FINA Committee Report

Official Opposition Supplementary Report

The Official Opposition concurs in the pre-budget report of the House of Commons Standing Committee on Finance, “Securing the Future”. The Report emphasises that the federal government must make national security its top priority. Toward that end the Report recommends enhanced security spending, something that the Canadian Alliance has long advocated.

The Report reiterates the need for sustained fiscal discipline. This can be accomplished by limiting program-spending growth to the sum of inflation and population growth, and by adopting a permanent program review process to reallocate funds from low and falling priorities to areas of increasing priority. Controlling spending can make room for deeper tax relief and debt reduction and engender a more innovative and competitive economy.

While many of the Report’s recommendations are consistent with the theme of fiscal responsibility, it neglects a number of critical issues. Despite its length, the Report does not adequately address Canada’s long-term economic decline, and makes few recommendations to remedy the situation. We must not allow the urgent need for new security resources and the onset of a recession to lure Canada back into economic complacency. Even after implementing the announced tax changes, Canada will still have the highest personal income and corporate tax burdens in the G-7. We still have the second highest debt to GDP burden in the G-7, and we expend almost 25% of our budget just to cover debt interest costs. These factors have contributed to the declines in our standard of living, competitiveness and currency.

In order to address the importance of several recommendations and highlight areas that have been omitted from the Report, the Official Opposition will concur with the Report and offer this Supplementary Report.

The Official Opposition’s Supplementary Report will address the following:

• Canada’s Long-Term Economic Decline;
• The Deficit of Resources for Defence and National Security;
• The Imperative of Spending Restraint;
• The Need for Vigilance in Debt Reduction; and
• The Importance of Tax Reform and Tax Relief.

Canada’s Long-Term Economic Decline

“The 1990s will always stand out as the poorest decade since the 1930s”

Canadian Chamber of Commerceⁱ

Many commentators have referred to the 1990s as the “Decade of Drift” due to the stagnant standard of living of Canadians. The federal government raised taxes over 63 times since 1993, while simultaneously slashing health transfers to provinces and the military. As a percentage of the U.S. standard of living, Canada has fallen to 70% in 2000 from almost 80% a decade ago.ⁱⁱ

Canada’s onerous tax and regulatory burdens have reduced our competitiveness. We continue to bring up the rear in too many areas such as productivity growth and personal disposable income. In comparison to the United States our productivity has actually fallen to only 79% from 85% a decade ago. The clearest evidence of this decline is reflected in the value of our currency.

The dollar was 77 cents US in 1993, but recently hit a record low of 62.37 cents, a 20% decline. Not only has our currency fallen against the U.S. dollar, but the Bank of Canada’s most recent Monetary Policy Report has also revealed that it has plunged over 20% since 1992 against a basket of six major currencies including the Yen, Euro, U.K. pound, and Swiss franc. Even the Mexican peso has recently faired better than the dollar. While the government has been trumpeting its success, our currency has never been so weak; the Loonie hit five record lows in November. Reversing the downward trend in our standard of living, productivity, and currency is only possible if we get our fiscal priorities straight and the basic economic fundamentals right through aggressive reductions in our tax and debt burden, plus regulatory reform.

A recent study by TD Canada Trust’s Chief Economist Don Drummond echoed this conclusion saying:

“… there are fiscal policy options that could provide support to the Canadian dollar – and these policies are all the more attractive because they would also promote higher long-term growth.”

Security Deficit

Although the Department of National Defence has seen its funding shrink by 30% in real terms since 1993, there is still no concrete plan of action to restore our military capabilities. The result of the defence deficit has been that Canada has not been able to vigorously contribute to the military aspects of the War on Terrorism. For example, after agreeing to put 1000 troops on 48-hour stand-by, the Canadian military still has a minimal ability to get its troops and equipment across the globe expeditiously.

The Report’s recommendations on defence do not go far enough. The most prominent recommendation calls for fast-tracking the review of the 1994 White Paper and for increased capital spending. The Official Opposition advocates immediate and significant new resources for our military. The departmental budget should be increased by $2 billion from the current level. Over time, Canada should aim to increase its spending on the military from its current level of approximately 1.1% of GDP to the NATO average of 2.2% of GDP.

We are encouraged that the Committee recognizes the link between the free flow of trade between Canada and the United States and improved national security. The Report presents a number of useful recommendations and observations including additional resources for the RCMP and CSIS, increased investment in trade infrastructure, and the development of a North American security perimeter.

Spending Restraint

Although this Report, like ones previous, has called for fiscal discipline, the federal government has actually increased spending drastically over the past few years. Last year, for example, program spending was up by 6.8%, more than double the rate of inflation and population growth. The federal government has exceeded its own planned spending target by over $13.7 billion since 1997.

Spending restraint was a consistent theme advanced by witnesses during the Pre-Budget hearings. David Paterson, Executive Director for Canadian Advanced Technology Alliance (CATA) eloquently summarized the attitude of the business community in Canada when he told the committee:

“We believe that the challenges that face us can be met without a major boost in government spending, without damaging Canada’s fiscal integrity. Increased spending on security is essential, but we believe it can be offset by reduced spending on less important programs. New initiatives can be postponed until a budget surplus has been restored to a more adequate level.”

Although the Report reaffirms the need to direct funds into high priority areas, there are few areas highlighted where spending reductions could occur. We believe that one obvious low priority area is corporate welfare and therefore conclude that the Industry Minister’s proposed multibillion-dollar Internet scheme should be rejected, particularly when areas like defence are severely under-funded. We would also look for significant savings in transfers to Crown Corporations, and by eliminating regional employment programs.

Even without reallocation of spending, a cumulative $50 billion would be available for further tax relief and debt reduction over the next five years if government spending was limited to the rate of population and inflation growth (about 3% p.a.) rather than the currently forecasted 5% p.a. increase.

Section 1.11 of the Report notes that past Committee reports have recommended that the government strive to limit expenditure growth to inflation plus population growth. It is very unfortunate that this pre-budget Report does not reiterate the past recommendation. However, we endorse the language in Section 1.9 stating that cutbacks in low and falling priority areas should be undertaken to finance high priority requirements.

Debt Reduction

Although the Report clearly calls for balanced budgets, and the need to reduce low priority spending to achieve that objective if necessary, there is limited reference to the long-term economic priority of public debt reduction.

We believe that another important reason to restrain overall spending is to accelerate debt repayment. Reducing our debt results in a permanent fiscal dividend, which can be used for strategic investments in other areas, like defence or healthcare, and future tax relief. Therefore, we support the Report’s recommendation that the federal government sell its remaining minority stake in Petro-Canada. We believe that this recommendation should be expanded to include the sale of the federal government’s working interest in the Hibernia oil field. The proceeds of these measures would reduce the debt by about $2.5 billion.

Tax Reform and Relief

The Federal government can accelerate tax cuts, maintain a balanced budget and increase spending in key security areas only if it eliminates wasteful spending and reallocates funds from low and falling priority areas.

While we support the Report’s recommendation to continue the process of tax changes, we take issue with the assertion that the amount of tax cuts equals $100 billion cumulatively. In fact, actual tax relief is less than half than the amount advertised in the Report. What matters is money in the pockets of Canadians. Over the same period as the government tax plan, CPP premiums are scheduled to increase by about $30 billion. Thus, the CPP increase alone reduces the net tax cut by 30%. Furthermore, the government counts indexation as a tax reduction when in fact it is simply a cancellation of $21 billion in future tax increases. And, strangely enough, the government methodology considers the almost $8 billion expenditure increase of Canada Child Tax Benefit as a tax cut. The Auditor General, Statistics Canada and economists in general consider the CCTB to be spending program. After accounting for these items the Liberal tax plan is less than $43 billion over five years, or about 67% less than advertised.

Under current government spending projections we anticipate an underlying budget surplus of up to $9 billion for this year alone and an additional $30 billion over the next 5 years. The government has more than adequate fiscal capacity to accelerate targeted tax cuts, particularly if spending growth is restrained.

Employment Insurance Premiums

Employment Insurance (EI) premiums constitute a job killing tax that disproportionately affects low-income Canadians. They must be reduced as quickly as possible. Even though EI premiums are slowly being lowered, payroll taxes (EI premiums and CPP) continue to rise every year and will increase by approximately $1.5 billion next year. Unfortunately for taxpayers, EI premium reductions are being more than offset by rising CPP contributions.

We concur with the Report that EI premiums should be reduced to a break-even level and further recommend that the EI program be fundamentally reformed as a stand-alone insurance-based system. The cumulative EI surplus was $36-billion as of March 31st of this year, more than double the financial requirement for benefit payments in even the most severe downturn. Reforming EI into an insurance-based system, with contributions based on actuarial principles, would result in significant savings for both businesses and workers, and would stimulate employment.

Capital Taxes

We strongly agree that capital tax is a direct tax on innovation, and therefore support the Report’s recommendation that it be eliminated. The elimination of the capital tax is affordable, sensible and timely, and should be acted upon immediately.

The recommendation makes reference to harmonization with provincial governments on the subject of capital taxes. We believe that the federal government needs to take leadership on this issue and commit to reduce its rate unilaterally. In the name of fiscal prudence we are willing to see it phased in over a number of years, beginning with a significant reduction for next year.

Resource Taxation and Regulation

Perhaps one of the most troubling elements of the Report is it failure to address the various tax, regulatory and environmental issues faced by the resource sector. While the Report calls for an extension of spending for the Canadian Film Fund and supports special tax incentives for the Canadian film and production industry, it entirely neglects the concerns of the resource sector.

We are calling for tax fairness for the resource sector. Specifically, we believe that the announced reductions in corporate tax rates to 21% should apply equally to the resource sector. Furthermore, we remain deeply concerned that the Report fails to address the financial impact of the Kyoto Protocol on the resource sector, and our economy as a whole. The oil and gas and mining industries, alone, account for almost $100 billion in production and over 350,000 jobs in Canada. The cost of compliance with Kyoto is estimated to be between 1.5% and 10% of GDP, or a staggering $15 to $100 billion.

We believe that we should only ratify Kyoto if the following conditions are met:

• Participation from the United States and Mexico;
• Inclusion of clean-energy export credits within the protocol;
• Provincial consent; and
• Parliamentary approval.

Tax and Regulatory Issues Related to Venture Capital

The importance of venture capital in a healthy and vibrant economy cannot be understated. The Official Opposition believes that through tax and regulatory reform significant progress can be made in fostering capital formation in Canada for the benefit of entrepreneurs and the economy as a whole.

The current regulatory regime has deficiencies, which restrict both domestic and foreign investment in typical venture capital vehicles. For example, investments by Canadian pension funds and other large passive investors in certain types of vehicles are included as foreign property holdings, regardless of the fact that the investments are domestic. This illogical policy clearly hinders venture investment and can be easily remedied. We urge the government to make the necessary regulatory change to correct this situation immediately.

Additionally, Canada taxes capital gains realized by foreign investors, creating a tax regime which contrasts negatively with those of other countries including the United States. This is a major issue for passive non-taxable entities such as pension and endowment funds and therefore we support the recommendation of the Canadian Venture Capital Association that taxes on capital gains realized by foreign investors be eliminated.

Conclusion

The Official Opposition believes that along with strategic investments in national security and our military, tax reform and tax relief must remain a top priority. We concur with the Report that a return to budget deficits is not an option and that the federal government must exercise fiscal restraint and fund increased spending needs from off-setting reductions in low and falling priority areas. The measures initiated by the government to date do not go nearly far enough in arresting the declines in our currency, standard of living and competitiveness. The Official Opposition believes that we can not afford to miss the current opportunity to set our fundamentals right to improve economic security for all Canadians.