[Recorded by Electronic Apparatus]

Tuesday, April 30, 1996

.0933

[English]

The Chairman: À l'ordre, s'il vous plaît. We are looking into the Budget Implementation Act, 1996, Bill C-31.

I understand Mr. Campbell has just arrived and will be giving us a brief resumé for about ten minutes, after which we'll be open to questions.

[Translation]

We will continue until 11:00 a.m., after which I would like to have the steering committee meet for about five minutes.

An hon. member: Good idea.

The Chairman: We have something else, Martine.

The Clerk of the Committee: Yes.

The Chairman: While we're waiting for Mr. Campbell, could we talk about the Sub-Committee on Financial Institutions?

[English]

Thank you, Mr. Campbell. We're looking forward to your brief presentation before we go to questions.

Mr. Barry Campbell (Parliamentary Secretary to the Minister of Finance): Thank you, Mr. Chairman. It is my pleasure to be here on this occasion, having sat as a member with members of this committee in the past. This is my first appearance as a parliamentary secretary. It is a pleasure to be back here in this capacity.

Mr. Chairman, thank you for this opportunity to discuss the Budget Implementation Act, 1996. Let me start by citing the context for this bill. As I'm sure you've heard many times in the House recently, the 1996 budget, coupled with the two previous ones, helps Canadians to secure the future in a number of key areas.

First, the financial security of this country has been secured. We are on track to meet or exceed our budget targets for this year and next.

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Second, we are taking action to define a more appropriate role for the federal government in today's economy. For example, measures in this bill will allow the Minister of Transport to privatize the government's fleet of grain hopper cars.

Looking ahead, we're exploring alternative ways to deliver services. In the coming months and years we will introduce new service agencies and other mechanisms to deliver services to Canadians with the emphasis on better service and greater efficiency.

A number of legislative amendments in this bill will give the government the administrative mechanisms necessary to ensure a smooth transition to the new service delivery modes. For instance, changes proposed to the Canada Labour Code and the Public Service Staff Relations Act will permit the introduction of successor rights. This means that unions may continue to represent their employees as they move from public service employment to other employers within federal jurisdiction. Collective agreements of course will continue to be enforced in the new environment.

We also want these new service agencies to have the tools they need to operate effectively and affordably. For example, we will amend the Financial Administration Act to allow for multi-year appropriations for these organizations, which will assist in their long-range planning.

Currently, we are considering this option only for the three new agencies announced in the budget: the Parks Canada agency, the single food inspection agency, and the Canada Revenue Commission.

Let me stress, however, that in each and every case where government wishes to use multi-year appropriations we will have to gain Parliament's approval, through either an appropriation act or specific legislation.

In moving forward with these changes, we have to continue paying attention to the employees of the federal public service, the administrative arm of government.

As you know, all collective bargaining in the public service came to a halt when the previous government implemented the Public Sector Compensation Act in 1991. Beginning next February, this act will cease to apply to bargaining groups at the end of their collective agreements. At that time we will return to collective bargaining.

In negotiating the terms and conditions of employment with unions over the next three years, however, we will suspend binding arbitration as a dispute-resolution mechanism. Simply put, we cannot risk awards being made by independent arbitrators who are not accountable to Parliament. Employees of the House, Senate, Library of Parliament, and CSIS are exempt from this suspension. This is because they are prohibited from striking and must rely on binding arbitration. For these groups, however, arbitrators would be required to take into account wage settlements of comparable occupational groups within the public service.

This bill would also provide authority for a 2.2% wage increase for non-commissioned members of the Canadian forces. This measure will address the disparity in wages between members of the armed forces and public service employees, a disparity that existed before the wage freeze.

As well, we are amending the Public Sector Compensation Act to reinstate performance pay after a five-year suspension and annual increments for those employees for whom it was suspended when we introduced the in-range increment freeze two years ago.

[Translation]

I would now like to discuss the provisions of the Bill dealing with pension reform.

All public servants, whether or not they are transferred out of the Public Service, will benefit from the changes being proposed to the Public Service Superannuation Act.

These include the right to benefits after two years and new provisions relating to the freeze on pension funds.

In addition, it will be easier to transfer public servants' pension benefits to other organizations.

I want to emphasize that the government will hold consultations on the detailed proposals before they come into effect.

Amendments to the Public Service Superannuation Act will also make it possible, for a limited time, to cover employees transferred to new organizations from the Public Service.

[English]

Before moving on to other topics, I would like to mention two further measures the government will take so we can deliver better service while being fiscally responsible.

First, we will modify the Financial Administration Act to give Treasury Board the authority to establish group insurance plans for the public service, to set terms for the management of those programs, and to acquire such programs by contract. This will allow these programs to be managed in a way that is more consistent with insurance practices in the private sector.

Second, we propose to amend the Public Service Staff Relations Act so the government can better meet its ongoing youth employment responsibilities. We plan to provide students with learning opportunities and to facilitate their transition from school to work. Their employment benefits will reflect their trainee status.

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While speaking of students, let me note another aspect of this legislation. The bill will remove the ten-year ceiling that was imposed on the repayment schedule of students who borrowed money under the Canada Student Loans Act. This will benefit students and serve the government by reducing loan defaults.

Let me now turn to another basic theme of the budget: securing this country's social programs.

As I'm sure you all know, this budget seeks to amend the Federal-Provincial Fiscal Arrangements Act. We propose to provide secure, stable funding for the CHST, the Canada health and social transfer, for an additional five years, through to 2002-03. There should be no mistake about our commitment to this funding. In fact, in the three years beginning in April 2000, CHST levels are projected to rise. By 2002 - 03 total CHST entitlements are expected to be $2.3 billion higher than the level set for the next fiscal year, 1997-98.

To provide additional assurance to Canadians, moreover, this legislation sets a floor, a guarantee that cash transfers will be maintained at or above the $11-billion level.

[Translation]

This legislation sets out a new formula for allocating funds to the provinces under the Canada Health and Social Transfer. As a result of the new allocation, which is to be phased in over a five-year period, current disparities in per capita entitlements among provinces will be reduced by half.

I should also point out that the phase-in period will give provinces time to adjust to the new allocation, as well as the certainty to undertake their own fiscal planning.

This consolidated, comprehensive transfer reflects a more subtle and thoughtful approach to federal-provincial relations. It gives the provinces enhanced flexibility to design and administer their own programs, while at the same time protecting social programs that Canadians depend on and support.

[English]

Next I would like to mention the changes this bill proposes to the Unemployment Insurance Act.

Effective January 1 of this year, the maximum insurable earnings are to be reduced to $750 per week, in comparison with the $845 level that would have resulted under the current legislation. Similarly, the maximum weekly benefit drops from $465 per week to $413. These measures will save $200 million in the second half of this year and will reduce the UI payroll tax burden on working Canadians.

This bill also amends the Old Age Security Act to lengthen the period of time before newcomers to Canada become entitled to the full guaranteed income supplement, or spouse's allowance. Under the current system, some immigrants obtain full benefits with as little as one year's residence in Canada. Restricting this easy access will improve the fairness of the system and lessen the burden on taxpayers.

I would like to focus on one final measure. This bill provides approximately $960 million in adjustment assistance to the Provinces of Nova Scotia, New Brunswick, and Newfoundland-Labrador over a four-year period. This is intended to cover a share of the initial revenue losses they will experience under the harmonized sales tax regime they have agreed to.

We firmly believe that, given the benefits that will flow from harmonization, the total cost to the federal government is a reasonable investment. It is in keeping with firmly established practices of providing assistance when federal initiatives entail major structural change for provinces.

Let me emphasize that this adjustment assistance will not jeopardize our deficit targets. These targets remain secure.

In addition to the three provinces previously mentioned, Prince Edward Island, Manitoba, and Saskatchewan would also qualify for assistance should they agree to harmonize sales taxes. However, Ontario, British Columbia, Alberta, and Quebec would not.

[Translation]

This is something that warrants further clarification, particularly in light of comments it has prompted both in the House and in the media. Adjustment assistance is aimed exclusively at those provinces where harmonization would erode current retail sales tax revenues by at least 5 per cent.

The province of Quebec is not in fact suffering any loss of revenue as a result of harmonization and it is therefore not eligible to receive adjustment assistance. Also, Quebec chose to harmonize its sales tax over a six-year period. The province is thus in a position to generate additional revenues, by taking advantage of the large tax base associated with a value-added tax, while continuing to tax many business inputs.

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On the basis of the partially harmonized sales tax that was in effect from 1992 to 1995, Quebec would not be eligible for assistance, nor will it be eligible when that harmonization process is complete.

[English]

The three Atlantic provinces that are now harmonizing have decided to move to a single tax all at once. This means they will not have the option of boosting revenue during a phase-in period. Therefore the adjustment assistance is essential to ensure they have the opportunity to participate in a single sales tax system on the same basis as Quebec and the other large provinces.

Mr. Chairman, I have taken a fair amount of time because this bill touches on many pieces of legislation. It is a complex bill and I've not gone into great detail since we will be dealing with questions in a moment.

Let me conclude with one observation. This bill is the heart and soul of the government's fiscal agenda as laid out in the budget. The story here is quite simple: getting government right. It's a principle we all agree with in principle, and I trust that in our discussion we will conclude that the measures set out take us towards that goal.

Mr. Chairman, I might just add that as I look around the room, there are a frightening number of officials with us today. That doesn't reflect, I hope, the minister's lack of confidence in my presentation this morning, but rather the fact that, as I've explained in my brief overview, this legislation touches on a number of distinct areas of responsibility and so we have representatives from several departments with us.

In the course of questioning - and I take your guidance on this - as questions arise with respect to particular departmental responsibilities and particular pieces of legislation, I have asked those officials responsible, one or two of them that is, to come to the table so they can deal with technical questions. They have, I believe, organized themselves accordingly. I hope that would be agreeable.

The only other suggestion I would make, in the interest perhaps of not keeping this many officials for the entire meeting, is, if possible, to group questions on particular aspects of the bill. That may, however, simply not be practical in light of the way things go with the committee.

The Chairman: We have only an hour and 15 minutes left. I suspect it will give more flexibility to members to question if they don't have to stick to a rigid regime.

Mr. Campbell, let me thank you for your excellent presentation on this brilliant budget, and because it is so excellent

[Translation]

... perhaps we can get unanimous consent to adopt it with no further discussion.

Mr. Loubier (Saint-Hyacinthe - Bagot): You say we have an hour and 15 minutes left to examine the Bill; is this the only time officials will be available to answer our questions?

The Chairman: The steering committee will be meeting immediately after this session.

Mr. Loubier: Can you tell me approximately how much time has been set aside for questioning officials?

The Chairman: We can call on them as required.

Mr. Loubier: Fine.

I have three rather technical questions. It would be helpful to have officials available so as to avoid unnecessary political debate.

With reference to the Canada Health and Social Transfer, I believe the Parliamentary Secretary referred earlier to a $3 billion increase in federal government expenditures for the CHST in the year 2001 or 2002. I would like to see that $3 billion increase split between tax points - something the federal government cannot object to because the provinces already have them - and cash transfers. So, that is my first question.

My second question has to do with provisions relating to a ceiling on UI. I would like senior officials to tell me who will be affected by this new ceiling and who will benefit by it. What I'm really getting at here is the size of the businesses that will be affected: Are these provisions a gift to small, very small, medium-sized or large businesses?

My third question is on the GST. The Parliamentary Secretary made a purely political statement earlier when he said that harmonization of the GST and the Quebec sales tax had meant additional revenues for the province through a broadening of the tax base. However, the tax base was broadened not as a result of the federal initiative, but in order to meet the specific requirements of the government of Quebec.

.0950

Where is the logic in saying that provinces like Quebec, that have already harmonized their sales tax with the GST, and thereby shown themselves to be good corporate citizens, or rather good provincial citizens, will not be entitled to any form of compensation?

If Quebec's sales tax now stood at 15 per cent and it had not harmonized that tax with the GST, as it did in 1991, the provincial sales tax plus the GST would have amounted to 23 per cent. Would the federal government have provided compensation for this loss of revenue of 7 percentage points, or would we simply have been ignored, since it was Quebec who had done the harmonizing? Where is the logic in all of this?

In other words, if Quebec had done a poor job of managing its public finances, if it had been forced to bring in a 15 per cent QST plus a federal tax of 7 per cent, and if it were now going to bring that total tax down to 15 per cent, as the three Maritime provinces have, would it not be entitled to compensation?

Those are my three questions; my colleagues will probably have others if time permits.

[English]

Mr. Campbell: Mr. Chairman, my brilliant plans have totally collapsed because the officials are having trouble hearing the questions. I will try to get officials to the table with me.

First, with respect to the GST, we have some officials here. With respect to the UI ceiling, if there are officials.... As Mr. Loubier said, these are technical questions. On the CHST as well -

[Translation]

The Chairman: Who would like to answer the question on the GST?

[English]

Mr. Watson.

Mr. Samy Watson (General Director, Tax Policy Branch, Department of Finance): Yes.

[Translation]

The Chairman: Thank you.

[English]

Mr. Campbell: Mr. Watson will begin with the last question

[Translation]

... Mr. Loubier raised about the GST.

[English]

Mr. Watson: If I understand your question correctly, the issue is why Quebec did not receive any compensation.

I think if you look at the set formula, it will answer the technical aspect of this question. The set formula is for provinces that lose more than 5% of their retail sales tax revenue when making the transition to a value-added tax.

[Translation]

Mr. Loubier: I'll try to clarify my question, because the technical aspect is not really what concerns me; I am more interested in the issue of equitable treatment for the provinces. I fully understand the technical side. If we calculated the average provincial sales tax in the Maritime provinces, plus the current GST, we would arrive at an overall figure that exceeds the 15 per cent tax the federal government would like to put in place from coast to coast.

I'm concerned about the fact that the criteria for providing compensation to the Maritime provinces do not apply to Quebec, although the government of Quebec decided as early as 1991 that harmonization of its sales tax and the federal GST was in the interests of both parties. One would almost think there was a deliberate attempt to define these criteria once Quebec had already completed the harmonization process, so that there would be no possibility of Quebec's being eligible for compensation. So, that's my question: Where is the equity in all of this?

If we were to start the harmonization process all over again, based on a different taxation rate set by the government of Quebec, there would be compensation for the province. Are you not really saying to the provinces of Canada that are incapable of putting their financial house in order or controlling their spending or their debt that they will be compensated if they have a higher tax rate - in other words, one that exceeds 15 per cent once the federal GST has been added in?

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[English]

Mr. Watson: Let me say two things about that. One is that it's either 15% or 14%. The other aspect is that when you apply this formula - it applies to all provinces - Quebec would not have the 5% revenue loss either today or in 1990. If that formula was in existence in 1990 when Quebec signed its MOU, it still would not have had that extent of revenue loss. So in that sense it has an even application even over time.

[Translation]

Mr. Loubier: Mr. Chairman...

The Chairman: We have very little time available, Mr. Loubier. We can try to get answers to your three questions now and you can always come back to them again later.

[English]

Mr. Campbell: With us next is Diane Carroll from HRD. She is going to speak to the issue of UI.

Ms Diane Carroll (Acting Director, Policy Analysis, Department of Human Resources Development): Perhaps I could start with just a little bit of the rationale behind the reduction in the maximum insurable earnings under unemployment insurance.

The main rationale was to bring the maximum insurable earnings more into line with the average industrial wage. Until the early 1980s the maximum insurable earnings under unemployment insurance were very much in line with average industrial wages - they were quite similar - but since that time the maximum insurable earnings, because of the formula that exists within the Unemployment Insurance Act, have grown quite dramatically compared to the average industrial wage. In fact, in 1995 the $815 maximum insurable earnings were equivalent to about 40% more than the average industrial wage at the time.

If it was allowed to grow under the current formula, it would grow to about 47% above that average in the year 2000. So the drop in the maximum insurable earnings to $750 was very much for that purpose, and at $750 it is still about 30% above the average industrial wage today. That will drop off to about 17% of the average industrial wage in the year 2000 with the projection in wage growth.

So, yes, in terms of who it actually affects, it will in total reduce the premium payment of both employers and individuals by about $900 million in 1996. About $525 million of that would be the employers' share of the reduction.

In terms of the individual, if you are comparing it to what people were paying in 1995, at the maximum level, compared to paying a $2.95 rate on $815 in 1995 and a $2.95 rate on $750 in 1996, it means that at most an individual would have about a $100 reduction in premiums. If you compare that to what it would have been if it was allowed to grow to $848 in 1996, it's about $150 less in premiums for an individual who was making the maximum insurable earnings at that point.

On the other side, it also means that those individuals could have their benefit payment substantially reduced. For somebody with a very high wage level, if you compare what they'll get to what they can currently get in 1996 - a maximum cheque of $465 versus $413 - and given that the maximum number of weeks that you can collect under the new unemployment insurance program would be 45 weeks, they could in total have about $2,340 in reduced benefits.

So, yes, it does benefit the people at the high end inasmuch as they will have lower premium payments, but on the other side they could have a substantial reduction in their benefit payments as well. The objective behind it was certainly to bring it into line.

In terms of businesses, I think in general it is recognized that it obviously is benefiting more the employers who have people at more than $35,000 in income, because that's where the premium cut is. But if you look at the whole package of premium reductions, there are about two-thirds of small businesses, based on the $2.95 rate in 1996, that will pay less than they do today. That will continue into 1997, depending on the rate at that time. So there is certainly from the MIE itself....

On top of that, part of the whole unemployment insurance package is to provide two-year transitional premium relief for small business, which gives recognition to the fact that going to an annualized MIE in 1997 does have implications for small business, particularly those that employ part-time workers.

The Chairman: Thank you, Ms Carroll.

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[Translation]

The third question dealt with transfers to the provinces.

[English]

Mr. Campbell: With respect to the CHST, we have Andrew Treusch from the Department of Finance. I believe the question concerned the growth in those transfers over time.

Mr. Andrew Treusch (Federal-Provincial Relations Division, Federal-Provincial Relations Branch, Department of Finance): The 1996 budget announced a long-term funding arrangement for the Canada health and social transfer. The arrangement is for five years, the period 1998-99 to the year 2002-03. For the first two of those years total entitlements to all provinces will be maintained at the level of $25.1 billion, and they will neither grow nor decline.

For the subsequent three years of the arrangement, entitlements will resume growth at a rate linked to the growth of the economy. It should be at an increasing pace over those three years. By the year 2000 the escalator for entitlements, that is the rate at which they are increased that year, is linked to growth of the national economy less 2%; the next year it's growth of the economy less 1.5%; and in the final year it will be growth of the economy less 1%.

In terms of what the budget projections show, entitlements nationally to all provinces over the five-year period should increase from $25.1 billion to $27.4 billion. The actual rate of growth, of course, will turn out to be a little higher or a little lower depending upon the pace of growth of the economy.

The Chairman: Thank you, Mr. Treusch.

[Translation]

Mr. Loubier: What I really wanted to know was how the $3 billion increase referred to by the Parliamentary Secretary would be distributed. How will that increase be distributed between tax points and cash transfers? How will it be apportioned between the two?

[English]

Mr. Treusch: We could provide in writing tables showing the distribution of the Canada health and social transfer in cash and tax for all ten provinces for the five years of the arrangement.

[Translation]

Mr. Loubier: But are you in a position to tell me now whether most of the $3 billion increase will take the form of tax points as opposed to cash transfers? I'm not asking for detailed tables, which we could always consult if we needed additional information. I want to be given some confirmation today that the federal government will not be increasing the cash component of the Canada Health and Social Transfer.

[English]

Mr. Treusch: In our current estimates of cash transfers over the five-year arrangement, cash in the initial year will be $11.8 billion. We would expect that would decline to $11.1 billion in the second year. Our current forecast shows that growing to $11.3 billion in the last year.

We should recall as well that there is a cash floor provision in the legislation before you that ensures that whatever happens cash will in any case not be lower than $11 billion. We are looking at growth in the cash, and of course it is that portion that is determined by the growth of the total entitlement itself.

In terms of the value of the tax transfer, one expects that tax transfers by and large will grow with the rate of the economy, and we are projecting that to continue over the five years of this arrangement. Again, economic events will tend to change that pattern and it may be faster or slower in a particular year.

The Chairman: Thank you, Mr. Loubier.

Mr. Grubel, please.

Mr. Grubel (Capilano - Howe Sound): Thank you very much, Mr. Chairman.

I'd like to first ask questions on old age security and on unemployment insurance, if I may, please. I'll try to be as precise as I can.

The Chairman: You're always very precise, Mr. Grubel.

Mr. Grubel: One of the most important and fundamental changes announced in the budget amounted to the abandonment of universality of access, a very sacred principle that has guided Canadian policy for a long time in the sense that individuals and families above certain incomes, if they reached these levels, would no longer receive benefits at all rather than getting them and having them clawed back. That destroys the idea that everybody gets the same amount. So the cornerstone of the Liberal ideology was abandoned in this budget.

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I see no mention of this in this implementation act. It deals only with the old age security benefits payable to immigrants. How does this work?

Mr. Campbell: Let me respond to that quickly, Mr. Grubel. The senior's benefit and the things that flow from that initiative are not in this bill. They will be the subject of separate legislation. This bill does address the latter point, however, which is the availability of some of those supports to people who have recently arrived in this country. Officials are here and can deal with that aspect of it, if you wish.

Mr. Grubel: I understand. When can we expect the bill implementing the other parts of the budget?

Mr. Campbell: I do not know. Perhaps the officials have some indication.

Mr. Réal Bouchard (Director, Social Policy, Federal-Provincial Relations Branch, Department of Finance): In the fall.

Mr. Grubel: In the same way, something concerns me greatly about the UI system and the entire budget. Mr. Campbell had to listen to me speaking on this in the House the other day. The cumulative surpluses generated by the UI system will produce a reserve of $10 billion to $14 billion in two to three years. It's always difficult to get the precise numbers because of the problems of fiscal years, etc., but clearly the reserve is of unprecedented size. They have never before exceeded $2.2 billion, but they will probably reach $4 billion by the end of this year and maybe as high as $8 billion or $10 billion by the end of this budget cycle.

Are the officials here prepared to discuss with us their plans for restoring these reserves or reducing the premiums such that the accumulation ceases?

Mr. Campbell: I don't know whether the officials are here to comment on anything that you raise. You are aware that we moved into that surplus situation just recently. You wouldn't want to leave anybody with the impression that there has been a surplus over a long period of time. In fact the account was in a deficit for a long period of time, moved back into balance, and is now starting to be in surplus, although I don't dispute your suggestion as what may happen over time.

Also, in the budget papers there are references to a premium rate for planning purposes, but those final decisions have not been made and will not be made for some time.

I don't know if you have a specific question on UI with respect to the legislation before us. You will note that the legislation, as I said in my opening comments, only deals with a small aspect of the UI reform and does not address the surplus issue.

Mr. Grubel: According to the government's own document, they have built into the revenue forecast UI system surpluses of $4 billion and $5 billion in the next two years. Even though we have just begun to accumulate, the government's own projections imply the generation of a very large surplus. When can the government tell us what measures it is contemplating in order to get rid of those surpluses? The tax that collects the premiums is not to be used to finance general revenue.

Mr. Bouchard: I have a few comments to add to what Mr. Campbell just said.

You're right, at the end of 1995, for the first time in years, the UI account was going to have a small surplus of nearly $1 billion. At the end of 1996, with the current contribution rate of $2.95, we are heading towards a surplus of $4 billion to $5 billion, but that was foreseen in last year's budget of course. That surplus was put in place to ensure that when the next recession hits, there will be a fund to help prevent a huge increase in the contribution rate.

.1010

As for the next year, as Mr. Campbell just said, for planning purposes an assumption was made in the budget, but the final decision on the premium rate has not been made. It will be decided in the fall, as it is every year when we set the premium rate for the following year. At that time, depending on the strength of the economy and the financial position of the UI account, the rate will be set. The decision has not yet been made, but for planning purposes an assumption was made.

Mr. Grubel: It's clear that if tradition is followed and the premiums are lowered, the surplus generated by the UI fund will decrease next year and the year following. Is that correct?

Mr. Campbell: Mr. Drummond.

Mr. Don Drummond (Assistant Deputy Minister, Tax Policy Branch, Department of Finance): Just to clarify the math, the cumulative surplus of course would not decrease, but the annual increase in the account would decrease. For example, the cumulative surplus at the end of 1995 was just short of $1 billion. If it was $5 billion at the end of this year and then the rates are cut, presumably the cumulative surplus would stay at about $5 billion, but you would no longer have that ongoing annual surplus.

Again, this is not a problem that can be looked at in isolation, as I know you're aware. You had to wrestle with that issue when your party put out the alternative budget proposals last spring. The unemployment insurance account is consolidated into the government's books, so if you stop the build-up of that annual surplus, that means less of a reduction in the deficit. So that of course will be one of the considerations when we come to setting the premium rate.

Mr. Campbell: I would also add one other point that I neglected to state at the beginning. At times, Mr. Grubel, you or your colleagues have raised the spectre of a potential recession down the road, and of course you would not be suggesting that we not build up a surplus to avoid the necessity of raising premiums during a recession.

Mr. Grubel: I find it very interesting that when I ask a question, the answer is what the Reform Party had considered as a budget plan. I think this is a discussion about the government's budget and what it is planning to do.

There is a serious problem and dilemma in this budget. The dilemma is that if there is to be a limit, as there should be historically, economically and ethically, on the amount of reserves built up for the UI fund - and I accept that there should be a build-up, but I looked at the historic figures and it was never more than $2.2 billion, never more than 20% or 30% of the entire annual spending.... By the end of this budget cycle, 1997-98, the accumulated surplus for planning purposes will reach approximately 93% of projected total government figures of annual spending by the UI fund.

When can I hear from this government an explanation as to an appropriate reserve relative to annual expenditures? When will the premiums be reduced?

Second, if this is done, is the government still expected to meet the targets that it is so proud of meeting every year?

I remind this committee and the government that if in 1997-98 the UI fund no longer generates a surplus because the premiums have been put where they are supposed to be according to how the system operates, the deficit will not be $17 billion but $22 billion. Seventeen billion dollars is 2% of GDP. Therefore, 22% cannot be equal to 2% of GDP, and the entire budget plan will have fallen apart.

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That is why I'm pressing for some answers on when all those beautifully announced, proud, deficit targets...when we will get action that is correct on one side.... Does the government have any answer to what it will do with respect to the simultaneous implied missing of the target?

The Chairman: Mr. Grubel, I suspect this is an answer that could come only from politicians as opposed to public servants, would you agree?

Mr. Grubel: There is no dispute. In a way, even though I have studied economics for a while, I would just like to be sure that I have my facts right, because if I go public on this.... The technical experts here can tell me where in my reasoning there are flaws, and if there are none, I accept it completely.

The Chairman: Do our technical experts agree with Mr. Grubel's analysis?

Mr. Campbell: I would agree. Someone once described economists as people who have a keen sense of the obvious. This is a new situation in terms of the surplus-building. As I explained earlier, we just came out of a deficit and are moving into a surplus, and no one disputes your suggestions about where this might go over time. But I'd just like to conclude, Mr. Chairman, by saying that obviously this is a matter that the minister has under consideration. The next decision point would obviously be in the fall when we look at the premium rate.

Mr. Grubel: Mr. Chairman, I've made my point. I raised the question, and I thank you for this opportunity.

The Chairman: We look forward to your advice as to what that surplus should be.

Mr. Pomerleau (Anjou - Rivière-des-Prairies): Give it to him.

The Chairman: We will be giving it to Alberta to get them to harmonize.

Mr. Grubel: We might consider, as a finance committee, bringing in a couple of experts to help us determine what might be, in the history of these developments, the optimum ratio that we should go for.

The Chairman: Sure. Thank you, Mr. Grubel.

Mrs. Brushett.

Mrs. Brushett (Cumberland - Colchester): My first question comes from apparel manufacturers regarding the sales tax adjustment. With the harmonized GST, some of my manufacturers indicate it will be more complicated for them with each province varying now, and when the apparel price ticket isn't exposed, as it is in a grocery store, that this, again, will generate some costly problems. Could you address this regarding each province and the additional burden on paperwork, if it does exist, or is this somewhat of a myth rather than a reality?

My second point is regarding charities, and I'm not sure that it comes under this implementation bill. It was in our budget and it has also been brought to my attention that we have improved upon our taxation of charitable donations immensely and that the public is very pleased. However, in terms of giving a capital gain charitable donation...in the United States you will get the increased value of that capital gain and so you get a better deduction on your income tax, whereas here in Canada we don't give the capital gain portion, we give the original cost. I hope I've made that clear. This, again, is a concern. If we're encouraging taxpayers to be more charitable, how can we address that?

Mr. Campbell: I'll address this, Mrs. Brushett.

With respect to charities, of course, the technical changes to the Income Tax Act will be in the technical bill, which we'll see in due course. It is not the subject of the budget implementation bill. This committee made some very strong recommendations with respect to charities as a result of the pre-budget consultations last year, which were reflected in the budget.

There has been some comment that we should go further or should consider going further than we have with respect to gifts of appreciated property. The budget indicated that further work will be done with respect to charities to see how we can provide further assistance. That's an ongoing process and may well become the subject of further discussions before this committee in due course.

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Mrs. Brushett: Thank you.

Mr. Watson: Your first question had to do with tax-inclusive pricing. I think the way it's set out in the announcement on GST is that, obviously, if everybody is at the same rate and everybody's in, tax-inclusive pricing isn't a problem. If you have some provinces that are in and some provinces that are not in, there are some problems that would have to be overcome.

In the memorandum of understanding we indicated we would be consulting in this area with business and working with the provinces to find the smoothest way of doing this. It's something that the minister also stressed in his remarks in front of the House, that business will be consulted on how best to do this so as not to create any further....

The Chairman: Thanks, Mrs. Brushett.

[Translation]

Mr. Bélisle, you have the floor.

Mr. Bélisle (La Prairie): Could the Parliamentary Secretary or any of the officials present confirm that in a recession, transfers decline at a proportionately higher rate than the economy? So, when a recession does occur, federal government cuts to health and education spending are proportionately greater than the percentage of economic decline. Depending on the way it's calculated, a factor of less than 2 per cent is applied.

Can someone confirm that during an economic slump, there is a proportionately greater decline in transfer payments? Is that in fact what occurs?

[English]

The Chairman: We'll give Mr. Treusch a moment to get organized at the table.

Mr. Treusch: The question is about the balance between transfers to other levels of government and other areas of federal expenditure, as well as what happens in a recession.

In a recession two things would happen to the new Canada health and social transfer. First, it is likely that the overall escalator, which is linked to the growth of the economy, would tend to slow. At the same time the value of the tax transfers would also tend to slow since they more or less will grow in line with the economy. Depending upon the timing of those two events, the federal cash transfers to provinces would tend to increase.

This has been our experience in the past with an arrangement that was similar in structure - established programs financing - and it's for this reason that these transfers have an overall stabilizing effect on provincial revenues. By that, I mean provincial revenues after federal transfer payments...our experience has been they are more stable after than before.

With respect to the balance of expenditure reduction on transfers to provinces and other areas of federal expenditure, there are many ways to produce numbers on making such comparisons. It's probably worth indicating that the equalization program, which is now worth about $8 billion, has been exempt from expenditure restraint over its current five-year.... The Canada health and social transfer, which replaced the Canada assistance plan and established programs financing, has been restrained. There have been reductions in the overall level particularly for 1996-97 and 1997-98.

Thereafter, however, there is growth, both in the cash portion and in overall entitlements. In the budget document itself there is a table showing the reductions in departmental spending. You can compare that with the reductions in transfers to provinces and I think you will find them broadly similar or consistent.

[Translation]

Mr. Bélisle: And can you tell me what happens during an extended period of recession? Transfers are currently calculated on the basis of a four-year average.

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What concerns me most about this - and you have just confirmed my impression - is that in a recession, transfers decline proportionately faster than the economy, although the needs of the population are actually greater, particularly in the areas of health and education.

So, I would like to know what happens during a lasting recession, since your calculations are based on a four-year average.

The Chairman: With our government? That's a hypothetical question, isn't it?

Mr. Loubier: So there'll be an election in the fall?

[English]

Mr. Treusch: I'll comment on the transfers issue. A recession of a duration of four years would be quite unusual in Canada, I would think, by historical norms. Certainly, recessions are typically much briefer than that.

What would happen in a recession is the scenario I tried to portray at the outset. When the escalator is linked to the growth of the economy, that escalator will decline with the recession, but so will the value of the tax transfers. The provincial revenues will be declining with the recession and therefore federal cash transfers will increase. Again, our experience has been that these transfers are stabilizing.

I might add one thing that would interest the hon. member. The escalator that's linked to the economy is actually based on a three-year moving average of change in the economy, and this is done, again, to stabilize and smooth the change.

So if we had a situation where, in the coming year, the economy slipped sharply into recession, the design of the transfer will mitigate the impact of that on provincial governments and their fiscal outlook. By taking the average of three previous years and averaging it, there will be an overall smoothing.

[Translation]

Mr. Bélisle: I have one last question on the harmonization process.

Yesterday it was confirmed that the federal government will be providing cash transfers, rather than tax points, to the three Maritime provinces that have agreed to harmonization.

The federal government has announced it will be spending $961 million to harmonize its tax with provincial sales taxes in Nova Scotia, New Brunswick and Newfoundland.

As I see it, by not transferring tax points, the federal government is in fact buying extra tax room for the sum of $961 million. In the three provinces, the new harmonized tax will be set at 15 per cent; but all three already had sales taxes in place. One had a 12 per cent sales tax, and the other two had an 11 per cent sales tax. So, 15 per cent minus the 7 per cent GST leaves the provinces with total tax room of 8 per cent, if I can put it that way.

Since taxpayers in every province, and particularly the three Maritime provinces, have a limited ability to pay, in future, the governments of those provinces will be unable to levy taxes at other levels or find alternate ways of making up lost revenue in periods of recession or economic downturn.

Basically, for the sum of $1 billion, the federal government will be buying additional tax room and taking back tax points from these provinces. Is that not the exact reverse of what has always been advocated?

There is currently a lot of talk about decentralization and fiscal federalism. But isn't it true that in this instance, not only is the federal government not transferring tax points, it is actually taking back provincial tax points? What is your reaction to that?

This is certainly a concern in a so-called federalist system where there is more and more talk of decentralizing fiscal federalism. Now we see the government interfering with these three provinces' ability to levy taxes by taking back some tax room, in exchange for a lump sum payment of $1 billion - that's not exactly peanuts.

In future, these provinces will have no flexibility whatsoever. They won't be able to tax at a rate higher than 8 per cent. If you subtract the federal 7 per cent tax from the total tax of 15 per cent, you're left with 8 per cent. In the long term, they will be the losers.

Isn't the fiscal federalism everyone talks about exactly the reverse of what has occurred here?

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[English]

Mr. Campbell: Mr. Watson and Mr. Drummond.

Mr. Watson: I'll say a couple of things on that. One is that in the memorandum of understanding there are provisions made for protocol in terms of how rates go up. The other thing is that in a harmonization, sometimes there is decreased flexibility in exchange for that. The federal government has offered to administer increased flexibility for provinces in terms of both personal income tax and capital and payroll taxes and has agreed to administer capital taxes for these provinces.

I would say that they probably have more increased flexibility than reduced flexibility in the sum total. I would also say that the transitional assistance is to help give provinces time to adjust in terms of moving from a retail sales tax to a value-added tax, and it ends in four years.

Mr. Campbell: Mr. Drummond.

Mr. Drummond: As you indicated with your questions, one of the goals is to have a national harmonized tax system, and we would like to have that ideally at a single tax rate. Failing that, an interim step towards that would be to have the minimum amount of variance. You already know where the harmonized rate is in Quebec. Looking at where the retail sales taxes already are in the provinces, that would have left the harmonized rate with the Atlantic provinces, at the current retail sales tax rates, quite a bit higher.

As you mentioned, I think one of the goals of the harmonization is actually, as you indicate, to get a more national system in place. This requires that the combined rate in the Atlantic provinces be considerably lower than it was, and of course that is what feeds into the adjustment formula that provides the amounts of money you referred to.

[Translation]

Mr. Bélisle: You spoke earlier of increased flexibility within the system as a whole. Does that mean that if any of these provinces find themselves facing difficult circumstances in future, the 15 per cent tax could go up? Or will equalization payments rise?

How will an increase be achieved under the circumstances? You say this provides greater flexibility. But if problems arise in future and these provinces have to make up lost revenue, could the 15 per cent harmonized tax be increased, or will equalization payments simply rise should that occur?

[English]

Mr. Drummond: I've heard this reference before, that with this harmonization the equalization payments will go up. In fact, for two reasons the equalization payments will go down.

One is that there's a lower tax rate, of course, in the Atlantic provinces. Secondly, if you look at the estimates of what the Atlantic provinces provided for the impacts of their economy, they've estimated an augmentation and a growth rate between one-half and one percent a year, with the permanent gain of about two percent. Obviously, those are estimates and one can quibble around those amounts, but I think it's undeniable that with the competitive gain the harmonization would give, just as Quebec has realized with their harmonization, there will be a strengthening in their economy and that will be a second factor that will lead to lower equalization payments rather than higher payments.

[Translation]

The Chairman: Thank you, Mr. Bélisle.

[English]

Mr. Grubel, please.

Mr. Grubel: I have a couple of questions. One of them concerns the accounting for the adjustment assistance. It says here...year one, it is to be spent over four years. In which budget will these expenditures be appearing?

Mr. Drummond: In accordance with the accounting conventions set out by the accounting community and by the Auditor General, a liability is to be booked when it's incurred. There was a reference in the budget to the harmonization process. The letters to the three participating Atlantic provinces were sent out in March 1996. Those letters, from the federal perspective, gave an unconditional offer and a commitment to provide this adjustment assistance according to the formula.

So the perspective from the accounting community and the Auditor General is that the liability was incurred in the 1995-96 fiscal year, and that's when it will be booked. It will appear in the year that's just closed a month ago, for those three participating provinces.

As other provinces come in, it will be booked in the year in which that commitment is incurred. That is similar to the type of accounting conventions in the employee downsizing package in the 1995 budget; that was in the 1994-95 year. If you look at the upfront payments relating to the elimination of the western grain transportation assistance, that was booked as well according to that convention, in the year in which the liability was incurred.

The fact is that the provinces may be drawing the money out over a four-year period, but the federal deficit would be booked in the year 1995-96.

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Mr. Grubel: So you discussed that with the auditor.

Speaking as a layman on accounting, it seems to me very strange that in regard to an agreement signed in principle, which isn't even in effect yet and could still be derailed, we have now put all of the expenditure on that into last year's budget. Explain that to Canadians. I know you have a good answer; you gave it. I just want to go on record that this is truly an astounding practice.

It raises somewhat the question of whether that was done for cosmetics or economic or financial soundness. It's very strange.

I'd like to ask an empirical question. What would have happened if the combined rate had been set at 16% rather than 15%? What would have been the increased revenue in those provinces per year?

Mr. Drummond: Maybe I'll just take the first question and Samy can take the second part of the question.

There are both sides to this perspective, of course. One of the reasons why the accounting profession came down to the view that you record the liabilities when they're incurred is, of course, you could imagine the abuses that could come with the other situation, where governments did make various different commitments and kept postponing the date in which they recorded those in their books.

I think this practice is very much to get at that. If you make an unconditional offer, and it's only conditional on the other party agreeing to it, you have incurred the liability as of that date. That's when you should recognize it on your books.

Mr. Grubel: Do you think that is consistent with the way we treat CPP applications, the way we treat the contingent liabilities from the CMHC and all those kinds of things?

Mr. Drummond: There are all kinds of parallel conditions like that. For example, when the government did hold Petro-Canada shares and those Petro-Canada shares would fall and be considerably less than their book value, the Auditor General was constantly pressuring the government to recognize their revaluation at that time.

We have certain provisions assigned for all the sovereign debt the government has. If the Auditor General, in viewing that portfolio, judges that this stock of loss provisions is no longer adequate - even though nobody has defaulted yet but their perception is it's not worth what you're carrying it at - it would be reflected at that time.

Similarly, we have a provision set aside for student loans that are in default. Every year at the close of the year the Auditor General would view what are the prospects of the government collecting that money, and even if somebody has not given it or declared bankruptcy, there will be a valuation of the current value. And it is recorded in that year, not when the actual event happens.

Mr. Grubel: Does this cover just one year or indefinitely into the future? Is it the present value of all future applications or only those in that year?

Mr. Drummond: In the case of the transitional, the adjustment assistance for the harmonization, the four-year amounts will be represented in the year in which we incurred the liability.

Mr. Grubel: What about the student loans, for example?

Mr. Drummond: For the student loans there's a provision against the current stock of what the prospects are for collecting that. A provision is set aside in the books that's reflected in the deficit and the debt numbers for that.

As you indicated, there are still some exceptions and there are some debates in the accounting community. One of them, for example, would have been the prior practice of the government entering into 35-year commitments on subsidized mortgages for social housing. One could have argued that when the government made a commitment to that social housing project, you should have recorded the 35 years. Certainly, some would be sympathetic to that view. In fact, the government has not done that, and it's one of the reasons why every year you see an expenditure going out to a housing project that might have been completed some time ago.

Mr. Grubel: That's why the public sector borrowing requirements are so vastly different from the deficit.

Mr. Drummond: That difference is almost uniquely reflected in the current surpluses in the public service superannuation accounts.

Mr. Grubel: What is the elasticity of revenue with respect to that rate?

Mr. Watson: On your 16% question, that's something for which I would have to go back and do the calculation. We can pass it to you.

Mr. Grubel: I explained a little bit why I asked this question. Let's assume for a moment going from 15% to 16% would have raised a billion dollars. Did it raise half a billion dollars? Maybe we should have raised it to 17%. Then the rest of Canada would not have been asked to come up with a subsidy for these provinces to adjust for revenue losses. I wonder how much this idea of having one combined equal rate in Canada dominated this thinking.

Have you made a calculation on what it would have to be for Ontario, for example, to be revenue neutral?

The Chairman: That's a good question.

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Mr. Watson.

Mr. Watson: I'll answer the last part. Ontario's revenue neutral rate is around 7%.

Mr. Grubel: But what is it combined?

Mr. Watson: Seven plus seven would be fourteen.

Mr. Grubel: Right, 14%.

Mr. Drummond: Returning to the Atlantic provinces, one of the objectives is to have a single rate, of course, but that's not the only consideration involved here. Even if we can't get that, it's desirable to keep the variances as small as they can be, but we also know that a number of goods prices will fall, particularly as the rate drops. But even without a rate drop, as the indirect taxation of business inputs is removed from a harmonized tax system, there will be some relative price changes. There will be some services that weren't taxed before that will now be taxed, causing some relative price increases, and of course the higher the combined rate, the greater those relative price increases.

It was the view of the Atlantic provinces that this change in relative prices will be very severe at a combined rate above 15%. They did not have much interest in achieving a harmonized system at a rate higher than that, so certain adjustments like a combined rate in the neighbourhood of 15% were necessary to make this step toward a national harmonized system.

Mr. Grubel: Provinces want these wonderful benefits from a harmonized system - savings on administration for businesses, and for government the prospect of a national sales tax - but they say you can't make it more than 15% because if we don't get our revenue, we know the feds will come through and British Columbia and Ontario can be counted on to make up this difference.

I'm going to have a lot of difficulty selling that in British Columbia.

The Chairman: Mr. Grubel, are you advocating a combined provincial-federal sales tax rate of something greater than 15%? Is this your party's position?

Mr. Grubel: No, my party doesn't have a position. On radio shows and in the media I hear British Columbians asking why they are going to be taxed proportionately to their population outside of those provinces, to the tune of another $1 billion, so that the Atlantic provinces can be talked into accepting this at 15%. They just put their foot down - we won't take 17%, which would be revenue neutral. That's a nice luxury to have, and earlier I think Mr. Loubier was referring to unhappiness in Quebec about this. If we had just waited a little longer, imagine how many billions we would have gotten by holding out?

I just wanted to put this on the record. I know there may not be an answer to this question.

The Chairman: Mr. Drummond.

Mr. Drummond: To clarify one of your final remarks, Mr. Grubel, you put it that the Atlantic provinces would look to the federal government, and via the federal government to other provinces, to make up the difference in the revenue shortfall. I want to clarify that the provinces are still absorbing half of that revenue shortfall. They absorb the entire amount of the first 5% of the revenue shortfall, and then over that four-year period the compensation for the remaining 95% goes 100%, 100%, 50% and 25%. So between the 5% threshold and that declining scenario, it works out to roughly 50% for the federal government and 50% for the provinces.

So it's certainly not the case that the Atlantic provinces are turning to the federal government for all of the....

The Chairman: Thank you, Mr. Grubel.

Mr. Fewchuk.

Mr. Fewchuk (Selkirk - Red River): Good morning.

First, how will the commercialization of the grain hopper cars affect farmers? Second, where will the moneys from the sale be used?

Mr. Campbell: Some officials from the Department of Transport have been waiting for a question on the grain hopper cars. They've been very patient.

Mr. John Dobson (Senior Policy Adviser, Surface Policy and Programs Branch, Department of Transport): My name is John Dobson. I'm with Transport Canada. I'm a senior policy adviser specializing in grain transportation.

First of all, the sale of the hopper cars will increase the freight rates grain farmers pay by an average of 75¢ a tonne commencing in 1998 at the earliest - provided the cars are sold by that time. The other thing that we expect as a result of the decisions on the hopper cars is to move towards a more commercial and efficient grain transportation system, which we hope will lower system costs for everybody, including the farmers. Another element of the decision was to introduce a productivity adjustment factor, which would also benefit farmers as the system becomes more efficient.

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Mr. Fewchuk: Where will the moneys be used?

Mr. Dobson: I presume the proceeds will be used to reduce the deficit - sort of an offset.

Mr. Campbell: Good answer, Mr. Dobson.

Mr. Fewchuk: Is the government looking at giving farmers an opportunity to purchase these hopper cars?

Mr. Dobson: Most certainly, yes. The government indicated that it's going to be inviting interested parties, including producers or producer groups, to make offers for the cars.

[Translation]

The Chairman: Thank you, Mr. Fewchuk. Mr. Loubier.

Mr. Loubier: Mr. Chairman, I would like to return to the discussion I was having earlier with one of the officials on the GST. A number of comments have been made since the discussion began and I'm not absolutely sure that all of them are totally accurate.

Mr. Drummond, I was quite shocked to hear you say earlier that the Maritime provinces would be absorbing part of the costs, because half of their lost revenue from sales taxes would be compensated for by a portion of the $961 million federal payment.

I do not agree with that statement, but it's possible I misunderstood you or that your comments ware not that clear - or perhaps a little bit of both. So, if you don't mind, I would like you to repeat the answer you gave.

As for the other part that isn't covered by the federal subsidy, the Maritime provinces will immediately start receiving compensation in the form of equalization payments. If the federal government doesn't cover 100 per cent of the loss associated with a reduced tax base in the Maritime provinces, equalization payments will automatically make up the rest, will they not?

[English]

Mr. Drummond: As I was explaining, over the first four years of the harmonization agreement the provinces and the federal government will be sharing roughly 50-50 on the revenue shortfall. I arrived at that figure by looking at the adjustment formula that's been specified. The provinces absorb the entire amount of the first 5% of the revenue shortfall. Beyond that 5%, i.e. the remaining 95%, the formula amounts were determined by the federal government covering 100% of the residual in the first year, 100% in the second year, 50% in the third year, and 25% in the fourth year.

If one averages out those four numbers - 100%, 100%, 50% and 25% - times the 95%, with the provinces taking the remaining 5%, you get a figure that the provinces and the federal government are sharing roughly 50-50. Of course beyond the four-year period the provinces would be left to adjust to the entire amount of the shortfall, because the adjustment assistance only covers the first four years.

[Translation]

Mr. Loubier: You have confirmed that starting in the third year, if the federal government is only covering 50 per cent of the provinces' revenue loss, equalization will automatically kick in and make up the other 50 per cent. In other words, Maritimers will not be paying the other 50 per cent out of their own pockets.

So, you're looking at a three-year arrangement, that includes full equalization, meaning that the $100 to $125 million in lost revenues will be made up by Canadian taxpayers as a whole, in addition to the $961 million federal subsidy.

Starting in the fourth year, it will be 100 per cent - in other words, between $250 and $300 million per year that the Maritime provinces will no longer be paying, but that will be borne by the rest of Canadian taxpayers through equalization payments, if economic growth there is not consistent with your optimistic projections.

[English]

Mr. Drummond: No, in fact the relationship would go in the opposite direction and the equalization payments to the Atlantic provinces will go down, because there are lower tax rates. That's the first influence. Secondly, as it gives a positive impetus to their economies, the amount of revenue they would get for tax effort would go up. So there will be two influences lowering equalization payments, which of course is going to be a fiscal savings for the federal government.

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[Translation]

Mr. Loubier: Mr. Chairman, I would like to be given a clear explanation. Maybe we're the ones that don't understand how the equalization formula works, but it seems to me that if you voluntarily reduce the tax base in the Maritime provinces - which is exactly what will happen under the new arrangement, that brings the overall average sales tax of 19 per cent down to a new harmonized 15 per cent VAT - you are clearly affecting those provinces' ability to raise new tax revenues.

Then if you tie that in with the equalization formula, it means that equalization will automatically make up the rest if need be - either partially or totally - depending on the exact terms and conditions the federal government has negotiated with the Maritime provinces.

Indeed, we already know what those terms and conditions are. The federal government is handing over $961 million to the Maritime provinces, and starting in the third year, the federal government will only provide compensation for 50 per cent of the Maritime provinces' lost revenues.

Forget about economic growth. If the tax base is reduced by 4 points, the other 50 per cent will be picked up through equalization that will be paid in addition to the $961 million that has already been agreed to.

So, don't talk to me about economic growth; the real issue here is the equalization formula.

[English]

Mr. Treusch: On the equalization formula and how it interacts with the GST harmonization announcement, there are two factors here. One is a province's fiscal capacity, to use the terminology of the program. That is, a province's ability to raise revenues, as you well know, will vary with its economic circumstances. So a province like Newfoundland would have a lower fiscal capacity or ability to raise revenues than a wealthier province like Ontario.

The second concept, which Mr. Drummond referred to, is a jurisdiction's tax effort. Obviously, the two are not the same thing. You can be a have-not province, a less wealthy province, but have very high tax effort, and vice versa, you can be a wealthy province and have low tax effort.

Overall, the GST harmonization package involves a reduction in the tax effort of the three harmonizing provinces. There's nothing in that package, in the direct thing, that changes the fiscal capacity of the recipient provinces. That is why Mr. Drummond talked of it tending to reduce equalization payments to those three recipient provinces - other things being equal.

[Translation]

Mr. Loubier: According to your terms, then, this means that in the fifth year, no more compensation will be paid because the agreement will have expired. The Maritime provinces will then have two choices - either to make up the entire amount of lost revenue by increasing income taxes or other taxes, such as sales taxes, or to try to stabilize their revenues through equalization, if consumption doesn't increase.

One way or the other, 4 percentage points will have to be made up for by taxpayers, whether they are living in the Maritimes or the rest of Canada, and as you have just pointed out, starting in the fourth year, the governments of the Maritime provinces will be in a position to increase income taxes or other taxes, like consumption taxes. But if they don't do that, and economic recovery or economic growth flowing from harmonization is not adequate, equalization payments will have to make up the rest.

If one takes that reasoning to its logical conclusion, that is clearly what will happen.

[English]

Mr. Drummond: I think the range of choices is much broader than that. First of all, although you want to dismiss it, they think it will generate some additional economic growth, and obviously that will benefit their tax base. You can be skeptical of that and we'll see what that produces over the first four years, but that's definitely one of the factors they're looking for.

Second, they can cut their expenditures over that period. That's something they and all of the other provinces have been embarking on, and some of those Atlantic provinces have been getting themselves in much better fiscal shape. Some of them are producing actual budget surpluses, while some of them are moving into current account surpluses, i.e. excluding their capital expenditures.

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Certainly, as they look out to the four-year period, I'm sure it's one of their hopes that without an increase in their tax effort they will be in fairly reasonable fiscal shape. I don't want to give a forecast for them. It's a long way out for them to be giving a forecast, but I think those are at least two other possibilities.

The one we don't see as a possibility is the one you mention on equalization. I've tried to explain it and Andrew has tried to explain it. In fact, our anticipation is that our equalization payments would go down. So I don't view that as one of their possibilities.

Finally, if they didn't get the economic growth and if that didn't engender it and their budget balances weren't where they were, yes, they might have to look to some alternative sources of revenue either from personal income taxes, other excise taxes or corporate income taxes. I'm sure they'll make an evaluation of that when the time comes.

The Chairman: Thank you, Mr. Loubier. Mr. Dhaliwal.

Mr. Dhaliwal (Vancouver South): Thank you very much, Mr. Chairman.

I heard your explanation to Mr. Grubel on the liability factor. I'm rather surprised, coming from the business world, that although they are not compatible, I could sign a ten-year lease and have it written off in the year I signed it because I'm making a commitment as an expense. That's not the way it's done in business. You expense it when you incur it, not when the liability is actually agreed to.

So I'm rather surprised by the explanation you have given to my colleague Mr. Grubel. It's quite different from the business community and how we expense items on our statements. Anyway, I'm not going to ask that question because I'm sure Mr. Grubel will follow up.

My question is three-fold. First, maybe you can inform me about a fund we used to have that I believe is called a revenue stabilization fund. I don't know if it's in existence and I would like to ask if that can be clarified. When a province had a de-production in its revenue, it could apply to the federal government to be compensated.

In British Columbia when we had the recession in the early 1980s, we were able to apply to the revenue stabilization fund. I'd like to find out how that plays into the $960-some-odd million we're giving to the provinces. I wonder if they are still able to apply to this revenue stabilization fund.

Secondly, perhaps you could qualify for me when you talk about the drop-in revenue to the Atlantic provinces, are you talking about total revenue for the provinces or are you talking about that part of the revenue that comes from their sales tax? Also, if the $960 million is based on the total revenue, will that change depending on their revenue because those are estimates you have given us?

They could have an improvement in their economy and their revenue could go up, or they could have a problem in their economy and it could go down. I'm trying to figure out if that $960 million is fixed or if it's flexible depending on the total revenue of the Atlantic provinces. When you say revenue, are you talking specifically about the sales tax revenue or the overall revenue of the province?

Thirdly, if British Columbia joined in, what would be the revenue neutral position? I thought I heard someone say 14%, which doesn't make sense to me because there's always some saving in combining the tax. If there are some saving factors, how can the revenue neutral position be 14%? You're combining it to have one collector. Maybe I'm wrong. Maybe the revenue neutral is 12% or 13%. How could it be 14%?

Mr. Campbell: Mr. Drummond will take the question on stabilization and Mr. Watson will answer the questions on harmonization.

Mr. Drummond: Maybe at first I'll just clarify about the bookings. I wasn't suggesting nor is the accounting community suggesting that we expense in one fell swoop our ongoing expenditures, whether it is a leasing arrangement or my salary or a whole bunch of other expenses incurred, year-in and year-out. When you've set up a legal obligation to provide something or, as an example, you've incurred an environmental liability, that is the sort of thing the convention says should be booked up front.

On the stabilization program, yes, there is a stabilization program. It is not applicable to this situation of course as it only kicks in when the revenues fall because of changes in the economy. A province cannot reduce its own tax effort and have its revenues go down and expect to receive a payment from the stabilization program.

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On the example you gave of British Columbia, in fact it was related to the recession but it was more particular than that. It was the decline in the resource prices in 1982 that kicked in the stabilization. It wasn't because British Columbia lowered its tax effort on the wood sector, which is what kicked that payment in.

Similarly, the second payment was made to Alberta in the mid- to late 1980s and that was because of, again, the decline in oil prices. It wasn't because the tax effort went down.

Most of the remaining provinces in one year or another had claims during the earlier part of the 1990s because of the weak tax bases throughout the recession. It wasn't because they lowered their taxes. If a province decided to lower its taxes, that would be filtered out of the calculation as solely the economy would affect it.

The program was modified in the 1995 budget so only revenue declines of greater than 5% would qualify. Previously there wasn't a 5% threshold. This would not be expected to be applicable in the GST harmonization. It would have no bearing on this program whatsoever.

Moving to your third question on how the adjustment formulas work in the revenue loss, it's not based on total revenues and in fact it's not even based on sales tax revenues. It's based on the difference between a hypothetically projected course of revenues under the old system and under the new system.

For example, if in a province you expected the revenues would have grown at 5% a year under the retail sales tax system, we would project that out. Then we came to a common set of assumptions on how the harmonized revenues would grow and we compared the difference between those two. That doesn't even necessarily mean the absolute levels of revenues would fall. The shortfall is measured between what they would have been otherwise and what they'll be under the new system.

Now a different way of doing that would be ex post. I think that's what you were asking. We could have tried to measure what they would have got under the retail sales tax system and compared that to what they actually got. That of course would have necessitated a hypothetical calculation as well because we would never have known what they would have continued to get under their retail sales tax systems. It will have been gone as of April 1, 1997.

That was the way the federal government did it in 1972 when it introduced a major tax reform and gave a revenue guarantee for the provinces. For a five-year period the federal government had to estimate what the provinces would have received if they had kept the old system in place. It was a nightmare. It led to all kinds of court cases and it ended up with a compensation amount that far exceeded what the federal government anticipated, which is why we've done it this way.

It's a calculation made up front. There's no guarantee ex post that it's going to be exactly the right amount of money because we don't know what the retail sales taxes would have given. But it gave certainty for the federal government and it gave certainty for the provinces. So both can plan the harmonization exercise and both can plan their own fiscal exercises. I think it's far superior to the way it was done in 1972 when we tried to do this revenue guarantee mechanism.

The Chairman: Is that it?

Mr. Dhaliwal: My other question was about B.C.'s combined tax rate.

Mr. Watson: Again, following up from what Don was saying, we are looking at moving a provincial sales tax into a value-added tax. That of course is the difference between what the base is comprised of in terms of each province.

In British Columbia's case, at 7% they actually make money. They make about $240 million. So their break-even rate is under 7%. It's around 6.65%. There are two reasons for that. One is that British Columbia's current provincial sales tax base is quite narrow. So broadening that based on a number of products generates a number of revenues.

Another aspect of British Columbia's current provincial sales tax is that about 50% of the revenues British Columbia gets on its provincial sales tax come from taxing business inputs. That would be a reduction when you're moving to a value-added tax. So you have that reduction coming from the move to a value-added tax and you have revenues coming in from broadening the base from quite a narrow one to a broad one.

So at the end British Columbia makes money at 7% and its break-even rate is around 6.65%.

Mr. Dhaliwal: The break-even point under the combined rate is 13.65%.

Mr. Watson: The combined rate, yes.

Mr. Drummond: I'd just like to clarify that and the language you used in the question. That would be a revenue neutral rate, and to the extent there were administrative savings that would be an additional saving to British Columbia.

As Samy was mentioning, a $240-million gain to harmonize at a combined 14% rate would just be what would keep their revenue flow unchanged. As the federal government absorbed the cost of the administration in the province of British Columbia, there would be additional savings to British Columbia. There are additional savings to the Atlantic provinces above and beyond what's in the adjustment formula.

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Mr. Dhaliwal: I want to follow up with Mr. Drummond. Obviously, a lot of assumptions are being made when you come up with this subsidy for the Atlantic provinces. There is a whole bunch of hypotheses. We assume that dropping the rate will stimulate some economic activity, and if it stimulates more activity than you anticipate, shouldn't the subsidy numbers drop or be adjusted so that we're not compensating the Atlantic provinces when they've actually had an increase in stimulants as a result in the drop in the rate?

Mr. Drummond: In theory, yes. In practice that would have embroiled us in a nightmare scenario because there's no way ex post we could have calculated exactly how much of their economic growth came from the harmonization. One of the things in economics is it's easier to make these kinds of calculations ex ante than it is ex post. Suppose that the Atlantic provinces grew by 3.5% in 1998. How would we find out what their growth rate would have been without the harmonization, and how could we go back and change the formula? Would it have been 2.5%? Would it have been 3%?

The Atlantic provinces have made some estimates. They referred to 0.5% to 1%, but it would be very difficult ex post to verify whether those were the right numbers or not.

Again, we've gone to great lengths in this exercise to avoid the type of scenario that developed in 1972 whereby we were constantly having to make estimates over a five-year period. Yes, there probably has been some roughness in the estimates, but at least there's certainty in this process and everybody can get on with their planning. We're not going to have to go back, over a five-year period, constantly checking those assumptions and trying to infer what the counter-factual scenario would have produced.

Mr. Dhaliwal: So regardless of their growth, that won't change the figure. If they have a huge increase and stimulant in the economy, it's not going to affect the subsidy.

Mr. Drummond: No, the combined amounts to the three provinces of $961 million will be paid from the federal government when the detailed memoranda of agreement are signed, and we anticipate that will take place this fall. Those figures will not be revised as the economy develops.

Ms Whelan (Essex - Windsor): I wanted to ask a question for Ontario, based on what you just said about British Columbia. Ontario does not now have its provincial sales tax on business input, does it?

Mr. Watson: Yes. Ontario gets just over 30% of its provincial sales tax revenues from taxing business inputs.

Ms Whelan: So it would lose 30%, which is why the rate would only be revenue neutral. Is that the idea?

Mr. Watson: Yes. Ontario has a base that's a bit broader than British Columbia's, so when you make that transition it can lose about a point.

Ms Whelan: If you run the numbers for 1995, and I'm assuming the numbers are available instead of these estimates...is that how you're doing it? Are you looking at the actual numbers from 1995 - what Ontario got, what the federal government got - to determine what the projections would be?

Mr. Watson: No, what's important is what Ontario gets right now in provincial sales tax and where it gets it from. There are two factors really: how much of it is from business inputs, because with a value-added tax you're going to lose that revenue; and how much revenue you would gain from the base broadening. Those are really the two factors.

Ms Whelan: But you have actual numbers for 1995 to -

Mr. Watson: Yes, for Ontario. I doubt if the 1995 numbers are already in, but it's probably 1994 forecast growth.

Ms Whelan: But we are using actual numbers -

Mr. Watson: Yes.

Ms Whelan: What are the administrative savings for the province of Ontario alone?

Mr. Watson: Ontario, right now, spends about $40 million on the administration of its provincial sales tax. That's the government expenditure. You have to also think of the business expenditure, because business spends money complying with both taxes as well.

Ms Whelan: Does that $40 million include the amount the province pays to business to collect the provincial sales tax?

Mr. Watson: Is that on the vendor points? I believe it is. Is the idea that they pay vendors to collect the tax?

Ms Whelan: What does $40 million work out to as a percentage of the 14%? How does this -

Mr. Watson: No, if I remember the number correctly, Ontario makes about $900 million in provincial sales tax revenues, so $40 million is not a very big percentage.

The Chairman: Are there any further questions, Ms Whelan?

Ms Whelan: Well, I think $40 million is a percentage.... We're talking about revenue neutral, and we talked about the different percentages. I guess the goal is to end up with one rate that reflects the entire country, but I guess my concern is that when we talk about revenue neutral we seem to stick with whole numbers all the time.

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I'll give you an example. In the United States the State of Tennessee has an 8.25% state tax. We always talk in whole numbers in Canada. I'm just wondering if there is any consideration to end up with revenue neutral in exact numbers.

Mr. Watson: Ontario's revenue neutral in exact numbers is 7.13%.

Mr. Drummond: I think your question was whether a province and a harmonized system have to have a whole number as their tax rate. No, they don't, particularly to the degree that you have tax-inclusive pricing, you wouldn't be...I think there would be a problem with 7.13% if it wasn't tax-inclusive pricing. Then you truly would need a calculator as you went around to the cash register. But with a tax-inclusive pricing presumably such a scenario could be accommodated.

The Chairman: Thank you, Mr. Drummond. Ms Chamberlain.

Mrs. Chamberlain (Guelph - Wellington): Because Paul Martin indicated that there are over 100 tax changes in this bill, to make it clear for Ontario as we go through the negotiations in the hope that they would also harmonize, is there going to be some sort of really basic chart put out? For instance, the chartered accountants are endorsing this proposal. But the chartered accountants in my area are asking why there are changes. What's happening? How are we going to do that? I think it has a lot of merit, but I don't think we've sold it particularly well.

Mr. Watson: We've done it in two ways. One is that a notice of ways and means is available to interested parties. There's also a publication that was put out at the time of the announcement called Towards Replacing the Goods and Services Tax, which has more of a layman's explanation of all the changes that were made.

The other thing is Revenue Canada is putting out fact sheets to absolutely all interested individuals in that regard. Anybody affected by it is getting an even more detailed fact sheet in terms of how it impacts on them.

Mrs. Chamberlain: I know this is all very new and we're working through the process, but I really would throw out to you that we need to do more in that regard to have the pressure where it should be, which is at the grassroots level. All the people who would benefit from this tax have to be putting the pressure on all governments of all provinces. That's really the way to do it in my opinion.

The Chairman: I disagree with you, Mrs. Chamberlain. We've done a tremendous job of selling it, because the press support for us in harmonization has been overwhelming.

Mr. Pillitteri.

Mrs. Chamberlain: Well, The Financial Post.

Mr. Pillitteri (Niagara Falls): I remember through consultations some provinces vary on business input costs and the taxation. Will it have any effect on how much compensation it will have on the two remaining provinces that qualify, the provinces of Manitoba and Saskatchewan, in comparison to the Atlantic provinces? If I recall it right, the Province of Saskatchewan did business input costs at somewhere around 60% versus 30% in Ontario. Is that same formula applicable to the Atlantic provinces or the two remaining provinces, or will the payment to Saskatchewan be higher, because they have a higher business tax and therefore they would be losing much more revenue?

Mr. Drummond: The same formula is going to apply to all provinces. In the case of Ontario, as was mentioned, their break-even rate is at 7.13%. They could harmonize it at a 15% rate and not incur any revenue loss. Hence, applying that formula would not kick out any adjustment assistance.

To another province, for example, for Manitoba to harmonize at their current retail sales tax rate would involve some revenue loss. The larger the dependence there was on business inputs and the more services exempted from their retail sales tax, you would get a different balance between those revenue losses. If you were quite dependent on business input taxation, you would tend to have a larger revenue loss and hence the formula would tend to generate a larger number.

In the case of Ontario, and similarly British Columbia, as we mentioned, it could harmonize at its current retail sales tax rate and not incur a revenue loss, so applying the same formula would not generate an adjustment amount from the federal government.

The Chairman: Thanks, Mr. Pillitteri.

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If we were to harmonize with Ontario at a tax neutral rate, say 14.13%, what would be the impact on inflation, i.e. the costs of goods and services including the taxes?

Mr. Drummond: We would anticipate that there would be very little impact. There would be a number of different factors that would wash out and generate in that amount.

A perspective that is sometimes advanced in Ontario and British Columbia is that as we remove the taxation from business inputs, that's an increase of the taxation on consumption. I think it's a basic fallacy involving a misunderstanding on how the incidence of taxes work out. Business is not an entity that absorbs those taxes on them. They of course pass them on to the next level of production and the next level of production cascades those up there. They are being paid at the consumer level right off the bat. So under a harmonized system of value-added tax, you would get a lower price coming from the removal of the taxation of business inputs.

Secondly, and offsetting that somewhat in some provinces, is the fact that you have some services, of course, and to a lesser degree some goods that are not taxed by the retail sales taxes that would become taxed under a harmonized tax system. So you would see some prices moving up, but, on balance, you would tend to see a fairly neutral impact on the price level.

In the Atlantic provinces, of course, you will see a reduction on the price level because there is a third factor there, and that's that the combined tax neutral rate would go down.

The Chairman: So your studies indicate that consumers in Ontario, if we were to harmonize at a tax neutral rate, would not pay more money overall for their goods and services.

Mr. Drummond: Look at it in its simplest form. The consumer bears the entire burden of the sales tax now. Businesses are not absorbing it. They may pass to the consumers under a harmonized system at a revenue neutral rate. It would be at the same amount, and there would be the same amount of revenue coming from the combined federal and provincial taxes, so there would be the same burden on the consumer as the price level would not be expected to change.

The Chairman: Ms Chamberlain is absolutely right. This is not the message that is coming back to us as members of Parliament. Everybody says you're giving business a huge break and you're imposing that tax on consumers, and consumers are going to pay more.

Mr. Drummond: Mr. Chairman, there's a missing link as people tend to think that businesses are absorbing those taxes on their inputs, but they're not; they're passing them through to the consumers right now.

The Chairman: So the consumer will not suffer at all, but as taxpayers we will not have the duplicating systems, we will get rid of the costs of administering one whole system, and we'll have much more competitive businesses because their cost of compliance is much less. They're not taxed on business inputs.

This is a win-win situation. Everybody is regarding it as a zero-sum gain, though.

Mr. Drummond: This was a debate that raged at the time of the replacement of the federal sales tax with the goods and services tax. The federal sales tax was also embedded in the business input prices, and there was a lot of skepticism that business would just take that amount of money to increase profits and not pass it on to consumers.

Certainly, by monitoring the price system after the implementation of the GST - and borne out in the report that the consumer office put out at that time - businesses did in fairly short order pass on those savings to the consumer level. So just as they passed on the savings under the old system and under the retail system, they are passing those tax savings on to the consumer.

The Chairman: Just before we go to Mr. Grubel, we have the blessing of having this room for a little extra time today, and I have no hesitation, but I'm in the hands of members. Would you like to continue some questioning here, particularly since we have officials from eighty zillion departments with us?

[Translation]

Mr. Loubier: Everyone knew that our discussion would last until 11:00 a.m., and that following that, there would be a steering committee meeting. If people did not adjust accordingly, as we did, then you should come back to this provision another time and immediately adjourn the meeting.

The Chairman: Could I let Mr. Grubel have one more question? It will be the last.

Mr. Loubier: Yes, of course.

[English]

The Chairman: Mr. Loubier likes you, so watch out.

Mr. Grubel: I'm so pleased.

Mr. Drummond, the question I have is about the hiding of the tax in the price. Will that take place only in the Atlantic provinces or in all of Canada?

Mr. Drummond: First of all, I really don't think it's hiding of the tax. Hiding of the tax would be if it was tax-inclusive pricing: when you saw a tennis racket that had the tax included in it and you never found out how much tax was in it. That's expressly not the intent of what we're suggesting. The intent is that you will know when you look at the thing on the counter how much it's going to cost, tax inclusive. The consumer deserves that amount of information. But when you pay for it, right on your bill you will find out how much tax you paid. We suggested that would either be in the printing of the rate or it would be the actual amount of the tax you paid.

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As far as I'm concerned, there's nothing hidden. I think that's a much more transparent system than what we have right now.

Second, the pricing mechanism, how the purchase prices are displayed and how the taxes are paid, is a provincial responsibility. The federal government only has that authority in the Northwest Territories and in a few federally regulated industries, so it's entirely at the discretion of the provinces.

In the signing of the MOUs the Atlantic provinces indicated their intention to change their legislation so that there will be the tax-inclusive pricing and the tax burden will be shown on the receipt. Whether other provinces change that or not, in an unharmonized system, is at their discretion.

Mr. Grubel: I'm glad I asked this question. The GST portion of what is being paid in Ontario now will not, when this act comes into effect, be tax-inclusive prices, as required...?

Mr. Drummond: The federal government has no authority to change that. If the Province of Ontario wished to do it, they could do it. We have no indication that they are going to change their system, so I presume it's not changing, but I emphasize that determining how those prices are shown is not in the federal jurisdiction.

Mr. Grubel: Even though the GST is a federal tax?

Mr. Drummond: That's right.

Mr. Grubel: I'd like to come back to what this battle is about. The battle is not so much about the rates and whether consumers will pay more; it is about whether the provinces will give up their right to encourage or discourage certain types of expenditure.

Just this morning I had somebody in my office. It is an amazing thing, but right now in Ontario female sanitary products are not taxed by the sales tax. You can imagine the battle there will be when this is brought in and a necessity like this suddenly carries a 15% tax. That's where the battles will be, and that is not going to be easy to overcome. There are so many special interest groups on that list of products. You should get yourself one. You'd be astounded by how much representation we have had in the two years that I've been here from people who are saying ``Don't you dare touch my specific exemption''. So let's aim that properly.

The Chairman: Mr. Grubel, I recall that the initial position of your party was that we should have expanded the base rather than -

Mr. Grubel: Absolutely -

The Chairman: Okay.

Mr. Grubel: - and I repeat that. But we're not on trial here. This budget is on trial - at the next election.

The Chairman: Thank you.

Mr. Loubier, Mr. Dhaliwal indicated that he wanted one half-second question. Is that okay?

[Translation]

Mr. Loubier: Mr. Chairman, I just want to point out that we are very busy and that our schedule is very tight.

[English]

The Chairman: I'm sorry, Mr. Dhaliwal.

On behalf of all members, I would like to thank Mr. Campbell and the officials he brought from seven or eight different departments for this explanation. We appreciate your cooperation. I know it was very short notice, but we're privileged to have had the opportunity of working with you all.

This meeting is adjourned.

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