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Published online by Cambridge University Press: 07 November 2014
The slowness of the industrial recovery is gradually disclosing unmanageable situations in public finance. From the standpoint of public debt, countries engaged in the export of staples fall into three classes: (1) those where widespread default occurred in 1931 or 1932 on both public and private debt and where little or no resumption of debt service has occurred, such as most of the South American republics; (2) those where a critical position appeared early in the depression, followed by collective adjustment of internal debts and measures designed to maintain the level of prices, such as Australia and New Zealand; and (3) those where little or no public default or manipulation of debts, foreign exchange, or price levels has hitherto occurred, such as the Union of South Africa and Canada. Newfoundland occupies a curious position, more like that of European countries, having undergone a political as well as a financial reorganization. The Argentine occupies a position intermediate between groups (1) and (2).
1 Cf. Select Standing Committee on Banking and Commerce, Minutes of Proceedings and Evidence (Ottawa, King's Printer, 1933.Google Scholar) re debts and interest rates. The Committee was almost wholly concerned with the amount of debt rather than with mechanisms of adjustment. Members attempted chiefly to minimize or exaggerate the seriousness of the problem for political purposes. No reference was made to techniques of conversion developed elsewhere, nor to the obstacles (other than constitutional) to conversion in the provincial and municipal fields, nor to the special problems raised by optional payment bonds.
2 The term “burden of debt charges” has no precise meaning and is deliberately avoided at this point. The harmful influence of the debt service has probably increased far more than the percentages shown, for reasons outlined in section II below. Cf. Withers, W., Retirement of National Debts (New York, 1932).Google Scholar
3 Not to be interpreted as a balancing of each individual budget, but as a balancing sufficient to provide for the deficits of some out of grants-in-aid made or forfeited by others.
4 These and the following ratios assume the same national income as given in table I. In practice a balancing of budgets involving destructive taxation and withdrawal of support by inflationary borrowing would probably have reduced it.
5 If the reduction of interest charges were not applied to foreign holders but confined solely to the domestic debt, it would be necessary to eliminate practically 100 per cent. of the interest now being paid thereon.
6 A general survey of the forces which have driven Canadian governments into various forms of costly intervention will be found in Innis, H. A., “Unused Capacity as a Factor in Canadian Economic History” (Canadian Journal of Economics and Political Science, vol. II, no. 1, 02, 1936)Google Scholar and among earlier papers by the same writer, referred to therein. See also Innis, H. A. and Plumptre, A. F. W. (eds.), The Canadian Economy and its Problems (Toronto, 1934), pp. 55–61.Google Scholar
7 If prior to a depression commodity taxes are being shifted forward, the effect of a general decline of income during depression is to set up the same reactions as though an increase of tax rates had occurred. Instead of supply prices being raised demand prices are lowered.
8 When the rents from capital invested in buildings yield a net return comparable with that on other forms of investment, the tenant may be said to have the tax shifted to him. When the net yield from rents falls below such a point, the tax is not fully shifted and may not be shifted at all.
9 From the taxpayer's standpoint, arrears of commodity taxes may also be incurred wherever taxed goods are bought on credit, the producer or merchant having advanced the tax to the government.
10 The same forces also check a revival of new construction for commercial and industrial purposes.
11 The popularity of monetary remedies combined with emphasis on the economic effects of international war debts and on the moral virtues of paying what one owes rather than forgiving one's debtors has checked the growth of literature on debt in general. A readable if somewhat exaggerated treatment of the subject, followed by an excellent restatement in technical form, will be found in Renatus, K., The Twelfth Hour of Capitalism, translated from the German by Dickes, E. W. (New York, 1932).Google Scholar
12 Theories which treat the service of internal debt as no more than a collection of offsetting book entries are valid only on the assumption that the economy has fully adjusted itself to the associated burden of taxes, that there are no distributional effects, and that the recipients of interest payments taken as a group continuously spend or invest for themselves, or loan to others who are spending or investing without preference for gilt edge investments, an amount equal to their current receipts from the government. The weakness of such assumptions is evident in the local and provincial finance of debtor areas dependent on exports.
13 The amount of deposits created by each member of the banking system being limited by the cash reserves which it is thought prudent to hold, an increase of savings deposits at the expense of current accounts only increases loaning power in so far as it withdraws legal tender from the pockets of the people and diminishes the probability of sudden demands by depositors for cash or withdrawal of funds to other banks.
14 If this were not the case, surely savings deposits would have grown more rapidly and the public's purchases of government bonds been larger. In the past two years the public has on balance bought almost no Canadian government bonds.
15 A more harmful combination would be a larger amount of debt payable abroad combined with a lower value of exports, less taxation of income and non-essentials, and an attempt to maintain the currency at an artificially or undesirably high level abroad. In other words, the situation as it existed during most of 1931 and 1932.
16 It is possible that some redistribution takes place from the well-to-do, to members of the $3,000 to $8,000 class who rely on insurance, annuities, and government bonds for a part of their income.
17 The wide extent of rigidity in its various forms is stressed in recent literature. See Innis, and Plumptre, , The Canadian Economy and its Problems, and Mackintosh, W. A. et al., Economic Problems of the Prairie Provinces (Canadian Frontiers of Settlement, IV, Toronto, 1935)Google Scholar; also a short summary by the writer, “Internal Obstacles to Recovery in Canada” (Royal Economic Society Memorandum no. 51, 02, 1935).Google Scholar
18 This may restrict the creation of publicly owned capital or result in its being created subject to a heavy mortgage. Also it may intensify the inequality of incomes though if it has the effect of bringing the ownership of the country's capital within Canadian borders the power of progressive taxation to redistribute incomes is increased.
19 This assumes full employment of employable labour and capital goods and no increase in lending to foreign countries.
20 If, however, freight rates and railway earnings were so low that the railways were obliged to enter the capital market for funds to overcome depreciation or obsolescence, the tendency to augment capital accumulation would be checked, the encouragement to farmers, forest industries, etc., being offset by a greater scarcity of capital funds for large borrowers.
21 Corporation bonds convertible into common stock are a step in this direction.
22 Training for legal and financial posts in Canada has been largely of the trade school variety, the effect of which is to promote efficiency in routine and hasten the decline of mental activity. An established reputation for soundness and reliability may usually be built upon such training when combined with ability to satisfy the requirements of institutional advertising and is usually a guarantee that a man's mental and inventive powers have begun to deteriorate.
23 Since this was written, a provincial Commission supervising the finances of four defaulting Ontario municipalities now merged into the city of Windsor has recommended that bondholders be given new securities paying from 1½ to 4 per cent., and that $125,000 be set aside for each additional $100,000 spent by the municipality, $75,000 applicable to additional interest payments and $50,000 applicable to sinking fund ( Financial Post, Toronto, 04 11, 1936, p. 20).Google Scholar This plan has been accepted. Compared with earlier proposals for a reduction of principal this may be interpreted as a concession to bondholders which, in view of the possibility of a higher price level, is not unreasonable.
24 See Britnell, G. E., “Saskatchewan, 1930-1935”, p. 143 supra, as an example of the difficulties of one province.Google Scholar
25 Most of the provinces compel their municipalities to retire debt out of taxation, by either the sinking fund or the instalment method.
26 Chiefly small places in older parts of the country, which did not undergo rapid expansion prior to the depression, such as Owen Sound, Chatham, Glace Bay, Woodstock, Pembroke, St. Catharines, Joliette, St. Thomas, Kingston, Stratford, as well as others which have benefited from the expansion of mining and the protected textile industry. See Comparative Statistical Charts of Canadian Municipalities, for 1933 and 1934 (A. E. Ames and Company, Toronto)Google Scholar, showing funded debt, tax arrears, and tax collections, in arrays.
27 Chiefly in areas dependent on wheat or automobile production, also in residential “satellite” towns around Montreal, Toronto, Winnipeg, and Vancouver largely occupied by working men subject to frequent unemployment.
28 Total maturities of bonds during 1936 are estimated at $328 mn. out of a total debt of roughly $7,000 mn., $209 mn. of which is federal, $70 mn. provincial, and $49 mn. municipal. See Maturing Principal and Interest Payments of Canadian Bonds in 1936 (A. E. Ames and Company, Toronto, 1936).Google Scholar In 1937, $326 mn. of tax free 5 per cent. and 5½ per cent. federal bonds mature, the conversion of which will add to the yield of the income tax as well as lower interest charges. The reader is warned against being misled by statistics of maturing debt which include treasury bills. A constant sum of, say, 10 million dollars borrowed on treasury bills necessarily matures and is renewed three or four times a year, grossly exaggerating the opportunities for profitable conversion.
29 Revenue Act Amendment Act, 1934, c. 57, s. 6.
30 Unlike the credit standing of private persons, corporations, and the lesser governments, the credit standing of a national government as measured by interest rates is primarily a reflection of central banking policy at home and abroad, especially in a period when the restraints of the gold standard are not in force.
31 Banking policy which has been used to raise bond prices can also be used to depress them, thereby reducing the amount of premium to be paid.
32 This would, of course, include corporate bonds, at present free from corporate income tax. It would not apply to $326 mn. tax free Dominion of Canada bonds still outstanding, which mature in 1937. It would not be administratively practicable to tax incomes from private mortgages at the source, except where these were handled by institutions.
33 In the case of bonds sold at low interest rates prior to the War, it would seem reasonable to impose a moderate rate of tax on the assumption that most of the present owners acquired them subsequently, at yields higher than the coupon rates. It would probably be necessary to assume that bonds issued since the outbreak of the War were all in the hands of the original purchasers. This would involve some unequal treatment of the holders but the inequities would be trifling when compared with those resulting from direct repudiation or from indirect repudiation through inflation of the currency.
34 Wealthy Canadians who have made a custom of cashing coupons (especially those payable in U.S. funds) in American cities in order to escape detection by Canadian income tax authorities would have an added inducement to continue doing so. Such evasion could be checked, though hardly eliminated, by imposing the tax on foreign as well as domestic bondholders subject to remission in the case of foreigners on presentation of a standard form of endorsement (as in the case of the recent French tax on rentes, noted in The Economist, London. 08 3, 1935, p. 262).Google Scholar
35 Cf. Innis, and Plumptre, , The Canadian Economy and its Problems, p. 322.Google Scholar
36 Cf. the adjustments recently made in France to soften the effect of the 10 per cent. reduction in interest payments enforced under the Decree Laws of 1935.
37 Cf. the suggestion made in Innis and Plumptre, The Canadian Economy and its Problems, p. 321.
38 The surtax, however, applies to all income including that from preferred and common stocks, mortgages, and real estate, as well as to taxable earned income over $14,000.
39 The Australian government's subsequent treatment of the small minority of dissenting bondholders seems to have broken both the terms of the non-callable bonds and the conversion offer as originally made.
40 A coupon tax on government bonds alone would, however, be discriminatory and would justify the criticisms of the Austrian tax of 1868 (see Appendix, s. 1).
41 Considerable literature on the subject appeared in Great Britain after the War. The most recent and thorough discussion is in the Report of the Committee on National Debt and Taxation (H. M. S. O., London, 1927) (cmd. 2800).Google Scholar
42 Ibid., pp. 225 and 291. A levy sufficient to extinguish about 40 per cent. of the national debt was expected to save £60 mn. annually. The actual reduction of interest payments apart from cancellation of payments on war debt to the United States (£20 mn.) has been £61 mn. In estimating net savings allowance must be made for the reduction of taxable income.
43 From the standpoint of those creditors who think there are no political or economic limits to the sacrifices which a government and its people should make in their behalf, default is always unwillingness rather than inability to pay and equivalent to repudiation.
44 The action of the Ontario government in refusing to meet payments for electric power for which it had contracted was an indirect form of repudiation which did not, however, affect the treatment of the government's own bondholders. Whether or not the same objective could have been attained by other methods is not a matter on which it is possible for an outsider to express an opinion. It should be noted, however, that in this case both the public discussion and later negotiations were spread over a long period. During the negotiations the prices of Ontario bonds fell, relative to prices of federal bonds, and they continue in a slightly lower relative position. Like other attempts to adjust individual situations, the amount of effort and dislocation of confidence involved seems out of proportion to the modest results achieved. It must, however, be remembered that collective debt adjustment requires leadership from federal authorities whose attitude has been, and continues to be, one of indifference to the unmanageable plight of subsidiary governments.
45 To these should be added the officials of trade associations of banks, insurance and trust companies, and investment bankers, as well as their auxiliaries in the financial press and intelligence services.
46 Renatus, , The Twelth Hour of Capitalism, pp. 246 and 207.Google Scholar
47 A policy of collective debt reduction could not take care of the extreme cases of public insolvency which have developed in Canada over the last five years, but it would limit them to a manageable number. Moreover, it would increase the ability of strong governments to assist weak ones, thereby reducing the losses to bondholders.