Taxing Questions

Over the coming days, we will learn whether U.S. lawmakers have been able to reach a compromise on how best to tackle the federal deficit. Already this week we have seen both President Obama and the Republican Speaker of the House of Representatives, John Boehner, make their respective pitches to Americans.

While all sides agree that spending needs to be curtailed, there are differing views as to by how much and in what areas. That there are differing views on government spending is normal and in fact healthy. We are about to embark on a similar such debate here in Canada.

However, where the divide between the two sides is more pronounced and the debate potentially less healthy is on the question of taxes. More specifically, should taxes be increased to bolster government revenues?

The Democrats would favour some increases as part of what the President has called a balanced approach. The Republicans favour no increases. At all.

This intransigence on the question of taxes, while rooted in the Republican mindset, is becoming further entrenched due to the presence of the Tea Party - a group which is fast becoming the conscience of Republican party. Republican lawmakers have both an eye forward to the 2012 elections and the memories of the 2010 elections, and know that they need the support of the Tea Party.

On or before August 2, we will have a better sense as to how this conflict of views plays out. In the weeks that follow, we will also see how the markets, rating agencies and the public respond.

As we watch this all unfold, it is useful to consider whether there are any lessons for Canada. To date, the discussion as far as Canada is concerned has been about the parallels between what is happening in the U.S. today and what happened in Canada in the 1990s, when we embarked on a deficit reduction program.

To be sure there are useful comparisons that can be made, particularly as it relates to how to implement program cuts. However, the area which interests me and which I think we need to consider more fully in Canada is the question of taxes.

The Conservative Party of Canada does not favour tax increases - quite the opposite. Their long-term focus is on further reducing taxes. This is the mindset that drove the GST cuts, and is the mindset which will further govern how they manage Canada's economy.

There are real similarities here with the Republican position. Unfortunately, in the U.S. this position has over the past three decades effectively taken off of the table one of the major tools available to a government to manage the affairs of state. Pity the politician in the U.S. who openly contemplates a tax increase, regardless of the need it could serve.

Unfortunately, this "stigmatization" of taxes is becoming more and more a part of our political discourse in Canada. We are not far from the point where the merits of a policy initiative or course of action take a back seat to rhetoric on taxes.

When considering any new initiative, costs have to be considered and choices need to be made. One of the choices should be around whether taxes are an appropriate and effective means of funding an initiative. The U.S. has taken this off of the table, which in part has fueled the crisis in which they find themselves.

A lesson for us? We would do ourselves a favour in Canada if we pulled back from the current path we are on, and resist the temptation to take taxes off of the table. Good policy requires a thoughtful consideration of all of the options.

A Royal Mess

In recent days, our papers, tweets and news stories have been filled with the latest surrounding the royal visit to Canada. Well, here in the hallowed halls of A Guy Watching Politics, we decided to get on board with such regal themes - but in our own way.

Now, before any of you monarchists reading this shout "off with his head", I should clarify. When I say "royal mess" I am not referring to the state of our constitutional monarchy. What I am referring to is the global economy; something Canada needs to see stabilize or our deficit reduction plan could get royally...you know.

By now we all know the lines. The recent financial crisis was the worst faced since the Great Depression - true. But Canada fared better than most western countries due in part to the regulatory framework governing its financial institutions - also true.

This is not to say we didn't suffer. A quick look at our deficit and our job loss numbers will illustrate how difficult this was for Canada. Yet while it may have cost us a King's ransom, in the end we came through better than many of our global colleagues.

So what is the danger now?

Recall that we entered the initial crisis in relative good economic health. Yes, we were already running a small deficit, but by and large we were in good shape. The measures taken in the 1990s helped ensure we were able to better withstand the crisis than others with poorer public finances.

However, should the global economy enter into another such crisis, this time arising from sovereign debt in the EU and the US, what tools are left to help us? Interest rates can't be lowered and governments do not have the capacity to take on more debt, as states are running huge deficits.

In 2008-2010, we had monetary and fiscal space within which to act. This is no longer the case - our toolbox isn't empty, but we have used the best tools already. Not just Canada, but everyone.

This in part explains the strong interest in states like Canada and the U.K. to review public spending. Governments need to get back to a stronger financial footing sooner rather than later, in the event that things do not improve. If economic growth cannot be counted on to get you out of deficit, public spending has to be addressed. Sadly, this truism is lacking from our political discourse.

***

So dear reader, when you see yourself getting transfixed by the latest comings and goings of the royal visit, consider the following:

- the global economy is in somewhat of a royal mess;

- we paid a King's ransom in terms of job loss, lowered interest rates and massive injections of government dollars to survive the initial crisis;

- today, governments' ability to withstand a similar such crisis is more limited as they have already used the tools available leaving them in a position in which all the King's horses and all the King's men might be unable to fix the economy again.

All to say, our policy makers face some hard facts and tough choices. What are they doing to prepare Canada and Canadians for what might come our way? This should be a major topic of discussion, but it isn't. This is something on which government should be engaging public opinion. They are not.

I know it isn't always pleasant for a government to seek views and open debate on such controversial topics. However, as the saying goes heavy is the head that wears the Crown...

Checking your winter coat and looking between the cushions

Finance Minister Flaherty tabled his budget this week. As expected, it was essentially the same budget that had been tabled in March, with a few additions and tweaks including the end of the per vote subsidy, and HST compensation for Quebec.

While there were no surprises, the one issue which is sure to generate a great deal of discussion over the next year is the government's objective to cut $4 billion from public sector spending. Note, I did not say the government's plan.

Why? There isn't one. What we have instead is a process that is supposed to identify these cuts, with the plan being presented in the 2012 budget.

Heads-up, you do not find $4 billion between the cushions and in your winter coat. Yet, this is in many respects the tone used by the Finance Minister in response to questions about whether such cuts were possible.

As discussed in this blog many times, the government has taken the following things off of the table when it comes to fighting the deficit:

- no increase to taxes, including the GST
- no cuts in transfers to provinces
- no cuts in transfers to individuals

Add to this the certainty that the government will not be abandoning its crime agenda and the expenditures it will require, and you have the focus squarely turned on a broad basket of government spending. Areas such as the environment, defence, culture and the CBC, foreign affairs, trade, and federally funded social programs are now on the table.

Mr. Flaherty thinks that the $4 billion objective is not ambitious, and in fact is less challenging than what the private sector might set as an objective. I am not sure I agree.

The private sector has as its goal profit maximization. The government does not. What we should expect from government is better efficiency in its operations; in its spending of our money. This does not necessarily mean cuts or the elimination of programs.

Further, the responsibilities of government are broad and varied, and in some cases the weight of those responsibilities trumps questions of cost. This does not mean waste is ok, but it does mean that the cost-benefit model of government is by definition different than that of the private sector.

So what would I like to see? To start, a terms of reference of sorts. I would like to know with more definition what structure and parameters the government has set for this exercise. For example:

- We know the dollar objective in terms of an overall reduction in spending, but what are the criteria against which a program or initiative will be assessed?

- On what basis will decisions be made to reduce or eliminate spending in one area or another?

- Is the sale of government assets on the table? If so, which ones and why does government believe these should no longer be in public hands?

I think we also need to discuss the more long-term "what next?". Say we are successful and through economic growth and targeted cuts we balance the budget. What next? Ask yourself the following:

- Are we well-positioned to deal with the demographic time bomb in front of us (e.g. fewer workers, higher social costs)?

- Are we fiscally equipped to deal with the economic fallout from climate change (e.g. erratic/catastrophic weather)?

- Are we prepared for the shifts already well-underway in global trade, and the growing dominance of countries like China, India and Brazil?

Addressing these issues will require thought, dialogue and money. We are discussing climbing out of a hole, but when we are out there is a mountain in front of us. This should be part of our national dialogue.

By taking options off the table and downplaying the challenges in front of us, we have taken the wholly reasonable question of fiscal responsibility and turned into a discussion on government waste. That won't do.

What do you think?

Let's give them something to talk about...

In line with some of my recent posts about setting the agenda, I found Jeffrey Simpson's piece in today's Globe and Mail to be an excellent read. Entitled "Let's have a mature discussion about public finances", the piece discusses the all-too-often tendency of politicians to avoid discussing the hard challenges we are facing.

http://www.theglobeandmail.com/news/opinions/jeffrey-simpson/lets-have-a-mature-discussion-about-public-finances/article1851297/

Mr. Simpson correctly points out that restoring some measure of balance to our national finances will require Canadians to consider real, difficult choices. Window dressing cuts, such as those recently announced in Ontario regarding "perks" or those announced in Ottawa this last year regarding public service wages, are not going to accomplish anything meaningful.

However, putting these on the table and suggesting that they are meaningful unfortunately takes our focus away from questions about tax policy, health care spending (a BIG ticket item looming for the federal and provincial governments), and how best to enhance productivity.

In a recent post I noted the following: "Put another way, long-term issues require thoughtful consideration, engagement and ultimately hard decisions - decisions which will inevitably anger as many people as they please. In other words, they are fraught with risk for the politician who knows that he or she may be knocking on doors in 6-8 weeks asking for a vote." This is the problem that the election around the corner creates.

The thing is, in today's world problems - including many of the ones we are facing in Canada - do not wait around patiently for us to get our act together. The government that is formed after the next election will, whether they like it or not, be tasked with moving Canada forward. If that's the case, don't you think it would be better if we started talking about it now?

Thoughts?

The $15 billion swing...

On Friday (of course on a Friday), the Department of Finance released Canada's Annual Financial Report for the 2008-2009 fiscal year. Basically, how we did from April 1, 2008 through to March 31, 2009.

In case you were wondering, we did poorly.

At the beginning of the fiscal year, Canada had a budgetary surplus of $9.6 billion. 12 months later, we had a deficit of $5.8 billion. Yes, that's right. National finances suffered a $15.4 billion swing. In the wrong direction.

Now, I don't know about you but if I my household finances suffered a swing of similar proportions, there would be a heck of a conversation looming...

Being a Department of Finance document, there were lots of other statistics - the vast majority of which I won't bore you with (geeks go here: http://www.fin.gc.ca/afr-rfa/2009/afr-rfa09-eng.pdf).

Now, for those concerned about the national debt (i.e. 1 of the 2 people who have commented here), we are still sitting at a comfortable 29% debt-to-GDP ratio. This is one of the numbers I suspect will get bandied about as the government is challenged on the deficit.

It gets at the ability of a country to serve its debt, and by all measures Canada is in good shape (and for that matter in much better shape than other G7 countries). Expect the government to play this up.

But let's go back to our question of the deficit and more importantly how it can be eliminated. As noted in previous blogs, it is unlikely that economic growth will take care of things for the government. Most economists expect this deficit to grow over the next few years until it approaches the $50 billion level. If we believe this needs to be addressed, what's the solution?

I'll put some thoughts down:

• As mentioned in earlier posts, increase the GST. It is consumption oriented and the previous cuts only favoured those who spend more on luxury items. Increase the tax and make sure to carve out those items which are not luxury (key foodstuffs, baby items, books - most of this is already done, but address any remaining items).

• Continue to increase consumption taxes for cigarettes and alcohol.

• Review federal assets, including foreign real estate holdings, to identify savings through divestiture.

Will any of this do the trick? Not any one item. The biggest bang will come from the GST, but I would worry about two things. First, the courage of any government to move on a tax increase. Second, the fact that for all of the spending cuts or revenue increases a government can get in place, there will be a long line of other financial asks waiting in the wings.

What I am trying to say is that the politician who tells you no tax increases is likely wrong. The politician who says no cuts to programs is also wrong. For Canada to get out of this hole the government (whoever is in charge) will need to raise taxes. They will need to cut spending (if only to make room for spending in new areas). It won't be fun, but it will be interesting...

Thoughts?

Uh, we seem to have lost several billion dollars. Has anyone seen them?

Yes, we have a deficit. And yes, it's big and growing. So what should we do?

In answering, I think it is important to consider how we arrived at the current state of affairs. Without question the economic stimulus introduced though Budget 2009 (or Canada's Economic Action Plan if you prefer the marketing approach to government policy) accounts for a lot of the deficit.

But what else? Well, increased government spending pre-economic crisis ranks right up there. Over the past several years, under both Conservative and Liberal governments, federal expenditures have steadily risen.

For a time, this was ok as the economy and government revenues (through taxes) were growing more quickly. The GST alone was bringing in billions each year. Eliminate the deficit - sure! Need a Canada Foundation for Innovation? No problem! Pay down debt? Bingo!

Things were so good, in fact, that in 2006 the decision was made to reduce that cash cow of cash cows. The cuts the Conservatives made to the GST (in two phases) took billions out of the government's coffers.

Ok, fine. So what about spending? Did government adjust for this loss in revenue? In a word, no. Corporate and personal taxes were lowered, thereby reducing revenues further. And overall program spending rose (defence was a big leader), further chipping away at the remaining surplus.

The result was that Canada was close to or more likely in deficit this time last year. Pre-crisis. The ensuing stimulus measures, combined with a sharp reduction in government tax revenue as the economy faltered, then took things to the levels we see today.

I raise this because knowing how we got there should help us figure out how we get out. It's like when you lose your keys. The first thing someone says is, "Well, where did you last see them? Retrace your steps."

In our case, we have "lost" billions. Retracing our steps leads us, from my perspective, to this conclusion. Spending must be lowered and selected taxes must go up.

Ok, that was the easy part. Now for the challenge. What spending gets cut? What tax gets raised?

For me, returning the GST to pre-2006 levels - while not a political winner - may be the route to go. I would not be surprised if at some point the Liberals float this one to see how it plays.

On spending, the winding down of the stimulus measures will help. However, there are big ticket items out there including a new spending accord with the provinces on health care. You think saving GM and Chrysler were expensive, try health care on for size.

Then you have the Liberals, who having moved away from the green shift are now looking to invest heavily in a green economy. That can't be done on the cheap.

I raise this because for every expense that is cut, there are 5 new unfunded ideas lining up and needing money to get them going. That isn't to say they aren't good ideas or the right things to do. It's just that they are expensive and money will be tight.

This is the challenge facing anyone who wants to be PM and form a government. Still want the job, Mr. Ignatieff?

And in this corner, coming in at tens of billions dollars, we have the deficit....

The deficit will be HUGE. I don't mean big when compared to recent years. I mean big when compared to some of those beasts we learned to despise in the mid- to late-90s. Put another way, we have not slipped into the red...we have plunged into it.

Over the next day or so, I want to talk about this change in our financial situation. Some points to consider:

• How did this occur? Is it all because of the stimulus measures (i.e. Canada's Economic Action Plan), or did things like pre-crisis government spending and tax cuts contribute to this?
• How bad is the situation?
• How can we get out of it?

This last bullet is important to me. The plan to eliminate the deficit will ultimately reflect views on the role of government. For many economists, expecting pure economic growth (and resulting tax revenues) to put Canada back in the black is not reasonable. If they are right, it comes down to choices.

• Should government spend less? If so, where?
• Should government tax more? If so, where?

Our political leaders do not really want to discuss either option, for fear of attack and a drop in support. Why alienate voters now?

Well, this voter would prefer to know heading into an election what the plan is and we will get there.

What about you? Views, thoughts? Let me know...

Dear Canada, you're not as rich as you think

Earlier today the Minister of Finance, Jim Flaherty, let us know that (a) we will be in deficit longer than expected and (b) that our deficits are going to be much higher than expected. Not to worry, as there is a plan (not shared) to get us out. That plan will apparently not involve cuts to individual transfers (OAP, for example) or higher taxes.

So what will it involve? That old favourite, cuts to government spending. Now government spending as been increasing for some time and there are big ticket bills yet to come (e.g. a new health care accord with the provinces). So what is left that hasn't been looked at through several years of various spending reviews? And what savings are truly out there without introducing cuts to services?

This is the sort of topic that I hope the other parties will pursue. In the same way they will be challenged (accused?) on tax increases, they should be challenging the government on where it wants to cut spending.

The size of the deficit presents an opportunity for parties to present their views on how to address it. As voters, we should take the time to consider these different plans as, like it or not, deficits will be with us for some time. This should be part of our public discourse over the foreseeable future. We'll see.