Honing Canada’s Edge: Fiscal Priorities in an Era of Global Uncertainty

September 7, 2001

Dear Prime Minister,

Early last year, the members of the Business Council on National Issues (BCNI) warned that without vigorous action to consolidate Canada’s advantages and deal with its shortcomings, our country risked a precipitous decline in the standard of living of its citizens. We are pleased to acknowledge that your government acted with commendable speed in addressing the most urgent concerns that we raised.

In particular, the decision in October 2000 to accelerate personal and corporate tax cuts proved to be not merely good policy in its own right, but brilliantly timed from a cyclical point of view. The infusion of new spending power reinforced consumer confidence even as the abrupt slowing of demand in high technology shook equity markets and prompted a sharp retrenchment in business investment.

That said, the marked decline in overall corporate profitability is having a serious impact on economic growth across the continent. Indeed, it is now clear that prospects are weakening for major economies across Europe, Asia and the Americas. Central banks worldwide, led by the United States Federal Reserve, are making determined efforts to stimulate renewed growth, but the probability of global recession looms larger by the day.

Yesterday, the Board of Directors of the BCNI met in Vancouver to discuss Canada’s prospects, and we respectfully suggest that innovation and prudence must be the watchwords if Canada is to continue moving forward amidst this global uncertainty. Your government deserves great credit for the immense progress our country has made over the last eight years, and the wise policy decisions of the past leave Canada better prepared to weather a global downturn. We suggest, however, that Canada’s hard-won gains are fragile and that without great restraint in the management of the public purse, there remains a real risk that they could evaporate. While today’s real and pressing fiscal constraints will require difficult trade-offs, we believe that with creativity and cooperation, there remains considerable scope for innovative ways to improve the lives of Canadians.

WELCOME PROGRESS IN REDUCING DEBT

The robust economic growth of the past few years has led to substantial progress in reducing the burden of federal debt. The May 2001 budget update projected a record $15 billion in debt reduction for 2000/01, capping four years of accelerating surpluses. As Finance Minister Paul Martin pointed out, total debt repayment will have reached more than $3 billion over four years. In the process, the federal debt-to-GDP ratio will have dropped from a peak of 71 percent to 53 percent. This means that the government has available an additional $2 billion a year no longer required to pay interest, a vital source of fiscal flexibility in today’s more challenging times. This is a truly remarkable record, one that will pay dividends to all Canadians for years to come.

The budget update in May of this year showed that even using pessimistic economic assumptions, further surpluses are likely this year and next. It suggested that after accounting for last year’s Health Accord and other spending measures introduced since the autumn of 2000, the government should be able to shave a further $11 billion from its debt load by the end of fiscal 2003.

To the extent that the rapid expansion of the tax base over the past few years spills over into better than planned revenue moving forward, we believe that it will be important to keep paying off debt aggressively. The government has limited itself to two-year rolling targets for budgetary purposes. But recent private sector forecasts suggest that while short-term surpluses may be even greater than those projected in the May budget update, the government could fall into a deficit for planning purposes as early as 2004/05.

Including that of provincial governments, Canada’s total public debt remains close to $800 billion, a heavy burden that continues to put at risk both economic growth and the ability to support vital public programs. We strongly urge your government to consolidate its progress in reducing debt and suggest the adoption of a longer-term target, the reduction of federal debt to a more prudent and competitive level of 25 percent of GDP by 2010 and of combined public sector debt to this level by 2015. Such a goal will require at the very least closer collaboration on fiscal strategy between federal and provincial governments.

We recognize that a commitment to continuing debt reduction through a period of slower growth will require difficult trade-offs. In particular, any economic downturn will inevitably lead to an increase in the number of Canadian families facing real and pressing needs for short-term assistance. We remain wary, however, of attempts to find quick fixes to perennial challenges such as the elimination of poverty, and we are especially sceptical of one-time measures designed to load ongoing costs into a single fiscal year. As we are sure you will agree, any proposal for new spending or for tax relief must not only make a measurable contribution to Canada’s economic and social fabric, but also be sustainable through good times and bad times alike. Reducing the burden of public debt remains the most effective way to guarantee the future integrity of Canada’s social safety net.

A TIME FOR INNOVATION IN SPENDING

The surging revenue of recent years has enabled the federal government to be all things to all people. It has been able simultaneously to make a significant dent in public debt, reduce personal and corporate taxes and engage in a wide variety of new spending initiatives. Total federal spending, however, is on course to grow considerably faster than inflation and population over the next five years, an alarming pattern that clearly cannot be sustained indefinitely. This will require more complex and difficult choices among priorities in future.

Canada does face ongoing challenges in the delivery of key public services that may require substantial additional spending. Some, like health care, flow from the inexorable demands of demographics. Others, such as education, research and public infrastructure, represent core investments in our nation’s capacity for economic and social development. As a result, we see a real need for a renewed focus on maximizing the value that taxpayers receive for their money.

The essential questions raised by the federal government during the program review of the early 1990s remain relevant today. Does each program the government supports continue to serve the public interest? If so, are there ways to run it more efficiently or make it more affordable? Is each program best run by the federal government, or could it be delivered more effectively in whole or in part by another level of government or by the private or voluntary sectors?

As your government contemplates a growing list of proposals for additional spending, it is clear that program review must be revived as a continuing and rigorous feature of fiscal management. Rolling reviews, at least once every five years for any given program or tax expenditure, would have a dual purpose. First, they would keep a focus on efficiency and effective delivery within continuing programs. Second, they would help to identify changing needs in our society and potential candidates for reallocation within the overall spending envelope.

We strongly support your government’s commitment to innovation and, in the months ahead, we look forward to engaging in a national dialogue on how to ensure that Canadian workers, enterprises and government institutions become global leaders. We suggest strongly, however, that the essence of innovation lies not in spending public money, but rather in finding new and more effective ways of achieving public and private goals. How money is spent is more important than how much is spent. Structural reform represents a powerful tool for improving the lives of Canadians without net increases in public spending.

In this respect, we would highlight three challenges. First, as noted by the Organization for Economic Cooperation and Development in its recent report on Canada, comprehensive labour market reform played an important role in boosting employment and improving economic performance in the 1990s. This reform, however, was undermined by last year’s decision to backtrack on the intensity rule intended to discourage frequent use of the Employment Insurance system. We concur with the OECD’s conclusion: "The reversal of this limited move towards experience rating is regrettable and sends wrong incentive signals to both firms and employees that in the past have unduly benefited from the system and diminishes the scope for job-boosting reductions in payroll taxes."

Similarly, the OECD noted that support to agricultural producers has begun to rise again despite the significant progress made over the past decade in increasing the efficiency of the sector. Even though the government has provided billions of dollars in repeated emergency relief, western Canadian agriculture in particular is effectively on the verge of bankruptcy, with potential social and economic implications that are staggering. We still see the possibility of building in Canada a preferred base for globally competitive agri-business enterprises, but the solution does not lie in greater public spending on support for producers. Only structural measures to liberalize markets and encourage greater investment in new technologies can prevent the ultimate demise of this vital sector.

Finally, we note the myriad of unresolved issues affecting Canada’s Aboriginal people. Here too the federal government spends billions of dollars a year. Yet the economic and social outcomes are abysmal, fuelling a climate of frustration that is causing widespread conflict, discouraging business investment and undermining the economic prospects not just of Aboriginals but of all Canadians. Your government is demonstrating a laudable determination to improve accountability to ensure that federal spending has greater impact in improving outcomes for Aboriginals, but even efforts to consult the individuals and communities affected have been mired in controversy.

While these examples illustrate the difficulties that can flow from serious attempts to review any government program, we believe that a constant willingness to question the old in order to invest in the new is critical to ensuring that Canada is able to craft unique and innovative pathways to global success.

RETHINKING CANADA’S TAX STRUCTURE

The OECD strongly recommended that Canada put a brake on public spending in order to concentrate on debt reduction and further tax cuts. Given the uncertainty of the global economic outlook, however, we recognize that Canada cannot afford huge new tax cuts any more than it can afford massive new spending programs. The competitiveness of Canada’s personal tax system remains a real concern, one that will become more pressing as American tax rates continue to fall in the years ahead. However, the federal cuts announced in October 2000 reflect the most urgent priorities that the BCNI identified in 1998. Further deep and broadly-based personal income tax cuts remain an important goal, but we do not see them as prudent at this time.

We do believe, however, that there is room for tightly focused measures and creative changes to Canada’s tax mix that would make Canada’s tax system significantly more competitive at little or no net cost to government revenues. We see potential for action in both corporate and personal taxation.

Corporate taxation. The federal government has begun the process of cutting the corporate income tax rate by seven percentage points over four years. Ontario and Alberta have announced the goal of cutting their provincial corporate income tax rates to eight percent. These reductions will make the combined statutory rate in these two provinces highly competitive within North America. As the smaller economy, however, Canada cannot win the competition for investment simply bymatching the attractions of the United States. We must ensure that our country offers a clear and compelling advantage.

We see three key issues in the short term. First, the bold move by Ontario and Alberta challenges Canada’s less prosperous provinces to remain competitive in attracting business investment and jobs. Second, there is a need to resolve the continuing impasse on the definition of taxable income for resource industries. Third, corporate income taxes are just one facet of the total tax burden facing Canadian businesses. When all taxes, subsidies and regulatory costs are taken into account, it is clear that Canada has a long way to go if it wants to reverse the decline in its share of North American and global investment.

Business investment is a key driver of the productivity growth that in turn leads to higher incomes and greater employment. Dramatic cuts in business taxation were not solely responsible for Ireland’s ability to double its standard of living in a decade, but they have had a powerful and enduring impact. Yet even after Canada’s planned corporate income tax cuts, the effective rate of tax on capital investment in this country will be more than four times that in Ireland.

The most urgent and most effective means of stimulating business investment would be the elimination of capital taxes at both the federal and provincial levels. The burden of these taxes is felt most dramatically by the very companies on which Canada is relying for growth: those that invest heavily in research and in the adoption of new technologies and those that are trying to build critical mass in order to compete successfully with the best in the world.

The total revenue from these taxes is about $4.9 billion a year, of which the federal government collects $1.4 billion. Elimination of federal capital taxes would pay off quickly in terms of stimulating investment and building the tax base. While fiscal circumstances may require a phased approach, we believe that reducing capital taxes and making a commitment to their rapid elimination should be your government’s top fiscal priority for the 2002 budget.

Two further areas for action lie within provincial jurisdiction. First, the provinces of Ontario, Manitoba, Saskatchewan and British Columbia should join the rest of the country in converting their sales taxes to value-added taxes. Whether or not they harmonize with the federal Goods and Services Tax, the elimination of sales taxes on business inputs would be equivalent to a 2.5 to three percentage point cut in the rate of tax on business capital with no net revenue loss.

Second, to ensure that all regions of the country can compete effectively for new investment, other provinces will have to bring their corporate income tax rates into alignment with those of Alberta and Ontario. The new government of British Columbia recently moved in this direction. Moving all provincial rates into a range of between eight and ten percent would cost about $1 billion a year in total, and would have a powerful impact on investment and job creation across the country.

Personal taxation. There is even greater scope for creativity within the personal tax system. Economic evidence strongly favours consumption as a more efficient base of taxation than income. Because greater savings both build personal wealth and increase the supply of capital for business investment, a dollar raised by taxing what people spend does less damage to economic growth than a dollar raised by taxing what they earn. In principle, therefore, higher consumption taxes and lower income taxes may be more appropriate than Canada’s current mix.

It is possible that Canadians might in future embrace bold trade-offs such as funding lower income tax rates with either a higher rate or broader base for the GST. In the meantime, Canada can make real progress toward consumption-based taxation within a progressive income tax system, simply by emphasizing the incentives for saving and investment.

As a first step, we would suggest raising annual Registered Retirement Savings Plan and Registered Pension Plan contribution limits. The cap would remain at 18 percent of earned income, but the income limit would rise to the new threshold of the top income tax bracket, resulting in a maximum contribution of $18,000 a year that would then be indexed to inflation. This would have an initial cost of about $760 million a year, falling to $550 million by 2004 because of the already scheduled rise in the annual limit to $15,500. It should be noted that while raising contribution limits reduces tax revenue in the short term, it will lead to higher future revenue as money is withdrawn, just when governments will need to meet growing age-related commitments such as public pensions and health care.

To reinforce opportunities and incentives for savings across the board, we also recommend the creation of a second-tier education and retirement savings plan similar to the Roth Individual Retirement Account in the United States. In this type of tax-prepaid plan, contributions would not be tax-deductible, but income would accumulate and be withdrawn tax-free either in retirement or for education.

The contribution limit for the new savings vehicle, which might be called an Education and Retirement Savings Account (ERSA), could be $12,000 a year regardless of income. This feature should be of particular value to entrepreneurs and farmers, who may have assets that could be contributed but little taxable income. While the combined contribution limit of $30,000 a year might seem high, it would still be much lower than in the United States or United Kingdom.

Existing Registered Education Savings Plans and the proposed Registered Individual Learning Accounts would be rolled into the new ERSA. The government could help families of modest means to save for education and retirement by making matching contributions, as it does now for RESPs, and by allowing employers to do the same for employees.

Reduction or elimination of current tax expenditures could make these additional incentives for savings and investment possible at no net cost to federal revenue. We would suggest three possibilities, all of which would improve the equity and simplicity of the tax system: the pension income credit, the credit for contributions to labour-sponsored venture capital corporations and the $500,000 capital gains exemption for farmers and small business owners. Given the expanded savings opportunities for all taxpayers, entrepreneurs and farmers should not be worse off, provided that they are offered transitional relief and enhanced contribution rules along the lines recommended by the Technical Committee on Business Taxation. Eliminating all three would raise federal revenue by about $1.3 billion a year, almost twice as much as required to cover the short-term cost of higher RRSP and RPP contribution limits. In the longer term, the government also could consider offsetting the revenue lost to the growing pool of tax-sheltered retirement savings by phasing out the age credit and reducing the maximum age for contributions from 69 to 65, or whatever age at which senior’s benefits begin being paid. If implemented today, these two measures would generate an additional $1.6 billion a year in revenue.

The overall impact of these recommendations on corporate and personal taxation would be to improve substantially the competitiveness and economic efficiency of Canada’s tax system with little change in revenue. In our view, the process of eliminating federal capital taxes and the combined personal tax changes should be included in the next federal budget. The extent to which provincial governments see the wisdom of creating a more competitive environment is their choice within Canada’s federal system. The federal government, however, should renew its efforts to encourage harmonization of sales taxes with the GST and consider creative ways to help the governments of less well-off provinces to cut their corporate tax rates.

WORKING TOGETHER ON NATIONAL PRIORITIES

Sound fiscal policy is just one aspect of a successful strategy for ensuring Canada’s continued growth and prosperity in the face of global uncertainty. As in fiscal policy, the challenges we face as a country tend to cross jurisdictional boundaries, requiring cooperation between levels of government. Furthermore, their nature and scope require the active participation of the private and voluntary sectors in addition to governments.

The member chief executives of the Business Council on National Issues remain committed to doing their part in helping to address these great national challenges. In addition to fiscal policy, we will be focusing our energies on four priorities in the months ahead: public health care; the regulatory environment; global and North American integration; and the environment.

Health care. Public and private expenditures on health care continue to rise faster than the size of the economy. Even as our growing and aging population strains the capacity of the existing infrastructure, public health authorities are being forced to compete for talented professionals able to sell their services anywhere in North America. New technology allows more cost effective treatments to be introduced, but also creates demand for treatments hitherto unavailable. Health care has become the dominant issue of public finance and a source of great acrimony between the federal and provincial governments.

The important competitive advantage once provided by Canada’s public health care system has been seriously eroded. Rebuilding that advantage will require innovative approaches on two levels. The first is operational: how to organize and manage health care delivery in a way that fosters cost-effective innovation and makes optimal use of both capital and human resources. The second is one of financing: how best to fund public health care in ways that help to manage supply and demand while ensuring timely and universal access to a wide range of high quality services. We plan to contribute to both of these discussions.

Regulation. We see powerful opportunities for the federal and provincial governments to make Canada a more compelling location for global enterprises through regulatory reform. The most obvious opportunity is to follow through on the promise of the Agreement on Internal Trade. We urge First Ministers to renew their commitment to its principles; to fulfil all of its existing commitments; to enhance its coverage; to make it easier for governments and private parties to seek redress; and to include clear consequences for violations. In an era of global integration, the continued existence of barriers to the movement of people, goods, services and capital within our borders simply makes no sense.

More generally, regulatory processes that are complex, expensive, time-consuming and unpredictable also undermine Canada’s ability to attract and retain business investment. Canada’s regulatory standards are and should remain high, but improving the transparency and predictability of the regulatory process could pay huge dividends.

Other regulatory issues such as the limits Canada places on corporate ownership in key sectors of the economy could prove to be highly controversial. We would suggest, however, that only by having the confidence to let Canadians participate fully in the world economy can we hope to increase the number of global champions based within our borders.

Global and North American integration. The benefits of Canada’s enthusiastic participation in the global economy are obvious. At the same time, it is clear that the process of multilateral trade and investment liberalization is under siege. We cannot emphasize strongly enough the importance to a country as trade-dependent as Canada of launching a new round of multilateral trade negotiations at the meeting of the World Trade Organization in Doha this autumn. It is vital for Canada to develop a comprehensive strategy for these negotiations, one that will have demonstrable benefits for Canadians and that will reinforce Canada’s reputation as a leading force for progress within the multilateral framework.

At the same time, the renewal of the long-running dispute with the United States over softwood lumber is a sharp reminder of the need to devote greater attention to the management of Canada’s relationship with its single most important trading partner. The continuing litany of trade disputes has in turn become intertwined with a growing list of non-trade issues such as defence and security, terrorism, illegal immigration and narcotics trafficking. The breadth of this bilateral agenda combined with the growing integration of the broader North American economy points to a clear and compelling need to nurture Canada’s relationship with the United States more systematically and to address emerging issues both rapidly and aggressively.

Canada has the option of dealing with each of these bilateral issues in isolation as they arise. We suggest, however, that it is in Canada’s best interest to pursue a more comprehensive strategy for managing our country’s relationship with the United States and the process of North American economic integration. The BCNI played a key role in initiating discussion of the original Canada-United States Free Trade Agreement, and we are committed to pursuing all possible avenues for enhancing Canada’s prospects as a sovereign country and a uniquely successful society within an integrating continental and global economy.

Environment and climate change. The July negotiations in Bonn on the Kyoto Protocol on global climate change helped to clarify some of the principles for implementation of the Protocol, but many uncertainties remain. Before any decision on ratification, there must be a broad and fully informed national dialogue about the concrete steps Canada would have to take in order to meet its Kyoto commitments and the implications of these measures for consumers, for industry and for governments, particularly given Canada’s energy-intensive, export-oriented economy. Given the growing integration of the North American economy and United States interest in providing market opportunities for greater hydrocarbon energy development in Canada, it also is vital to consider the implications of ratifying Kyoto in the absence of American and Mexican participation and of any recognized credits for Canada’s energy exports.

Climate change remains only one aspect of the broader challenge of establishing Canadian leadership in environmental issues. As Canada prepares for the 2002 global summit on sustainable development in Johannesburg, we must consider the roles that the private sector could or should be expected to play in building social and environmental as well as economic infrastructure in the developing world. A common understanding of these roles will be vital in ensuring that all parts of the developing world benefit fully from trade and investment liberalization.

BUILDING ON A STRONG FOUNDATION

Canadians have every reason to be proud of our country’s recent performance. For the past three years, Canada’s economy has grown faster than that of every other G-7 country, including the United States. Such performance, however, is no grounds for complacency. Other countries outside the G-7 continue to catch up with and surpass our standard of living. Lagging productivity points toward slower income growth in future. Canada’s slide in the ranking of competitiveness by the World Economic Forum from a high of fourth to its current seventh has been followed by its recent loss of top spot in the United Nations Human Development Index.

We remain convinced that our country has unique advantages that make it possible for all Canadians to be winners in a world of convergence, and as a result of the prudent fiscal policies pursued by your government since 1993, Canada is better positioned than ever to bring together the elements of a winning strategy. Such a strategy must involve all sectors of our society. In particular, businesses large and small must invest with increasing vigour in improving productivity and competitiveness. As the Economic Development Committee of the National Liberal Caucus recently observed in its excellent report on skills and learning, however, "business investment in innovation cannot be divorced from consideration of the economic environment created by taxes." More broadly, we would suggest that it is vital for governments at all levels to ensure that the country’s fiscal and regulatory environment reinforces the business case for investment.

We believe that there is much that your government can and should do to sharpen Canada’s competitive edge even within a framework of fiscal prudence. At the same time, we commit ourselves to doing our part in tackling these great challenges. In particular, we want to make sure that you are aware of the broadening of the BCNI’s mandate to permit an even more active role on the global stage. In addition to our traditional focus on encouraging innovation and competitiveness at home, we intend to be far more active abroad in helping to build Canada’s brand as a vibrant multicultural society that is home to innovative global enterprises.

Prime Minister, thank you for this opportunity to renew our continuing dialogue. We look forward to working with you and your colleagues in the months ahead to restore both the reputation and reality of our country as the best place in the world in which to live, to work, to invest and to grow.

Sincerely,

On behalf of the Board of Directors,
Business Council on National Issues

David P. O’Brien
Chairman

Thomas d’Aquino
President and Chief Executive