What will COVID Mean for the Future of Fiscal and Social Policy?

It is the stated goal of the Canadian federal government to foster “a strong and inclusive labour market that provides every Canadian with opportunities for a good quality of life.” The legacy of COVID has, however, led to policy incoherence, with some significant reforms directly putting this goal into question.

The federal government has repeatedly stated, in different ways, a concern for a more fair and a more inclusive society, one in which all Canadians can become all that they can be and lead the lives they value. For example, in a statement specifically directed to economic policy the government stresses that fiscal and monetary policy should be coordinated to support “a strong and inclusive labour market that provides every Canadian with opportunities for a good quality of life.”

What will COVID, the policy response to it and the legacy it sets, mean for the movement toward this goal? I answer this question by addressing three more specific questions, and suggest that while there is both possibility and challenge in the framing of social and macro-economic policy, there is unfortunate policy incoherence on the horizon that will do more to weaken than strengthen the development of an inclusive labour market.

To invoke Edvard Munch’s famous painting “The Scream” is almost cliche, but it is nonetheless a remarkable summary of how many might feel about fiscal and social policy directed to inclusive growth.

1. Is a Basic Income in the social policy future?

The Canada Emergency Response Benefit (CERB) clearly demonstrated the power of federal income transfers to lower the poverty rate. In fact, the official poverty rate fell by almost one-half between 2019 and 2020 to reach an unprecedented low, well below the poverty reduction target the federal government set for 2030.

It is no small wonder that this experience might raise the expectations of many advocating for a Basic Income.

Even if this experience makes clear that the federal government could effectively take over, or at least complement, the income transfer space traditionally in the domain of provincial social assistance programs, it is also clear that a universal demogrant is not part of the social policy future.

That said, Canadian social policy has always been made incrementally, and there are two considerations that both constrain and offer an opportunity for a more robust income safety net at the federal level.

The first is the pervasive influence of the distinction between the deserving and the non-deserving poor.

Whether from an ingrained belief, or from an appreciation of Canadian political culture, this distinction has framed social policy since 2015. Children in some sense are deserving, and so the federal government has taken significant strides in reducing child poverty. The elderly, of course, have long been seen as deserving and there have been repeated expansions of income supports to those in retirement. We have a Basic Income for children, the Canada Child Benefit, and we have a Basic Income for the elderly, the Guaranteed Income Supplement.

But the Poverty Reduction Strategy set targets to lower the rate of poverty by one-fifth in the near term and by one-half in the longer term for the entire population. The working-age poor, particularly those living on their own, have been recognized as falling though a gap. Public policy considers them to be among those “working hard” to join the middle class, and therefore expected to rely on labour market engagement to move above the poverty line. They, in other words, are not “deserving” poor.

The oxygen for discussions of Basic Income, at least in the near term, will be taken up by another group of “deserving” poor, those of working age with disabilities.

On June 22nd Minister Qualtrough re-introduced legislation to enact a federal income transfer program to support this group. Bill C-22 is entirely void of any design details, leaving eligibility and benefit rates to be determined by regulations, but it is certainly most likely to borrow from the targeted negative income tax structure of its cousin programs. A good deal will depend upon how “disability” is defined, but when it is up and running and somehow coordinated with provincial programs, it will likely leave many working age people out of scope.

The political economy of deserving versus non-deserving, as opposed to a rights-based framing, is a constraint on the future of social policy. But there is also opportunity in how rights-based advocates have come to understand the design of a Basic Income. My own observations suggest that there has been a considerable evolution from the notion of a universal demogrant to that of a negative income tax, with an appreciation of the design trade-offs associated with targeting, with a budget constraint, and with labour market incentives.

An ongoing conversation about Basic Income could well begin with the recognition that the government in an incremental, yet significant way, has complemented provincial programs through refundable tax credits, and that the way to further this agenda is to continue to press for working-age singles to be included.

This could happen through the continued evolution of the Canada Workers Benefit, adding to it not just a more generous benefit structure but also a component that is not conditional on employment income.

It could also happen through constructive engagement with provinces that wish to comprehensively reform their social insurance programs toward a Basic Income in a way that fosters agency among those in need. Prince Edward Island has moved in this direction, the legislature’s Special Committee on Poverty releasing a consensus report recommending a Basic Income Guarantee.

2. Are enhanced business subsidies part of the COVID legacy?

The big bugaboo in this discussion, one that sits at the heart of the deserving versus non-deserving distinction, is the belief that income support can encourage people to work less.

No single group in Canadian society has made so much of the work disincentives criticism, and to such great effect, than some lobbyists claiming to speak for the small business community. Yet, subsidies to business have most likely led to over-insurance and a powerful moral hazard that will put a break on innovation and productivity if they become a part of the post-COVID future.

Certainly public finance principles rationalize government interventions when there is a market failure, while recognizing that there will be an efficiency trade-off associated with changes in behaviour—be it labour supply, labour demand, or saving and investment—that are a response to taxes and transfers.

As fiscal policy moves forward it is important to consider how COVID support programs to businesses have performed, the unintended consequences associated with them, and the lessons for the future.

The Canada Emergency Wage Subsidy (CEWS) was by far the most significant of these programs, indeed of the entire package of COVID-related federal government expenditures with the monies spent on ostensibly maintaining the attachment of workers with their employers rivaling total direct transfers to individuals.

A major lesson of the pandemic is that a program like CEWS should not be looked at as a model for business sector support, whether in times of a sharp shock or whether as a long-term structural policy.

CEWS was slow off the mark at the onset of the pandemic as the bulk of business closures had already taken place before the program started accepting applicants in June of 2020. I have detailed this experience in an article to be published by the American Enterprise Institute.

It can also be reasonably argued that CEWS over-compensated businesses in a poorly targeted way lowering business closures during 2020 significantly below previous levels, something that can be a drag on innovation and efficiency.

At the most basic level, CEWS fell well short of its stated goal of maintaining the tie between workers and employers during the successive ways of the pandemic.

Going forward there are much more efficient and effective ways of achieving this goal. Aspects of a reformed Employment Insurance program, particularly its “work sharing” provisions are better suited. And besides the Employment Insurance program is hard-wired to maintain a tie between workers and employers because employer premiums are not experience-rated.

The CEWS teaches us that it is much more effective to compensate impacted individuals directly than through their employers.

But this experience has had important political economy consequences that bode ill for efficient and equitable fiscal policy. Lobbyists claiming to speak for small businesses were emboldened in a significant way, public attention being artfully shifted from the plight of essential workers early in the pandemic to the plight of troubled firms, with significant policy consequences.

The federal government was very attentive to a whole host of concerns that can only be charitably described as poor public policy. These include repeated extensions of the CEWS, intergenerational transfers of capital gains, and most recently campaigns for extensions and forgiveness of loans taken through the Canada Emergency Business Account (CEBA).

There is an important discussion to be had about the moral hazards associated with these changes, and their consequences for a dynamic and efficient small business sector. Indeed, all of this is piled onto a corporate tax structure that is increasingly making small businesses a tax haven and putting a break on productivity growth.

But the coup de grace in this unfortunate policy evolution is the government’s acquiesce to the demand for an expanded Temporary Foreign Worker program. Employers now have the opportunity to hire up to one-fifth, and in some cases 30 percent, of their low-wage workforce through the Temporary Foreign Worker program.

This represents a major wage subsidy, even if it is not recorded as an expenditure in the government’s books. It is just the opposite of what policy directed to an inclusive labour market should be doing. Low wage workers, those who have a tenuous foothold in the labour market either because they themselves are recent immigrants, have a disability, or are young, will likely see more limited wage growth and job opportunities as a result of this policy change.

This change may also potentially shut off the possibility of upgrading employment and human resource practices in the care economy, particularly in Long-Term Care facilities and in early childhood care. The pandemic illustrated that the use of contingent and itinerant work arrangements in long-term care homes had devastating and shameful consequences. The challenge for a policy maker wishing to promote an inclusive labour market is to transform this sector into a “craft” based economy, with upskilling of workers who offer community and family based care and support.

An unfortunate legacy of COVID on public policy directed to employers is the threat of growing inefficiencies and inequities as a result of subsidies that cannot be rationalized by any sort of market failure.

3. Will the management of the macro-economy encourage an inclusive labour market?

Income inequality is the clearest, though certainly not the only, marker of an inclusive labour market. There are important long-term structural causes of growing inequality in market incomes, but the COVID crisis directs us to also focus on cyclical aspects of inequality. It calls for more timely and progressive fiscal policy in macro-economic management.

Higher inequality makes macro-economic management more difficult.

Certainly, it is important to no longer frame policy in terms of representative agent models and trickle down economics. It is not clear that this was ever a good guide for policy, but it was the framing of the 1980s and 1990s, no consideration at all being given to the distributional consequences of macro-policy.

Inclusive growth means that policy directed to growth and business cycle stabilization go hand-in-hand with concerns over income distribution.

What did COVID teach us about macro-economic policy?

Well, big shocks matter!

We knew this from the experience of the Great Recession in 2008; we knew this from the bursting of the commodity price bubble in 2014; and now we know it all the more clearly as a result of a world-wide pandemic.

Big shocks matter beyond the fact that they are big, they also matter because they can have long-lasting consequences well after they have passed. There is a threat that income inequality jumps after a big shock, but does not return to its original level in its aftermath, ratcheting up as those who are hardest hit are also permanently scarred.

The Gini coefficient based on market incomes did in fact jump significantly in 2020, reflecting the fact that many Canadians, particularly those in professional and managerial occupations, kept working throughout the pandemic while others in more public-facing occupations suffered significant disruptions in their work and family lives.

But strikingly this increase was more than completely undone by the tax-transfer system, the associated Gini falling to its lowest level in 45 years.

This is an amazing development that echoes back to the recessions in the early 1980s and early 1990s when the tax-transfer system was more responsive and progressive.

These policy-induced recessions were intended to lower inflation, and solidify the independence of the Central Bank. But they had significant consequences for income inequality, which rose but did not return to pre-recession levels, The Canadian tax-transfer program was sufficiently progressive to completely undo these developments, with the after tax transfer Gini staying constant in spite of rising market income inequality.

But this was not the case after 1995 when the government made a determined effort to eliminate the deficit, cutting important transfers and the unemployment insurance program. As a result of these cuts after tax and transfer inequality has tracked rather than moved against market income inequality … except in 2020.

The Bank for International Settlements calls this “inequality hysteresis” a successive ratcheting up of inequality, that in turn risks making the macro-economy more unstable and risks further recessions and higher inequality.

… inequality increases faster and more persistently in the aftermath of recessions. Furthermore, greater income inequality is associated with deeper recessions, and with the reduced effectiveness of monetary policy in steering aggregate demand. Taken together, these results point to the risk of an adverse feedback loop: recessions persistently worsen inequality, and greater inequality serves to deepen recessions. These results highlight the importance of taking inequality into account when designing and implementing fiscal and monetary policy.

da Silva et al, Bank for International Settlements, May 2022

Big shocks matter, but the nature, the timing, the duration of big shocks are fundamentally uncertain. How do we conduct policy if we appreciate that we live in an era of fundamental uncertainty about big risks? How do we do it if we appreciate that growth and distribution are linked, an inherent part of inclusive growth in the long term but also an inherent part of macro-management in the short term?

We do it with rules-based program design as much as with discretionary choices. This calls for stronger automatic stabilzers, and this part of the Canadian policy tool kit needs to be enhanced, even if we accept that there will always be a role for discretion.

Most urgently this calls for two reforms. First, a more progressive income tax structure, which most notably requires a broader tax base. The obvious reform, that also has important implications for horizontal and vertical equity, is to stop giving capital income a free ride in the tax system. A higher inclusion rate for capital income is called for, moving from the current 50 per cent to at least 75 per cent, a rate that in fact has a precedent in the Canadian income tax structure.

Second, a much more robust Employment Insurance program is called, offering more complete income insurance, including wage insurance, broader coverage, and a capacity to respond in a more timely way to sharp regional and national downturns.

Post COVID policy incoherence threatens an inclusive labour market

Public policy may continue to make determined and important changes in a progressive and inclusive direction, and even take steps toward a tighter social safety net that some will appreciate as a basic income.

But other choices bring the very goal of a “strong and inclusive labour market” into question and in the long term threaten the sustainability of more generous transfers to individuals. The labour market will be more inefficient and inequitable because of sustained subsidies to small business and increased reliance on temporary foreign workers.

And more polarization and inequality of jobs, wages, and market incomes will in turn make the maco-economy more unstable and more challenging to manage.

What will COVID mean for the future of fiscal and social policy? The future is unclear not because of inherent uncertainty, but rather because of explicit choice and the incoherence that it has engendered.

[ This post is based upon my comments to a panel discussion on “What will COVID Mean for the Future of Fiscal and Social Policy?” organized by Michael Smart and Trevor Tombe of Finances of the Nation, and held as part of the 56th Annual Meetings of the Canadian Economics Association at Carleton University, Ottawa Canada on June 3, 2022. You can download a copy of my presentation at this link. ]