Walking a Tightrope: The Need for Balance in Canada’s Fiscal Strategy

September 29, 2005

Thank you for the opportunity to appear once again before this committee to discuss priorities for the next federal budget.

I would like to make three points this morning.  First, Canada’s business leaders are increasingly worried about Canada’s ability to sustain its strong economic performance.  Second, the government needs to rein in the runaway growth in federal spending and achieve a better balance between new spending on social programs and reinvestment in economic growth.  Third, lower taxes are an essential part of a successful strategy for improving Canada’s productivity and competitiveness.

As Prime Minister Paul Martin recognized in a speech last week, Canada faces two particularly daunting challenges: at home in the form of an aging population; globally in the way countries like China and India are transforming the competitive landscape.

All the good-news statistics of recent years — strong economic growth and job creation, trade and current account surpluses, low inflation and interest rates — have created a dangerous complacency.  Beneath the surface, more ominous developments are lurking. For instance:

• Intense global competition, high energy prices and a rising dollar are hammering Canada’s manufacturers.  They have lost 108,000 jobs in the past 12 months.


• Labour productivity growth for the past two years has been almost zero.  Relative to the United States, our productivity performance has dropped off a cliff.


• As our competitors go after investment by cutting corporate taxes, Canada is being left behind. The C.D. Howe Institute has pointed out that Canada now has the second highest marginal effective tax rate on capital in the world.


• One result: inward foreign direct investment, a major driver of innovation and job creation, has withered.  Growth last year was marginal, and 2003 marked Canada’s worst performance in attracting investment since the Great Depression of the 1930s.


• This already is having an impact on our standard of living.  The gap between Canada and the United States, which narrowed significantly through the 1990s, is widening again.

Canada has to get serious about reinforcing its competitiveness.  Fiscal discipline is an essential foundation, and we applaud the government’s bedrock commitment to staying out of deficit.  But Canada needs more than fiscal discipline to ensure its future growth.

The next step must be to put a lid on runaway spending.  Program spending last year grew by more than 15 percent.  That was roughly eight times the rate of inflation, and more than three times faster than nominal economic growth.  Such a pace simply cannot be sustained unless the government plans either to hit Canadians with higher taxes or to break its promise to stay out of deficit.

It is perfectly reasonable to take some of the dividends that flow from fiscal discipline and use them to improve the lives of Canadians today, but governments need to reinvest in future growth as well. In this respect, I cannot help noting that the government describes much of its social spending as an economic investment.  It says money for child care, for instance, will boost Canada’s future productivity by contributing to a more skilled labour force. 

It is true that well-spent tax dollars can help to build a stronger economy.  Spending on education, on research, on infrastructure and for a wide range of other purposes can add to Canada’s ability to attract investment dollars and skilled people.

But whether public spending actually helps or hurts future growth depends on how well the money is spent, on what results are achieved for each dollar taken out of the economy in taxation. With so much of the current spending binge consisting of hand-offs to other governments, it is almost impossible to tell how well the money will be spent.  In any case, no sensible economic strategy can be based solely on ramping up public spending.

All taxes reduce growth, and taxes on investment, on capital and on corporate income do the most damage.  As capital flows ever more freely around the world, other governments have figured out that cutting corporate taxes pays off with stronger growth, more jobs and higher overall tax revenue. 

We have talked before about Ireland, and how it has used extremely low corporate taxes to drive its stunning growth over the past decade. Between 1993 and 2003, Ireland went from a per capita GDP of only two-thirds of the European Union average to one that is 25 percent higher than the EU average.  Residents of Ireland now enjoy a standard of living that is 44 percent higher than that of Canadians.  That is an extra US$13,770 per person, per year.

But even big-spending activist governments have figured out that penalizing investment does not pay.  Consider Sweden, where government spending accounts for more than half of the economy.  Swedish taxes on personal income, payrolls and consumption are much higher than in Canada.  But its taxes on corporate income and capital are lower.  In fact, Sweden’s effective tax rate on capital is less than one-third of the rate here — and Sweden’s real per capita growth last year was almost 50 percent higher than ours.

Canada, for its part, has cut corporate tax rates in recent years, and I cannot help pointing out the result.  In 2003 and 2004, the corporate tax rate was cut by a total of four percentage points.  Yet over the past two fiscal years, federal revenue from corporate income tax has grown by $7.7 billion or 35 percent.  Corporate income tax now brings in more cash than the GST.

It is therefore unfortunate that the government has decided to delay legislation of the additional tax cuts announced in the February 2005 budget.  The Minister of Finance has made it very clear to the investment community in Canada and globally that these cuts will proceed on schedule, and we take him at his word.  However, Canadian manufacturers in particular have to make major investment decisions now about whether and where to invest, and they will only be able to invest with certainty once these tax cuts are legislated.

We therefore would urge parties on both sides of the House to find ways of working together to take action sooner rather than later to give Canadian communities the help they need to attract investment and jobs in today’s highly competitive world.

To conclude, Canada’s economy is walking a tightrope.  We have come a long way. But to arrive at our goals as a society, Canada’s strategy for enhancing competitiveness and growth must be balanced.  Tax cuts by themselves will not do the job.  But neither will any strategy that ignores tax policy as a powerful tool for building competitive advantage.  If we want Canadians to enjoy the highest possible quality of life over the next decade and beyond, the next budget must include significant tax cuts, and not just more spending.