companies it invests in nor should it try to get representatives on corporate boards of directors. The nest egg fund should not be used as a vehicle for nationalizing businesses.
What's the Real Upside Here?
Once the personal income tax has been eliminated, the government can do the whole thing again with the corporate income tax and eventually with all the sources of government revenue. Even the amount of the budget given to reducing the national debt would be self-financed. The debt would be eliminated automatically.
But what's the real upside here? Merely a lighter financial load for we weary taxpayers? (Or at least the grandchildren of we weary taxpayers!) No! Hardly.
The level of taxation affects the economy. It affects the attraction of foreign investment. It affects entrepreneurship and new business growth. As a tax free country, and not just some tax free tiny little oil fiefdom but a major country with the second largest land area in the world and one of the richest troves of minerals in the world, Canada would become a magnet for investment, entrepreneurship and the creation of wealth. Canada could become like Hong Kong in its heyday, an economic powerhouse, but with our greater resources, we would make Hong Kong look like a pussy cat.
Canada could be at the forefront of science, business, and the arts. It could become the most important economic power in the world. Or at least running a close second to China if it continues to grow into an economic power to be reckoned with.
Certainly, Canada would eventually outstrip the United States in economic power if the U.S. continues to debauch its currency and spend itself into the poorhouse through its imperialist adventures. Canada - no taxes, no debt. United States - taxes, ballooning debt. The United States will suffer a brain drain as its best minds emigrate to Canada.
This idea, this paradigm shift in the way we look at the financing of government, is an idea whose time has come. Write the Prime Minister! Write your member of parliament. Let's make this happen. If not for ourselves, for our children and our grandchildren and the future of this great country.