FINA Committee Meeting

STANDING COMMITTEE ON FINANCE

COMITÉ PERMANENT DES FINANCES

EVIDENCE

[Recorded by Electronic Apparatus]

Thursday, December 2, 1999

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[English]

The Chair (Mr. Maurizio Bevilacqua (Vaughan—King—Aurora, Lib.): I'd like to call the meeting to order and take this opportunity to welcome everyone. This is the final session before the committee meets to write the report and make recommendations to the Minister of Finance. So we'll be sharing with you some of the thoughts and ideas that we heard as we travelled across the country, and of course we'll be looking for your input as to what type of recommendations you would like to see in the budget 2000.

This afternoon we have the pleasure to have with us the following individuals: David Rosenberg, vice-president and senior economist, Nesbitt Burns; Professor Pierre Fortin, Department of Economics, University of Quebec in Montreal; David Laidler, Department of Economics, University of Western Ontario; Jim Stanford, economist, CAW Canada; John McCallum, senior vice-president and chief economist, Royal Bank of Canada; Joshua Mendelsohn, vice-president and chief economist, Canadian Imperial Bank of Commerce; Tim O'Neill, executive vice-president and chief economist, Bank of Montreal; William Robson, senior policy analyst from C.D. Howe Institute; Andrew Jackson, chief economist, Canadian Labour Congress; and Professor Marc Van Audenrode, chair, Department of Economics, Laval University.

We're waiting for two or three more individuals, but we'll start.

Many of you have appeared before the finance committee. You know how this works. You get 7 to 10 minutes to make your introductory remarks, and thereafter we'll engage in a question and answer session.

We will begin with Mr. David Rosenberg. Welcome.

Mr. David Rosenberg (Vice-President and Senior Economist, Nesbitt Burns): Thank you, Mr. Chairman.

At the outset, I would like to put forward a question to the government side. What is so sacred about allocating 50% of the so-called fiscal dividend to new spending and the remainder divvied up between tax and debt reduction, and why should we feel compelled to divide the fiscal pie in such a preordained way, as if fiscal policy were on autopilot?

Fiscal policy, in my view, always involves tough choices over what to do with programs that have outlived their usefulness, what new spending initiatives are needed to serve the public good, and how the tax system can be altered to best maximize our economic potential and standard of living.

I want to go back to last year's budget just for a minute. While the government responded to the polls showing health care to be at the top of Canadians' list of concerns, nearly $4 billion of new expenditures were earmarked for the ensuing four years toward “building a stronger economy”. At the same time, the tax relief that could achieve that goal that was contained in last year's budget was tiny, to say the least, amounting to a negligible 0.2% of GDP for this year, and left top marginal rates for individuals at a still burdensome level of just under 50%, depending on the province.

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So if 1999 was the health budget, 1998 the education budget, and 1997 the child benefit budget, the one we see in February hopefully will be dubbed the tax relief budget that aims, for a change, at strengthening family incomes and bolstering confidence in an economy that has relied far too long on riding the coattails of the United States.

Members of Parliament should be aware that future economic historians will note that real disposable income per capita in the 1990s fell almost 5%—a legacy few other industrial countries share, and a decade without precedent in recorded Canadian history. Adjusted for inflation, population growth, and taxes, personal income is no higher today than it was in 1988, and that is a haunting statistic.

Accordingly, I would make the case strongly that from here every dollar possible from the so-called fiscal dividend be allocated toward reviving household incomes for everyone, and after this decade of lost income growth, this should be the government's number one priority.

Thank you very much.

The Chair: Thank you very much, Mr. Rosenberg.

We'll now hear from Professor Pierre Fortin. Welcome.

Professor Pierre Fortin (Department of Economics, University of Quebec in Montreal): Mr. Chair and members, my remarks will touch basically on three subjects: first, the prospective economic environment in which fiscal policy is likely to operate; second, the broad split of the projected economic surplus between debt reduction, tax reduction, and expenditure increases; and third, the potential contribution of fiscal policy to accelerating productivity.

I think first the basic economic and fiscal projections of the economic and fiscal update are quite reasonable, including the setting aside of an additional economic reserve of prudence. What will determine whether the economic assumptions are fulfilled or not is whether an economic slowdown will occur over the planning horizon.

I want to point out to the committee in this respect that there is no rule in scientific business cycle analysis that sets a maximum length for an economic expansion. However, there's a major fact that describes very well the occurrence of recessions in the last 50 years of macroeconomic history in North America, and that fact is that without exception, all major recessions—in 1960, 1975, and 1982 in the United States; and 1960, 1982, and 1991 in Canada—have been engineered by central banks fighting inflation.

At this time there is no high level of inflation to fight either in Canada or in the United States. A burst of inflation related to an explosion of world commodity prices is not impossible, but very unlikely until 2005.

So the worst situation we could face is some central bank action in the United States or Canada, not really to reduce inflation but to prevent inflation from rising. That could generate a short pause in economic growth, but nothing like the big setback that hit us in 1990 to 1993.

So put me in group O, the group of optimists, concerning economic prospects for the next five years. It is my view that very likely the average economic scenario presented in the update will unfold as projected, and that the contingency on economic reserves will not be needed and therefore can contribute to debt reduction.

In the very short run, one particular cloud hanging over the Canadian economy is that our central bank could increase short-term interest rates prematurely. No one knows for certain where the lowest sustainable non-inflationary unemployment rate is in Canada. It could be 7%, but it could also be 6% or 5.5%. Apparently, the bank has determined that the current unemployment rate of 7.2% is close enough to the critical, but unknown, non-inflationary level that interest rates must begin to be raised again.

There is a big risk that the bank is wrong. Until two years ago it believed that Canada's unemployment rate could not fall below 8.5% without generating ever-rising inflation. It was wrong then, and it may be just as wrong now if it believes that the unemployment rate cannot decline under 7% without launching inflation.

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As the experience in the United States in this decade has shown, the key to good monetary policy is to keep testing and probing lower and lower unemployment as long as there's no solid evidence that inflation is really threatening again. The pre-emptive attack approach is the wrong way to go, because it means fighting inflation in advance of really seeing it, and taking the risk of keeping unemployment higher than really needed. We should remember that one point of lower unemployment is that it means 225,000 more jobs in Canada and some $20 billion more output.

What rule of thumb should the government follow in the split between debt reduction, tax reduction, and expenditure increases? I think the update has set the right framework for thinking about this question. As many have emphasized, federal finances are still currently in a fragile situation. A 1% across-the-board increase in interest rates would soon add $5.7 billion to interest charges on the federal debt, and hence to the fiscal deficit. So I think it is wise to continue to set aside the contingency reserve grossed up with an additional economic prudence factor, and to apply it to debt reduction if it is not needed during the fiscal year.

But I do not believe the government should go further and make additional instalments to repay the debt. At three percentage points per year, the current pace of reduction in the debt-to-GDP ratio is quite respectable. It is well understood by the public and allows the government to pay attention to other pressing needs on the tax expenditure side of the budget equation.

How, then, should the fiscal surplus for planning purposes be split between tax reduction and expenditure increases? I think the answer once given by the Prime Minister, 50-50, is the correct answer. This would imply that program expenditures would increase by just about the same percentage as current dollar GDP, on average, so that the weight of the federal government in the total Canadian economy—which has recently fallen back to its level of 50 years ago, as shown on page 86 of the update—would essentially be maintained.

I do not think it would be a good idea to have program spending grow faster than nominal GDP again if we're not to forget the hard lessons learned from the budget horrors of the last two decades. But I do not believe it would be a good idea to keep program spending growing more slowly than GDP either. I must admit that this advice, on my part, is based on personal values. I think it would be absurd to throw overboard the kind of Canadian society our parents and grandparents have taken a decade to build with the somewhat higher, but not exaggeratedly higher, level of public services rendered in Canada than in the United States, and the top rank on the United Nation's development index that goes with it.

I will add that my first priority for program spending growth would be that government return to the health care sector the funds it has withdrawn by cutting transfers to provinces over the past decade. This could be done by increasing the transfers or by imaginatively spending more federal money directly in the health sector to relieve the provinces from their current financial straitjacket.

My key point is that our health care sector is deteriorating outrageously by the day, and something must be done about this quickly. This is not the time for Canada to start spending again in every direction, but it is the time to improve the way we do what we already do.

Now, given the economic and fiscal assumptions of the update and my preferred 50-50 split between tax reduction and expenditure increases, some $12 billion to $15 billion of tax relief could be offered to Canadians by 2005. There are major political and economic reasons that tax relief is necessary. The stakes are the basic credibility of our democratic institutions and the international competitiveness of our private sector. The need for tax relief is nowhere more evident than in the areas of personal and corporate income taxes.

I think here the government should take advantage of the prospect of tax cuts to review the structure of taxation so as to spur productivity growth—this is my third and final point—which has been seriously lagging in this country over the last 20 years. The great thing with tax reduction is that it makes changes in the structure of taxation possible without making losers. We may have here the opportunity of the century to do so.

Fiscal policy cannot be everything for productivity, but it could certainly do a lot by encouraging saving and investment. There are many ways to generate more savings in Canada. One of the most effective is to exempt all savings from personal taxation, thus actually making personal income tax a consumption tax. Two such schemes have been proposed: the flat tax advocated in Canada by Mr. Dennis Mills, and the progressive consumption tax advocated by Senators Domenici, Nunn, and Kerrey in the United States.

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According to the latter proposal, all new savings would be removed from the personal income tax base, and all old savings disposed of and brought back into the consumption flow would become taxable. This would amount to putting all Canadian savings in a mammoth RRSP. I think the committee and the minister should focus on the potential such a progressive consumption tax would have for promoting savings in Canada.

We also know for sure that Canada is seriously lagging behind the United States in the area of business investment. Here the policy tool is the corporate income tax, and the bottom line is that the effective rate of taxation on business capital is 31% in Canada, 22% in the United States, and 10% in Ireland. Based on these numbers, guess who got the highest and lowest rates of foreign direct investment and the fastest and slowest growth rates of income per head in the industrial world over the last decade?

In this light, I think taxes on business capital should be reduced by a large amount in Canada. This is the only point on which I would differ with the update. I think that in the area of business capital taxation, the department plans to move ahead too slowly and too weakly.

Thank you very much.

The Chair: Thank you very much.

We'll now hear from David Laidler of the Department of Economics at the University of Western Ontario.

Professor David Laidler (Department of Economics, University of Western Ontario): Thank you, Mr. Chairman.

Let me begin with the last question that was posed to us: what can we do about productivity with economic policy? I'm not one of those who believe in picking winners and micromanaging innovation. It seems to me that a stable background of macroeconomic policy and a microeconomic structure of taxes that doesn't distort the incentives that confront the private sector are the two things the government can provide that really will help productivity, if anything is going to.

On the monetary front, I think things are in relatively good shape at the moment. The inflation targets are working well. I would note that over the last couple of years they, if anything, helped to keep monetary policy accommodative, and appropriately so at a time when many people were calling for tighter money to support the exchange rate. The inflation targets are up for renewal in 2001. That has to be discussed, but I don't think this is the time to discuss it.

On the matter of the macro stance of fiscal policy, clearly we're in pretty good shape, but I am among those who think that the current level of debt is outrageously high, that $40 billion per annum spent on interest is ludicrous, and that the faster we can get that down, the better. I would give very high priority to continued debt reduction.

On the matter of the microeconomics of fiscal policy, let me just utter two sentences about health and education. I speak as an interested insider. I think these two things are national disgraces, but I'm not at all clear that the solution either to health care problems or to education problems lies in more federal expenditure on them. There are much more complicated issues that need discussing there, but again, not here.

As far as the microstructure of the tax system is concerned, it's a dog's breakfast. I would suggest that instead of thinking in terms of piecemeal tax relief, the committee think instead in terms of an overall reform of the tax system, with an eye to evening out the many perverse incentives that currently lurk within its structure.

As Pierre Fortin has just remarked, we really do have a once-in-a-generation chance of doing something about the structure of taxes. Because tax reform doesn't have to be revenue neutral, we can compensate the losers this time around.

I've made a brief list of things that I would like to see in tax reform. Let me just go down the list.

I was very impressed with the report of the Technical Committee on Business Taxation. Given that we have this report, which has looked into the highly distortionary field of corporate taxation in this country and has already provided us with a blueprint for getting out of that mess, that would probably be the place to start with tax reform.

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Once you are reforming company taxation, you have to look at the personal income tax, because dividend taxation and capital gains taxation do have to be integrated with the structure of corporate taxation.

The next think I would be looking for is a restoration of full indexation to the personal income tax. The lack of full indexation of the personal income tax seems to me to be economically indefensible. The only possible excuse for it was that it was a good way of helping to get the deficit down quietly. Those days are past and gone. I would give high priority to getting indexation back into the PIT.

I would say the same thing about the 5% high income surtax. That was there for deficit reduction purposes. I would just note that the income tax is not a tax on being rich, it's a tax on getting rich, and if you're a young person who wants to get rich you're probably going to go to a jurisdiction that doesn't tax you high on the margin. I am one of those who think high marginal income tax rates potentially create a brain drain problem. I am concerned about it, though I certainly agree that there's much more to the brain drain issue than the level of taxation.

Then I would go to the clawbacks of income support measures that are built into the income tax structure at the moment. We have an extraordinary sawtooth of variable marginal tax rates, depending upon when the GST tax credit is clawed back, on when the child tax credit is clawed back. I would want to reduce the progressivity of those clawbacks to iron out the incentives in the structure of the personal tax. I didn't note this in my written submission, but of course there are all sorts of perverse incentives that come from the structure of provincial taxes and benefits and that need to be looked at as well.

Finally, I'm going to be an academic and put two things on the table that are not politically very popular. It seems to me that for payroll taxes overall the academic evidence is that they're not terribly distortionary as far as the overall supply of labour is concerned. I'm not terribly concerned about the level in Canada, except at very low levels of income where they start to interact with minimum wages and welfare benefits and create problems for people with very low skills.

So I'm not much in favour of an overall lowering of the level of payroll taxes, but may I just enter a plea for reconsideration of experience-rating the EI system in order to get some of the distortions out of the allocation of the labour force, which it currently leads to.

Finally—I think it will be the only time this is mentioned this afternoon—the base of the GST is rather narrow and its rate is rather high. It would be possible to broaden the base and lower the rate, and that would be economically desirable. I do recognize that it's politically very difficult, but I am an academic and I felt that I just had to say that.

Finally, if one is thinking in terms of tax reform rather than piecemeal tax relief, that's going to take thought, time, and careful planning. That means proceeding slowly. Given my concerns about the high level of the public debt, I wouldn't be the least bit concerned if we started planning now for meaningful tax reform in two or three years, in the centre, when we really did have the debt-to-GDP ratio a fair way further down.

Thank you.

The Chair: Thank you very much.

We will now hear from Jim Stanford.

Mr. Jim Stanford (Economist, Canadian Auto Workers-Canada): Thank you, Mr. Chair.

Thanks for the invitation to appear. I'm glad I got here, along with everyone else who was on the 1 o'clock Air Canada flight from Toronto. If we'd had a suicidal pilot or anything like that, the economics profession would have been dealt a serious blow. Luckily, the pilot didn't know that I worked for the CAW. Air Canada pilots have a thing about the CAW these days, so that was kept under wraps.

Anyway, I'll do three things here in my presentation, which is in the green booklet.

First, I'll give my take on the fiscal forecast, my interpretation of the finance minister's fiscal update and where it's going. I think his projections of the latent surplus and hence the amount of fiscal room for initiatives, either on the tax side or the program side, is a bit conservative.

I applaud his efforts this year to extend the planning horizon to five years and incorporate, I think, a greater degree of transparency and honesty into that forecasting exercise, but I crunched the numbers, and even using the same consensus forecasts about inflation, growth, and interest rates, I come up with surpluses that are about one-fifth bigger.

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In terms of that fiscal planning exercise, I do applaud the initiatives he has made this year, but I do still express my view that there are some conservative assumptions, combined with the $3 billion contingency fund in that exercise, that impart a conservative bias. I think there's even more room for initiatives on the program side and the tax side than his update suggested. I looked at a latent surplus of something close to $12 billion in the fiscal year you're looking at, fiscal 2000, and something close to $18 billion in the second year.

In terms of priorities for what to do with that latent surplus, I put the full weight of my remarks on the need to rebuild program spending. It was reductions in federal program spending that bore the brunt of the fiscal transition of the mid-1990s. It is quite wrong—and I think most members of the committee would agree with me on this—to argue, as many do today, that we taxed our way out of that deficit. Higher taxes as a proportion of GDP accounted for less than one-fifth of the change in the final federal balance expressed as a share of GDP, whereas reductions in program spending as a share of GDP accounted for something close to two-thirds of the shift in the final balance.

Federal program spending has been cut by one-fifth as a share of GDP since 1994. Most worrisome in my view, it's still falling as a share of GDP despite the much improved fiscal situation we have. That suggests that not only are we not going to repair the damage that has been done to infrastructure, public programs, and social benefits, we're in fact going to see that damage continue.

In terms of David's question at the beginning—what's so sacred about the 50-50 rule?—in my books, the only thing sacred about it is that it is a key element of the platform the existing government was elected on. I don't know what democracy and accountability count for any more, but if they count for anything, that 50-50 rule should be a guidepost for you.

I point to the results of the seven provincial elections that have been held within the last two years. Tax cuts were an issue in every one of them, and only one government succeeded with a radical tax cut package. I think that's because the majority of Canadians recognize the value they get from public services. That feeling is still there.

In terms of my two bits about a top priority for rebuilding program spending, in the portfolio of items you have to look at I would put in a plug for significant investment in a national public early childhood development program. That has been a major priority of our union. This year we made some progress we're very proud of in our bargaining with the major automakers around child care accessibility for our members. We think the cost of a public national program, including child care, is well within the reach of the government, and that would be an important thing to do, not just for enhancing the future prospects of those children but also for maximizing the labour force participation of their parents.

Finally, in terms of the tax cut issue, I range from being skeptical to viewing with alarm what I see as increasingly shrill and often extreme calls for tax cuts—especially personal income tax cuts—coming from many business and financial lobbyists and economists. I find the contrast quite startling between the alarmist words we're getting—like “cut taxes now or our economy will fall apart, all the smart people, all the wealth creators will leave, all the incentive will be gone”—and the real evidence we're getting about what's finally happening in our economy.

For the first time in the 1990s, we're seeing sustained economic progress and a sustained rise in living standards for people like the members of my union, thanks to falling unemployment and thanks to a modest rise in earnings. At the very moment when finally the typical Canadian is going to feel that things might be getting better, we get the alarm bells ringing that the world is falling apart in Canada because of our taxes.

I just do not accept that there is significant evidence for it. Much of the evidence that's advanced is clearly shallow, ranging to false. I'll just pick a couple of examples. The Financial Post this week—they employ me to write a column, so I have to be a little careful here on what I say—ran as a cover story a poll of CEOs calling for personal income tax cuts as the most important initiative. Well, this is a group of individuals whose average income is over $1 million, so I don't think any of us should be surprised that they would identify cuts to the personal income tax system as a priority. They mentioned the need to compete with the stock market millionaires in the U.S., with the huge gains people in some companies make through stock options in the technology field ad so on.

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We could cut our personal income tax rates in Canada to zero and we still wouldn't compete with the stock market millionaires in the United States, so I don't see the value of that argument. If we start to design important programs in our economy to try to keep up with those who are winning from what is clearly an unsustainable paper lottery in the U.S. stock market, then I think we'll be making major mistakes.

It's quite wrong—the evidence is there—to blame higher personal taxes for the decline in disposable incomes in Canada. Personal taxes have increased marginally in the 1990s but they're starting to decline now. They fell at an average rate in 1997 and probably again in 1998, once we see the data.

The decline in personal disposable incomes in Canada is driven almost exclusively by a decline in pre-tax incomes in Canada as a result of our poor macroeconomic performance and, significantly, as a result of the retrenchment in public transfer payments, an important component of personal incomes.

I would prefer to see all of the surplus reinvested in public programs. I doubt that's saleable politically for your government, so I'd consider it a step in the right direction to stick with the 50-50 rule you were elected on.

I would certainly like at this point to highlight the view from the other side of the tracks, if you like, for those Canadians who earn $40,000, $50,000 or less, for whom personal income taxes are moderate in Canada, more moderate than they are in the United States, and for whom the consumption of public services makes up a very important share of their standard of living.

For those Canadians, a reinvestment of the surplus funds in program spending should be the top priority of your government. I think that's justified on both ethical and efficiency grounds.

Thank you.

The Chair: Thank you very much, Mr. Stanford.

We'll now hear from Mr. McCallum. Welcome.

Mr. John McCallum (Senior Vice-President and Chief Economist, Royal Bank of Canada): Thank you, Mr. Chairman. It's a pleasure for me to be here, although I'm not sure if I'm not in a dangerous position between these two gentlemen.

I think the fundamental challenge for Canada in the coming years is to balance two possibly conflicting objectives. On the one hand, there is our desire for a distinct national identity—a kinder, gentler society, to use that cliché—and on the other hand, there is our need to be competitive.

I hope Jim won't say I'm one of these shrill people, but I do think there's some evidence that the costs of becoming uncompetitive are becoming more severe in this globalizing world. It's all very well for Canada to have higher taxes than the U.S., and it always will have—we are kinder and gentler, which I buy into altogether—but we cannot afford, although this is what we'll get under status quo policies, a tax gap vis-à-vis the U.S. that keeps on getting bigger and bigger. That's what we're seeing in the personal tax side and that's what we're seeing in the corporate tax side. Therefore, I think we do have to assign a pretty high priority to lower taxes.

What importance should be attached to debt versus spending versus taxes? I know the government is committed to 50-50 now, but if one looks into the next mandate, that might change. We're talking in terms of five-year planning these days. I would favour approximately half for lower taxes and a quarter each for debt and spending. Let me go very briefly into each of the three areas.

On the debt, I think I would do what essentially the government appears to be planning to do, which is to have a never-ending string of balanced budgets, but with very substantial contingency reserves. In the event those are not used, they would go to pay down the debt. It seems to me that under that policy we'd get an adequate rate of debt reduction relative to GDP.

On the spending side, I would suggest spending going up at the rate of about 3.5% per year, relative to an assumed GDP growth rate of 4.5%. That's allowing real per capita spending to rise somewhat, but it's not rising as fast as GDP.

I'd mentioned three areas of spending. One, it's true that our national infrastucture is in a state of some disrepair. Whether one looks at the Mounties, the armed forces, or the state of our roads, more money is needed.

Second, I would certainly put more money into what one might call the areas of greatest or most pressing social need: homelessness, aboriginals, foreign aid, and things of that nature.

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Third, in the new economy, information-based industries are critical. Those are areas where Canada has been lagging rather badly behind the U.S. I would put some money into basic research and things of that nature. However, I'd keep the total spending growing at not more than 3.5%.

With regard to taxes, I will mention primarily personal income tax and business tax and give you three reasons for assigning a high priority to lower personal income tax.

The first is the very simple point of putting more money back into the pockets of Canadians after a very dismal decade in which the average household has seen declining take-home pay.

The second is the idea that marginal tax rates higher than 50% are bad. They add to the underground economy. They constitute disincentives. I'd agree with the idea of getting rid of the surtax, as David Laidler mentioned, but I'd also emphasize that high marginal tax rates are not just the domain of rich people. Some of the highest marginal tax rates of all are for those earning between $25,000 and $30,000, who might lose, for every extra dollar they get, up to 70¢ because of the clawback of various social programs in combination with taxes.

So I would assign a high priority to reducing those clawback-induced high marginal tax rates by extending the period of the clawback so it is much more gradual, rising to a higher level of income.

Last but not least, we stick out like a sore thumb in this country in terms of our very high level of personal income tax as compared with other countries, including, but not only, the U.S. We're about 30% higher than they are.

It's true that the brain drain numbers today are not huge, but I think we are really facing the tip of an iceberg if we don't take action. The United States has surpluses like we do, they have a Republican Congress, and they are going to be cutting taxes. If we stay where we are, the gap, as I said earlier, is just going to get larger and larger. I don't think that can be sustained in a world where U.S. corporations are scouring the globe for talent, in a world where the Canada-U.S. border is coming down, and in a world where anti-Americanism among younger Canadians is definitely on the wane.

So it's not just a brain drain issue. I think there's a threat of that if we stay where we are in a world where the U.S. is coming down in taxes, but it's also the other two reasons I gave you at the outset in favour of a large attack on personal income tax. You need a lot of money to do that, because almost half of government revenue is personal income tax. Any sizeable tax reduction will take quite a lot of money.

Finally, I agree with Jack Mintz, who paraphrased Bill Clinton in saying that the business tax is stupid if your idea is to produce a more prosperous, competitive Canadian economy. In terms of the location of economic activity, I suspect you'll get more bang from the buck through reforms to the business tax system than you would in personal income tax. Another advantage is that it costs a lot less. Mintz estimates it would cost, I think, $2 billion to get a one-third reduction in the corporate tax rate. I think you could get quite a sizeable increase in economic activity if you did that. As Pierre Fortin mentioned, Ireland is an example.

I think I'll leave it at that. I don't want to sound alarmist, but if we look forward a period of five years, with the Americans not standing still, I think there is an element of urgency to take some action on both personal and corporate tax. That is why I would put somewhat greater emphasis in that area.

Thank you very much.

The Chair: Thank you very much, Mr. McCallum.

We'll now hear from Mr. Mendelsohn.

Mr. Joshua Mendelsohn (Vice-President and Chief Economist, Canadian Imperial Bank of Commerce): Thank you, Mr. Chairman, and thank you for the invitation to appear this afternoon.

I'm going to try to avoid repeating some of the things others have said, although I clearly will be taking exception to some things. It's a bit unfortunate that I follow John McCallum, because he and I are pretty much on the same wavelength, I think.

I want to focus on a couple of things. One, despite the fact that both I and many others in this room are focusing on tax reductions, we do not live in a dream world where we believe taxes are the only element hurting the Canadian economy or the only element that will fix the Canadian economy. It is clearly part and parcel of a broader set of issues, but to deny that Canada's high tax structure is doing damage is also being very disingenuous. And there are numerous issues here.

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Secondly, I raise some questions about what makes public sector spending so holy and beneficial. It's not necessarily beneficial. What we need to do is evaluate public spending on an ongoing basis, and—as I'll talk about in a few moments—for any program that is put in place, have a sunset clause on it where it is reviewed periodically, whether it's five years or whatever the normal period, so that we can determine whether it's meeting its objectives, and if not, how we should alter it, or in fact if it needs to be scrapped.

Let me go back a bit. In the context of the fiscal projections and the fall economic statement of the finance minister, I found that statement, that assessment, more heartening than I have in past years, certainly. Many of the issues I'm concerned with...including the fact that it's the taxpayers' money, it's not the government's money. I think that's a very clear statement that needs to be repeated: it is their money.

There is also the fact that we are paying some of the highest taxes in the G-7 economies. Bracket creep is clearly an issue. Even if we were to reduce taxes, we still do not have full indexation, so progressively we are still eroding the income base until we go back to full indexation, and I believe that needs to be done fairly quickly.

Now, in view of Canada's high and very progressive tax structure, my belief is that it has contributed to poor productivity performance and the long-term depreciation of the Canadian dollar, which in turn reinforces that poor productivity performance.

As for the evidence, obviously there's mixed evidence. But I want to make a couple of observations on the productivity issue.

There's been an ongoing debate about whether the measurements are right, whether we're a tenth of a point higher or a tenth of a point lower than the U.S., or whatever. That to me isn't an issue; that to me is a red herring. Over the long term, sure, the rate of growth of productivity is important, but productivity gaps in many, many areas do exist in wide scale. The issue is how do we maximize Canada's productivity performance and our long-term competitiveness without relying on a cheap currency? In point of fact, that's the only thing that's giving us our competitiveness these days—in many industries, not all.

While I'm on this issue, I want to note that while I'm focusing on personal taxes—again echoing what some of the other speakers have said, partly because of the political imperatives of the day—there is also a clear need to reform Canada's corporate tax structure and the resulting distortions that we face from that.

Now, I find it interesting that the OECD, the IMF, and a whole host of international bodies have come back to Canada.... In fact, in the 1999 IMF review of Canada, it says that the staff believe priority should be given to reforming income taxes in order to improve incentives to work and save, and that restructuring these taxes would leave a permanent legacy of higher growth and prosperity in Canada.

Now, the IMF is not the be-all and end-all. They clearly have made mistakes in numerous areas. But having said that, I think what is also important about the tax system is the incentive system.

Unfortunately—I'm just speaking for myself, but I do know I've heard this sentiment reflected more and more often—we tend to disparage success. When is the time going to come when we start applauding it? When are we going to say, fine, it's great to become wealthy and successful—although obviously, in a socially responsible and legal fashion, of course? When are we going to do that? We are not doing that. In fact, we are saying that if you're successful, somehow you've done something wrong.

One of the elements I keep being concerned about here is that when we talk about renewal of government transfers back to the original numbers, and spending here, spending there, what we're effectively saying is to continue to protect the Canadian system as it is today. There are many, many good things about the Canadian system, many things that the Americans would love to have that we have up here. But not everything is perfect, and the issue is that we need to move forward through an incentive process that restructures this economy.

• 1625

Let me go back to productivity. There are some numbers that come out. When people talk about U.S. productivity in manufacturing, they often point to the fact that the high growth of productivity is in two or three sectors: information technology, computers, and commercial and industrial machinery. That's true, but the U.S. has changed its manufacturing output so that these sectors are increasingly important sectors of that economy and they reap the benefits of the changing technologies and the changing world demand structure, while we still have not really tapped into that in a very big way. And the tax structure certainly does hurt us.

Let me go back to the issue of disposable income. It's interesting, we're all using similar things. I have a chart in front of me that shows U.S. real disposable income from 1983 through June of this year, and from 1989 on, the year in which Canada and the U.S. were at roughly the same level—and this is in local currency—the U.S. income is up about 17%, and of course Canadian income has gone nowhere; in fact it has gone down.

Recent reports saying that we're going to finally catch up to 1989, rather than making me feel comfortable, scare me, because it reinforces the lost decade, if you will, and we need to get off that kind of process.

But it's true, it isn't taxes that have done most of this. The charts show, even if you take off the taxes, it isn't just the taxes. It's employment. But to what extent has our tax structure and our approach to subsidies and the like supported a system that doesn't allow for the creation of jobs—and for the creation of high-value jobs—and productivity, that hinders the future development of this economy?

That's really where I'm coming from in terms of the tax cuts, that we do need them. I'm looking at it as much from an incentive process as anything else. That's why the 5% surtax becomes important, because it's a very visible image of penalizing a group despite the fact that the reason for the tax is now totally gone and there's no justification for it.

Finally, let me just talk about the 50-50 issue. I mentioned earlier on that I don't know what is sacred about public spending. Certainly there are good things and there are areas.... The health care system certainly is one that we need to support. The educational system is one that I strongly believe should be supported. But—and I think David Laidler raised the issue—putting money into it isn't necessarily the best answer. In fact it may be the worst answer.

I'm not going to deny the fact that if one puts more money into health care and it reduces or eliminates, hopefully, the need for various patients to go hundreds of miles or down to the States to get treatment that they should be getting closer to home, that certainly is necessary and desirable. But one can also look within the system and see where the cracks are and where the fixes have to be, so that we don't just paper over the cracks by putting more money into it.

Education is another one, and I'll leave the higher education out for a moment, but simply deal with the elementary and high school levels. Canada is one of the highest per capita spenders on education, and yet we all know that the results are far from ideal. What is in the system that we need to look at and revamp, rather than just throw money at?

So to me the spending is not God-given, it's one I would look at as doing judiciously.

In regard to the 50-50 rule, it may be necessary for the next two years, because the government has committed itself to it. I still don't believe that. I think it's how you define the 50-50. There are a lot of issues of where the base is, and so forth. So I leave that for some questions.

At the end of the day, what I'm really getting at is that there are no free rides in international commerce. The social programs and amenities that we enjoy as a country don't arrive as manna from heaven, but are fully paid for by the strength of our economy, or not paid for by any weakness. If that strength erodes further, those social programs will be at risk, and so will Canada's standard of living in the future.

Thank you.

The Chair: Thank you, Mr. Mendelsohn.

We'll now hear from Mr. O'Neill.

Mr. Tim O'Neill (Executive Vice-President and Chief Economist, Bank of Montreal): Coming at this position on the list, you feel a little bit like Zsa Zsa Gabor's seventh husband—you know what to do, but you're not sure how to make it interesting. But I have a couple of summary comments.

• 1630

First of all, the cost of the debt burden in Canada is still significant, and I would agree with David Laidler that a greater focus on that ought to be part, at least, of our contemplation of what should be done with the surpluses. Higher real long-term interest rates, reduced fiscal flexibility in situations where you hit an economic air pocket that you hadn't anticipated, and, quite frankly, the continued use of resources to service the debt that could be better allocated elsewhere are key components of that cost.

It's clear that Canada's tax system has a higher burden than is the case in the U.S., and it is uncompetitive in that sense with respect to our major trading partner. Structurally, it also contains—as I've already mentioned—important disincentives to work and I think, as a consequence of those two things, impaired productivity and investment growth.

My third point would be that the relatively lower level of program spending does not appear obviously in any way to be adversely affecting the economy—if I could turn the argument around the other way—and as has been mentioned by international standards, we compare fairly well in major areas of spending like health and education. It may even be true that the lower level of spending has engendered a salutary effect on the efficiency with which money is spent in the public sector.

So my recommendations in brief would be that a larger proportion of the surplus be allocated to debt reduction than what's currently being contemplated; that program spending be allowed to grow no faster than the rate of inflation plus population growth; that economic considerations dictate that corporate tax cuts and tax reform take priority over personal income tax cuts; and that where we reduce personal income tax, they should focus on two key areas—the disincentive effects of the high effective marginal tax rates at low income levels and the high marginal tax rates that kick in at modest levels of what is regarded as “high income”. Where spending initiatives above those I've just suggested are going to be contemplated, they should encompass investment, not consumption spending.

Our economic outlook is that the economy is not going to be facing a recession over the next five years, but I think there is a legitimate risk. And here I may differ somewhat from Pierre's view on the U.S. economy, and the Federal Reserve in particular. I think there's a very significant risk that the Fed will have missed the boat and will have to be fairly aggressive in tightening next year. It's not in our forecast, but it's a real risk, in which case we'd be looking at a very weak 2001—not necessarily a recession, but certainly a very weak growth level below the 2% we're currently forecasting.

Let me come back to several policy principles that I think ought to guide the discussions. Some of this has already been said, but it strikes me that the mix of debt reduction, tax cuts, and spending has to begin with choosing that mix that contributes most to productivity, and through that, to economic growth and improvement in living standards, while still serving equity considerations—the efficiency-equity trade-off.

Secondly, the allocation within those three categories, particularly taxes and spending, has to be based, it seems to me, on their effectiveness in solving whatever economic and social problems are deemed to have the highest priority.

One of the things that public policy often suffers from is the law of unintended consequences. You have to be sure you have the right solution to the problem, not the one that people feel most sincerely is the right one.

Secondly, this presumes that the problems that are identified are ones for which a solution is required. To put it in a somewhat different fashion, if you have a solution to offer, you'd better make sure you have a problem that actually needs solving. And I'm not sure the debate we have seen in a number of key public policy areas actually reflects clear evidence that there's a problem that needs solving, or that the solutions being offered are precisely the correct ones.

One other point I'll make here is that the choices in fiscal policy—and this is not an issue that seems to be getting a lot of attention—have to consider the implications for other policy areas, most notably that the more stimulative fiscal policy is, whether that's through tax cuts, spending increases, or both, the more restrictive monetary policy will inevitably be. That reflects the fact that the Bank of Canada will be targeting a particular rate of economic growth that's consistent with its inflation targets. So let's keep that trade-off in mind as well as some of the other ones that have been discussed.

• 1635

With regard to specific recommendations, let me go back to debt reduction. I've referred to the costs in terms of high real long-term interest rates, high debt servicing requirements, and the fact that we're still relatively vulnerable to flights of quality. We certainly saw that through the Asian crisis, where the U.S. became the country of choice for those looking for a safe haven. I've made reference to the trade-off between the two macro policy levers. The fact is that debt reduction will be a neutral policy choice with regard to its stimulus effect on the economy in the short term, at least.

With regard to the fiscal flexibility that's available if in fact we hit a more severe economic air pocket than I'm expecting, the financial market response to having to go off the fiscal program is obviously going to be less severe in an environment where we've already established that we're going to allow debt-to-GDP to decline not only by allowing the denominator to grow but also by reducing the numerator.

The final point I'll make in that regard, and then I'll move on to tax cuts, is that the cost of the tax burden, which is obviously there, is, in my view, relatively less critical at this stage.

There are two things. First, the brain drain to the U.S. is in fact low, by any historical standard one would want to use, despite the fact that we've had a decade-long underperformance in the economy relative to the U.S. Second, some people point to the weak growth in investment, particularly foreign direct investment. I again would attribute that to the weak cyclical performance, not to a structural impediment in the tax system.

Having said that, I think tax cuts are important and ought to be second in choice to debt reduction but overwhelmingly preferred to higher real per capita program spending. I would focus my efforts more on business taxes because of the negative impact they have on both investment and productivity.

If the government were to contemplate increasing real per capita expenditures, that is, increase spending faster than the rate I'm suggesting, let me offer, finally, a couple of points in that regard. First, the focus of spending ought to be what will increase the economy's capacity and/or what will increase its productivity. In other words, in the very conventional way in which economists look at this, it should be an investment rather than a consumption expenditure.

Second, I think we should avoid sector-specific spending—for example, on R and D in the high tech sectors. We have had a number of attempts at developing an industrial strategy in this country. I think a new one, however it's guised or disguised, isn't likely to be as unsuccessful as previous attempts.

Where spending is earmarked for infrastructure—and here I would argue that really is an investment as long as it's real infrastructure and not roofs on skating rinks—the target ought to be solving the highest priority problems and avoiding regional balance considerations.

I have two final points. Let's distinguish clearly between investment spending in the way I've just described it and what is now being called strategic spending. That's a concept that I think is far too vague and elastic to be really of much functional use in making spending decisions.

Finally, distinguish between spending that is good and spending that is essential. I think spending might be argued to be essential if in its absence economic growth, productivity, living standards, and/or the quality of life would clearly deteriorate, and if the evidence is available that in fact that would be the case.

We've had a lot of discussion about the need for spending because we need to get back to levels we had previously. It begs the very critical question of whether the allocation of those levels was in fact the most effective way for society to allocate its resources.

If we're going to seriously consider spending in areas that have been referenced, let's be clear that we have evidence that such spending is necessary and that the type that's being suggested is actually going to be effective in solving the problems that are deemed to exist in those areas.

Thank you.

• 1640

The Chair: Thank you very much, Mr. O'Neill.

Mr. Robson.

Mr. William B.P. Robson (Senior Policy Analyst, C.D. Howe Institute): There are worse things than being Zsa Zsa Gabor's seventh husband. You could be Henry VIII's fifth wife, for example.

I also want to thank you for the opportunity to appear—again, in my case. I don't know if that's true for everybody. But just because you're willing to see some of the same faces, I won't presume you're willing to hear the same old words.

Nevertheless, for the sake of those who missed those riveting sessions in Mississauga, I will very quickly recap a couple of points about the $23 billion in cumulative room to move that was identified in last month's fiscal update. Echoing Pierre Fortin, I support the process that produced that number. I think it is a realistic and useful estimate of how much room to move we have, while maintaining very strong confidence we will still have budget surpluses. But I would emphasize that this number is one that deducted prudence cushions and neglected dynamic effects, so in that sense there's not a lot of downside risk in it, but there is a lot of upside opportunity. If we were to meet again in five years' time, in December 2004, smart moves in upcoming budgets could leave us well ahead of where the fiscal update envisaged us being at that point, and we could have a payoff that's bigger than $23 billion, thanks to lower debt and a more buoyant economy.

In the rest of my 10 minutes, I want to say a few things about how we might make that happy result more likely, in the hope that it will be of some use to you as you finish your report.

First, following on what some other members of this group have said, I hope you will recommend dropping the commitment to spend half the projected surpluses. It makes a nice sound bite and certainly maps easily on polls where people are asked what they would do with an extra federal dollar. But as was hinted at just now, if you don't have any indication of what your baseline or timeframe is, it can be very misleading.

I'm not going to drag you through the math here, but if you're in a situation like we are now where you're looking ahead and seeing a surplus expanding every year, and you increase your spending every year by half the amount of the expected surplus, you're going to ratchet spending up. In a very simple example, you could end up at the end of five years' time having spent 80% of the surplus you forecast at the beginning. So I worry about that type of rule. Some of us at the table may argue that you could boost that $23 billion to a much larger number by spending 80% of it, but I wouldn't come down on that side of the argument.

That brings me to the second reason for disliking the 50% rule, and that is that it short-circuits what ought to be a fairly serious discussion of how various changes in the federal budget can enhance our future prosperity. At every stage we really have to ask, what impact can we expect this to have in the future on Canadian jobs, investment, and incomes? How certain are we of that impact?

The third issue—and perhaps an awkward one in this room—is whether the federal government is the best agency, the best place to look, to carry out those things.

I think straightforward answers to those questions can lead you in a different direction than the rule saying we should spend 50%.

At this table I may be a minority voice on using unneeded prudence cushions to pay down debt, so I'll make a very brief pitch on its merits.

As far as impact goes, it will reduce federal interest costs, and that expands the capacity of every subsequent budget to deliver lower taxes, more programs, or a healthier bottom line. How sure are we of those effects? We're dead certain. It's simple.

Is the federal government the right agency? We're talking about the federal budget, but that aside, I do want to point out that the federal government has the fiscal capacity, as provincial and local governments don't, to get the country's balance sheet in better shape as we go forward. We have demographic pressures that are looming not all that far away any more. The federal government has the greatest capacity to prepare us to deal with that.

The reason for pointing this out, though, is that this isn't necessarily some abstract question for far off in the future. We face it right in the current fiscal year. In the fiscal update there was a $3 billion contingency reserve shown for this fiscal year and also a $2 billion surplus on top of that. The economic news lately has been better than otherwise, so we may even come in a little better than that total of $5 billion.

• 1645

What I'm wondering about is what are we going to see at the end of this year? Are we going to see a repeat of last year's almost $7 billion spending overrun that erased a very healthy surplus, a lot of that spending backdated? Or are we going to reap the fruit of good luck and good management and pay down the debt? The benefits, as I said, of paying down debt are dead certain, but equally certain is that you have to actually pay the debt down to get them.

When it comes to spending, asking those three questions about the impact, your certainty, and your confidence that the federal government is the right place to do it often delivers some sobering answers. I could go through a long list, but in the interest of time, I won't.

EI benefits are a good one to subject to that kind of scrutiny. As I say, I'm not going to go through all the reasoning, but there is one thing I do want to point out, because I know that area is under pressure. We're getting into the steepest part now of the Canada pension plan premium hike. We're going to go from 7% to 7.8%, employer plus employee, next year. The federal government is the only government with the capacity to offset that in any significant way when we look at the total burden of payroll taxes in Canada.

To offset it completely, you'd have to cut the employee rate in 2000 by 35¢, not the 15¢ that's planned—that would be $2.6 billion roughly next year—and you'd have to do it the year after and you'd have to do it the year after again, because those taxes are going up. That's a huge bite out of our budget room, and I wouldn't recommend going the whole hog necessarily, but to the extent you raise the benefits in ad hoc ways on the grounds that there's a lot of money in the EI account, you're making that task of offsetting those tax increases that much harder going forward.

On transfers to the provinces, again, I won't go through the whole list here. Just quickly cutting to the end, as far as the federal government's role is concerned, I'd recommend that as you look at tax cuts in the upcoming budget and especially going forward as the extra money that was earmarked for the CHST runs out, earmark part of the tax cut you recommend as room for the provinces. If they need the revenue, let them move in and take it. They keep saying they need more money. Make that room available. See if they take it.

When it comes to some other areas such as defence, remuneration of civil servants—particularly top-level ones—and research, some of the hard infrastructure that's been mentioned, those are areas where those positive impacts I was talking about are more reasonable to expect. In many cases they're more certain, and the aptness of Ottawa being involved is pretty clear.

But I do worry that the sense that there's money to spend is prompting a bit of an overexpansive mood among many federal bureaucrats and perhaps among many of your colleagues as well. Asking and answering these questions is more than just going through the motions, and I really would like to see the Department of Human Resources Development, for example, held to a standard in justifying the money it's beginning to splash around, as the Department of Finance seems to be when it advocates tax cuts.

Let me touch on tax cuts now. I'm very encouraged by the tone of much of the fiscal update and many of the discussions there have been around this table on the importance of getting taxes down.

I'll turn to those three questions. What impact ought that to have? Economic theory has emphasized for a long time the costs of high taxes on labour and on returns to saving.

How certain are we? I've always had a double-barrelled uncertainty on this score. First of all, some of the estimates of how important these effects are in real life have tended to be imprecise. Second, there's no guarantee of course that any federal tax cut that's actually going to happen will address some of the worst problems economists tend to identify.

Lately some of the fog on both those fronts has lifted. There's been some very careful cross-country work on government budgets and growth, and in those cross-country studies, the effects of taxes on income and return to saving do tend to show up strongly.

This is a bit unfair, but Andrew Jackson is going to have a chance to rebut me when I talk about the murky evidence you have, this diagram in front of you. Select your beginning and end years with a bit of care, select your sample of countries with a bit of care, neglect to look at the whole government budget and the different types of taxes, and you can prove just about anything with a scatter plot like this. But the longer the timeframe you look at, the more countries you include in your sample, and the more careful you are to take the whole government budget into account—the fact that taxes pay for things and there are surpluses and deficits implied by certain levels of taxes and spending—you start to see those effects coming through quite clearly. And actually, as a footnote, some beneficial effects of government spending on certain types of things come through from those studies as well. But the negative effects of taxes on work and on saving are pretty clear.

• 1650

The other reason for my saying some of the fog is lifting is that I think I'm detecting in this committee's deliberations and in the fiscal update a strong and appropriate focus on getting the rates of tax on work and saving down. So I would say getting our personal taxes down and our business rates down as part of a package looks like a good bet for making that $23 billion budget payoff grow.

As for the federal role, the third question on taxes, Ottawa should take the lead. Despite the presentation in the fiscal update, the federal tax load is still growing. When you count taxes properly instead of netting the various transfer payments out and just forgetting about them as though they weren't there, but when you add them in and look at them as part of the personal tax burden, our tax burden as a share of GDP is scarcely down. When you look at it in absolute amounts, it's still going up. The next fiscal year, federal taxes, with the status quo policy, would top $22,000 for an average family of four. That's a record, even after you allow for population growth and inflation.

So I hope you'll be aggressive in your report. I hope you'll be aggressive in calling for higher personal tax brackets, lower rates, the removal of the personal and corporate surtaxes, and ultimately, though maybe not right away, improving the tax base by moving to a more sensible set of deductions. Make the advocates of spending fight you and each other for every extra dollar, and keep your eye on that $23 billion payoff and make it grow.

Thank you.

The Chair: Thank you very much, Mr. Robson.

We'll now hear from Mr. Jackson.

Mr. Andrew Jackson (Chief Economist, Canadian Labour Congress): I'm glad to be following Bill, because I'm going to cover some of the same ground.

I'll begin by saying I actually very strongly agreed with one thing Bill said, which is that a criterion for looking at these issues, particularly the division between spending and taxes, should be the impacts on investment and on jobs and how certain we are about those impacts.

One thing that's been a bit unfortunate about the debate leading up to this budget is it has tended to be cast in terms of equity versus efficiency issues. There's a way of setting up the issues where social advocates want spending on social programs while business is calling for tax cuts to promote growth. We get a counter-position of growth to fairness.

The key point I really want to make is that the linkages from tax cuts to economic growth are a lot thinner and more tenuous than you would believe from an awful lot of what you read in certain newspapers these days, and also a lot weaker and more tenuous than the economics literature that's available would have us believe.

It's particularly important to bring this forward as an issue when you look at the kinds of tax cuts that are being advocated, for example, by the BCNI and the Chamber of Commerce and indeed people around the table. They are tax cuts that would be quite regressive in terms of their impacts on income distribution: getting rid of the high-income surtax, cutting top income tax rates, easing the burden of tax on capital gains. All these, as I pointed out to the committee before, would produce much larger tax cuts for high-income earners and very little—indeed, in many of these formulations, absolutely nothing—for people at the bottom of the income distribution.

The only really morally defensible basis for calling for tax cuts now is indeed that they will stimulate growth and expand the pie.

How to approach that question? I'm not sure whether I'd get much debate from my colleagues. Let's look at the relative impacts of a public spending increase, as opposed to a personal income tax cut, on economic growth over the next one or two years. Most of the macroeconomic models around would in fact show that we get a bigger impact from the spending side than the tax cut side, because of leakages to savings and imports. The proposition that's really being put forward is if we cut taxes and get the incentive structure right, we're going to raise the long-run rates of economic growth.

• 1655

Just to be clear on whether there are areas of agreement, I think we can all agree that high rates of both public and, I would argue, private investment in machinery and equipment, research and development skills, and so on are extremely important for long-term economic growth. So the question is how do we raise the investment level in our economy? How do we raise efficiency?

When it comes to taxes on personal income, I think it was Tim O'Neill who talked about disincentive effects on work. I think frankly, if you dig into that literature, almost all of it found that the so-called disincentive effects of high marginal tax rates on willingness to work just evaporate on examination, and particularly for prime income earners.

Just to unpack it in English, the proposition is if that if there are high marginal tax rates, people are going to be cutting on their hours of work and sitting around slacking. The reality is that Canadians are working longer and harder than ever before. You could just as plausibly argue that high tax rates in fact are leading people to work longer and harder in order to achieve the same amount of after-tax income.

So it's theoretically ambiguous in any case, and there's very little evidence for the impacts of taxes on work incentives. There used to be more solid evidence for women, but in the case of Canada the research has shown that women and men are close.

When it comes to the brain drain story, which is the other one.... Tom d'Aquino accused me the other day of just sticking my head in the sand. There are a lot of anecdotes around, but the fact of the matter is we have no data to support the anecdotes. The Halliwell study for Industry Canada, which is the most recent data available from the U.S. current population survey, shows that the proportion of Canadians resident in the United States is at an all-time historic low for the century. We had a recent survey of university graduates in Canada showing 1.5% leaving for the U.S., a trivial proportion, most of whom will in fact come back. A very large chunk of them were nurses moving because there were no jobs.

It's also actually and implicitly a fairly racist proposition, because when we look at emigration, it's obviously greatly eclipsed by immigration. In fact we we have four university graduates come to Canada for every university graduate who leaves. Even if you go to the PhD level, we have a balance of immigrants and emigrants. So I think the idea that we're suffering a large brain drain itself is problematic. To blame it all on high tax rates is doubly problematic.

Next, we have the alleged linkage between personal taxes and savings rates. The argument is if we tax incomes, and particularly property income, we're going to be eating into national savings rates and thereby into investments. So without even venturing onto the terrain of the linkage between savings and investments, I'll just quote from a review of a recent OECD study on taxation and economic performance:

Empirical studies for OECD countries have generally found it difficult to establish a statistically significant and robust role for after-tax real interest rates in estimates of savings functions. On balance, it appears that taxing capital income reduces savings, but not by very much.

So impacts on savings are low. The studies in the United States show that the effects of the 1980 tax reforms, the great supply-side revolution, had no impact on savings. Indeed, I think anybody who argues that low taxes are going to generate high savings runs up against the fact that the U.S. has an incredibly low and, indeed, negative savings rate. In fact what's keeping the U.S. boom going is that they're spending like crazy. They're not saving any of this income. So I think that's a complete non-starter as an argument.

Indeed, people made the observation, and I think it's dangerous, coming from the CLC, to make it, but I think if there is an argument for tax cuts leading to growth and investment, it would be more on the corporate side than on the personal tax side. I think it certainly comes out of the literature that there's a stronger impact.

However, again, I think the evidence, when you survey it closely, shows—scarcely surprisingly, when you think about it—that by far the largest influence on rates of business investment is output growth as a whole. Businesses will invest primarily when they see the opportunity to sell products from new investment—products or services. The after-tax cost of capital does insert a kind of wedge into that decision, but most studies have shown that effect to be really very small. Just to quote from a study by Philip Gerson of the IMF, in a recent working paper—the IMF is being quoted here on numerous occasions, but unfortunately in a lot of their recommendations they don't read their own working papers—it says:

While many of these studies find that investment is negatively related to the cost of capital, most find that the size of the effect is rather small.

• 1700

In this OECD study on the effects of taxation on the economic performance, they go through ten recent econometric studies on the effects of the after-tax cost of capital on investment. Three found no effect at all. Four found small negative effects.

Recent studies done of the impacts of different tax rates in the United States between different states in the U.S. have generally found very little impact on investment depending on capital tax rates between states.

It is true that the Mintz report has argued, to quote from them, “that taxes do have a significant investment on business decisions”. Actually, I think on close examination this is like Donald Macdonald and the royal commission and the leap of faith for free trade, because in the Mintz report, when you look at it, he only cites three studies, which were themselves quite ambiguous for that statement.

The major background study that was in fact done for the Mintz committee by Mckenzie and Thompson found that the changes in the relative cost of capital between Canada and the U.S. had “a small, but statistically significant, impact on relative investment levels...for equipment investment, although not for structures investment”.

It went on to argue that the major ingredient in the cost of capital between the two countries was in fact interest rates rather than the effect of taxes.

They came to the conclusion that a 1% increase in the Canadian cost of capital overall would lead to a 0.03% decrease in the rate of growth of the Canadian capital stock, which is a small impact. Indeed, I'm struck by the fact that my friend and colleague, Jim Stanford, if you look at Paper Boom: Why Real Prosperity Requires a New Approach to Canada's Economy, actually finds a rather more robust impact from profit rates on investment than in fact most of the literature around. I wouldn't dispute his finding, which was that 11% of the fall in business investment in Canada is explained by changes in profitability as opposed to these overall macroeconomic effects.

I think the important point—and it's not just a debating point—is that if you proceed on the basis that you're going to get significant output and growth, and efficiency and productivity effects, from tax cuts, that might be an interesting experiment to run; however, you might just sacrifice large chunks of tax revenue for very little payoff. So you have to subject these proposed changes to a cost-benefit analysis.

I again commend to people's attention that we did run one big experiment under the previous governments on giving incentives to saving and to investment, the lifetime capital gains exemption. There was a whole range of studies done of that measure, edited by one Jack Mintz and published in a special issue of the Canadian Public Policy, which found there was a very regressive impact from those changes in terms of income distribution, and an absolutely negligible impact on growth.

So it's believed, I think, that cutting corporate taxes and personal taxes is going to result in significant impacts on investment. In honesty, there are studies that point to some modest impacts in that direction. I don't dispute that profitability is an important consideration in investment, but you have to go through an awful lot of channels to get, for example, from higher after-tax profits to increased rates of investment. A lot of corporations are buying up their shares today rather than investing them.

So I come to the other set of studies, which again Bill mentioned, and I think he fairly said that a growing number of studies in fact show quite significant growth effects from certain categories of public expenditure. So to flag those very quickly—and again, I think they're quite unsurprising if one thinks about it for a moment—there are quite robust impacts from investments in public education on growth, and particularly from primary education. I think when Jim rightly points to the importance of an early childhood education program, we shouldn't see that solely as a “social measure”. And I think a lot of research done by Fraser Mustard and others has shown that in fact in terms of impacts on “human capital”, investments in early childhood education have a very significant payoff.

• 1705

There's a lot of evidence of quite significant impacts on private sector productivity of investments in public infrastructure, particularly transportation and communications. I think it's also worth noting that there's beginning to emerge now a kind of interesting literature, which is drawing a link between having a relatively equal distribution of income in after-tax terms and growth rates, and Danny Roderick from Harvard is one of the major authors of that work. Again, I think the key link is that if you have a relatively equal income distribution, relatively low rates of poverty, you're going to have positive impacts on “human capital”, lower social costs in terms of issues like crime, higher rates of health and so on.

You saw my “scatograms” here, which were done hurriedly this morning and were passed around. Really, the main point I'm trying to make here is that if you're trying to draw any kind of close correlation between the overall tax burden and growth as measured by per capita income, or for that matter in productivity as proxied by labour productivity in manufacturing, you're going to get a pretty weak relationship overall.

I'll commend Bill's attention to the OECD study, where they actually take more or less the same tax period and the same measure in order to derive their estimate of the impact of tax cuts on GDP. The main difference I made here was to convert GDP growth to GDP growth per person, which seems to me a reasonable change. Part of the reason the U.S. has been growing faster than other countries is that its population growth has been growing faster.

Anyway, I think one can produce different studies with somewhat different results. Again, if you take the taxation and economic performance study from the OECD and recent surveys by the IMF, which do argue the case for tax cuts, actually the efficiency impacts are really very small and modest. The bottom line for the OECD is that if you cut taxes by 10% of GDP you “may” get an increase in the long-term growth rate of as high as 0.5%. That's not a terribly strong relationship, although of course if we could increase growth rates by half a percent, that's not to be sneezed at.

Also, that study doesn't offset against that what would be the impacts of cutting taxes by 10% of GDP in terms of income distribution, in terms of the level of public investment. We'd pretty well have to gut huge areas of program spending in order to do that.

So I'll just conclude by saying I think these economic efficiency impacts of tax cuts, particularly on the personal income tax side, are greatly exaggerated by a reasonable reference to the literature. And I really reiterate what Bill said, which is that I think in fairness—and debate does become polarized—if you pressed all of us, we should all concede that there are positive impacts on growth and productivity from both the possible measures on the tax side and on the spending side. Just to get into a spending versus taxes thing really isn't a terribly intelligent discussion, because one could do many different things on both sides.

I would stress it's not an argument where those for tax cuts are the only ones taking economic efficiency and growth issues seriously.

The Chair: Thank you very much, Mr. Jackson.

We'll now hear from Mr. Van Audenrode.

Professor Marc Van Audenrode (Chair, Economics Department, Laval University): Thank you, Mr. Chairman.

At this point nobody believes it's possible to add anything to a very long shopping list that my colleagues have presented you with, but it is possible and I'm going to show you.

• 1710

Let me start with a general remark on something some of my colleagues have raised. I would insist a little bit about how fragile the equilibrium in public finances and the equilibrium with the federal government finances are still. There essentially are two sources of danger for this equilibrium. One is a recession, and the second is a sudden rise in interest rates.

Let's talk about the recession. There's no recession forecast for the immediate future, but we have to recognize the fact that the growth of our economy is being strongly sustained by our exports, which in turn have been strongly sustained by the strong growth of the U.S. economy. Nobody has been able to predict such a long period of growth for the U.S. economy, and nobody has been able to explain why it has lasted so long. That therefore raises a doubt about our ability to predict when it's going to end, so we should be very careful at that level.

I'm not going to insist a lot on the problem of interest rates, but nobody can predict when the Bank of Canada is going to embark on another inflation ghost-busting operation that could cost a lot of money. I would say this advocates for being prudent probably for one more year, while trying to pay a big chunk of the debt in order to try to start a very strong reverse snowball effect that would clearly solidify the state of our public finances at this point.

Okay, getting to the shopping list, I would say the single most important and identifiable source of surplus for the federal government has been and is going to be the surplus in the EI account. It was $7.5 billion last year, and it's going to last for many years. Many economists have criticized European countries for years for just financing their general programs through payroll taxes. It's clear these taxes create a wedge between wages and labour costs, and this is linked to persistently high unemployment.

It is clear that our labour market could do without that tax for another few years. It is also clear that at some point we have to look at a strong reduction in EI contributions. This is even more required in that as a tax, EI contributions are strongly regressive. The existence of maximum insurable earnings and maximum contributions can be justified when EI contributions are just contributions to an insurance system. When they are a tax, they become strongly regressive, and at least this will have to be taken into account. A very small part of low-wage-earning people are contributing disproportionately to deficit reduction and to the creation of that surplus. That will be taken into account when looking at the general balance of the progressivity of our income tax system.

That's the first thing. The second point I wanted to raise—and I haven't heard this enough—is the fiction that Canada's public finances are good and healthy just because the public finances and the finances of the federal government are healthy. There are still quite a few provinces and territories that are hurting. There are still many municipalities, school boards, universities, and hospitals that basically have been at the receiving end of the giant game of snow shovelling that this federal government started a few years ago in order to bring its finances into order. They are still hurting, so one of the things this government should probably do is restore some of the funding towards these institutions and levels of government, because, in addition, these levels of government are providing the services that are the closest to the people.

A third point that I really want to raise, which nobody else has raised, is the horizontal equity aspect of our tax system. I'm surprised that nobody has talked about this. Families, especially families with children, have been hit over the last few years by all the measures of cost-cutting and spending reductions. They basically have had to absorb many increases in the hidden costs of education and school transportation. They have been at the receiving end of the reduction of municipal subsidies into social, cultural and sporting activities. I have paid for that, and I've been hit disproportionately by all these cost-cutting measures.

• 1715

At this point, if you look at the tax break that the federal government gives to a family with two children and earning $50,000, which is not rich, and if you compare it to a family earning $50,000 with no children, and if you look at what the U.S. federal government does—basically, these are two comfortable families earning around $50,000 Canadian dollars—the Canadian government gives a tax break to that family that is around $850 a year, while the U.S. federal government gives a tax break of close to $1,300 a year. That's 50% more. And we are not talking about Norway, France, eastern European countries, etc. We're talking about the U.S. The Americans are doing much more to help families at a very middling and reasonable level of income. If I put these figures not at an absolute level but at one proportional to the level of taxes that these families have to pay, the difference is humongous.

I would say the poor level of help that families receive from the federal government is a national disgrace, and we have to correct that very quickly. I'd say it is time that you say you don't have to be poor for the federal government to care about your kids. Our system has become very inequitable recently, and this is much more obvious than the vertical inequalities that all my colleagues have been talking about in this round table.

That's all I have to say.

The Chair: Thank you very much.

That was the final presentation, and I feel everything is so clear now. I understand which way to go.

We'll have a ten-minute question and answer session, beginning with Mr. Epp, who will be followed by Mr. Loubier.

Mr. Ken Epp (Elk Island, Ref.): Thank you.

I feel like I'm very far away, but I was anticipating being called away to other duties.

This has been very interesting. I remember last year, when it was my first year on the finance committee. After having heard a whole bunch of witnesses in our committee, we finally came to this one, where all the guys who came in knew what they were talking about for sure. I remember being amazed at how much diversity there was then, just as now. I guess it's true that if you ask twenty economists what to do, you should have about thirty opinions. You delivered today.

I have a couple of questions. First of all, with respect to tax rates, all of you are talking about tax rates costing the government money. Do any of you at all buy into the idea that if we were to cut the tax rates, government revenues might actually go up?

Mr. David Rosenberg: I think all you have to do is take a look at Ontario's experience. Here you have a government that cut personal taxes aggressively, and here we are today with personal income tax revenues that are 7% higher than they were at the time when the Tories took power back in 1995. So, go figure. There is also a situation in which program spending is actually up by more than that amount. So I think when you are as overtaxed as Canada is, you can certainly build an argument that those multiplier impacts are minimally a third.

I'd take a look at the U.S. tax situation. What was the last thing the U.S. did? Amazingly, a Democrat cut the capital gains tax rate a couple of years ago. When you take a look at the tax revenues from capital gains now, that cut has more than paid for itself.

So notwithstanding what the textbooks would tell you, when you take a look empirically, around the world you can find examples of where, when you cut taxes, you certainly get back more revenues than you otherwise would have by stimulating risk-taking investment and economic growth. I think actually, just taking a look at the Ontario experiment, that is probably the best case in point.

• 1720

The Chair: Thank you, Mr. Rosenberg.

Mr. McCallum, followed by Mr. Laidler.

Mr. John McCallum: Mr. Chair, I'm afraid you're not going to get unanimity, because I don't believe for one moment that if you cut personal income you'll get more revenue than you otherwise would have gotten. I mean, this is a free lunch that's just too free to be imaginable. It would suggest that you cut income tax by 20%, so why not 80%? Why not take it to close to nothing, because then your revenues will explode? I think there's some payback, but I don't think you'll find that you'll more than make up the revenues, especially in the case of personal income tax.

On other kinds of taxes, it might be closer—and here I think I'm quoting Jack Mintz again. On certain kinds of business taxes, you could get your business taxes to a level lower than those of your neighbours. You'll then create an incentive for corporations to shift income into your country and also perhaps to shift economic activity into your country. In the case of corporation tax, then, I could conceive of your statement being correct. But for a big, broad tax like personal income tax, I find that very hard to believe.

Mr. Ken Epp: If I could just enlarge on it before another person speaks, I have no problem with saying that if you cut your rate to zero, everybody knows your revenue from income tax is then going to be zero. But if you put it at 100%, your income tax revenue would also be zero. Who would keep working if they had to send everything they earned to the government? There is a place in between, and if you visualize that—as I know economists love to do, so I'll do this from your point of view—you have this curve where the income tax revenue is zero or zero at either end. In between, depending on where you are on that heap, you may have passed the point of maximum revenue at a given rate.

I guess I'm exploring whether or not we're over that rate, because the message we keep hearing from Canadians is that they feel they're taxed to death. It therefore seems to me that we might really give the economy a boost if we did give them a really good cut.

Anyway, carry on, please.

The Chair: We have Laidler, Robson, Mendelsohn, and Fortin.

Prof. David Laidler: I'm one of those people who believes we're well in the wrong side of the Laffer curve from the point of view of supply-side economics in Canada. I lived in England before I came to Canada in 1975. I'm prepared to believe that when the top rate of income tax was cut from 96% to somewhere around about 50% and then 40%, revenue went up because people moved back to Britain from Switzerland and the West Indies and started declaring their income. But we're nowhere near that here.

I would caution as well about evidence from studies of the capital gains taxes alone. If you cut capital gains taxes and leave income taxes alone, smart accountants will convert income into capital gains very quickly. The revenue from capital gains taxes will go up, but the revenue from income taxes will go down.

So there's no doubt that it's a mistake to read from a proportional cut in a tax rate to a proportional cut in revenue. I'd be absolutely astonished if, in Canada, we were on the wrong side of the Laffer curve and we could rely on tax cuts to generate an increase in revenue. I think Alan Greenspan has had more to do with the revenue from the Ontario income tax than Mike Harris has.

Mr. William Robson: It's just too bad that that same effect didn't wash over into Ontario's neighbouring provinces, I suppose. I just can't help pointing that out. Nevertheless, I'm fundamentally in agreement with David Laidler.

It's not usually respectable for economists to argue in favour of the more-than-offsetting revenue effect that you're talking about, but such situations clearly do exist. We have a great example here in Canada with the foreign property rule. That's a tax. There's a special tax levied on people who own too much foreign property in their pension plans. It's levied at a prohibitive rate and it raises very little revenue. If it were actually levied at a lower rate, we might actually see some revenue from that tax. There would be a more-than-offsetting impact. As it happens, though, I'd like to see that particular one go to zero.

On business taxes, I think the tax base is probably getting to be more elastic all the time. Therefore, that's one area in which you're certainly not looking at one-for-one decreases in revenue if you cut your tax rates.

• 1725

On capital gains, David makes an important point about the possibility of translating income, but at a point in time there are people who are locked into situations they'd like to get out of, and certainly in the short run from releasing that situation alone you can end up reaping some additional revenues.

So the very unexciting answer is that it depends, but there are certainly examples where the cheat sheet in the fiscal update that shows those revenue impacts has to be taken with a grain of salt, for the reasons you're alluding to.

The Chair: Mr. Mendelsohn.

Mr. Joshua Mendelsohn: I guess I'm going to muddy the waters a little bit more for you.

I would agree. The problem we're facing here—and I think it goes back to some of the issues Andrew Jackson and some others were talking about—is that when you point, there is evidence, there isn't evidence. There is the attempt to measure one variable against another, a direct impact or a reasonably direct impact.

I don't have the answer here, but I think the problem is that the economies we live in today are increasingly complex. The reaction functions, the behaviour patterns are more complex perhaps because people are more knowledgeable. They've been attuned to different reactions. They respond differently.

In the short run, my inclination would be to say that if you're just going to reduce taxes marginally, no, you're not going to recapture it in added revenue; in fact you lose. But the question becomes—and that's where my focus is—what happens in the long term if you change an incentive system, if you change the returns that are available, by whatever tax structure you want to change? I don't have the answer to this one, but at that point I expect you will get a different answer, a different result.

It is true, as was said before, that taxes are not going to generate necessarily in the short run additional investment, for example, and therefore additional output.

I was responsible for a study—I'm going way back now to the mid-seventies at C.D. Howe—on tax incentives to boost investment. The end result was that it's demand, it's the ability to sell their product, which was noted before, that is going to create that investment. The question is what creates the demand? It's the employment. It's the income. It's the ability to spend. It's an integrated system.

So I think the notion that it's a one-to-one is one we have be very careful of, because we're going to get all sorts of different answers.

Ontario is an interesting case because, I would also have to concede there, it owes more to Greenspan than it owes necessarily to the taxes. I think the Ontario government itself basically shies away from taking all the credit on the tax side as being the source of the growth. They do recognize very strongly that the U.S. has been a source of that growth.

The Chair: Mr. Fortin? No? Anybody else?

Mr. Epp, you have one question.

Mr. Ken Epp: I want to ask just one quick question about debt. Several of you mentioned it, that it should be a priority. It seems to me that at times when our economy is really rolling along reasonably well and the interest rates are low, that would be an excellent opportunity to reduce the principal amount of our debt. Yet some of you were tentative or you didn't even mention it.

Those of you who didn't, can you tell me why you'd like to keep the debt high?

The Chair: Mr. Mendelsohn.

Mr. Joshua Mendelsohn: I don't think I didn't mention it because I want to keep it high; I think it was mentioned by others, so I skipped it.

To be quite fair about it, I think the question is how much are you going to lower it by? If you take the entire unanticipated surplus, as I tend to refer to it, the sort of year-end piece that's left there, I would most definitely say there's only one thing to do with that, and that is put it toward the debt reduction.

At the minimum you've got the $3 billion, yes; I would say if you go to $4 billion or $5 billion, I'd be quite happy with that. But I also have to balance in my own mind what my own feeling is about the longer-term contribution to some of the beneficial effects of growth as opposed to what you might save by just another $1 billion, let's say, in debt reduction if you did it at the front end. If you did it at the back end, there's no question in my mind, and the quicker it's done away with, the better.

The Chair: Thank you.

Mr. Loubier.

[Translation]

Mr. Yvan Loubier (Saint-Hyacinthe—Bagot, BQ): Thank you, Mr. Chairman.

[English]

The Chair: Oh yes, of course, sorry. Mr. Rosenberg.

Mr. David Rosenberg: I gave a fairly quick preamble at the beginning. I would just say that to me the key measure of fiscal stress is not the debt level, but debt-to-GDP, and we're at a stage now where that is coming down. Even if you're not paying down the mortgage, it's coming down just through economic growth. But I would fully agree that the contingency reserve at the least should be used as the down payment. The debt-to-GDP ratio, which has already been down 10 percentage points in the past couple of years, is going to continue to decline.

• 1730

The question is why is this debt-to-GDP ratio overly high? What is the symbol that's showing us that? I would argue that we have this very rare situation in Canada where our interest rates out the yield curve, out to the 30-year bond, are below those of the U.S. So the markets are certainly not telling you the level of debt in this country as it stands right now is unacceptably high. It's expectations that matter.

It was back in the late 1980s and early 1990s, when our bond spreads out the curve were 200 basis points or higher, that the market was signalling the policy-makers that the debt situation was dire. We managed to turn that around. So the fact that our interest rates are below the U.S. and it's not an inflation story, because our inflation is pretty well the same, is I think a symbol that investors are comfortable with the progress Canada is making on the fiscal balance sheet. I mean, what better indication of that is there than that last week Newfoundland got upgraded by Standard & Poor's to single A-minus from triple B?

I think the fiscal progress has been a good story. When I take a look and I see that GDP is down, that total public sector spending as a share of GDP, while off its peaks, is still higher than it was 10 or 20 years ago, what sticks out like a sore thumb is the fact that federal government revenue as a share of GDP is still over 17%—at the high end that it's been in the past 20 years, and two percentage points higher than when the Liberals took office. That's next to a $1,000 extra bill for the average household.

I'm not saying the debt isn't high and shouldn't be addressed, but the fact of the matter is that it's already down 10 percentage points and will continue to go down. The question for the government is what is really the number one priority from this day on? The reason I chose to focus on the tax side is that this is where I think the more pressing need is at this time.

The Chairman: Thank you, Mr. Rosenberg.

Professor Wilson, go ahead.

Professor Thomas A. Wilson (Director, Policy and Economic Analysis Program, University of Toronto): I'd just like to argue that I share the view that in the medium term, tax reductions are terribly important. I'll say a few words later on, if there's an opportunity, about which taxes should be cut.

But I think in the short run, the priority clearly should be on debt reduction. I say this for a number of reasons. The economic outlook has strengthened over the last two months since the original fiscal dividend exercise; the projected surpluses are higher now in the first couple of years. This is exactly the time when the good news should be translated into higher debt paydowns. We should have a medium-term plan, but then the debt paydown really should be the residual. I think when we see good times, that's the time to pay down debt more rapidly.

I also think we should be planning to have sufficient debt reduction so that, given the minister's and I think the government's commitment never to run a deficit ever again, we've got to have a big enough cushion there to avoid the risk of perverse fiscal policy in the event of a recession. So if we were to have a recession in a year or two from now—even though it looks unlikely in terms of the current outlook, things can change—and if we were to have the worst-case kind of recession, an inflation acceleration in the United States, the Federal Reserve tightening up, so we'd face both declining real demand and rising interest rates, we want to have a big enough cushion there so the government's commitment to not running deficits would not force us into cutting spending in the recession or raising taxes. The other thing of course is that running a larger surplus now eases the burden on the Bank of Canada in its need to control inflation.

The Chairman: Monsieur Loubier.

[Translation]

Mr. Yvan Loubier: I would like to continue this discussion on taxation bearing certain comments in mind and then I would like to move on to another topic.

Although the analyses presented today do not acknowledge the consequences of lower taxes, reality has nevertheless shown that the impact is quite dramatic. For example, whereas the general individual tax burden has jumped 40%, particularly since 1993, the GDP has risen by 27%. These two figures therefore indicate that some individuals have grown poorer.

• 1735

As for the imbalance that exists between income categories and tax contributions, once again, certain facts are clear. For those earning between $30,000 and $70,000 per year, which includes approximately 27% of all taxpayers, the federal tax rate is more than 50%.

The other fact that I consider quite important, and I believe that Mr. Mendelsohn and Mr. Van Audenrode alluded to this earlier, is this whole issue of equity of the tax structure. It is quite surprising that some of you are not convinced about the impact that lower taxes would have on average income earners in particular, whereas the absence of full indexation alone results in flagrant imbalances between federal and provincial taxation, particularly in Quebec.

We just saw such an example this afternoon at the Finance Committee: the zero tax threshold for families with two children is much higher at the federal level than it is at the Quebec government level, for example. A family with two children is taxed, at the federal level, starting at an income of $10,700, whereas the province does not start taxing until the income reaches $30,200, if memory serves me correctly.

When you see such imbalances, such as the growth of GDP in comparison with individual income tax, you can understand that reducing income tax for taxpayers in this category would have a definite impact. Perhaps we should not reduce taxes for all income categories, but do so for this category of taxpayers in particular, particularly since this category is the one assessed to have the highest marginal propensity to consume. Consequently, any tax savings resulting from a measure contained in the next budget could be totally spent or invested and this would have a significant impact.

I would like to hear what you think about this because, with only a few exceptions, you do not seem to be convinced about the impact that reduced taxes would have on economic growth.

I'm going to ask you my other question right now in case I run out of time. I would also like to hear your opinion on anything pertaining to the debate on integrating the currency of North America and even that of the three Americas. I do believe that Mr. Robson and Mr. Mendelsohn spoke earlier about the productivity of businesses and the fact that we could not continue basing the performance of our businesses on the devaluation of the Canadian dollar.

I would, therefore, like you to talk about the possibility of integrating first the currency of North America and then of the three Americas in terms of stability and then in terms of increased productivity for Canadian businesses.

[English]

Mr. Joshua Mendelsohn: Let me respond this way. I'm not one who's in favour of the common currency, because I don't think common currency is the answer. I think common currency is often used as a mechanism to try to force or bring about change to some degree, abstracting the political pressures within Europe that brought about the introduction of the euro.

The process was that if we have a common currency, we can in fact use that as a straitjacket to bring down fiscal deficits, to bring down debt loads, to restructure our economies. It is a reflection of their failure amongst the various countries to in fact, in many cases, such as Italy, where there has been traditionally a lack of strong effort or capacity to do this, that this is more a mechanical exercise. At the end, it may prove very fruitful.

I think the same challenge faces us in Canada, which is why I raised some of the other issues I did. That is, if in fact we move forward and introduce policies that promote our economic competitiveness on grounds other than the currency, or improve our productivity, improve our competitiveness, those industries that rely on the cheap currency are going to lose, because they need to move forward. That currency will move up of its own and will stabilize at some level. I don't know what the proper level is.

• 1740

The challenge I have with a fixed rate is this: at what rate do you fix it? If you fix it at 50¢ U.S. per Canadian, you're worse off, because in fact you're adding even additional protection to Canadian industry. If you fix it instantly at 80¢ or 85¢, I suggest that many Canadian industries will not survive.

What is the proper rate, then? The purchasing power parity number is a long-term concept that I don't think holds in this case.

I would prefer to see us undertake policies to reach a higher level of stability and a higher level of overall performance through choice and election rather than mechanically. When Margaret Thatcher tried that, it worked to a degree when she shadowed the Deutschmark with the British pound. But that was an inflation issue, trying to prevent business from giving in to labour demands. So there are different reasons for that.

We do need, however, some flexibility in our exchange rate. No matter how far out we look, the structure of the Canadian economy will certainly be different to a degree from the structure of the United States economy. It is more resource-oriented. It is more regionally diverse in that respect. Consequently, we will need some flexibility in there.

So I'm not in favour of a fixed currency or a fixed exchange rate.

The Chair: Mr. Laidler or Mr. Fortin.

Prof. David Laidler: With regard to the issue of a common currency, I think the major objection is political, frankly. I can't conceive of a common North American currency that would not be the United States dollar run by the Federal Reserve, which is accountable to the U.S. Congress. I can't imagine the Americans giving that up, and I don't see why we should create a hierarchy of political power within North America.

The next one down the line is some type of fixed exchange rate arrangement. They have worked really badly in the last 15 years. They've been the source of all manner of instability. It's difficult to hold a pegged exchange rate.

Moreover, in this discussion I think there has just been insufficient attention paid to the fact that there is a border between Canada and the United States that most members of the labour force find very hard to cross. Asymmetric shocks have to be absorbed within the Canadian economy. I agree with Josh Mendelsohn that a little flexibility in the exchange rate to help absorb those shocks is well worthwhile.

That's not a plea for soft monetary policy. I don't recall hearing many people complaining that the Bank of Canada has been soft in its monetary policy in the last decade. I don't give much credence to the argument that soft money policy has been responsible for lagging productivity growth.

The Chair: Mr. Fortin.

[Translation]

Mr. Pierre Fortin: I would like to answer the question about lower taxes. First of all, I think that contemporary literature analyzing the American experience from the early 80s, where individual and corporate taxes were reduced by 20 to 25 percent, proves that this idea that North America was sitting on the wrong side of the Laffer curve was just a crackpot notion. In France, this curve is referred to as the Colbert curve. It was, in fact, Colbert who had developed this idea. This is a crackpot idea because we are far from being there. I think that the reaction of the committee members, earlier, was the right signal to give.

And then, the reason why we intuitively do not feel prepared to say that a significant reduction in income tax will, in itself, stimulate exceptional economic growth, is that... The real reason which prompts us to ask for tax reductions is that, with the elimination of budget deficits, the percentage of GDP representing interest will gradually decrease. We are, therefore, simply suggesting that we replace this amount with tax reductions and offset the decrease in interest to be paid in order to balance everything. In practical terms, that means that the money that would have been spent on interest will now instead be spent by people who will have it in their pockets and use it as they wish.

In a nutshell, this will not change buying power whatsoever. The country has a capacity to produce goods and services on a short-term basis and this capacity cannot be overshot without triggering inflation. Should this happen, even if decreased taxes were to boost the economy, making it inflationary, you would immediately see a jump in interest rates which would prevent this reduced taxation from having an expansionary effect.

• 1745

Furthermore, it is just as ridiculous to say that the recent drop in taxes in Ontario—and this is how colleagues in general appear to be reacting—contributed significantly to the economic growth of this province. Indeed, that would be like saying that the sale of peanuts during the weekends in Italy caused an increase in car accidents in Scotland, because the frequencies of the phenomena both increase over the weekend, as everyone knows. There is really no link between these two things.

What happened is that the interest rates dropped in North America, particularly in the United States, our exports climbed and Ontario benefited. Furthermore, Ontario's economy was the regional economy that declined the most in Canada during the recession. It is therefore logical that, in times of growth, its economy recovers faster than the others.

There is, however, one area where significant tax reductions would have an impact. This would be in the corporate sector, in conjunction with the competition that exists throughout the world to obtain direct investment from international corporations. It is obvious that Ireland's decision to reduce the capital tax burden which was, I believe, sitting at 22%, as compared to 10% 10 or 15 years ago, had a major impact on the flood of foreign investment in Ireland.

Obviously, if Canada were to do the same thing, there would be a flood of investment, but this would not be the result of any savings from Canada, or additional work or effort coming from Canada. It would essentially be the impact of the decision made by foreign or Canadian corporations who wish to expand or set up shop in Canada.

Consequently, if we want investment in Canada to really climb, we are either going to have to remove corporate tax or change the way that individual income tax is structured so as to remove taxes on savings to the maximum. In order to do that, we may have to analyze the system suggested by Mr. Mills, and also the system suggested by American senators such as Mr. Domenici, who has suggested the USA Tax.

Mr. Yvan Loubier: I would like to ask a supplementary question in conjunction with what you have just said. Do you find that it is just as, as you say, ridiculous that since 1993-94, it has been the income category I mentioned, namely, those with average incomes earning between $30,000 and $70,000 per year, who are contributing the most, all things being equal, to the campaign to put public finances back in order, when in fact we are in a situation where we have forecasted surpluses, for the next five years, of between $95 and $150 billion?

This morning, economists from Toronto agreed with you: they felt that Mr. Martin had once again underestimated the surplus we would have in the next five years. This is becoming a habit. We can't seem to change it. Would you find it a crackpot theory that we should give some respite to these categories, to these middle- income families who made most of the sacrifices when we tried to put our public finances back on a sounder footing?

Mr. Pierre Fortin: I'm not saying it's a crackpot theory in that case. The government has a decision to make. It can go one way or the other. What I called crackpot was saying that we were on the wrong side of the Laffer curve. But I think we know where we stand now.

However, I feel it is a good idea to squarely target the middle class for massive tax cuts across Canada in the next 10 years. Personally, I think there should be at least $30 billion in overall tax cuts over the next 10 years, and on the whole the middle class should benefit. At the same time, though, I would make a particular effort to bring down the maximum marginal tax rate in Canada, and bring it closer to that in the United States, as John McCallum suggested a few moments ago.

Mr. Yvan Loubier: Thank you.

[English]

The Chair: Mr. McCallum.

Mr. John McCallum: I have just two quick points to supplement what's been said about the common currency.

By the way, I agree with David Laidler. North American common currency is a euphemism for Canada using the U.S. dollar, so politically that's not likely to happen any time soon. I think what we're really talking about is a pegged exchange rate or a currency board.

• 1750

The two points are...for a country like Argentina, Mexico, or Brazil, with a history of gross monetary instability and hyperinflation, there's a certain appeal to just dumping their rotten system and using the U.S. dollar, though even then I don't think it's going to happen any time soon, if only because they wouldn't have any lender of last resort and their banks are not exactly stable.

In Canada we went through considerable pain in the early 1990s to get our monetary house in order. We went through further pain more recently to get our fiscal house in order. Arguably we have at least as much monetary and fiscal discipline as the Americans, and the proof of that, as was pointed out a few minutes ago, is that our interest rates today are lower than the American rates. So we don't have that same incentive as point one.

For point two, I think the best example to illustrate the benefits of a flexible exchange rate was the Asia crisis. When the Asia crisis occurred, commodity prices around the world tumbled and the resource-based countries like Chile, Australia, New Zealand, and Canada experienced significant currency depreciations, which offset in part the impact of that Asia crisis and which depreciations were at least partially temporary.

My argument is that you have to take the hit from the Asia crisis somehow, and far better to take the hit in these temporarily weaker currencies, which permitted continued growth and job creation, rather than take the hit in defending the currency by higher interest rates and arguably putting us into a downturn.

To look at fixed rates, which haven't done very well, there are only two major countries in the world that have true pegged exchange rates today. They went through that experience. Those countries are Argentina and Hong Kong. They are not in good shape today. I would argue that our flexible exchange rate has served us well. Nowhere has that been more apparent very recently than in the consequences of the Asia crisis in this country.

The Chair: Thank you.

Mr. Jackson, followed by Mr. O'Neill.

Mr. Andrew Jackson: Very quickly, I agree with just about everything John said. The point I wanted to make in terms of the positive impacts from the flexible exchange rate is this. In certain quarters the recent slide in the Canadian dollar is seen as a terrible thing, but I think it's absolutely clear that the recent growth we've had in our economy has been driven in a very important way by that change in the exchange rate, the cushioning impact following on from the Asian crisis.

The point I wanted to make...and I was really glad to see it made yesterday by the new dean of the business school at U of T, who I heard took a 90% pay cut to come back to Canada. The point he was making, which I think really gets overlooked a lot in the debate, is that Canadian businesses, particularly businesses selling into the United States, which is the case for an awful lot of the high tech sector calling for tax cuts so vocally...I mean, they have an incredible deal at the moment. They're selling in U.S. dollars and they're paying people in Canadian dollars.

If you're paying people in Canadian dollars...I think most people would agree that the purchasing power of a Canadian dollar is about 80¢ U.S. The exchange rate is 67¢. That's an incredible incentive, in fact, for companies selling into the U.S. to locate in Canada. It's an incentive effect that greatly outweighs any possible tax reduction.

I mean, it's just absurd...not that people here are falling into that trap, and certainly not John, because he's far too sensible. It's absurd for people like Sherry Cooper to call for major cuts and fixing the Canadian dollar. They're policies that run in completely opposite directions. We should be maximizing the leverage that we have from the depreciation of the exchange rate.

The Chair: Mr. O'Neill.

Mr. Tim O'Neill: I have one small caveat there. One of the consequences of a lower-valued currency, of course, is that your purchasing power internationally, at least in the short term, is declining. It's not something you'd look forward to. It nonetheless does have similar effects. I think one of the key points, though...and I'm in the group that feels that a common currency or fixed exchange rate is conceivably the worst possible policy we could find. I'll make a long list of what I think would be silly policies, and that would be at the top.

One of the arguments—there are other good ones that have been made, I think—that are often made is that it protects against the volatility in currency and the problems that creates. In fact, if you go back over the last 20 to 25 years, the Canadian dollar is one of the least volatile currencies. I would argue, in fact, that it may well be the case that the Bank of Canada has been too focused on and too concerned about the currency, rather than insufficiently concerned. It may be criticized on those grounds, and certainly all of the points that have been made about why you would want a flexible exchange rate are appropriate ones.

• 1755

Let me also pick up on something that Pierre mentioned. Hopefully this is not grossly oversimplified, but in looking at the stimulative effects, in the longer term, of tax cuts, we have to make a distinction between personal income tax and business taxes, as I think Pierre pointed out. Both of them are going to stimulate spending in the short term—sort of a demand-side expansion.

The key point, though, is that investment has two other impacts. One is that it's a capacity-expanding expenditure, so in the long term you are going to improve your trend growth rate in the economy. Your capacity to grow in the future is enhanced because of that. That's not the case when you increase the capacity for consumption spending. Reducing personal income taxes doesn't, in that sense, expand your economy's capacity to generate output in the future at a higher rate than you've hitherto been able to. And to the extent that investment spending has embedded in it technological change, it also has a productivity-enhancing role to play.

While it may be true, as Andrew Jackson pointed out earlier, that the size of the impact looks relatively small, I would argue that a half a point increase in the trend growth rate in the economy is a very significant long-term improvement. The effect of compounding that over 20 or 30 years is very significant. I don't think that even the most optimistic literature about the impact on private sector productivity from infrastructure spending would claim anything remotely close to that kind of impact.

The Chair: Mr. Robson, then Mr. Mendelsohn.

Mr. William Robson: Since everybody is picking up on the currency union point, I'd just like to amplify one thing, if I may. The machinery at the core of a monetary system—the central bank, lender-of-last-resort facilities, and the regulatory and legal powers that go along with that—is very difficult to pick apart.

One of the things that bothers me about the debate about North American monetary union is that no one has told me why we could expect the U.S. Federal Reserve to provide us with the same types of services that we now get from the Bank of Canada without an extension of legal and regulatory power into Canada, which no one seems willing to contemplate. This is a topic that has also come up in a different context that I believe is of some interest: the question of whether Quebec, as an independent country, would want to use the Canadian dollar. I tend to think that the same difficulties arise, and I have the same reservations about the North American monetary union idea.

In your first question about personal income tax burdens and families, you mentioned the specific example of families with children. I was wondering if Professor Van Audenrode was going to come in on that point. I neglected it in my presentation.

Mr. Yvan Loubier: Two children—

Mr. William Robson: Or three.

Canada's tax system is almost unique now in the world, I think, in providing no recognition of the existence of children for many families.

At the end of my presentation, I sneaked in a quick plea for the re-establishment of a sensible system of deductions, because that's how you do it and that's how you get the horizontal equity that was referred to here. In Canada we have had a very big problem with sorting out the issue of defining the tax base in a sensible fashion and then putting your social policy transfers on top of it as a separate issue.

We have tried to make up for problems in the tax base, like the lack of deductions, for example, with further complications of our system of transfers, and we're making a worse mess. We have to get the tax base right. I think the deductions that would put a family with two or three or four children into the situation you're describing—where they don't start paying taxes until a higher income level—are the way to go.

The Chair: Mr. Mendelsohn.

Mr. Joshua Mendelsohn: I just want to pick up on one point. I just don't want to leave the wrong impression; I mean, we all seem to agree that we don't want a fixed exchange rate, but then there were some comments from Andrew Jackson, and maybe some others, that somehow it's “I'm all right Jack, we have a low exchange rate, it's great, we sell everything”. What we have to understand is that there is a price to it. Whether you lower wages or you lower the exchange rate, there is a cost to the standard of living of every Canadian as a result of that. Increasingly, to the extent that you have companies or firms that don't export and don't have export earnings and need to buy capital equipment, that capital equipment becomes more expensive to them.

• 1800

So there is a cost in all of this, and to presume that somehow.... I'm not in favour of artificially raising the exchange rate. I don't believe in that. But at the same time, to leave the impression that if the exchange rate were to go down another 2%, 3%, 5% or 7% it would be fine, I think, is very misleading. It has a cost, a very expensive cost over the long term.

The Chair: Mr. Rosenberg.

Mr. David Rosenberg: I would tend to second what Mr. Mendelsohn had to say.

Of course Mr. Jackson decided to take a shot at my boss, who isn't here, but I'll take the high road and just say that everybody's been talking about what a great antidote the lower Canadian dollar was during the Asian crisis and for our beleaguered resource producers. Nobody's talking about what's happened this year. The Canadian dollar is up, and yet it's still the disappointment of the year on the upside.

Someone would have to explain to me what the Bank of Canada's policy really is. When you consider that commodity prices were going up in the spring—oil prices were already going up to $16, $17 or $18 a barrel—and the Canadian dollar hit 69¢ on May 3, the peak for the year.... The very next day, the Bank of Canada independently cut interest rates 25 basis points to lean against the currency going to 69¢, when the terms of trade were telling you we should be over 70¢. So what is the Bank of Canada's policy with respect to the Canadian dollar if they suppress it at a time when the fundamentals are telling us it should be going up? That's the big question, not what happened last year.

But why is the Canadian dollar trading as if oil prices were at $16 or $17 a barrel instead of $24 or $25, where they currently are right now? There's a serious mismatch between where the Canadian dollar is and where it should be, based on the fundamentals. And that's a question that hasn't be addressed.

The Chairman: Mr. Laidler.

Prof. David Laidler: Yes, there are two things.

The Bank of Canada's policy is to keep the inflation rate between 1% and 3%, and that's what it's been doing.

The second point is that it is very misleading to refer to the price of oil as having a positive effect on the fundamentals of the Canadian dollar. The empirical evidence and the theoretical work that has been done in the Bank of Canada over the last decade shows that the price of oil has a negative effect upon the value of the Canadian dollar, because Canadian manufacturing exports are extremely intensive in their use of oil and other energy products, and that indirect effect outweighs the direct effect of the price of oil. The commodities you must look at as drivers of the Canadian dollar are non-oil commodities that are produced in and exported from Canada.

The Chair: Thank you.

Mr. Szabo.

Mr. Paul Szabo (Mississauga South, Lib.): Thank you.

There seems to be a consensus that the 50-50 discussion is really quite academic, that 50-50 is not appropriate for all time. It seems to be some sort of reasonable starting point when you're moving out of a deficit scenario into modest surpluses that are small enough dollars to work with. But obviously once these surpluses get up to higher levels, all of a sudden you may find yourself having to spend where the need is not justified, but you still have to match the formula.

So I think you got some consensus on that one, Mr. Chairman.

I got the distinct impression from everyone that really productivity was what we were all talking about, that we're really looking for ways to improve ultimately the quality of life for Canadians, and that there are many ways to deliver that improvement in quality of life. Some are direct, right to the individual. Others are through things like improving the corporate side, so that we grow the pie, whether it be tax cuts or whatever.

I'm very interested, though, in how all this translates into the size of the debt. We've heard often from people who have come before us, “Isn't it outrageous that we have this large debt and we're paying $40 billion a year on debt servicing?” It reminds me of the initial reaction to a fiscal dividend, that the real fiscal dividend was the interest savings on debt repayment.

It's a very interesting argument. I always thought that since the national debt is basically the accumulation of our past deficits, there's good argument to say you have to pay it all down—but not if you have other opportunities to grow the pie or to improve quality of life at a greater rate than you would from the benefits of paying down debt.

• 1805

I guess the question really is, do you agree that we need tax cuts to continue so that we get in the ballpark or into the middle of the pack again? Do we need spending to directly address quality of life issues? And I'm pleased to hear all the talk about children and families generally, especially those who maybe aren't fully participating in the quality of Canadian life.

The balance of debt: is debt really bridge financing at a time when it's the cost of capital to provide those tax cuts that are going to provide pie growth...or strategic spending, where that also is going to stimulate the growth of the pie? Is the debt really a floater, or is it something we really have to get down, ignoring the debt-to-GDP, to some extent because there is some empirical level at which it must drop simply because Canadians feel it's absurd that we have a national debt?

The Chair: Mr. O'Neill.

Mr. Tim O'Neill: Obviously the choice on mix, as I said in my presentation, has to do ultimately with what its impacts are on productivity, quality of life, and so on. So what role does debt reduction play in that?

One role it plays, I think, is in reducing real long-term interest rates in Canada. That has to be one of the biggest benefits that come out of reducing the debt-to-GDP faster than is, say, currently being contemplated. Canada is still a high-debt economy, still a high-debt country. As I indicated, we're still about 20 basis points in terms of percentages above the average for triple-A-rated countries. Is that the right benchmark? I don't think any economist could tell you what the optimal debt-to-GDP is. What they can tell you is that we don't have it. We're above it right now.

Secondly, it buys a lot of room—Tom Wilson made reference to this, and I did at my presentation—if we hit a shock to the economy that's externally generated, let's say in this case, from the U.S. If the Federal Reserve were forced to be far more aggressive than most people are currently forecasting, you could be looking at a significant growth recession, or even a real recession, in Canada, say, in 2001.

In that environment you want to have lots of room for two things. One is to move off your fiscal track and get acceptance from financial markets. Let's not forget that the problem in the mid-1990s was not related to the specific deficits in any given year; it was the rising debt-to-GDP that was causing so much heartburn in financial markets. The second thing it does is allow you more room to use, if necessary—even instead of just passive—actual active counter-cyclical fiscal policy. We didn't have the room to do that in the 1990s. We could buy more room in the future with this.

It seems to me those are the three biggest benefits you get from using more of the surplus to pay down the debt directly and to reduce the debt-to-GDP faster than we're currently contemplating.

The Chair: Mr. Wilson.

Prof. Thomas Wilson: In the handout I gave you, and I'm sorry I had to come so late, we have a package of policies that involve personal income tax reductions, business income tax reductions—I'm including corporate and capital gains there—payroll tax reductions, spending increases, and debt paydown. The orientation of the package is heavy emphasis on debt paydown in the first couple of years, then much heavier emphasis on tax reduction in the later years.

We did look at the effects of each of these policies relative to a benchmark in which all of the so-called fiscal dividend, except for the contingency reserve, was allocated to spending, to non-taxable transfers to persons. So we were evaluating what each of these measures do.

Now, it turns out that the measures that are most favourable to growth—growth of output, growth of productivity, and growth of employment—are the combination of debt reduction, business tax reductions, and payroll tax reductions. I want to just emphasize that when you look at something like a PIT cut, its effect is very similar to a transfer payment increase. We're not taking into account possible effects of selective cuts of certain people on brain drain effects. These may be important. In a broad context, the big payoffs were from the reductions in the other taxes and the debt paydown.

• 1810

The reason you get these results is in part that there's a very important interaction with monetary policy. If we look at an initiative such as cutting personal taxes, we can't just view that in isolation and say there are going to be these wonderful demand effects, people will spend more on consumer durables, and so on. Because what will happen is the Bank of Canada, looking at the path it wants for inflation control, will be offsetting those demand effects.

We really have to focus on what the supply effects are, because if there are favourable supply effects, which the three policies I mentioned have.... The debt reduction and corporate income tax and business income tax cuts have very important long-run effects in improving productivity. The payroll tax cuts have very important short-run effects. They're like favourable supply price shocks. Those are how we can get some gains, because there the interaction with monetary policy can be quite favourable.

The Chair: I have the following: Laidler, Van Audenrode, Stanford, McCallum, and Jackson.

Prof. David Laidler: I have one very brief comment on the debt. There are huge dead-weight losses involved in collecting the taxes to service it. If we had the debt-to-GDP ratio now that we had in around 1984, you could abolish the GST and still have change. That's a measure of the order of magnitude of the fiscal burden the current debt outstanding puts on Canada's finances.

Prof. Marc Van Audenrode: On the debt, the last thing we want to do is corner ourselves with another magic number, like the debt-to-GDP ratio has to be 40% and inflation at 1%, with a deficit of zero. Then we get cornered and we can't do anything.

The message several of us have tried to pass on is that we want to make sure that should the Canadian economy hit some troubled times, we won't have to start the 1990s all over again, with tax hikes and program cuts and all these kinds of things. The impression we have is that at this point the debt-to-GDP ratio is too high to be sure this won't happen. That's the message.

The Chair: Mr. Stanford.

Mr. Jim Stanford: I have a couple of points, Paul. I think we would all agree the debt ratio needs to fall, and it is falling. It's falling quickly by any historical standard, and it will continue to fall, under any of the forecasts or programs we've put out. The fiscal burden associated with serving that debt is going to fall in step with it.

Here's an interesting experiment. Take your consensus outlook on GDP growth and then plot some scenarios. Plot the reduction in the debt burden with balanced budgets, plot the reduction in the debt burden with $3 billion contingency funds that are used to pay down the debt, plot the reduction in the debt burden with $10 billion contingency funds that are used to pay down the debt, and the three lines are virtually indistinguishable. The notion that financial markets would know the difference between our debt burden four years out, having paid $3 billion a year off or having paid nothing off, is fantastic to me.

If Tim were right that paying down the debt would lead to a sustained reduction in long-term real interest rates, that would be a powerful argument for me to pay down the debt. But I've seen no empirical evidence of a systematic or predictable link between a country's debt burden and its long-term real interest rates, including in the Canadian case.

In terms of the argument several have made that it's good to have a sizeable surplus as a cushion so that in the event of a downturn, you don't have to cut program spending and increase taxes, that's all based on the starting point that we accept the notion that Canada can never run a deficit again in any circumstance. That's what the finance minister in essence has stated. Then yes, we should have a surplus, because having a surplus to avoid the pro-cyclical changes in fiscal policy that would be required to live up to that promise would be much worse.

But we can also question that promise in and of itself. It isn't at all clear to me, despite our headache from the 1980s and 1990s, that if we have a cyclical problem, the government should not run a deficit. In fact running a deficit would seem to me to be exactly the appropriate thing to do in the event of a cyclical problem.

So for all of those reasons, I would put debt reduction at the absolute bottom of the list of priorities for what to do with this surplus.

• 1815

The Chair: Thank you.

Mr. McCallum, do you agree?

Mr. John McCallum: Well, strangely enough, I find myself closer, in what I said, to Jim here than to Tom or Tim.

Mr. Jim Stanford: I told you it would rub off if you sat down here, John.

Voices: Oh, oh!

Mr. John McCallum: Not quite as much. What I said was put about a quarter of the surplus into debt reduction, which is not that much different from my interpretation of what the government is now doing. But having listened to Tom, not having heard him for a while, I'm starting to waver a bit. Let me tell you two reasons I might be wrong and they might be right.

One, if you look at the demographics, we have about a ten-year window of opportunity before the baby boomers start to retire en masse. By that time, the burden on them of supporting all us old people will become much higher and health care costs will be higher. So one way of helping out demographically is to get that debt down as fast as we can in that ten-year window that now exists.

The second reason I might be wrong is that we might look back two years from now on this year as the best of times. I was part of this process with Paul Martin, and it seems to me, as Jim just said, that even if we just have balanced budgets, the debt ratio will come down to less than 50%. That's pretty good, given that it was 72% a couple of years ago. But as Tom said, all of that is predicated on the assumption of smooth, continuous growth over the next five years. What if there's a stock market crash? What if the interest rates go through the roof south of the border and we have a recession? All of those future surpluses we talk so freely about, in that circumstance, simply won't materialize. They'll be a mirage; they won't exist.

So to the extent you believe we are now in the best of times—and we're not doing badly, with employment growth, 7.2% unemployment, etc.—you can certainly make a case on the grounds of prudence for putting more into debt reduction than what I just expressed a view on.

The Chair: Thank you.

Mr. Jackson and then Mr. Robson.

Mr. Andrew Jackson: I just wanted to clarify what I was saying about the dollar. All I was trying to argue was that macroeconomic policy recently, including the depreciation of the exchange rate, being appropriately stimulative, and that basically present growth rates were a reflection of that past policy with a lot of impacts....

I do agree that constant depreciation is not a viable long-term economic strategy for Canada. I wrote a paper last year where I said part of the weakness in the dollar over time can be attributed to our productivity performance vis-à-vis the U.S.

But the important point I was trying to make—and I hope it wasn't a cheap shot at your boss—is that there is a continued need for macroeconomic policy now to be maintaining the pace of the expansion rather than tightening up. As was mentioned, that's why it was appropriate for the Bank of Canada to cut interest rates earlier, rather than to maintain an exchange rate. So I was in agreement with that.

People are throwing out these scenarios for the next year or two. The big question is hanging there: what is going to be the overall course of macro policy? I personally found it disappointing that the Bank of Canada did decide to match the American rate increase. I don't think there was much in the monetary policy report that really justified that decision.

I'm bothered by the notion that was thrown out that if we have a stimulative federal budget, monetary policy is necessarily going to have to tighten in response to that, and that would wipe out some significant part of the impacts on growth. It is an interesting question. With the size of the surplus we now have, we can all quibble about whether it goes to taxes or spending, but that's a lot of money that's going to go back into the economy, and it is going to have a stimulative effect. There is clearly some danger that that impact on growth could be offset by monetary policy.

I would just throw out in that context the observation that everything we've learned from the U.S. over the past couple of years does suggest that our potential for growth free of inflation pressures is much stronger than used to be believed, that the case for pre-emptive tightening is a lot weaker than used to be the case.

• 1820

Also, I think it's important to underline that if we look at Canada at the moment, indeed the unemployment rate has fallen—and that's very welcome—back to the 1989-90 rate. It's also true that in the last year or so we've seen significant growth of full-time paid jobs. But I think it's also really important to underline how much underemployment continues to exist in Canada. We've see fairly significant shifts out of self-employment into paid jobs, and there are still a lot of part-time workers who would like full-time jobs.

So I would argue that we have a lot more capacity to grow than many people believe, perhaps including the Bank of Canada. But I think it is an important issue for the committee to reflect on.

The Chair: Thank you, Mr. Jackson.

Mr. Robson.

Mr. William Robson: Just as a quick comment, I'm afraid I want to take exception to Jim Stanford's argument that zero, $3 billion, $10 billion a year doesn't make any appreciable difference.

Let me just mention the Canada Pension Plan. A few years ago, we went through quite a bit of difficulty. We were faced with a situation in which the Canada Pension Plan looked like it was going to run out of cash, we were going to see contribution rates go up to 14% plus, and it was looking unsustainable. We fixed that with a package of benefit changes and contribution hikes, and we put it into something that looks like it's probably going to be sustainable at a 9.9% rate for as long as any of us is going to be alive.

The difference that package made was much less than $10 billion a year. It wasn't much more than $3 billion a year, really, when you're looking at things over the next few years. Those differences really do add up to a lot, and if we're going to look out over the long term, I don't think it's at all defensible to say that a few billion dollars a year this way or that doesn't make any difference. When my children grow to adulthood, it'll make a big difference to them which choice we make. That's why I like the idea of including a bit of debt paydown in the fiscal package.

The Chair: Thank you, Mr. Robson.

Mr. Nystrom.

Mr. Lorne Nystrom (Regina—Qu'Appelle, NDP): Thank you very much, Mr. Chair.

I want to shift gears just a little bit this afternoon, if I could, and ask Mr. Stanford the following question—and anybody else who wants to comment can do so, because everybody's welcome. We've heard an awful lot today about the creation of wealth and capacity, competitiveness and productivity, and so on. The creation of wealth is extremely important. If we don't have a bigger pie, we're not really going to have more people working and money for social services and the like. But we've heard very little about the redistribution of wealth this afternoon.

As public policy-makers, we have to look at both sides of the equation and think about the common good. Committee members have heard me often talk about how I represent the inner city in Regina, where there's an awful lot of poverty and all the other problems that you have in the inner cities. The inequity, the gap between the rich and the poor, seems to have been growing in the last few years. We went through a number of decades when equality was actually increasing and the gap was narrowing, but now the gap seems to be widening.

An example of the inequity occurred just in the last few days, when our six large banks—we have a lot of bankers here—announced that their profits in the last year were $9 billion. Those were some of the largest ever, if not the largest in the history of our country. About a year ago, the top 24 executives had an accumulated compensation package, between salaries and bonuses and stock options, of over $250 million. That's about $10 million apiece, Mr. Stanford, and that's equivalent to the salary of about 12,000 bank tellers. Once again, that shows the tremendous inequity that there is in our society.

In light of that growing trend, what would you recommend to the finance committee or to the Minister of Finance on redistribution on the income side, so that the people who have been really paying for the reduction in the deficit the last few years because of cutbacks and transfers in health and education, social services and so on, can get more of their fair share of the pie?

Mr. Jim Stanford: Thank you for that question, Lorne.

I did not pay Lorne to ask that question of me. I'd like to make that clear.

Mr. Lorne Nystrom: Mr. McCallum did.

Voices: Oh, oh!

The Chair: Is he paying you for the answer? That's the question.

• 1825

Mr. Jim Stanford: In terms of the distribution of income, I think there's probably no more powerful force promoting a better distribution of income than growth, job creation, and the tightening of the labour market that we've seen in the past couple of years. And perhaps I'd have agreement from some of my more conservative colleagues here, but when you get the unemployment rate coming down as it has been, and when you get jobs created as they have been, you're inevitably going to get rising disposable incomes and falling poverty rates, and that's good all around.

So I put a real emphasis on the macroeconomic ingredients in redistribution, but I also put a lot of stress on the role of federal and provincial governments, and the role of the tax transfer and public programs. I do have a few numbers that I didn't mention in my presentation—they're included in my handout here—about the impact of the role of government on income distribution, based on the most recent Statistics Canada survey of income distribution in Canada.

The data goes up to 1997 now, and the interesting thing in 1997 was that the average effect of personal income tax rates fell for the first time during this recovery. This meant that the tax burden on individual households declined marginally, from about 20.2% to just below 20%. But the data is quite shocking in terms of who benefited from that decline in personal income taxes. In fact over 100% of the dollar value of that personal income tax was concentrated in the 20% at the top of the income ladder. The bottom 80% actually had a slight increase in their average effective tax rate. What that reflects is the overwhelming bias of the income tax cuts in Ontario and Alberta, and now in other provinces. Those cuts reward the high-income earners who collect the lion's share of those dollars.

Shockingly, in 1997, even though it was a good year for the labour market and should have been a good year for income distribution, the result or impact of the tax cuts on the distribution of after-tax income actually outweighed the progressive effects of the labour market. You actually had an increase in inequality during 1997 when it was measured by the ratio of the top to the bottom.

There's another experiment that I did with that same data. If you look at the distribution of market income—that's what you supposedly earn before transfers—the ratio of the top fifth to the bottom fifth is roughly 24:1 as of 1997, and that ratio has grown steadily. After taxes and after transfer payments, the ratio falls to under 8:1, at about 7.9:1. Immediately, right there, you get a major impact in terms of the tax and transfer system leading to a much more egalitarian society.

But then there's an additional step if you consider the value of public services that are consumed across the board. If we assume each individual Canadian consumes a proportional share of the public services such as health care, education, roads and so on—and I don't think that's too far off the mark, because I think the distribution of public services is something that everybody benefits from—the ratio of income inequality in Canada falls to less than 4:1. For the poorest fifth of the population, the consumption of public services effectively doubles their standard of living relative to their actual cash income, even including the transfers.

In a riding like yours, Lorne, or in terms of inner-city ridings elsewhere in Canada, where you have tremendous poverty and so on, the collection of taxes and then the spending of those taxes on valuable public services—whether that spending is on early childhood development, health care, education opportunities, or other forms of public consumption that everyone has access to regardless of their income—is an absolutely crucial ingredient in what we've been able to preserve in terms of equality of opportunity and access to opportunity.

Now, I know folks like David will have questions about the efficiency of public spending and the value of it, but even under very reasonable assumptions I think that's a very important part of their standard of living.

The Chairman: McCallum, Fortin and Laidler.

Mr. John McCallum: As I said at the beginning of my comments, I do think it's a question of balance, because I buy into the idea of our having a more solid safety net. I don't aspire to U.S. taxes. I don't like the huge increases in inequality that we see south of the border. And they are huge. On the other hand, we have to be competitive, so if we go too much in that direction, we won't have the jobs and the people and the wealth created in this country. So it is balance.

My argument is that we have to tilt that balance a little bit. I'm not arguing for any cuts. I'm arguing for some measures that favour low-income people, but we have to look a little bit at the high end as well, because I think the U.S. is becoming more and more of a magnet.

Let me just give you one illustration of Saskatchewan. A report was done for the NDP government in Saskatchewan, and I thought it was excellent, because I think the problem that Saskatchewan has vis-à-vis Alberta is like the problem Canada has vis-à-vis the U.S. Saskatchewan will never have its taxes as low as those of Alberta, and Canada will never have taxes as low as those of the U.S. But don't let that gap get too big, or activity will move from Saskatchewan to Alberta. Saskatchewan is responding by big cuts in income tax to preserve its competitive position and wealth, and that's what I think we in Canada have to do as well. But it's always going to be a question of balance.

• 1830

Finally, a lot of the problems in Regina, it seems to me, are related to problems of aboriginals. I said in my remarks that I put a high priority to areas of pressing social need, and nowhere is that need more evident than in the aboriginal population. It's not just a moral or social issue. It's an economic issue, because it's a ticking demographic time bomb. The only thing I don't know—there are lots of things I don't know, but I mean on this topic—is whether we know how to spend the money wisely. We've already spent $6 billion plus. I'm all in favour of more if we know how to do it. But it's not evident to me that Indian Affairs knows all the answers.

The Chairman: Mr. Fortin.

Prof. Pierre Fortin: Thank you very much.

I think one thing that should be said here is that income inequality in Canada is very much less than that in the United States, first of all. Our poverty rate as measured by international standards, meaning the percentage of people in Canada living below the 50% median, is 12%, compared to 20% in the United States.

This doesn't mean we should not do more to improve income equality, to reduce income inequality. The first thing to do is to push the monetary authorities so they continue to explore lower and lower unemployment rates. It is stupid to say that because the unemployment rate in Canada now is 7.2%, and that it is the same as it was in 1989, we should be happy with that, because we know that structural unemployment has fallen, and if we can reach 6%, we should do it as quickly as we can.

The third point I would like to make is that one way to directly help is to stop cutting EI benefits. I'm not saying anyone is considering this, but I think we've done enough.

Another measure that could be considered would be to fold the entire Canada health and social transfer into equalization payments. In other words, include this spending side of the equation, by the provinces, into the equalization formula. The problem is that the provinces that are poorer not only have less money to attend a given level of poverty through welfare, but they also have more poor. In other words, their responsibilities are higher than average. Therefore, there would be an argument here to put the CHST under equalization payments.

The Chairman: Thank you.

Mr. Laidler.

Prof. David Laidler: Yes, if I were concerned about inequality, which I am, I wouldn't look at annual income distribution data at all; I would look at lifetime inequality, which is very difficult to measure. But we do know how to get at that through a tax system—we tax consumption rather than taxing income. My ideal tax reform would tilt the Canadian income tax structure much further toward a consumption tax. I'd be willing to look at inheritance taxes as well. Those are under provincial jurisdiction in Canada. But if you're really concerned about inequality you want to get at the wealth and not the income, because as I said in my presentation, a progressive income tax is not a tax on being rich, it's a tax on getting rich, and you don't want to discourage people who want to get rich if you're interested in productivity growth in a market economy.

Finally, if you think that bank executives are overpaid, that's a problem for the shareholders. And if you think there's something the matter with the way the shareholders police the banks, you might look at the rules. And I would look at the 10% ownership rule.

• 1835

The Chair: Mr. Van Audenrode.

Prof. Marc Van Audenrode: I just want to make the point that inequality is actually the result of many things, and there are many tools to answer the problem of inequality. As Pierre has noted, they seem to be working relatively well.

Now, my impression is that if inequalities have increased in Canada in the last few years, it's not a problem of the tax system. It's more a problem of these other tools, like the reduction in EI and social welfare spending. So we should first look at these programs before looking at taxes to solve the problem of inequalities.

That being said, I don't deny the fact that there are some annoyances and some things that are bad in the tax system. One has been already talked about, and it's the minimum taxable income for families, which definitely should be raised a lot. There are many other examples that we could think of, these small things that annoy a lot of people and that are unfair.

Another example is—I'm sure I'm not going to be popular with my colleagues—that I have an employer who pays for a very generous retirement package, and I still get to deduct thousands of dollars to put into my RRSPs. I don't think that's fair. I'm very happy to do it, but I don't think that's fair. So all these small examples of annoyances should be taken care of.

The Chair: Mr. Wilson.

Prof. Thomas Wilson: I just want to make a couple of brief points. One is that the thing I'm most concerned about with low-income Canadians is that many of them face the highest effective marginal tax rates in the country. I sometimes joke that we should have a constitutional amendment that no one pays a higher marginal tax rate than the richest Canadian.

If you look at people in the $15,000 to $20,000 bracket, with clawbacks of cash transfers, child tax credits, and sales tax credits they can be pushed into marginal rates above 50%. If you take into account in-kind types of clawbacks—people losing access to social housing, subsidized child care, and so on—these effective marginal rates can be very high.

So one of the things I think should be looked at is how the tax system, the transfer system, and the welfare system interact to make sure that low-income families have adequate incentives to work and save. In the short term, I think what you can do to help is to increase the personal amount—as has been noted—and also reduce the EI contribution rate. This is a heavy tax on employment and on job creation in the short run.

Finally, I come back to business taxes. I think Pierre mentioned Ireland, but the Scandinavian countries have all cut their corporate rates. I think they now have a two-stage tax, with investment income typically being taxed at a flat 30% rate. These are not viewed as right-wing countries.

The Chair: Are there any further comments? Thank you.

Mr. Brison.

Mr. Scott Brison (Kings—Hants, PC): Thank you. I was pleased to hear Andrew Jackson say earlier that in fact reducing corporate tax rates would probably lead to the best economic growth of any tax reduction. I'm expecting to hear Herb Grubel say that increased levels of social spending would probably be a good idea at this time. But I was pleased to see on the road to Damascus that we're seeing some conversion and convergence on some of these issues.

I have a question for Mr. Stanford. You've said that we should now focus on reinvestment in social spending because of the fact that a large part of the balancing of the budget has come as a result of cuts to social spending. Isn't that a specious argument from an economics perspective? Isn't how we got to where we're at irrelevant? Shouldn't we be focusing on what would be the best decisions we could make now relative to the allocation of this fiscal surplus for the future? Isn't that an irrelevant argument that we got here by cutting social spending?

Mr. Jim Stanford: I think that's a fair point to some degree. The reason I make that argument is perhaps twofold.

One is to debunk the claim that is made very loudly that we got to where we are by increasing taxes. The economic evidence is clearly contrary to that. Yes, taxes increased in the 1990s, but they increased modestly. The bulk of the turnaround fiscally was achieved by program spending reduction.

• 1840

Secondly, I would emphasize that there have been significant and long-lasting, but often invisible and underreported, costs to that reduction in program spending. It's showing up in all kinds of ways and all kinds of places, to suggest that what we've done is not necessarily sustainable in terms of the decline, as John mentioned, in many components of the public infrastructure, which have suffered.

I've looked at public investment—I know Tim is interested in this subject as well. In Canada we are barely investing enough in the public real capital stock to offset depreciation, which means we're not growing that infrastructure in line with the economy. You just have to look around at the state of much of that public capital stock to see that's the case. Then of course the social costs, the increases in poverty that we've seen, ironically even during what should be good times, are to a large extent the result of reductions in unemployment insurance and other transfer payments.

That being said, I accept the point that others made that at this point you've got money to spend and you have to look at what's the best way to spend that. I think on that ground there's a very strong argument in favour of social reinvestments as well.

Mr. Scott Brison: Well, if you go back about 20 years, there was a relationship between taxes paid by Canadians and the services they received. That was largely due to the fact that they weren't paying such an egregiously large amount of their taxes to debt servicing. If you compare our debt-to-GDP ratios in the 1970s to those of the U.S., for instance, the U.S. had a higher debt-to-GDP ratio than Canada did, I believe. If you compare Canada to the U.S. and in fact to other countries in terms of spending as a percent of GDP—let's just focus on the U.S. for a moment—spending on health care, spending on the military, spending on any range of services or public spending, those numbers are not grossly out of whack with the U.S. Our taxes as a percent of GDP are actually out of whack. They're at about 28%, we're at about 30%. But the debt servicing charges we're paying in Canada are where you see a significant variance.

Shouldn't we be focusing on getting those fundamentals more in line with those of our largest trading partner and also with some of the other countries? The Scandinavian countries have been mentioned. Mr. Jackson and others have acknowledged the importance of corporate tax reduction. When social democratic countries like Germany are reducing their corporate taxes and we see the Scandinavian countries reducing these, shouldn't we be focusing on public policy dealing with these realities as opposed to some of the other perceptions that may be out there?

The Chair: Mr. Jackson.

Mr. Andrew Jackson: I just want to clarify a little what I was saying about corporate taxes. When I was talking about impacts of taxes versus spending cuts, I was trying to be quite clear that in an immediate stimulative sense to the economy, in terms of growth and job creation, spending has the greater impact. I was saying that in terms of studies of impacts of tax levels on long-term economic growth, there are a lot of studies that speak to significant impacts again on the public spending side. Of the studies on the tax side, I did make the point that it would appear there are stronger impacts on the business tax side than by cutting.

It is within a narrow frame that I would make that point. I just did it to make the interesting observation that I think so much of the corporate tax cut is from the business side. The BCNI and the chamber have been so heavily focused on tax cuts for high-income earners, and I think that's at odds with the message they're trying to send in terms of the impacts of growth. I'm certainly not myself saying corporate tax cuts should have any sort of immediate priority.

The Chair: Mr. Mendelsohn.

Mr. Joshua Mendelsohn: I just want to correct one element. I know I speak here as an economist representing a financial institution, but I also happen to be the chair of the economic policy committee of the Canadian Chamber of Commerce. By no stretch of the imagination is the chamber focused on high-income taxes only, on high-bracket individual income taxes only. It's across the board. I just want to make that clear.

The Chair: Any further comments?

• 1845

Mr. Scott Brison: On the corporate tax side or even on the personal side, there are strong arguments for significant tax reform as a vehicle for tax reduction at this time. Somebody made the argument that we have such a brilliant opportunity now for tax reform and using tax reduction as a way to ameliorate the impacts for some of them. We could eliminate a lot of the distortions in our tax code. I thought Mintz did a very commendable job in pointing out some of those distortions on the corporate tax side in areas of taxing capital or the profit-insensitive taxes, and also the degree to which we are taxing in a discriminatory way those sectors we should be trying to encourage—technology, the service sectors, etc.—and actually favouring the older resource-based sectors that we should probably be trying to grow from.

Wouldn't this be a great opportunity for us to be pursuing an aggressive tax reform strategy as a vehicle for tax reduction at this time?

The Chairman: Mr. Wilson.

Prof. Thomas Wilson: I couldn't agree with you more. In the tax reduction package we have, there's $2 billion allocated to corporate income tax cuts and capital gains tax cuts. Most of that is the corporate. But one important thing is that that magnitude of cut, which would finance about a three-percentage-point reduction in the large corporate rate, would facilitate the implementation of the Mintz committee report. So you could actually get the statutory rate down a lot more because you could put in place all of the base-broadening measures of the Mintz committee's report by combining reform with reduction.

I mean, the reduction means you don't have to gore too many oxen as part of the reform process. I think that's another plus for allocating a certain amount to these cuts, and it's not large. We're talking here, say, in the fifth year of the analysis, where the fiscal dividend is at least $30 billion to allocate, and where you might want to allocate half or 60%, something like that, to tax cuts, you're only allocating a small percentage of the cuts to the business income tax cuts. But I think those are the ones that have the greatest payoff, particularly when combined with the implementation of the Mintz committee reforms.

The Chairman: Mr. Laidler.

Prof. David Laidler: Very briefly, I agree entirely. I would go further and say the emphasis should be on tax reform, and the fiscal dividend should be seen as providing the opportunity to provide the tax reductions that will make the reform politically possible.

The Chairman: Mr. O'Neill.

Mr. Tim O'Neill: Just to add, you have the interesting problem that you have some large companies in this country who started out as manufacturing companies in, say, computer manufacturing who basically become service industries, and as a consequence of that, their effective tax rate has gone up just because they've changed the nature of the business they're doing. It's hardly an incentive for companies of the same sort as IBM to invest significantly in a country where their effective tax rate has gone up simply because they've changed the nature of their business.

I think the Mintz report clearly points to a significant need for tax restructuring. The political economy reality is that you probably can't do that restructuring in a neutral way. You have to do it in the context of lowering rates and just doing it more for some than for others. I think there's a fairly significant benefit coming from that.

The Chairman: Mr. Fortin.

Prof. Pierre Fortin: At this time, I think I'm going to simply suggest that I fully agree we should take advantage of this situation to reform the tax structure and not only reduce taxation overall. I would suggest the committee read the recent book by Larry Seidman, who is a professor at the University of Delaware, on the unlimited savings account tax, entitled The USA Tax: A Progressive Consumption Tax, published at MIT Press. It describes exactly what elimination of all savings from income taxation would mean, and the return then of all savings to be consumed into the tax base. I think the results are pretty interesting to study. I'm suggesting you go fishing and look at this. I think it's a very good idea at least to explore this possibility.

• 1850

The Chair: This will be your final question, Mr. Brison.

Mr. Scott Brison: Just before I ask my final question, I'd like to say that my party wasn't positively reinforced the last time we engaged in meaningful tax reform in this country, but we're not trepidatious about pursuing it again.

With regard to capital gains taxes and their impact particularly on the high tech sector, given the increasing rate at which stock options are used as compensatory assets, I'd appreciate your feedback on the priority we should be placing on reducing personal capital gains taxes. To reduce our personal capital gains inclusion rates to levels that would be roughly equivalent to those of the U.S. would cost the federal treasury $247 million per year. Again, this is a matter of public policy sometimes being built around perceptions as opposed to realities.

I would appreciate your feedback on that.

The Chair: Mr. Mendelsohn.

Mr. Joshua Mendelsohn: On the capital gains tax, I think that over time we probably should lower them, but I think we could achieve part of the process by attacking the more general income tax structure, because that in itself will automatically lower the capital gains component.

Also, when you're speaking about the United States, you're talking about a two-tier capital gains tax. There are the long-term capital gains and the short-term capital gains, and the rates are substantially lower than they are here. I would argue politically and in every other which way—even though I argue we should do it for economic reasons, but I think in this one it's going to be a really tough row to hoe—that if we're going to put our political capital into anything, it should go into the more generalized tax structure. I think that will offset some of it.

The Chair: Mr. Rosenberg.

Mr. David Rosenberg: I think that is vital in terms of promoting the future growth industry, which is the high tech sector. This is happening around the world. We just saw Australia cut their capital gains taxes, and it's hardly a bastion of conservatism. In the U.K. Chancellor Brown, just a couple of weeks ago, announced a huge reduction in capital gains tax rates, and again that is a Labour government. I think there's a growing awareness outside of Canada's borders as to how important stock options are in terms of compensation in this sector and how important lower capital gains taxes are in terms of boosting the stock market and the access to capital that ends up providing to businesses.

I should just add that if you're looking at a supply-side impact that raises the growth potential of the economy, I know that the Department of Commerce put out a study suggesting that lower capital gains taxes ultimately would give the U.S. an additional percentage point of non-inflationary growth potential, which is one of the reasons the Democrats were able to go on-line in terms of the capital gains tax of 1996.

Mr. Scott Brison: The unlocking of capital would be significant.

Mr. David Rosenberg: Right.

The Chair: On my list is Laidler, Fortin, McCallum, and Jackson.

Prof. David Laidler: I'm going to disagree again, sorry.

A voice: You're the academic.

Prof. David Laidler: Yes, I'm the academic. But this sounds to me exactly like the half-thought-through, winner-picking tax scam that got the Canadian tax system into the mess it's in.

I really do urge you to stand back and think about how you want to tax businesses. Then go through the implications of that for how you want to tax dividends, and go through the implications of that for how you tax capital gains. Stop trying to pick winners through the tax system, because it's going to be a disaster.

The Chair: Mr. McCallum.

Mr. John McCallum: I'm an ex-academic, but I think on this one I might be a bit closer to David Rosenberg. It's not necessarily a pick-a-winner strategy. You don't have lower capital gains just for the high tech. It would be across the board. If you look at the productivity debate, it's the high-tech information, computer-related industries that explain more than all of the gap in productivity growth between Canadian and U.S. manufacturing. We really are lagging behind in those industries, and I think those industries are important.

So I think it would be a good idea, in a well-thought-out, deliberative manner, to devise certain policies, perhaps the ones you've mentioned, that would give a boost to those industries. I think sometimes the optimal tax rate for Canada is not the optimal tax rate you'd get if Canada were an island unto itself, but it sometimes is closely related to the U.S. tax regime. It's not entirely driven by it, but we cannot afford to ignore it even if it is, in some sense, sub-optimal.

• 1855

The Chair: Mr. Wilson.

Prof. Thomas Wilson: I think we could have an immediate reduction in the capital gains tax by decreasing the inclusion rate to two-thirds. I think you can make a strong case for that, because that would effectively bring the marginal tax rate on capital gains and dividends into rough equivalence. Right now for top-bracket taxpayers the marginal rate on capital gains is above the marginal rate on dividends. I don't think you want to ever go below the marginal rate on dividends, because then you'll open up all of the surplus-stripping problems that led to the establishment of the Carter commission many years ago.

If you want to do something on the incentive side, I would suggest revisiting the existing $500,000 capital gains exemption. The Mintz committee recommended getting rid of that and replacing it for farmers and small business by having a more liberal rollover into RRSPs, which would save some revenue. If you want to then provide some incentives of a general type, not a winners-picking type, I would say that would be the source of the revenue. Don't draw on the fiscal dividend for that but use reform of the existing provision to generate a more effective incentive.

The Chair: Very quickly, Mr. Jackson.

Mr. Andrew Jackson: I have just two points. First, distributionally, any move towards easier taxation of capital gains is really perverse. Over half of all taxable capital gains goes to people with incomes of more than $100,000. A very huge chunk, actually, goes to those with more than $250,000. So I think people's political antennae should be twitching if those are the candidates for tax reductions in the budget.

Second, it strikes me that there's quite a lot of emerging literature that it's not a particularly good thing to be heavily tilting the compensation of senior executives towards stock options. Actually, The Economist, of all places, had a major article on this a couple of months ago.

You really have to pose this question: do you want senior executives to be personally driven by short-term appreciation of shares as opposed to longer-term corporate performance? I think there's significant evidence that this type of short-term thinking can lead to all kinds of unproductive corporate behaviour.

I guess the third point, just to repeat myself, would be that the studies done on the lifetime capital gains exemption showed almost no positive impacts on real investment.

I think it's bad policy, then, from three different points.

The Chair: We're running a little bit late here, but I'd like to very quickly go through some questions for which I need some very quick answers.

Assuming the 50-50 formula for the allocation of the fiscal dividend is abandoned, what would your split be? Some of you have already stated it, but I'd like to get a sense of that.

Mr. Fortin, I know you agree with the 50-50 split.

Prof. Pierre Fortin: I agree with it because it means for the next five years, for this planning horizon, it's exactly what would turn out to be the case if you simply increased expenditure at the same rate as GDP. In another period, it might not be 50-50. I support 50-50 only because it turns out, by chance, that it falls exactly where it should to maintain the spending-to-GDP ratio.

The Chair: Mr. Wilson.

Prof. Thomas Wilson: I have to leave, so perhaps I can just say my piece.

I don't usually disagree with Pierre, but I think we should be keeping spending, in the five-year window, lower than that, and putting a higher priority on debt reduction in the short run and on tax reductions in the long run.

I didn't add them up in the handout I gave you, but I think you'll see that I have a higher allocation to taxes than to spending, and I think spending is slightly higher than debt. So I have a spending proportion that's roughly 30% of the available fiscal dividend. This is with the fiscal dividend measured against the base of constant and real per capita spending.

The Chair: Mr. Laidler.

Prof. David Laidler: The Department of Finance is full of smart people who can convert expenditure increases into tax cuts and vice versa, so I don't think it's worth arguing about.

• 1900

The Chair: Mr. McCallum.

Mr. John McCallum: I originally said half for taxes, and a quarter and a quarter for spending and debt. That's still my position. I was a bit persuaded by Tom. It might change to a third, a third, a third; but right now I'm a half, a quarter, and a quarter.

The Chair: Anyway, there seems to be a departure from the 50-50.

Mr. Joshua Mendelsohn: In a sense, we answered this before, because the key is not the ratio. Fifty-fifty is clearly too much because it opens up too many doors. The key is, whether it's 15%, 20%, 25% or 30%, what you spend it on. And if you can make a strong case for contribution to growth and performance, whether it be public infrastructure or whatever, then so be it. It's when you get into these rather loose-ended, very touchy-feely kinds of areas that it becomes very difficult, and my concern with the 50-50 is that it creates a barrier or a threshold you have to hit whether you have good projects or not.

The Chair: Mr. O'Neill.

Mr. Tim O'Neill: If you use as your baseline for each of the next five fiscal years constant nominal spending levels and then look at what the “surplus” is—which is the exercise Jeff Rubin and and his colleagues went through that was reported in the paper today, so there's no difference between their views and our views on what the size is, it's just how you use the baseline—what you end up with is about 150. Of that, about close to 50 is taken through just increasing spending at the rate of population plus inflation. So in a sense, through that mechanism, you've allocated, using current spending as your baseline, a third to spending. Then you divide the other 90, whatever it is, 92, 93, 95.

I would argue for a bigger split. We've argued in the paper that we provided to use about three-quarters of a percent of GDP for debt reduction. Five years out that gives you around $8 billion, and then you get about a $15 billion tax cut, divided among a number of different categories. A fair chunk of it, bigger than Tom's, would be on the corporate tax side. So that gives you obviously a much different allocation from 50-50, much lower.

The Chair: What do you think is a healthy mix between corporate and personal?

Mr. Tim O'Neill: I think the answer to that question from an economist should always start with the phrase, it depends on what you are trying to do. If what you're trying to do is increase long-term capacity and productivity in the economy, in my view there's no question that the initial focus is going to be far better placed on business taxes because of the impact it will have on creating incentives for investment, both in terms of reform and in terms of levels. So in that context, then, if that's what you're trying to do, you give personal income tax lower priority.

If you're in Jim Stanford's position and you really want to put a lot more emphasis on equity, then you do it differently. Obviously you would either put far more into personal income taxes or ramp up the public spending distribution side of things. I don't think that's a particularly effective way of doing it, but certainly it depends on your priors.

The Chair: Mr. Robson.

Mr. William Robson: On that second one, the other “it depends” is that it depends on how you classify some of this stuff with regard to capital gains and employment insurance cuts. Is part of that corporate, or do we assume it all comes out of the employee's hide in the long run?

Giving the most expansive definition of the personal side, I think you'd probably end with about one-tenth in the terms of corporate, maybe a little higher than that, but you'd get more bang for those bucks, possibly.

In terms of the 50% rule, taking prices and population growth as the benchmark for spending, I would fight like crazy to give three-quarters of everything extra to tax cuts and one-quarter to debt, knowing that I was going to lose, even if I budgeted for that. I don't mean to express any kind of cynicism about the way spending actually develops in the wake of budgets, but I know that as a matter of fact, once the public accounts are published, there will be spending there that I didn't budget for. After the fact, a good fifth to a quarter will be spending. That's just how it's happening. Even as we speak, there's spending happening that wasn't in the budget.

So I would fight like crazy for three-quarters tax and one-quarter debt, knowing that only by doing that would I keep spending down below a third.

The Chair: Mr. Stanford.

Mr. Jim Stanford: In the same vein, knowing that I'm going to lose, I would argue for 100% on program spending, and that will be the line taken by the alternative federal budget, which is a project that'll come out early in the new year, for the fifth year.

It will obviously surprise Tim, but I'd put more of an emphasis on corporate tax cuts before personal tax cuts any day for the impact on real investment spending and job creation.

The Chair: Mr. Jackson.

Mr. Andrew Jackson: I concur with that. I want to make the observation—and I agree with David Laidler—that it's a bit silly to be bandying this around in the abstract. There are an awful lot of areas that can be classified to either side. Is an increase in the child tax credit a tax cut or a spending increase? It counts as a tax cut, but it's basically indistinguishable from a very targeted.... It's really a transfer increase, but you can argue about which way to classify it.

On the business side, I would argue that if you have scarce resources, you probably get quite a bit more bang for your buck in terms of the very targeted kinds of program spending that John Manley's pushing for, in terms of increasing funding for the National Research Council and Technology Partnerships Canada. Those will show up as spending, but in essence they are a direct reduction in the cost of capital to companies that are investing in research and development. So in a sense, they're analogous to an extremely efficient corporate tax cut.

So it's not a very productive debate in a lot of ways.

The Chair: Although it does give you a sense of...this is what I believe. I think you have to produce the best public policy you can, given your ultimate goals. And percentages matter up to a point, but the reason we have the 50-50 split is because, quite frankly, symbolically it represents a balanced approach. That's the reason—

Mr. Andrew Jackson: We voted for it.

The Chair: Yes. That's exactly why.

Mr. Tim O'Neill: Nobody agrees with the 50-50.

The Chair: That's right.

Mr. Laidler.

Prof. David Laidler: I'd say one word on the corporate versus personal thing. There's one good reason you might start with company taxation, and it is that the homework on the reform has already been done, in the shape of the Mintz report.

The Chair: That's right.

Prof. David Laidler: So you're much less likely to go off up blind alleys if you start on the corporate tax system.

The Chair: I had many more questions. Unfortunately, as chair, I gave everybody else the questions and didn't take care of my own. Nevertheless, I really appreciate your taking the time to come here. This is an all-star cast, and we're very privileged to have you here. We certainly appreciate the added value you brought to the debate.

We did get quite a number of answers. Of course, now we have to reflect upon what everyone has said, but I'm sure you'll see many of your points of views represented in the recommendations we make to the Minister of Finance. Thank you.

The meeting is adjourned to the call of the chair.