Monthly Archives: July 2014

Curious Cottage Competition

The Chronicle Herald published a report on Nova Scotia’s black-market cottage industry this morning, revealing that unlicensed, untaxed competition is forcing some landlords out of business. Interestingly, there is a subtext to the article: government policy has the potential to suppress otherwise healthy economic activity.

“Steven Hebb, general manager of Prince’s Inlet Retreat in Martin’s Brook, said there is a proliferation of unlicensed tourist accommodations, and the underground economy is driving businesses like his into the red.” According to a provincial Quality Visitor Services inspector, there were 700 unlicensed operators in 2006, a number that same source expects to be “much greater” in 2014. These black-market cottagers do not pay commercial property tax rates or utility rates, and because they’re essentially “underground operations,” they technically do not comply with local building regulations (although there is nothing to suggest they couldn’t or wouldn’t). In Martin’s Brook, located in the Municipality of Lunenburg, where Hebb’s rental units are located, commercial tax rates are nearly 150 per cent high than the residential rate, falling four cents and a half-penny short of $2 per $100 of value at $1.957, compared with $0.81 per $100 for resident property-owners.

laffer_curve

Avoiding these costs is precisely how black-market cottagers outcompete Hebb, and those in a similar predicament. Hebb argues that Nova Scotia’s provincial government, in addition to municipal authorities, could fix this issue by cracking down on the unlicensed operators, charging them licensing fees, and collecting commercial tax revenue from their ventures. His solution, however, seems to ignore the problem: high tax rates, expensive license fees, and burdensome regulations discourage economic activity. Nova Scotia’s provincial government, and several municipalities that rely on the cottage industry to finance public services, are certainly losing tax revenue, but it isn’t because the authorities are failing to levy it; it’s because higher rates have the potential to discourage taxable economic activity. This is the essence of the Laffer Curve, which shows that tax revenue is zero when rates are either 0 or 100 per cent: without taxes, there is no tax revenue, and when the government takes 100 per cent of a business’s revenue, there wouldn’t be anybody willing to operate a business.

In other words, why not reduce commercial tax rates and unburden cottage operators? The very fact that there are at least 700 unlicensed operators, who, in the absence of disproportionately higher tax rates, chose to operate a cottage rental business, suggests lowering taxes would reduce costs and encourage entrepreneurship across the board, thereby generating more taxable economic activity (read: tax revenue, tax revenue, tax revenue). It has the potential to solve Hebb’s problem, and it would generate additional tax revenue for the provincial and municipal governments.

Furthermore, one of Hebb’s competitors charges nearly 40 per cent less per week for a rental unit–$1,200, instead of $2,000. This is a significant difference in cost, and if unlicensed operators can manage to reduce the price of renting a unit by that amount, it could also encourage tourists to visit Nova Scotia, thereby generating additional tax revenue for the provincial and municipal governments.

In light of Economic and Rural Development and Tourism Minister Michel Samson’s announcement last week that government would shift its attitude and “enable business experts to make more decisions and allow government to focus on improving the economic conditions for the private sector, social enterprises, and communities to thrive,” perhaps this is a useful start.

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To Index, or not to Index, That is the Question!

In Nova Scotia, the provincial government indexes the minimum hourly rate to inflation, which allows those earning it to retain their purchasing power. The issue with this approach is it places the onus on firms to solve a political problem: whereas the government is concerned with ensuring all Canadians can afford necessities, the “bottom line” for most businesses is healthy margins, productivity, and sales. To quote Thomas Sowell, an economist at the Hoover Institute, “Making it illegal to pay less than a given amount does not make a worker’s productivity worth that amount–and, if it is not, that worker is unlikely to be employed.”

If wages rise faster than productivity, the cost of labour per unit of output increases. For instance, Footwear Unlimited pays employees the minimum wage–say $10–to produce 20 shoes in an eight-hour shift. The unit labour cost, therefore, is $4, i.e. ($10*8hrs)/20 shoes = $4 per shoe. Assuming productivity remains the same, increasing the minimum wage to $10.5 raises Footwear Unlimited’s unit labour cost by five per cent–$4.2 per shoe, despite neither producing more shoes, nor generating additional revenue. The result is a net loss, and to some companies, i.e. small businesses, it can be a death knell.

Some analysts argue labour productivity has outpaced the rise in minimum hourly rates, yet, though this is true for some economic sectors, it is not for all of them. The majority of minimum wage earners work in retail trade or accommodation and food services, for example, wherein productivity gains have been disparate. Between 1997 and 2013, labour productivity (which is the ratio between real GDP and hours worked) grew by nearly 53 per cent in the Canadian retail trade sector and 9 per cent in the accommodation and food services sector; adjusted for inflation, the average rise in minimum wages throughout Atlantic Canada was 37 per cent.

Productivity vs. Minimum Wages

In other words, firms in the retail trade sector experienced productivity gains in excess of the rise in minimum wages, whereas firms in the accommodation and food services sector suffered from the opposite. This illustrates the fundamental flaw with mandated wage rates (and, in particular, indexing them): some firms must pay higher wages without workers producing more, thereby sacrificing growth, forcing them to lay off workers, or, most concerning, shut down operations. To quote Sowell again, “The real minimum wage is always zero, regardless of the laws, and that is the wage that many workers receive in the wake of the creation or escalation of a government-mandated minimum wage, because they lose their jobs or fail to find jobs when they enter the labour force.”

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