A credible budget will have to include tax increases

TheGlobeandMail.com – Opinions – A credible budget will have to include tax increases: Hoping for the best is not an option when dealing with deficit

Published on Monday, Dec. 14, 2009. Last updated on Tuesday, Dec. 15, 2009.   C. Scott Clark and Peter DeVries

The Minister of Finance has once again repeated what he and the Prime Minister have said many times before: They’ll never raise taxes or cut transfers to provinces or to individuals to balance the budget. Instead, they will rely on economic growth – and if this is not enough, they’ll cut “other programs.” In other words, they’ll hope for the best.

A federal deficit is something that can’t be wished away, and if Canada continues its course, we’ll have a heavy one to carry. The Parliamentary Budget Officer estimates that by 2013-14, the government will have a deficit of $19-billion, and it could reach $26-billion if the economy performs worse than assumed. More important, the PBO has concluded, the deficit has a significant structural component equal to about 1 per cent of GDP. Without cutting spending or raising taxes, the deficit won’t go away.

It’s not surprising there’s a structural deficit. The potential growth of the economy will decline dramatically in the coming years, significantly restraining the growth of government revenues. Both Liberal and Conservative governments, meanwhile, have cut taxes dramatically over the past nine years, while increasing spending. The Conservative government alone has cut taxes by more than $100-billion since the 2006 budget. The cuts in the GST have cost the federal treasury $12-billion a year.

The Minister of Finance seems determined to close his eyes and hope things improve. The last federal budget contained a five-year forecast showing that, by 2013-14, the budget would be in surplus. In September, this was revised to a deficit of just over $11-billion. The only certain thing about a five-year forecast is that it will be wrong.

The coming budget must address the structural deficit. Moreover, the global and domestic economies will not behave nicely, and there will be unexpected policy pressures. The budget, therefore, should include a contingency reserve of 0.5 per cent of GDP. In total, the budget would need to find about $30-billion by 2014-15.

Measures should be phased in, so as not to threaten the early years of recovery. Indeed, a credible budget, one that would eliminate the deficit, pay down debt and allow for policy and economic uncertainties, would create confidence and reduce risk premiums on long-term bonds. This would strengthen investment and the recovery.

Can cutting “other programs” find $30-billion of savings? Excluding major transfers to other levels of government and individuals eliminates more than half of total program spending from restraint. Cutting spending on agriculture, aboriginals, international assistance, research, student assistance, certain Crown agencies and defence would be extremely difficult, given existing pressures.

Based on our experience, we estimate that the amount of program expenses that realistically could be subject to restraint is $55-billion, or 25 per cent of total program expenses. A 5-per-cent reduction to this base should be achievable but would yield under $3-billion in annual savings.

Any credible budget will have to include tax increases. The answer lies in taxing consumption. Simply phasing in a two-percentage-point increase in the GST would eliminate most of the structural deficit. This could be combined with an increase in the high-income tax rate, resulting in a more progressive tax system.

On the corporate side, our tax rate is already below the U.S. rate. It would be reasonable to freeze the corporate tax rate at 18 per cent. Finally, the number of “special interest” tax credits introduced since the 2006 budget should be re-evaluated.

This budget would eliminate the structural deficit and begin to pay down the federal debt. Program expenses and federal tax revenues, as a share of the economy, would remain well below their historical averages. The income tax system would be more progressive and supportive of economic growth.

We believe that the principles of realism, responsibility and prudence that underlie our budget should be used to judge the credibility of the government’s coming budget.

The Prime Minister and the Minister of Finance are right to point out how much better Canada’s financial situation is than in other G7 countries. But they must not forget that we didn’t get to be the best by hoping for the best.

C. Scott Clark served as associate deputy minister of finance (1994-1997) and deputy minister of finance (1997-2000). Peter DeVries was director of fiscal policy (1990-2005) at the Department of Finance.

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