By: Nick Pantaleo
Budget watch 2012 has focused primarily on speculation over the amount and scope of government spending cuts to reverse budget deficits.
We have seen this movie before – in the mid to late 90s when the federal government and certain provinces drastically cut spending. This led to years of budget surpluses and reduced debt and service costs. For those in need of a reminder, I refer you to an excellent video produced by the MacDonald Laurier Institute at http://www.macdonaldlaurier.ca/the-canadian-century-video/.
Can we count on that same level of economic growth this time around?
Many, including economist Don Drummond in his recent report to the Ontario government, think not. If they are right, that will put a dent in government plans to increase revenue through economic growth.
Raising revenue is an important government priority so that they can provide public goods and services. Over the years, governments have consistently returned to old methods to raise revenue.
The starting point is usually to broaden the income tax base, particularly the corporate tax base. This can take many forms. Some are described as “loop-hole closing” – in truth, most of these are really reversals of previous tax expenditure decisions that the government believes are no longer needed or affordable. Others include measures to combat inappropriate tax avoidance. Canada has seen both in recent years.
While supporters argue that base broadening increases the efficiency and fairness of the tax system, others caution that it has the effect of a tax increase and the government runs the risk of making the system uncompetitive, which is counter to its role to facilitate business investment in Canada.
Increasing income taxes is another tried, but not necessarily true, way to raise revenue.
While there have been mixed messages from the provinces, federal Finance Minister Jim Flaherty seems prepared to stay the course on corporate income tax rate reductions. Good thing, because raising corporate income taxes, and capital and payroll-type taxes have a negative impact on economic growth. It is also a very unreliable source of government revenue as many provinces discovered during the current economic downturn.
Personal tax rates, too, aren’t likely to be increased and many argue they are already too high. The question here is how long before governments take a hard look at personal tax rates and its negative impact on savings by Canadians - savings they will need if governments reduce spending in areas such as pensions and health care?
In today’s economic environment, the historic response of increasing income tax burdens to fund government spending is due for a re-evaluation.
A recent C.D. Howe paper reveals that the marginal cost of raising federal (and provincial) corporate and personal tax rates is very high, meaning that large economic gains could be obtained by improving how governments raise revenue. Other countries are taking actions in this regard, placing greater reliance on consumption taxes and making such systems more efficient.
Changing Canada’s tax revenue mix to ensure governments have an efficient and sustainable way of raising revenue will not be for the faint of heart – it will take leadership.
During the 2011 federal election campaign, it was reported that Mr. Flaherty wanted to overhaul Canada’s tax system. This is a good place to start in year one of a majority mandate but it can’t be a federal only initiative – the provinces have to be part of it. They too have a huge financial stake and the old methods are just not good enough.
What are your thoughts? Leave your comments below.