Canada attacks prosperity.

THE WASHINGTON ESTABLISHMENT- became unconvincingly solicitous of Wall Street last winter, feigning concern that U.S. stocks and bonds, along with the dollar, would surely collapse unless President Bush capitulated on major new taxes. Budget Director Richard Darman then negotiated a budget strategy with Congress that was widely condemned precisely because it did not involve significant tax increases, offering instead the prospect of lower tax rates on capital gains. Yet far from crashing, as the press had hoped, stocks, bonds, and the dollar soared.

Canada's Conservative government, by contrast, was recently hoodwinked into offering the sort of tax package that would make U.S. liberals ecstatic-an 8 per cent surtax on higher incomes, new taxes on the capital of large corporations, higher excise taxes on tobacco and gasoline, and higher sales taxes. The extra taxes on industrious families and large corporations are not significant revenue measures, but political junk food for the egalitarian Left, which, as ever, seeks to punish success. The results of these new taxes are quite predictable, Canada having experimented with a similar surtax in 1986. What happened back then was an immediate flight from the currency, pushing Canada's interest rates nearly three percentage points above U.S. rates. Productivity slumped, unemployment approached 10 per cent, and inflation was twice as high as in the United States. By the spring of 1987, the Mulroney government's approval rating in the Gallup poll hit a record low of 22 per cent.

A supply-side tax reform was subsequently announced, ending the surtax and reducing marginal tax rates for 1988. Employment promptly rose by 3.2 per cent, manufacturing productivity by 4.6 per cent, and fixed investment by 12.5 per cent. Tax revenues skyrocketed, bringing the budget deficit down to half the level of 1984-85, relative to GNP.

Why abandon such a successful tax reform in favor of failed soak-the-rich policies? One reason is that Canada's new budget assumes high interest rates and anemic economic growth (only 1.7 per cent) for 1990. Since those dismal assumptions raised estimated future deficits, tax policies were introduced to guarantee weak growth and high interest rates. Another apparent rationale is that the head of Canada's central bank has, like the head of the U.S. Federal Reserve, been holding out the false promise of lower interest rates in exchange for higher taxes-the stagflationary "policy mix" imported ftom Cambridge, Massachusetts. In reality, the Canadian dollar immediately tumbled upon news of the new taxes, as it did in 1986. Canada's assets must be marked down to reflect the reduced after-tax returns to Labor and capital, so foreign and domestic investors moved their money to the U.S. or Japan. That means Canadian interest rates will now have to be kept even higher, relative to declining interest rates in the U.S., to lessen the inflationary consequences of a falling Canadian dollar. The only thing preventing the Canadian stock market ftom collapsing right away, London's Financial Times explained was that markets had already discounted Canadian stocks in incorrect anticipation of even more new taxes on capital gains and banks. It should prove an interesting object lesson for those who claim similar taxes would somehow please U.S. financial markets.