Reform Party Views on the Finance Committee Pre-Budget Hearings,
Fall 1996, submitted as an appendix to the document
"The 1997
Budget and Beyond: Finish the Job"
1. Process
Reformers regret the decline in the number and variety of submissions made during the Finance Committee hearings relative to those received in preceding years. Comments by witnesses suggest that the reduced interest in the hearings is due to growing cynicism about the extent to which the Government paid attention to the testimony in the design of its policies. We recommend that the Government consider carefully the causes of this decreasing interest and how to deal with it.
We also noticed that some of Canada's most influential, independent think-tanks like the Fraser Institute, the CD Howe Institute and the Atlantic Institute and public interest organizations like the Canadian Taxpayers' Association did not present testimony. We believe that these organizations represent a valuable national resource that should be used extensively in the public consultation process, especially as it concerns highly technical matters of finance, economics and policy trade-offs, which special interest groups are much less likely to introduce into the deliberations.
There has been a lack of what might be called "average Canadians" to provide their input during the hearings. Finding such individuals is difficult. Therefore, we suggest that thought be given to the possibility of using a random process for identifying and inviting them. One such process might be selecting names from a telephone book and settling on one or two persons willing and able to participate in the process, after appropriate briefing and some help from staff.
2. Macro Policies - The Record
Reformers do not share the report's rosy view of the Government's fiscal plan and record. Deficit targets were set too low and resulted in unnecessary additions to the federal debt worth about $115 billion. In addition, some important shortcomings of the Government's fiscal record should be noted.
First, the burden of deficit reduction fell overwhelmingly on taxpayers. By the end of this mandate, revenue gains of about $25 billion will have accounted for more than half of the total reduction in the deficit. There were at least 35 separate increases in taxation rates, accounting for about a quarter of these revenue gains.
Down loading of the burden of adjustment onto the provinces accounted for another $7 billion in the reduction of the deficit. The federal Government trimmed its own bureaucracy through cuts to departmental spending by a mere $11 billion.
Finally, it should be noted that most of the bettering of targets was due to dramatic falls in interest rates in the U.S. and elsewhere. The Liberal Government cannot claim responsibility for these reductions in the cost of servicing the debt. The narrowing of the spread between U.S. and Canadian interest rates in recent months reflects increased confidence in Canadian fiscal policies, but if the Government had been more forceful in its deficit fight, these lower risk premiums on interest rates could have come into effect much earlier.
3. Fiscal Projections
The report notes that very soon the deficit will be so low that the federal Government's borrowing requirements will be zero. This achievement involves something of a shell-game. Future generations who have to service the debt will find no solace in the fact that part of their high taxes go to pay off loans the Government obtained from employee and CPP pension funds, rather than the general public. They are stuck with annual interest payments that are only a function of the size of the debt.
The most important short-coming of the projections is that they do not include a major fiscal surplus and a significant reduction in the debt to GDP ratio. The projection of a surplus would have permitted the promise of a tax cut and first installments on the reduction of the overwhelmingly large debt. All this would have been possible if the Government had been more aggressive in its spending cuts in past and the upcoming budgets, perhaps in the way Reform alternative budgets had proposed.
Tax cuts would have created an atmosphere encouraging consumers to spend more. Such spending would have put the economic recovery on a healthier path of expansion and reduced its overwhelming reliance on exports in the growth of aggregate demand.
A start to the process of paying down the debt and reducing the debt-to-GDP ratio more aggressively would have produced a virtuous cycle of lower debt-service costs and increasingly more room for tax cuts. It also would have raised the confidence of investors in the Government's fiscal policy, leading to still lower interest costs.
Most important, paying down the debt would have provided a cushion against the shock of an economic down-turn. Such a down-turn is inevitable. No economic expansion in history has lasted for ever. The Government should have made more serious efforts to protect its fiscal performance and the development of the debt to GDP ratio against this event.
4. Taxes and Spending
The tax reductions suggested in the report address important economic and social issues. Reform agrees in particular with the desirability of tax cuts that would encourage donations to charitable causes and improve the lot of the poor, low-income families with children and the handicapped. The latter problems have been addressed also in Reform's Fresh Start budget proposals.
However, the Government's suggestions for tax reductions and new spending initiatives suffer from the fact that they are made while the deficit is still large and the debt is still growing. Unexpected surpluses due to overshooting of deficit targets should be used to move to a zero deficit more quickly, not to add to the burden on future generations.
Reform does not support the proposed renewal of the Infrastructure Program, even at a smaller scale than the $6 billion of the first one. In his most recent report, the Auditor General is quite critical of the success of the Infrastructure Program. Reform shares this view. The jobs created by the first program were temporary and claims for the number of new jobs was exaggerated because much of the spending went for projects that would have been carried out anyway. A renewed Infrastructure Program cannot be defended on economic and financial grounds. It is a transparent political ploy.
5. More Government, No Tax Cuts
The Government relied heavily on increased tax revenues of $25 billion to reduce the deficit. As a result, the after-tax income of the average Canadian family is about $3,000 per year lower in 1996 than it was in 1993. This fall in real income per family could have been smaller if the Government had cut its spending more aggressively, as Reform had suggested in its alternative budgets.
In about two or three years the Liberals will balance the budget, probably relying on growth in tax revenue much as they did in the preceding three years. Reform is concerned with the further decreases in after-tax family income which this policy will have. In addition there is the concern that thereafter increases in tax revenue will again be used to increase spending and the size of government. The Report's suggests that the extra moneys due to the better-than expected performance of the economy in recent quarters should be used to increase spending. This recommendation shows that our concerns are well founded. We are equally concerned by announcements of some Ministers like Sheila Copps that she has a number of spending initiatives ready to go once the deficit has been eliminated.
The selective tax-cuts proposed in the report also indicate the continued tendency of the Liberal Government to micro-manage economic and social conditions in Canada. These recommendations suggest that Liberals continue to be out of touch with developments in Canada and around the world. People have experienced the heavy hand of government in their lives and did not like it. They want Government to limit itself to the creation of an economic environment for private initiative to flourish and the maintenance of a basic social security net to help those who cannot help themselves.
Reform offers to establish such a role for government. We would maintain the basic social programs like OAS, EI and CPP. At the same time, we would encourage the further expansion of private charity. For this reason we support strongly the report's suggestions for permitting the tax-free donation to charity of appreciated capital assets.
6. Employment Insurance Premiums
The Report outlines the Government's reductions in EI premiums. In the light of the rate at which the EI system's deficits have been eliminated and surpluses have accumulated, these cuts are token. Needed are substantial cuts that would limit the EI reserves to about $5 billion, which will be achieved by the end of 1997. There may be room for larger reserves, but in the absence of a careful analysis about the exact target for such a reserve, $5 billion appears reasonable in the light of deficits during preceding downturns in economic activity.
The maintenance of EI premiums at unnecessarily high levels has a number of short-comings. First, jobs are killed because the mandated premiums add to the cost of labour. As a result, many firms cannot afford to hire labour. Second, the tax is regressive because the rates on total income paid by high-income earners is lower than that paid by those with low incomes. Third, the tax is on labour income alone and is used to reduce a general deficit. Taxes on business, sales, capital gains and other personal income should be used to eliminate this general deficit. Finally, when there is an economic down-turn in the future, the Government will suffer not only a reduction in income, it will also be required to support the EI system in deficit by drawing down the reserves. Keeping the general deficit under control during a down-turn will be so much more difficult.
7. Unemployment and Employment
The report presented the Government's record of job-creation and unemployment. However carefully the words were chosen in this section, they could not hide a dismal record of achievement. The growth in employment barely kept pace with the increase in population, natural and through immigration.
The Government pins much hope on the job-creating effect of lower interest rates. We hope that these expectations will be met for the sake of the large number of Canadians seeking work and ready to enter the labour force. Needed will be a prolonged period of low interest rates and a willingness of people to borrow and spend more. They are more likely to do the latter if income growth lowers the relative size of the debt they carry. This fact makes income-raising tax cuts even more important in the restoration of genuine prosperity. We see nothing in the fiscal plan in this report encouraging on this account.
8. Labour Market Adjustments
The report discusses the testimony by Ian Sharpe concerning the explanations of some economists of the puzzling difference in the unemployment rates of Canada and the US. This difference in recent quarters was 5 percentage points and made the Canadian rate of 10 per cent double that of the U.S.
Sharpe explained that nearly 50 per cent of this gap was due differences in macro-economic developments in the two countries. We disagree with this conclusion since in recent years macro-economic determinants of employment were very similar in the two countries. Deficits as a percentage of national income were nearly the same. Interest differences encouraged U.S. more than Canadian growth, but on the other hand Canadian export surpluses as a percent of national income were much greater than those in the U.S.
Sharpe also attributed about a quarter of the gap in unemployment rates to differences in the measurement of unemployment and rates of immigration. According to his interpretation, only a quarter of the gap, like a residual, was due to differences in government policies affecting the operation of labour markets.
In the light of our views on the similarity of aggregate demand conditions, we attribute much more than a quarter of the unemployment gap to such differences in labour market policies. In this conclusion we are supported by recent publications of the OECD, most recently the annual report on Canada. These studies blame Canada's high unemployment rate on such policies as high marginal tax rates on income, generous unemployment and welfare benefits, minimum wages, other labour market regulations and unionization.
Canada may wish to retain the generosity of these programs alleged to be responsible for the high unemployment rates relative to those in the U.S. However, we consider it unfortunate that the report has chosen not to call for more detailed studies of these policies, if only to explain their role more carefully and to start a public dialogue about the undoubted trade-off between unemployment and the generosity of the social programs.
9. Miscellaneous Recommendations
a. Reform supports the views of merchants in the Atlantic provinces who have demanded that the tax-in pricing provisions of the Expanded Sales Tax be suspended until the introduction of a genuine National Sales Tax. They presented persuasive evidence of the extra cost imposed upon them by the need to switch computer systems, keep separate inventories, delivery systems and catalogues and to give up the opportunity to shift merchandise among different warehouses. If the GST is not eliminated, as the Liberals had promised they would, integration of the provincial sales taxes and the GST and tax-in pricing are desirable in principle and Reform has supported this policy. However, we agree with the merchants that tax-in pricing makes no economic sense in only a limited territory of Canada.
b. Reform supports demands for the elimination of the 10 per cent luxury tax on jewellery and watches. This tax is not equitable since there are many other luxury goods that are not burdened with it. One may question whether in this time and age jewellery and watches in fact are still a "luxury". We also believe that the elimination of this tax would not reduce total revenue to the Government, primarily because it would discourage the underground economy and smuggling. Lower returns to these illegal activities surely would discourage them, much like they did very successfully in other cases in history when luxury taxes were eliminated.
c. Reform shares the concern of the Insurance Bureau of Canada that an almost certain future natural catastrophy, like an earthquake in a densely populated area, will leave the insurance industry without the reserves needed to deal with its very high costs. We therefore support the industry's request that the Government permit it to create such a reserve by setting aside annually a sum of earned premium income before income taxes are paid on it. The annual losses in tax revenues for the Government would be small but the benefits of the reserve would be very great for all Canadians.
d. Reform shares the concerns of different regulated industries which in recent years have faced increasing burdens from fees imposed by the Government. We agree with the industries that such cost-recovery schemes are desirable but that they should have a role in administering them. In particular, the industries should have a right to replace bureaucratic procedures and personnel management styles with some more appropriate for the private sector.