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Last Wednesday, Finance Minister Bill Morneau delivered the government’s second budget. For weeks before the budget, the government had been preparing the public for a budget that would not include any new spending or ambitious policy initiatives. In addition, recognizing worsening global growth prospects and the complete “mystery” as to what the Trump government might do in the areas of taxation and trade, the budget would be prudent and cautious.

The 2017 budget did exactly that. The budget includes a large number of policy “announcements” covering a wide range of areas that, individually may be important, but in total add up to very little. For the most part, they are simply re-announcements/relabeling of actions already announced in budget 2016 and included in the fiscal framework.

Over the period 2017-18 to 2021-22, “investments” totalled $30.6 billion. Of this, $27.1 billion was paid for using “funds in the fiscal framework, sourced from department resources and/or projected revenues”.  The Conservative Opposition has claimed that the budget is a “big spending” and tax budget. This is far from the truth.

However, it does suggest that some existing programs may have been cut or there were “unspent” funds available from budget 2016. There was no mention of which programs, already funded in the fiscal framework, were being cut back, profiled or eliminated altogether.  Or if the funding could have come from “reserves” set aside in previous budgets, but never identified as such. Details on many of the proposed initiatives are being delayed into the future

This raises questions about the credibility of the revenue and expense forecasts.  Are there more hidden reserves to fund future initiatives, such as those emanating from tax changes south of the border?

The Finance Minister should be congratulated, however, for showing the Contingency Reserve as a separate line item rather than burying it in the major revenue components and for showing the five-year impact of the new policy initiatives on an annual basis.  In addition, the Canada Savings Bond program is finally to be phased out. As previous studies had clearly demonstrated, this was an extremely costly and inefficient way to raise funds.

The budget has been criticized because it does not include a plan to eliminate the deficit by some arbitrary date. The budget deficit is forecast to rise to 1.4 per cent in 2017-18 and then decline to 0.8 per cent in 2021-22. The deficit forecast includes an annual $3 billion Contingency Reserve. The debt-to-GDP ratio is forecast to rise to 31.6 per cent this year and then decline to 30.8 per cent by the end of the forecast period.

The promise to keep the deficit to $10 billion and eliminate it in 3 years was always “arithmetically” inconsistent with the Liberal policy platform. That was not hard to figure out. The government implicitly admitted this in Budget 2016 and has now reaffirmed this in Budget 2017. Budget deficits of 1 per cent of GDP or less hardly constitute a fiscal crisis.

Every G20 Minister of Finance would love to have this kind of fiscal situation. Eliminating the deficit would not only be bad fiscal policy, it would mean that the Liberal government would be unable to implement the programs and policies it was elected on.

So what will be the real challenge for the 2018 budget? Perhaps in the coming months Donald Trump will actually begin to act like a President. Or more likely, he will continue to act as an extremely unpredictable, narcissistic person with no grasp on reality. Either way, Trump’s actions could lead to difficult policy choices for Canada, if the US implements major reductions in corporate and personal income taxes. We are unlikely to know what will actually happen, until Trump tweets his policy decisions.

How should Canada respond to U.S. actions to drastically reduce corporate income taxes and taxes on high-income earners? There are two conditions that must be satisfied by our policy response. First, our tax system must be tax competitive (both corporate and personal); and second, whatever we do, we have to maintain a credible fiscal framework with a declining debt to GDP ratio. How can we do this?

There are two options for Mr. Morneau. First, he could respond by correspondingly cutting personal and corporate taxes and by finding revenue offsets through spending cuts and tax reform/simplification. Unfortunately, there is no room left for further significant spending cuts (leaving out entitlement programs) and tax reform/simplification would not yield sufficient revenues to offset the necessary corporate and personal tax cuts.

Or alternatively, the government could turn the tax “Trump challenge” into a major policy opportunity. This would involve creating a new tax mix (personal, corporate, and GST) that would not only offset the “Trump” tax reductions, but also promote innovation, investment, productivity and long-term economic growth.

The Finance Minister would do this by cutting corporate and personal income taxes by whatever amount is required to offset the Trump tax cuts. He would pay for them by rising the GST. This would not only maintain tax competitiveness with the US, it would also create major new incentives for savings and investment and long-term economic growth, while maintaining fiscal credibility. Such a change in tax mix may be fiscally neutral, but it would not be growth neutral. It could very well lead to stronger economic growth.

To put this in context, restoring the two-point cut in the GST introduced by the Conservative Government would generate over $14 billion annually. This would allow a significant cut in corporate income and personal income taxes.

This option would be politically difficult but in our view less so than the first. Regrettably, the Prime Minister in the past has said he would not increase the GST. However, the election of Donald Trump changes everything. Policy proposals that were rejected in the past will need to be reconsidered. Policy thinking has to change.

In the coming months Prime Minister Trudeau and Finance Minister Morneau should stop saying they won’t increase the GST. If President Trump actually introduces large corporate and personal tax cuts (along with major changes to NAFTA) then all tax policy responses will need to be considered. Given the government’s current tight fiscal situation, significantly cutting corporate and personal income taxes and increasing the GST to pay for them may be the government’s best policy response.

 

C. Scott Clark held a number of senior positions in the Canadian Government, including Deputy Minister of Finance from 1998-2001.  He has a PhD in Economics from the University of California at Berkeley and is currently President of C. S. Clark Consulting.

From 1990 to 2005, Peter C. DeVries served as Director, Fiscal Policy Division, at the Department of Finance.  In that capacity he was responsible for overall preparation of the federal budget.  He is currently a consultant in fiscal policy and public management issues.

Their Blog is 3dpolicy.ca

 

The views, opinions and analyses expressed in the articles on National Newswatch are those of the contributor(s) and do not necessarily reflect the views or opinions of the publishers.
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