Memorandum for The Honourable James Flaherty, P.C., M.P. Minister of Finance

April 21, 2006

Thank you for the opportunity to meet last week with you and with your Parliamentary Secretary, Diane Ablonczy, to discuss fiscal priorities for your first federal budget and beyond. On behalf of the members of the Canadian Council of Chief Executives (CCCE), I would like to take this opportunity to reinforce some of the key points that were raised during our meeting.

As the CCCE made clear in its response to the recent Speech from the Throne, we fully support the focused and realistic approach that your government has taken to the transition from campaigning to governing. The five priorities the government has laid out, including tax reductions, more innovative delivery of public services and more honest and effective government, will by themselves contribute significantly to a stronger economy.

At the same time, we recognize that Canada faces fundamental challenges that threaten our country’s ability to sustain its strong economic performance. The emergence of new economic powers such as China and India is reshaping global trade and investment flows and creating intense competition for Canadian enterprises in many sectors. The impact on Canadian manufacturers has been compounded by a rising Canadian dollar and high energy prices. In the face of these global pressures and the continued aging of our population, Canada must make strategic decisions about how to attract the investment and high-value jobs that will be needed to sustain and improve the quality of life of Canadian families over the next generation.

We believe that much can be done to strengthen Canada’s competitiveness and prosperity even within a minority Parliament. In a paper that we shared with you earlier this year, From Bronze to Gold: A Blueprint for Canadian Leadership in a Transforming World, we described a wide range of potential initiatives, and committed ourselves to working with your government and with opposition parties to build consensus in support of such measures.  This commitment was re-iterated by the Council’s Executive Committee at a meeting with Prime Minister Harper on February 15.  As a country, we must ensure that public policy is focused on improving our competitiveness and productivity, on increasing the rewards Canadians receive from each hour of their work and from each dollar they invest for themselves or entrust to governments.

Within the broad agenda described in From Bronze to Gold, we would like to reinforce the importance of early action on three fronts, either within your forthcoming budget or as quickly thereafter as fiscal circumstances permit. The first is tax policy.  The second is reform of fiscal federalism and the economic union.  The third is the review and reallocation of federal spending.

TAX POLICY AS A DRIVER OF INVESTMENT, JOBS AND INCOMES

Strong economic growth will be vital to sustain and improve social programs, public services and infrastructure in the face of an aging population and intense global competition. The CCCE believes that personal and corporate tax policy remains the most powerful tool governments have to drive new business investment, foster the creation of new high-wage jobs and raise the real incomes of Canadian families. 

Corporate tax policy has the most direct impact on investment decisions. Business investment is critical both in expanding employment and in raising productivity through the purchase of new machinery and equipment embodying advanced technologies. And yet Canada persists in levying one of the highest marginal effective tax rates on investment in the world. Ireland has enjoyed stunning economic results by using corporate tax policy to create a compelling advantage in attracting new investment and jobs, and even a high-tax economy such as Sweden has an effective corporate tax rate that is only one third of that in Canada.

The previous government brought down the statutory corporate tax rate considerably and announced further cuts in corporate income and capital taxes in last year’s budget, to take effect beginning in 2008. These cuts were put on hold by the Liberal government’s deal with the New Democratic Party last spring, but re-announced in the autumn fiscal update, with acceleration of the elimination of the federal capital tax to 2006.  The Conservative Party consistently supported these measures while in opposition and during the election campaign, and we are counting on the support of both Liberals and Conservatives for their inclusion in your forthcoming budget. Canada’s credibility in both domestic and international capital markets requires enactment of these measures as quickly as possible.

An aggressive approach to corporate tax rates is especially important for Canada as we compete for investments in operations designed to serve customers across North America. Given the natural pull of the much larger market to our south and the continuing potential for security-related delays at the border, it is in Canada’s interest to offer a compelling advantage on the corporate tax front.

High corporate taxes are simply counter-productive. Ireland, with its 12.5 percent corporate tax rate, collects proportionately 25 percent more corporate tax revenue than Canada.  Despite the cuts in Canada’s corporate tax rate in recent years, corporate income tax now accounts for 15 cents of every federal tax dollar collected, up from just six cents in 1993. The C.D. Howe Institute has estimated that the previous cuts combined with those announced in the 2005 federal budget would stimulate a total of $56 billion in capital investment, raise GDP by
$5 billion a year and create 340,000 jobs.

What produces more money for governments is not a high corporate tax rate, but a business environment that enables more companies to make more money, generating more tax revenue both directly and through the additional jobs and incomes that flow from robust corporate investment and growth.

Addressing the corporate tax challenge is not a matter for the federal government alone. The federal and provincial governments must work together to drive down the effective tax rate on business investment. In addition to reducing the statutory corporate income tax rate at both levels, the effective tax rate could be reduced through the elimination of all federal and provincial capital taxes, conversion of remaining provincial sales taxes to a value-added base, more rapid depreciation rates on machinery and equipment and new or improved tax credits for investment and for research and development.

As the CCCE has noted many times over the years, business investment is affected by more than just corporate tax rates. As companies focus on investment in higher-value activities, the ability to recruit and retain skilled people is critical. In this competition for skilled and globally mobile talent, personal income tax rates are an increasingly important issue, one that is most pressing in sectors such as high technology.

While the aspect of personal tax policy most relevant to the competition for high-end talent is the top marginal tax rate and the income level at which it begins to apply, the CCCE noted in From Bronze to Gold that improvements to personal tax policy could contribute to economic competitiveness in a variety of ways. As discussed last week, this could include:

• Helping families get ahead, not only through the child care provisions that are your government’s immediate priority, but through reduction of the punitive marginal tax rates facing modest-income families as the result of clawbacks of the child benefit and other income-tested programs;
  
• Supporting creativity and innovation by reducing or abolishing tax on income derived from intellectual property ranging from artistic works to scientific patents;
  
• Recognizing charitable and voluntary organizations as the bedrock of vibrant and creative communities by completing the elimination of capital gains tax on donations of appreciated property such as corporate shares and considering additional improvements in the tax treatment of all donations;
  
• Encouraging Canadians to invest more in their own future through higher contribution limits to retirements savings plans, creation of a second-tier savings account that would not provide a deduction for contributions but would not tax withdrawals for designated purposes, and of course your government’s plans to enable tax-free rollovers of certain investments.

We recognize that political pressures of a minority Parliament, together with the absolute requirement for fiscal discipline – the need to stay out of deficit and keep paying down the still-huge federal debt – limit what you will be able to do in your first budget.  We remain committed, however, to working with all parties to support the use of tax policy to raise the quality of life of all Canadians as rapidly as possible over time. 

REFORMING FISCAL FEDERALISM AND THE ECONOMIC UNION

The second urgent area for action is the reform of the fiscal relationships between the federal and provincial governments and the achievement of related measures to strengthen the way the federation works for Canadians.

As described in From Bronze to Gold, the members of the CCCE are deeply disturbed by the trend in recent years toward ad hoc deals between the federal and provincial governments that have accelerated federal spending at an unsustainable pace. The areas in which Canadians are demanding more public services lie predominantly in provincial jurisdiction, but we believe firmly that taxpayers will be served best if the people who spend their money are responsible for raising it.

We suggested two possible ways to clarify roles and responsibilities.  One, consistent with the proposals of the Séguin Commission on the Fiscal Imbalance in Quebec, would be to abolish the Goods and Services Tax (GST) along with all federal health and social transfers, allowing each province to raise the money it needs to meet its own responsibilities.  This approach is the cleanest in terms of direct accountability, but raises other issues, most notably a widening of the gap between richer and poorer provinces in the absence of offsetting changes to the equalization program.

The other approach we suggested would be to maintain the administrative simplicity of a national GST and the distributional equity of the current transfer formula, while providing provinces with assured access to a stable and growing revenue base through dedication of the full GST revenue pool to health and social transfers. At the same time, accountability could be enhanced by assigning to the provinces collectively the responsibility to set the GST rate.

In either case, governments also need to grapple with reform of the equalization program. We are not convinced, however, that equalization alone can address the needs of Canada’s various governments while improving accountability.

Excessive reliance on equalization to increase the revenues of provincial governments also may exacerbate the challenges faced by Canada’s largest cities. Today’s reality is that the economic growth of the country and the quality of life of all Canadians depends to a great extent on the success of our large cities.  These cities have suggested that too much of the economic riches they produce are being taken away to subsidize current consumption in other parts of the country and too little is being reinvested in the prerequisites of future growth. In effect, cities are facing an excessive marginal tax rate within the federation, and if we want to expand economic opportunity and prosperity for the country as a whole, we have to consider reducing the rate at which we redistribute income between different parts of the country.

The management of a federation is a complex business.  Whatever path may be agreed in terms of reform of fiscal arrangements, Canada’s business leaders remain deeply concerned about the evolution of the country’s economic union.  There is still much more to be done to streamline the movement of people, goods and investment within Canada while reducing the burdens faced by taxpayers and industry alike.

Regulatory reform is a critical issue, especially in terms of reducing regulatory costs, time frames, uncertainty and overlap between jurisdictions.  The CCCE has been a strong supporter of the Smart Regulation initiative. The work of the Advisory Committee on Paperwork Burden Reduction is especially important, since it focuses on relatively simple ways to cut the cost of complying with regulations without undermining high regulatory standards.  It also is important to encourage regulatory convergence wherever appropriate, both within Canada and internationally.  In particular, we believe that the formation of a single regulator for Canadian securities markets would have a dramatic impact in strengthening investor protection while cutting the cost of capital and improving the ability of entrepreneurs and growing companies to raise money and expand into global markets.

SPENDING REVIEW AND REALLOCATION

Governments, like Canadian families, always will face new priorities and new issues that must be addressed. In recent years, Canada’s unusually strong economic growth has enabled the federal government to accelerate program spending at a very high rate. Spending that rises faster than the economy that forms the government’s tax base, however, clearly cannot be sustained indefinitely.

In 2003, the CCCE recommended development of a rigourous and ongoing process for the review and reallocation of federal spending. We put forward what we called the “5 percent solution”, an approach that would require each minister and deputy minister to identify each year the least effective five percent of spending under their direction.

The previous government subsequently conducted a one-time review based in part on this principle.  The result announced last year was identification of $11 billion in savings over five years, mostly from process improvements in areas such as procurement and real estate management. Even if all projected savings from this review are realized, it is vital to establish a permanent spending review process, one that would become the initial stage in the annual budget cycle.

The purpose of the “5 percent solution” is to improve accountability. Even where a given program serves a valid purpose, regular review challenges public servants and ministers to do better.  It pushes them to create value, not just to eliminate waste.  The goal must be to change the culture of government, to ensure that every year, every minister and senior official takes a hard look at how they are spending taxpayers’ money and how this money might be used more effectively in the future.

Even if limited to direct program spending, exempting debt service, transfers to provinces, Employment Insurance and old age pensions, a review exercise with a five percent target would identify more than $3 billion each year for potential reallocation to new or growing priorities. Every family reviews its needs and wants on a regular basis, and shifts its spending accordingly. Canadians have a right to expect no less from their governments.

BUILDING PROSPERITY THROUGH PRODUCTIVITY

The concept of productivity is hard to communicate and often misunderstood.  Some Canadians see it as code for making people work harder for less money. But improving Canada’s productivity performance is the key to ensuring that Canadians enjoy a steadily improving quality of life in the face of the daunting competitive and demographic challenges that we will face over the next generation.

A business environment that is competitive is one that is open to the world and that uses tax and regulatory policy as tools to enable Canadians to be more productive and to encourage enterprises to grow globally from a Canadian base.  A social environment that is competitive is one that draws on effective public and private investment to create communities in which everyone has opportunities to get ahead and in which talented and mobile people want to live and work. An economy with high and growing productivity is one in which families will have more money to spend and governments will be better equipped to provide the high quality public services that Canadians want.

In 2001, the CCCE adopted the goal of making Canada “the best place in the world in which to live, to work, to invest and to grow.” This remains our central objective today, and the members of the CCCE look forward to working closely with you and your colleagues as you decide how best to shape Canada’s strategy for competitiveness and growth.

David Stewart-Patterson
Executive Vice President