Why increasing government spending makes economic sense

Author’s note: The latest BC government throne speech promised “to help solve big challenges – like inequality and climate change – with growth that is inclusive and sustainable.”

CCPA-BC will closely analyze the upcoming BC Budget to determine whether the government’s intention is backed by the increased levels of public investment needed to meet the big challenges of our time. BC still has a lot of catching up to do after decades of chronic underinvestment in services and infrastructure. A major increase in public spending is essential not only to tackle urgent social and environmental crises, but also to build a stronger economy.

The following article was originally published in December 2021 and is particularly relevant now with the coming introduction of BC’s 2022 provincial budget.

What does it mean for governments to be fiscally and economically responsible today and in an eventual post-pandemic world? During the initial phase of the pandemic, there was a brief period of cross-party agreement on the need for large-scale emergency public spending, but this temporary agreement obscured a pre-existing problem: long-term underinvestment in key public services and infrastructure—a shortfall that is economically and socially destructive.

As just one example, the recent catastrophic floods in British Columbia show the urgent need for massive public investment to strengthen and adapt our infrastructure in response to climate change. While some will try to raise the alarm about upfront expenses of such investments, the fact is that failing to make them would be far more costly in economic terms. More importantly, as this year has shown us, this work simply must be done to protect the lives and livelihoods of British Columbians and to keep our society and supply chains functioning for everyone.

For decades, “fiscal responsibility” has been too often equated with cutting or constraining public spending. From this view, some have insisted that even though we might like more robust public investment—think bolder action on climate change, poverty, affordable housing and child care—we can’t afford it, or we need to move slowly. In fact, provincial operating spending has actually declined as a share of BC’s total economic pie (Gross Domestic Product) in recent decades. That is, as the economy has grown, we have dedicated a smaller share of our societal resources to public spending, even as the stark need for this type of investment has grown.

Yet, a growing body of evidence tells us that spending on public services, social supports and physical and social infrastructure comes with major economic benefits. This research, which I outline below, shows that public investment pays off economically in myriad ways including higher productivity and growth, spurring additional private investment and adding more jobs. In most jurisdictions, levels of public spending are simply too low both to meet urgent societal challenges and by more conventional economic measures. Of course, the economic importance of investing in people and communities should not be surprising since value in the economy is created by working people (and the point of an economy is ultimately to serve people). 

BC remains stuck in outdated economic thinking, which doesn’t adequately account for the large benefits of public investment. While public spending increased temporarily during the pandemic, BC’s most recent budget (Budget 2021) projects a gradual return to the status quo ante (in terms of public spending relative to GDP) over the next two years. For example, operating spending will have dropped from 21.5 per cent of GDP in 1999/00 to a projected 20.0 per cent of GDP in 2023/24. If we instead returned spending to 1999/00 levels, we’d have about $5 billion more available that year (and ongoing) to invest in urgent social and environmental priorities.

Budget 2021 also signalled the intention to bring deficits to an end in the medium term, with a formal plan to come next year. The government’s consultation survey for Budget 2022 reinforces this approach in a concerning way, asking respondents to choose between “substantial service cuts,” “small cuts” and “minimal cuts” to return to balance. This is, of course, a false choice. It’s also downright reckless when the pandemic has magnified deep inequalities in our society and we are emerging from a long period of chronic underinvestment in the public sector. 

Instead, the next BC budget should prioritize increasing public spending to meet urgent social needs and build a healthy and sustainable economy over the long term. This should include expanding climate action at a scale that reflects the urgency of the crisis, accelerating transit investment, making major new investments in dedicated affordable housing, re-committing to a rapid roll-out of $10-a-day child care, further increasing funding for health and seniors’ care, strengthening K-12 and post-secondary education and addressing the poisoned drugs crisis. 

Inadequate public investment not only means we fail to meet urgent social and environmental needs, but also hampers economic growth in the process—making us all worse off.  

Public investment strengthens the economy

A recent report by the US-based Economic Policy Institute finds that public investment increases productivity and growth across the economy. The report finds “investments in public capital have significant positive impacts on private-sector productivity, with estimated rates of return ranging from 15 percent to upwards of 45 percent.” Another report from the Roosevelt Institute argues that sustaining higher levels of demand through new public spending and permissive monetary policy could bring the US closer to full employment and increase growth.

Recent research across the broader set of advanced economies suggests similar productivity and growth-enhancing effects of public investment. An analysis by economists from the International Monetary Fund examining 17 OECD countries (including Canada) finds that public investment “raises output in both the short and long term, crowds in private investment, and reduces unemployment, with limited effect on the public debt ratio.” The positive effects are even larger the more “slack” there is in an economy, such as when emerging from a recession or period of stagnation, the study finds. 

An academic meta-analysis of 68 studies on the productivity of public investment arrives at a similar conclusion, finding that “public capital is undersupplied in OECD economies.”

Thus, a growing body of evidence shows that public investment has large, long-term economic productivity and growth benefits. That’s in addition to providing more immediate economic stimulus in recessions and other times when economic resources aren’t being fully utilized. 

The general economic case for public investment is strong, but the evidence is also clear in specific areas of public spending. The most top of mind example at the moment may be rebuilding and adapting our physical infrastructure to respond to climate change in the wake of BC’s recent floods. This includes reinvesting in chronically underfunded public bodies like the River Forecast Centre. Beyond the pressing need for this type of infrastructure investment and rebuilding, taking action on climate change also means reducing greenhouse gas pollution as rapidly as possible. This will generate major long-term economic payoffs compared to the status quo, with research showing that each year of delay in action comes at a significant cost. Consider just one important component of public investment needed to reduce greenhouse gas emissions: public transit. In addition to reducing pollution, transit investment is widely recognized to boost incomes and economic productivity. It also eases costly traffic congestion, as studies across cities including Vancouver, Toronto and in the United States have found. 

Beyond its climate benefits, major economic gains from public transit result from spin-off benefits that emerge when individuals and businesses are located close to one another in an urban area. As one recent study put it: “The benefits of urban living hinge on the relationships among people and firms. As more people live in a city or region, others already in that area benefit,” such as through more job choices and better matching between jobs and employees, greater opportunities for collaboration and in-person learning, and more access to cultural amenities and services. Since low-income families are more likely to depend on public transportation, investing to enhance it also has an equalizing effect.

The housing crisis is another area where public investment can have a large economic payoff by addressing housing shortages and high prices faced in many urban areas. High housing prices impose economic costs by making it more difficult for businesses to find workers, reducing consumer spending among those burdened by high rents and creating longer commutes and more traffic congestion. When high prices and housing shortages displace and exclude people from living in urban areas, this reduces the broader economic benefits that come from cities.

The housing crisis is multifaceted, but one important cause of it is the sharp withdrawal of public investment in non-market housing by federal and provincial governments beginning in the 1990s (a modest flow of public investment in housing has restarted in the past few years). A massive reinvestment in non-market housing is urgently needed. Public investment in housing is key to ending homelessness, in addition to generating the economic benefits associated with meeting working- and middle-class housing needs. Many studies have shown that housing and supporting people experiencing homelessness is highly cost-effective and brings down other public expenditures. It’s also worth noting that massive public investment in housing is affordable and feasible even absent the economic spin-off benefits since it can largely pay for itself through the rental income stream it generates.

The research on housing and homelessness dovetails with studies showing that poverty comes at a huge economic cost. As a report by the US Government Accountability Office put it:

“The conditions associated with poverty can work against this human capital development by limiting individuals’ ability to remain healthy and develop skills, in turn decreasing the potential to contribute talents, ideas, and even labor to the economy… [and] can also create larger challenges for economic growth.”

Making the investments needed to reduce and eliminate poverty is not only the right thing to do, but it also makes good economic sense once we account for the costs of poverty.

Another example of highly productive public spending is universal child care, where there is growing recognition of its economic benefits. Sky-high fees and inadequate spaces are a major burden on families with young children. Creating a universal public system, like the community-developed $10aDay plan, would save families thousands of dollars per year and be a major win for gender equality, since women disproportionately bear child care duties. Universal public child care has large and well-documented economic benefits, including by allowing more women to participate in the labour force. In fact, child care investment can largely pay for itself even without new taxes since the resulting increase in women’s participation in the labour market increases income tax revenues. After decades of advocacy and false starts, both the BC and federal governments have made significant commitments to funding such a system.

Finally, consider health care as a further example of an area where failure to adequately invest comes at an economic cost. Too much of our health care remains dependent on private expenditures in Canada and this for-profit health sector is a huge source of inefficiency. For example, numerous detailed studies show that implementing a universal, public pharmacare system would generate billions of dollars in savings to the Canadian economy while increasing equity and access to medicines. Leaving so much of our drug coverage to the private market is both hurting health outcomes and wasting billions of dollars per year, the polar opposite of fiscal responsibility. Research shows that a similar story plays out in areas like primary care, surgical wait times and seniors’ care: for-profit provision of care yields worse outcomes at higher costs. It’s no surprise that the United States has one of most privatized and least efficient health care systems in the world.

Funding the public good and tackling inequality

There is an urgent need for BC to increase public spending in a wide range of areas to meet the key challenges of our time. But some are preparing to argue that the cost of rebuilding from BC’s recent floods means we must “tighten our belts” in other areas. This is out of line with the evidence, and short-changing investment in other areas would make us all worse off. As in the past, a return to austerity and underinvestment would hurt our long-term economic productivity and growth and slow down the pandemic recovery effort. 

Increased public investment can be funded in substantial part by borrowing, particularly when used for the types of growth and efficiency-enhancing investments discussed above. However, taxing the wealthy is another important source of potential new spending power for the province. The federal government must step up to the plate with additional funding transfers to provinces, but BC has the capacity to raise additional revenue as needed and this observation is not controversial. For example, credit rating agencies like Moody’s note that: “British Columbia’s level of taxation is at the lower end of the Canadian provinces, presenting the province the flexibility to raise taxes… while still remaining competitive with other jurisdictions.” Provincial governments including BC should play a significant role in raising additional public revenues and do so in a way that helps tackle inequality. When it comes to corporate tax rates, BC should raise the bar—in cooperation with other provinces where possible and on its own as needed. Similarly, top personal income tax rates in Canada (federal and provincial combined) are still far from revenue-maximizing levels, which are in the 60-to-70 per cent range. BC should help lead the way by raising top marginal tax rates on the richest British Columbians.

Real estate is an especially promising and equitable tax base for the province since property wealth is a massive source of inequality and it can’t be hidden or moved across borders. BC’s recent policy reforms in this area are a good starting point, but they only scratch the surface. The new provincial property tax brackets and the speculation tax raise a couple of hundred million dollars per year, but this is a tiny fraction of the more than $1 trillion worth of increases in property wealth in BC since the mid-2000s. Additional brackets and more robust tax rates are needed. BC’s new beneficial ownership registry—an important policy that enables more precise tracking of land ownership—should also be used to apply top provincial property tax rates to the combined holdings of large landowners, rather than only based on individual parcels.

The BC government has made some important new social and environmental investments in recent years, but the province needs to break out of a budgetary framework that remains dangerously focused on constraining medium- and long-term public spending. A growing body of economic research—and unfolding events like the pandemic and floods—tell us that increasing public spending is both socially and economically essential. We must invest more together to meet the major challenges of our time—climate change, housing, child care, public health, poverty, and toxic drugs, among others—first and foremost because it is right, and because failing to do so would be economically and fiscally irresponsible. 

Topics: Children & youth, Climate change & energy policy, COVID-19, Economy, Education, Employment & labour, Health care, Housing & homelessness, Poverty, inequality & welfare, Privatization, P3s & public services, Provincial budget & finance, Seniors, Taxes, Women