FINA Committee Meeting

STANDING COMMITTEE ON FINANCE

COMITÉ PERMANENT DES FINANCES

EVIDENCE

[Recorded by Electronic Apparatus]

Thursday, April 29, 1999

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[English]

The Chairman (Mr. Maurizio Bevilacqua (Vaughan—King—Aurora, Lib.)): I would like to call the meeting to order and welcome everyone here this afternoon.

As you know, the finance committee is doing a study on productivity. This afternoon we have the pleasure to have with us a number of experts on this particular issue. Mr. Mike McCracken, CEO and chairman of Informetrica, welcome. Dr. Jonathan Kesselman, economist for the University of British Columbia, welcome again; you were here yesterday. And welcome to Mr. Fred McMahon, senior policy analyst, Atlantic Institute for Market Studies.

We will begin with Dr. Kesselman. As you know, you have approximately five to ten minutes to make your presentation and thereafter we'll engage in a question and answer session.

Once again, welcome. You may begin.

Dr. Jonathan R. Kesselman (University of British Columbia): Thank you.

I would like to talk about the relation between taxation policies and productivity. If we were to draw up a list of factors that determine an economy's productivity and living standards and then eliminate from that list those items not directly subject to policy control, what would we be left with? A very short list. There would be regulatory policies and labour market policies, and certainly taxation policies would be on any short list and is a very important item.

I should stress at the outset, though, that I don't see tax policy as being a panacea for any problems with the economy's productivity. Certainly it's a multi-factor phenomenon, but taxes are important. Business taxes certainly are part of the issues we would have to examine in a productivity forum. Last year's report of the technical committee on business taxation, the so-called Mintz committee, offered many constructive recommendations, all of them of course within the committee's mandate of revenue-neutral proposals.

In today's fiscal environment I would suggest that business tax cuts are a valid and deserving area for spending some of the surplus. Among the Mintz committee's many recommendations that are relevant to the productivity goal, I would highlight two. First, cut the general corporate tax rate for firms that are not in the manufacturing, processing, and resource sectors, which already enjoy lower rates. These other omitted sectors, many of the service sectors, software, and lots of high-tech and biotechnology certainly do need the lower rates we've been giving for a number of years in the manufacturing and resource sectors.

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The second item I'd highlight from the Minsk committee would be to make the employers' premiums for employment insurance experience-rated. That would mean that the more stable firms and sectors would no longer be forced to cross-subsidize firms and sectors with unstable employment patterns. While business taxes do require some attention, the personal tax should be, in my mind, the centrepiece for the taxation component of productivity strategy.

Of course the ultimate goal of raising productivity is to raise the real living standards of Canadians. A simplistic but popular view is that we need personal tax cuts simply to allow Canadians to keep more of their gross earnings. Undeniably that would raise people's spendable private consumption, but the personal tax changes must be designed to achieve much more than quick tax relief.

Personal tax reform should aim to enhance three things: in the short run, economic efficiency, which is how well resources are allocated; in the medium run, expansion of employment; and in the long run productivity growth. All of these outcomes will improve real living standards of Canadians.

In fashioning policies for personal tax, a key issue is rate cuts versus base reforms. What are their relative priorities? The most popular discussion of the personal tax in Canada focuses on rate cuts alone. Here I will argue that base reforms are more important to augment productivity growth, although rate cuts will play some role. My analysis and recommendations here are based on a paper, which I've already made available to the committee, currently being revised for publication in the journal of the Canadian Tax Foundation.

As background to this policy exercise, we need to do a brief review of what is known about tax policies and the economic performance of nations.

First, careful statistical analyses using cross-national data find no systematic relation between the size of government or total tax burdens and real rates of economic growth. This of course runs contrary to common wisdom that heavier taxation impedes growth.

Second, examination of the raw figures shows that some of the more heavily taxed countries of continental Europe have produced superior productivity growth to that of the U.S. or Canada. So do higher taxes actually promote growth? I wouldn't think that's necessarily a proper inference. A closer examination of the tax structures of the various countries reveals that the European countries use taxes much more heavily based on consumption, such as value-added taxes like our GST, and labour income, such as payroll taxes for social security types of programs. And they rely much less on capital income-based taxes than Canada or the U.S.

Third, in reviewing this evidence we obtained further confirmation of this view from a growing body of theoretical economic research that compares the efficiency and growth attributes of various tax bases. They find a consumption-based tax to be most favourable to the growth of productivity and living standards, followed closely by a tax base of labour income or payrolls. Lagging substantially in this respect is a tax base of total income that is labour plus capital income, and by far the worst is a tax base of capital income alone.

The economic reasons for these findings are complex, but one commonsense explanation is that taxing capital income or taxing savings reduces the rate of investment. With a smaller capital stock in the long run, total output is lower and so are the productivity and real wages of each worker. By shifting the personal tax base toward consumption and away from income, we can achieve these long-run benefits.

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So what is the base of our existing personal tax, which by convention we call a personal income tax? In fact, for more than 90% of Canadians it is much closer to being a tax on consumption rather than income. There are two reasons for this. One is the deductibility of savings for employer-based registered pension plans and individual RRSPs, with an annual ceiling of $13,500 per worker and 18% of earnings. This means that workers earning up to $75,000 per annum can shelter all of their capital income from tax if they wish. And the second feature is exempting from tax capital gains on homes, the other principal means of saving for most Canadians.

The 10% or less of Canadians at the high end are constrained by the contribution limits to registered savings plans. They are in effect taxed on any additional savings and the associated capital incomes in the form of interest, dividends, and capital gains. As a result, the personal tax in Canada is, as I've said, a consumption-based tax for more than 90% of our people and an income-based tax for the others. But this latter relatively small group accounts for a disproportionately large share of all savings and investment in our economy. In view of the findings that the efficiency and productivity costs are highest when taxing total or capital incomes, this is simply not smart economic policy.

The tax strategy I would propose is to reform the personal tax base so that a larger number of Canadians are taxed on a consumption rather than an income basis. I'm not proposing a full move to a personal consumption tax, as this raises difficult issues of transition and equity with respect to the truly wealthy, those with multi-millions or billions of dollars in assets.

There is an issue of how much emphasis should be placed on rate cuts versus base reforms. My focus here is not on taxpayers at the low and middle income levels, where of course clearly further increases in the taxable threshold are warranted. At higher income levels, the focus of my comments, some rate cuts are also needed. Ideally, over several years we should aim for top marginal rates, federal plus provincial together, of not much more than 45%. Typically it's around 50% in many provinces now. And the income level at which this top rate applies should be sharply increased from the current $60,000 to $70,000 up to probably in the neighbourhood of $150,000.

Still, heavier emphasis needs to be placed on base reforms shifting toward a consumption base than on rate cuts. Shifting the base toward consumption does reduce the effective marginal tax rate on capital income and savings, even reducing it down to zero, even if the statutory rate of tax is not changed. The empirical and theoretical economic literature shows that the efficiency and productivity gains will be larger for reducing marginal tax rates on capital income than on labour income. So a base shift is superior to a rate cut. That is a first approximation.

To implement this strategy I would advance two key proposals. First, raise the limits on contributions to registered savings plans. Raise the ceiling from the current $13,500 up to maybe $30,000. And even this figure pales in comparison with the American allowance for defined contribution pension plans of $30,000 U.S. per year.

Some companion suggestions for this first major proposal would be to explore the use of so-called Roth IRA schemes. This is a new American innovation. Explore their use in Canada. These allow no tax deduction for the contribution to the plan, but no further tax on investment earnings or withdrawals from the plan. Other companion measures eliminate the foreign content limit on registered schemes and extend dividend tax credit to registered schemes.

The second key proposal in shifting the base would be to reduce the portion of capital gains subject to tax from the current 75% to 50%. That would achieve several things. It would put us back to where we were in our treatment of capital gains in 1987 and earlier years. It would give added inducement to entrepreneurial and job-creating activity. It would bring us closer to the U.S. tax treatment of capital gains, which has been lightened considerably in recent years. Of course it would be moving us closer to a consumption base in our personal tax by reducing the effect of taxation on a key form of capital income.

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I would also propose other base reforms to offset some of the revenue costs of the proposals I've just made and to meet any public concerns that these key proposals are just tax breaks for the well off and also because these other items in themselves would be good tax policy. I would suggest that we limit interest deductions for investment expense to the amount of taxable investment income declared in a year. I would eliminate or phase out the lifetime exemptions for up to $500,000 of capital gains on farm and small business assets. I would institute or explore a corporate distributions tax along the lines of the Mintz committee to make sure we're not paying out dividend tax credits where in fact a corporate tax was not paid. I would move away from a wide variety of other schemes, such as the labour-sponsored venture capital funds and other special tax provisions that have not proved effective and that unduly complicate our tax system.

In closing, there is ample scope for personal tax reforms that would contribute meaningfully toward improved efficiency, job creation, and productivity growth, all of which are prerequisites for improved living standards.

These policies might involve cutting some tax rates but, much more importantly, they would shift the personal tax base to consumption for additional taxpayers. At the same time these policies would also achieve other important tax objectives, such as simplifying the overall tax system and making the tax treatment more even-handed and neutral across industries, sectors, and types of savings and investment.

The approaches to tax policy supported here would contribute more to the economy's performance than a strategy of highly targeted sectoral incentives and reliefs. That approach to tax policy has littered our past in areas such as energy exploration in remote, high-cost regions; multi-unit residential buildings; motion picture production; and many others. That approach continues to stuff the government's in-basket for tax policy ideas in areas such as the NHL franchises and stock options for executives in the high tech industry. There is a better way.

Thank you.

The Chairman: Thank you very much, Dr. Kesselman.

We'll now hear from Mr. McCracken. Welcome.

Mr. Mike McCracken (Chairman and Chief Executive Officer, Informetrica): Thank you.

I know that Dr. Kesselman is going to have to leave early. If you're expecting to be leaving for a vote, I would be happy to have you put any questions to him prior to that, because I'm here in Ottawa and I can continue afterwards.

The Chairman: Dr. Kesselman, at what time do you have to leave?

Dr. Jonathan Kesselman: I'll have to leave just after five o'clock.

The Chairman: Perhaps we'll do that. We'll start with some questions for you, and then we'll get back to Mr. McCracken.

Mr. Epp.

Mr. Ken Epp (Elk Island, Ref.): Thank you, Mr. Chairman.

That was a very interesting presentation, and I thank you for it. A whole bunch of things came to my mind. With regard to your idea of a consumption tax, would you expand the GST and HST? Would you increase the rates or the number of items to which it applies, or are you steering away from that? You never mentioned the GST except in passing.

Dr. Jonathan Kesselman: All of my recommendations here pertain to the personal tax and to shift its base toward consumption for a larger number of people. As I've said, probably 90% or more of Canadian taxpayers are already, in effect, subject to tax on their consumption even though we call it an income tax.

The GST certainly is an alternative way of increasing our reliance on consumption-based taxes. There might be an argument for increasing our relative reliance on the GST and cutting our relative reliance on personal and corporate taxes. That would be one way to do it. There might be political opposition to that.

But I think there are also good reasons for moving toward a consumption base on the personal side rather than leaning much more heavily on the GST. That is simply because within a personal tax we can take account of individual situations, such as disability and medical care expenses. We can take into account having a low income. Of course, for the GST we do that with the refundable credit.

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We can apply the personal tax with a progressive rate schedule. The GST, of course, is a flat 7%. If you raise the rate, it's going to be a flat 8%. So I think it's probably preferable to shift our overall tax system toward more reliance on consumption-type bases through these types of reforms to the personal tax than through trying to move to European style 15% and 20% value-added taxes—in other words, a 15% or 20% GST.

Mr. Ken Epp: I don't know if economists buy into this, but I believe intuitively it's accurate to state that the higher we tax something the less that activity will occur. In fact, if you were to tax something at 100%, it would normally cease altogether, whether it's buying, selling, or whatever. If you reduce taxes on something or make it tax free, then the market prevails. If it's favourable and good for our productivity as a country, which would then be good for the economy, then the reduced tax is going to increase that activity and increase the economic growth and our productivity as a nation.

You're not really talking along that line at all. You want to reduce capital taxes. I think you're saying that by doing that, you want to increase investment and capital, which is good for productivity. I hope I read you correctly there.

How about income? If you tell people that their marginal income is at 65%, which it is for a lot of the poorer people in our country, and if you look at the total implications of earning money when you're making $20,000, there's a tremendous hit on it and, as a result, a huge disincentive to take part-time work and that type of thing. What is the effect of those taxes on the economy and on productivity? I would think that's where we would want to put some emphasis.

Dr. Jonathan Kesselman: Here I'm talking about higher earners, which are not the largest part of the population but which are very important for aggregate savings and investment decisions, and even though the public may not like people who are well off, they are, as a result, very important for the economy's productivity growth, real wages, and living standards. So by reducing the tax on capital income, as you say, this will augment savings and the capital stock, and in the long run it will raise the wages of people with average and even below-average skills, and there will be more jobs.

I agree with you as well that people who earn, say, $20,000 to $30,000 and who have children are facing very high marginal tax rates because of the way we have structured some of our child tax benefits and other refundable credit programs, and I think that certainly does deserve some attention. It's not an easy thing to fix. Of course, you can fix it by scaling back the benefits, but that's probably not what we want to do.

In terms of productivity growth, savings, and long-run growth, if you focus on what needs to be done in the tax system that affects higher earners, I would say it's more important to be taxing them on a consumption basis than to be cutting their marginal tax rates. Now, there's probably room for some of both. But if we had to make a trade-off, it's important to remember that based on what we've observed in different countries and based on what we know from the economics, the cost to the economy in efficiency and growth is heavier when you tax the capital income at the margin than when you tax the labour income.

Mr. Ken Epp: One of the very important factors, in my view, is that the world has shrunk. We used to be almost isolated simply because transportation and communication were so slow and cumbersome, whereas now we trade money across the world in milliseconds and certainly goods and services are much more mobile. What is the effect of Canada's tax system versus that of our big neighbour to the south? You didn't really address that. You compared us somewhat to the Europeans, and of course we're competing with them as well. But our really big competitor is the United States, and their tax regime is really quite different. We're told, for example, that they have half the unemployment rate we do. As a result, their gross domestic product per worker is way higher and they have higher productivity. We're suffering in that area. So is there not an imperative for us, as a country, to bring our tax system more closely in line with what the Americans are doing?

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Dr. Jonathan Kesselman: I would say we should look at it. We should consider the effects of having a different tax system. In fact, the Canadian tax structure and tax mix is quite close to that of the U.S., much closer to that of the U.S. than to that of Europe. The U.S.—that is, the federal government and states—rely just about as heavily on the income tax as a percentage of total taxes as Canada does, which is to a greater extent than many other countries around the world.

If you look at my particular proposals, in shifting the base toward consumption for higher earners but not for multi-millionaires, these in fact would bring us closer to the U.S. system; that is, reducing our effective tax rate on capital gains to a 50% inclusion rate. If you combine that with my proposal for a top total marginal rate of 45%, in effect you'd have a 22% or 22.5% effective tax rate on realized capital gains. The U.S. recently moved to a top federal marginal tax rate on capital gains of 20%, but there are state taxes as well. We would be very competitive in that area.

My other main proposal was to raise the limits of allowable contributions to registered savings plans. Again, we would only be coming somewhat close to what the U.S. currently allows there.

If I could turn this around, we could alternatively, if we had the revenue available and didn't want to have many government activities that Canada does have that the U.S. does not have, cut our tax rate schedules to look very much like the U.S. federal tax and a typical state tax. We would still be taxing our residents much more heavily than in the U.S., even with the same rate schedule, because they allow a lot more items to be deducted. I'm not referring only to mortgage interest, but also to these much wider allowances for tax-sheltered savings and the capital gains treatment.

So, yes, what I'm proposing here would go some way toward making our system more like that of the U.S. And I think if I were stressing anything, it would be that if we're concerned about productivity.... Of course we cannot attribute whatever relative success the U.S. has had in productivity growth to taxes alone, and we also have to remember that U.S. productivity growth has been pretty poor in the international comparisons; only Canadian productivity growth has been poorer. So I would stress that we have to look not only at the comparison of tax rate schedules; we have to delve into the personal tax, into what's really being taxed, what is the base, what are the economics of what we're doing now—are they wise or are they not? I think they're not fully wise. And if we look in substance at the U.S., we will find they are already where I'm suggesting we should be headed in these areas.

Mr. Ken Epp: Mr. Chairman, I've used ten minutes. If others want to have some questions, I'm willing to stop.

The Chairman: Yes, thank you, Mr. Epp.

Mr. Szabo.

Mr. Paul Szabo (Mississauga South, Lib.): Thank you, Mr. Chairman.

Very slowly I'm learning more about the pitfalls of measuring productivity. I think it also applies to maybe some of the solutions for improving productivity. I wanted to focus on the one example of the RRSPs.

If you were to increase the limit from $13,500 to $30,000, I dare say that an awful lot of people, where both spouses were working, would all of a sudden become one spouse working because there would be a very significant jump in the opportunity to split income by purchasing spousals and achieve a windfall on a tax rate where the deduction was available at the highest marginal rate purchasing spousals. And they would come out, and with the structure of a RIF, be taxed on the way back into the taxpayers' hands at a lower marginal rate.

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In other words, the government could effectively lose 50% of the tax revenue on the incremental RRSP contributions. So there's a flaw here, in that your discussion sort of assumes that there is a perfectly efficient transfer of personal income tax revenue into consumption tax revenue, but this is an example of where there would be some leakage. In fact, to make it up you would have to increase tax rates as well in order to compensate for that loss. So I would issue a caution about simple solutions to complex problems.

If your objective were just to improve productivity—and maybe you can comment on this—it seems to me that since we only measure it in the private sector, all we have to do is privatize as much of the government's activities as possible, which are efficient and fully employed, and become as inefficient as possible by hiring as many people as we possibly can for jobs that are not meaningful. That would improve the employment rate in the private sector, because the private labour force participation would go down. The effective employment rate in the private sector would go up, and productivity would go up. So the conclusion, it sounds like, is that if governments were as inefficient as they possibly could be, productivity in a country would go up. It sounds too good to be true.

Dr. Jonathan Kesselman: I'm going to focus on your first comment, which is the only one that really addressed what I had to say, if that's fair enough.

Mr. Paul Szabo: Okay.

Dr. Jonathan Kesselman: I used $30,000, obviously, as a talking point and to provoke thought. What I'm saying is that even that is only two-thirds of what is allowed in contributions in the U.S. under defined contribution trustee plans.

First of all, I'm not proposing that we change the 18% of earned income limit, so it's not as if someone earning $50,000 could put $30,000 into the spousal plan. So that would provide some control on it.

Secondly, as we reduce tax rates, we flatten schedules a bit more, which seems to be the direction. It's certainly the direction at the provincial level, and it would be the general direction we've seen at the federal level, although not by great steps. By doing this, we reduce the incentive for this kind of spousal splitting.

But if, upon close examination, that were deemed to be a real concern of this scheme—that is, a high earner who's currently constrained by the dollar limit on these contributions now can contribute more and put it into a spousal scheme and then it's withdrawn within a short number of years—obviously we could rewrite the regulations on how much can be contributed to spousal schemes. That would be, I think, a fairly simple remedy.

Mr. Paul Szabo: I understand that there is an opportunity after a certain number of years to withdraw in the spouse's hands, and, yes, you could deal with the regulations. But what if you just leave it in and in fact fully realize the windfall on the rate differential? This is not available to RRSP contributors at the lowest marginal rate, when they pay 17% federal on the way to get the deduction and they're going to pay tax at seventy. So they have no opportunity for the windfall on the rate.

The other important thing it does is it enhances income redistribution in the reverse, because, as you know, a deduction in our tax scheme benefits a high-income earner over a low-income earner. So the more deductions you provide for Canadians and the more participation of high-income earners, the better the shelter of income earned in an RRSP program, etc., they're going to get. It's another example of how there would either be leakage or dilution of the progressivity of the income tax system in itself.

Dr. Jonathan Kesselman: What we have in mind here is shifting the base itself for people who are now being taxed really on an income basis to a consumption basis. That means, yes, they will pay less tax while they're working if they put more into the plan, but when they retire they'll be paying more. You may call it a deduction because that's how it would be implemented, but that's just the mechanism we use to implement a consumption-based tax.

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I think something more can be said for shifting the personal tax base more toward consumption for more people with earned incomes above $75,000. Yes, it would reduce revenues today, but it would give governments additional revenues 10, 15, and 20 years from now, when these individuals retire and we will face a real problem in financing hospitals, old age homes and all the very expensive medical care for seniors.

So we will have less revenue now, other things equal, but we will be building a kind of investment in terms of future revenue of government in the years when it will really be needed and there may be very difficult problems generating those revenues, because, as you know, retirees proportionately will be a lot larger part of the population and there will be fewer working-age people.

Mr. Paul Szabo: I think the theory, at least on the RRSPs, is flawed from the standpoint that the growth in the carry forward of RRSP room is an indication that more and more people are realizing there is a limit to how much you should be putting away in RRSPs. You can't utilize it all in your retirement years before you die, and if you have a big pool left and there's no tax-free rollover, you are going to be smacked at the highest possible rate.

Strategically, investors are basically saying there is only a certain amount you should be putting into RRSPs, in terms of a lifetime limit because the inefficiency in crystallizing that windfall gain on rate—you just can't do it if you have too much. I suspect for 99% of all Canadians, anything more than $500,000 in RRSPs at age 65 is more than enough.

Dr. Jonathan Kesselman: Okay, but what I'm addressing here is not average earners but above-average earners who are currently constrained by the contribution limit. These are not the people who are generally underutilizing their available room. Many people with sort of average earnings in blue-collar jobs, and sort of intermediate-paid people in white-collar, semi-professional jobs, wonder whether it's worth saving, in terms of looking ahead to when they retire. Unless they have enough savings and assets accumulated, they're going to be subject to all kinds of clawback provisions, whether it's GIS, OAS clawbacks—who knows. The seniors' benefit, which didn't go through, would have done more of that.

So if you're in the middle, it may not be rational to save that much. If you're at a higher earning level, it definitely is, because you're going to be beyond that anyway. There are people earning $90,000, $100,000, and $150,000 who are currently constrained in their ability to save in a way that is economically efficient and doesn't tax the current income.

Mr. Paul Szabo: Thank you, Mr. Chairman.

The Chairman: Thank you, Mr. Szabo.

Ms. Redman.

Ms. Karen Redman (Kitchener Centre, Lib.): Thank you, Mr. Chairman.

I have a learning curve on this productivity and I have moments of enlightenment. One of the moments of enlightenment I had at an earlier presentation by witnesses is that productivity is really backward-looking, not forward-looking. We're looking at the performance of one year versus the performance of a previous year.

I think back to the efforts in the fiscal constraints this government went through in bringing down the deficit, but paying down the deficit wasn't a means to itself. We paid down the deficit so we could free up money to put in other places for Canadians.

So I look at productivity. Now we have a good fiscal policy and a good monetary policy. Unemployment may not be where we want it, but it's coming down. Should we be looking at a longer-term productivity scale rather than the short run?

Dr. Jonathan Kesselman: I don't know whether you were here yesterday or had access to the minutes, but Professor Osberg was telling us that when we're thinking of many policies to improve productivity, such as adult education and post-secondary education, we have to look twenty years down the road and more, before enough people are affected and are enough of the total labour force that can really see the impact.

In the taxation policy area, I guess I was suggesting that improved tax policies—and I gave my interpretation as a professional in the area, but of course you could find professionals who might well disagree equally learnedly—appropriate tax reforms, and base reforms can lead to rising living standards for Canadians in three timeframes.

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In the short run, they can give us more efficient allocation of resources, such as time and capital. How do we use our time? Do we paint our homes, or hire other people to paint them and use our time to earn more money that we can pay them with? Of course the higher the rate is, the bigger the gap—the bigger the hurdle is to earn, pay taxes and then hire someone else. You hear of lawyers painting their own homes all the time. So in the short run, an improved tax system would improve the efficiency with which we use existing resources.

In the short to middle term, meaning two, four, or five years, I would hope and expect that improved tax policy would augment job creation. In other words, more people would be working, of those who want to work.

In the longer term of five to fifteen and even thirty years, with the increased accumulation of capital, the increased investment in new techniques, research and development, new products, we would get the productivity gains. But all of these things mean we would have more valued real output per person—per worker, per population. They are all crucial to raising living standards.

So we can debate about measures of productivity and whether Canada has really done worse than the U.S., or really done much worse than the U.S. Of course the U.S., as we've said, and I'm sure you've heard here, is not a wonderful model to take on productivity growth. They've done rather poorly internationally. But we certainly can say, looking at real income or real GDP per person in Canada, we have been lagging seriously behind the U.S., since the latter 1980s in particular. We were converging on the U.S. for the couple of decades leading up to the late 1980s, and then we started to see a growing gap. I think these policies try to address it in a variety of ways.

Ms. Karen Redman: You mentioned the U.S. earlier and you talked about models where they were having greater growth and productivity, and in fact we're the one country that's doing worse in productivity than the U.S. In the European models you referenced, how similar or dissimilar are their tax structures and mixes, compared to Canada's?

Dr. Jonathan Kesselman: There's considerable diversity within continental Europe. Britain and Ireland have rather different approaches, with more of an Anglo view of these policies. There is diversity, but on average, we would say the continental European countries rely much more heavily on payroll taxes than Canada. The U.S. also relies somewhat more heavily on payroll taxes than Canada. A payroll tax is a tax on labour income, not capital income, so it is one approach that's close to a consumption base. I'd have to give you the two-hour lecture to explain it, and I won't.

Secondly, they rely significantly more heavily than Canada—not radically more—on indirect consumption taxes, by which we usually mean value-added taxes, sales-type taxes. They rely relatively much less on income taxes, both personal and corporate, than Canada and the U.S.

The Chairman: Okay. Thank you.

A final question from Mr. Brison.

Mr. Scott Brison (Kings—Hants, PC): Thank you, Mr. Chairman.

Thank you, Dr. Kesselman. It's good to hear from you again. I enjoyed your presentation at the Canadian Tax Foundation and your paper on the brain-drain issue. You did some work on that as well.

The day before yesterday we heard from one of the presenters that productivity is closely related to investment, particularly foreign investment, in a country. There can be significantly positive impacts on productivity from increased foreign investment. With the mobility of capital, I'd appreciate your input and feedback on how the taxing of income on capital can have a deleterious effect on foreign investment in Canada, and ultimately on productivity.

If taxing income on capital is bad, then surely taxing capital itself is even worse, because we're doing that in Canada. One of the sectors we have in Canada that is doing very well and employs a lot of Canadians is the Canadian banking and financial services sector. In fact, over 50% of Canadians own shares in banks. But it's politically popular sometimes, or palatable, to attack banks just because they're banks. But that doesn't make necessarily good public policy. I'd appreciate your feedback on what effect the capital tax on banks and on our financial service sector can have ultimately on productivity.

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Lastly, I'll just shoot a few questions at you and get it all over with at once. In terms of a shift to consumption-based taxation, your views on that I share. One of the criticisms I hear from other individuals is that of potentially negative impact on product progressivity. I know one of the concepts you described at the tax foundation meeting was the lifetime horizontal equity issue. Is that what you were speaking of earlier in terms of this shift over a person's lifetime, that the progressivity issue would be addressed? I would appreciate your clarification on that, because I think it's important for people to have a better understanding of that concept.

Dr. Jonathan Kesselman: If I answered all of your questions in depth, I would force out the time for your other panel members.

Quickly, foreign direct investment generally is a way in which countries can access technology and managerial methods developed in the parent firm abroad.

Foreign direct investment, studies have been showing, can be very much affected by the tax climate, but in this case certainly much more the corporate income tax climate than the personal income tax climate. Here I would basically say read the Minsk committee report and what it has to say in that area. There are complex issues of how corporations....

If your corporate tax is too high, basically, through a wide variety of things from transfer pricing to how they finance themselves, if you're a high-corporate-tax country you can end up losing all your base. They do all of their borrowing in your country, so all of the interest expense is there and the revenue somehow appears elsewhere. But I would not add anything to what you'll find in an excellent report.

Capital taxes—again, they are covered carefully in that report. There is surprisingly little known and little work has been done from an economic and a careful objective statistical standpoint on the effects of capital taxes in Canada. As you know, most provinces have them, as well as the federal government. They're much heavier on the financial sector, although many of the provinces have them at lower rates on non-financial corporations.

No tax is a good tax, virtually. The question is, are these worse than the alternative for getting the revenue, assuming you need the revenue? So I will not say anything further than that. On capital taxes, read what the Minsk committee had to say. They did commission at least one study on it, although it did not really get into any empirical examination.

On your last matter, the critique of moving further to a consumption base in our personal tax and the effects on progressivity—well, I would go back first to my response to an earlier question as to why not use the GST. My answer was if you for good economic reasons want to shift your tax system to a heavier reliance on consumption-type bases, I would prefer to do it through the income tax or through the personal tax jargon. We could still keep calling it an income tax, as countries do, even the U.S., which is even further toward a consumption base, because we do have control over the rate schedules. We can keep it as progressive as we want.

If a shift to a consumption base is highly supported by economic efficiency and productivity and growth reasons, if we do that and then we don't like the effect of it on progressivity, we can of course change the rates. We can even raise them at the top end if that's what the government of the day wants. I was suggesting before that I didn't think the rates should go higher.

The Chairman: Thank you.

We'll now proceed to Mr. McCracken.

Mr. Mike McCracken: Thank you. Thanks for the opportunity to come before you and to talk about productivity. I didn't know that we were going to get into the intricacies of tax policy. It's a little early in the season for that. But there is perhaps some link, although you won't see much of that in my presentation.

• 1625

What I'd like to do is to essentially try to help you by separating out some concepts, setting a bit of the scene as to where we're at and talk a little bit about something called the production function. I think you have heard about it from others, but I hope I can simplify that a little bit. Then I'd like to talk to you a little bit about something called social capital or social cohesion, and conclude with a couple of comments on what we might do.

Just as backdrop to my comments, I'd like to have you think about a typical state as being made up essentially of three stacked boxes, one box being the workplace in which we find labour and capital and technologies and resources and management and producing goods and services. Essentially, the unit here is the worker or the firm.

Stacked on top of that is a marketplace in which goods and services are bought and sold, prices signal relative demand and supply, where inputs used by the workplace may also be traded. And here we think of transactions taking place between parties, or a market for a particular item.

Finally there is society, in which we of course find all of us and the people. Quality of life is a matter of concern, the structures amongst people and the concepts of family, culture, education, at least as it used to be known, and participation in society. Again we're talking about a unit here of a person or some subgroup of society.

In that same chart, just add some other words to what's in those boxes—and you have copies of all these foils—you can think of the employees, corporations, labour unions, consumers, retailers in the marketplace, minorities, majorities, safety nets, redistribution on a societal side. So you cam amplify each of these little boxes somewhat.

What I'd like to do, though, is to point out to you that the role of governments is an important part of this framework. In particular, the sides of these boxes are determined essentially by three influences—the traditions in the society, the laws of the state, and the external influences on the organization.

For example, looking at the workplace, it's the corporate laws and the labour laws that form a good part of the structure of the workplace. Intellectual property laws affect what happens there. Work ethic, discipline in terms of the traditions also have their effect.

Similarly, the marketplace is framed by laws defining private property, laws of contracts, coupled with the norms of society in terms of voluntary buy-and-sell decisions and honesty and service norms.

Finally, of course the society itself can be conditioned by both individual and group rights, constitutional issues, state responsibilities and, on the tradition side, the notion of caring and trust of the state, as well as the external pressures on international norms.

In some sense it's in this last societal effect and in the context of how all of these things work to move an economy forward, in particular the market system, that we find the role of capitalism, economics, and much of the discussion of productivity.

Now, if you take this framework, it's very useful to note three words that get mixed up a lot, but that over a number of years we have found to be quite conveniently allocated out in the following fashion. The term “productivity” is best reserved for discussions about the workplace, essentially about the firm. It's a concept at that level, or a government department or another organization, i.e., the workplace. It's the base for competitiveness and it certainly is an important part of the overall real-income gains. But we ought to recognize that there are some other parts to that.

The second element, the notion of competitiveness, which is the element we're seeing right here, is a concept of marketplaces where relative costs determine if operations of a firm, or indeed an industry, are sustainable on a long-term basis. But the issue there is one of competitiveness vis-à-vis other industries or other products or indeed internationally.

• 1630

Finally, a concept that is not unrelated to productivity and competitiveness, but not the same, is the notion of prosperity. Prosperity is a concept we associate with society and includes improvements in real incomes, quality of life, equity and environmental sustainability. Those are all its goals or objectives.

If we look at it in that way, we can ask ourselves what we might do in each of these areas to make improvements. In the area of productivity, the list is a relatively short one, in terms of direct effects on what you can do in a workplace. You can improve the human resources. You can have a higher investment effort, which some people think shows up in two ways. One is in the form of a higher capital stock per worker, and the other is where a better quality of capital stock is brought to the workplace.

You can try to foster the adoption of new technologies. You can provide a better infrastructure within which these firms operate in terms of roads, waters, ports, airports etc., and information infrastructures. We can also try to do what we call the productivity twist. This is not a new dance, but it's essentially a way of trying to ensure the growth moves toward those sectors that are relatively high in productivity, from those that are relatively low. That's something one would like to see happen. It's not always something one can control.

How you do it is of course the area of the government's side of the policies, and there's a lot of rhetoric. There are also lots of very loose chains in terms of what works, how quickly it works, etc. There is a strong belief in this town—or used to be at least—that less inflation has a lot to do with improving productivity. We've had a lot less inflation for some time, without any visible effects on the productivity side. So we remain alert and hope it shows up.

Better macroeconomic performance is something I certainly think would work a lot, but again we haven't seen that for awhile. There's the right framework policy. It's a generic term, in sense, and includes things like intellectual property law and improvements in the overall way way markets work.

On better education and training, again there are some long lags getting the signals right. These are often code words for not subsidizing, getting prices that are not non-distortionary, etc. There's ensuring people have the capacity to use the skills they have, and you have the right organizational structures. This is sometimes is affected by laws in a country where you can't adopt certain forms of organization that may be more appropriate for the circumstances.

It's interesting to look at these things because you'll see some of the suggestions you've no doubt heard about for productivity really showing up on the competitiveness end. Again, improving the efficiency and effectiveness of the marketplace is an approach toward improved competitiveness. Governments are involved in regulations, standards, taxes, subsidies, crown corporations and international agreements, again affecting relative prices and their performance—again a competitiveness issue not as directly affecting the productivity in the firm.

What do you do? You look at the standard list, improve the regulatory processes, reduce internal barriers, improve access and improve information infrastructures. Some think assisting Canadian firms to enter new markets may be of help, although a lot of these things have been tried with relatively modest pay-offs so far.

Finally, on the prosperity story you're looking for rising real incomes for all Canadians, sustainable environment, contributions to world economies through aid, adequate safety nets, and improvements in a balance, in the sense of regional economies, and amenities, in the sense of parks. There's also how you operate—in other words, the participation of citizens in processes being seen as important.

• 1635

How do you get there? The short list includes things like improved redistribution of incomes, efficient health care systems, high-quality education systems available to all, volunteerism and charity being encouraged, and involving citizens in determining their goals.

That's sort of the look at what you're trying to do. Let's talk more specifically about productivity. In particular, what you will have learned over the last two days is that at the firm level, if we think about productivity, it's essentially some ratio of outputs to inputs. It's sometimes written out as a production function, where output is some function of some set of inputs.

A lot of what you heard on the first day argued that the inputs were labour and capital, in some form. They went through various weighting schemes and measures of both labour and capital, to talk about the residual productivity that showed up and was not explained by changes in those inputs.

I'd like to take in a slightly different direction from what you have heard. The simplest form is to first recognize there is a legitimate role for some or all of government activities, as part of the production function at the firm level. Obviously, if you're a trucking firm you don't very do very well when there are no roads. If you have bad roads you don't do very well, and if they get improved you do better. That is a gain that will show up in you being able to produce more output with the same inputs at that point.

Of course, it's particularly advantageous if you don't have to pay for those roads. Then you can in some sense internalize the entire cost reductions associated with that. But this is equally true for almost anyone in business who requires, for example, such things as clean water as an input or someone to handle the garbage or sewage they're producing. Those are also handled by the infrastructure in society. Someone may want to know what the market prices are at the present time, so a statistical agency may be in place that adds those numbers up and tells them about them—again, a form of infrastructure.

However we measure it, there have been a number of attempts to do so. A number of empirical studies have found a positive role for infrastructure in the production function, as part of the explanation of what goes on. In a sense that also contributes to productivity. In particular, if you don't keep your infrastructure up and invest less in your infrastructure, you will have a productivity slowdown as a result. It takes time but you can manage to screw it up, with some effort.

The new growth theory, which you probably heard something about on the first day and possibly yesterday, also emphasizes technology. The t in the line here is an important part of the story about productivity growth. You will have heard about the virtues of R and D, innovation, and adopting new technologies. Some have suggested you can pick this effect up most directly by including the investment ratio directly, or the investment in machinery and equipment ratio directly in your production function.

If you go back a few years, though, the production function was written out much more broadly. It included what I call s, which is a whole series of factors dealing with the society you are in and the institutions in your society. In particular, the term now being bandied around quite widely is social capital or social cohesion. There's growing evidence that this also has a direct effect, a causal link, from improvements in social cohesion or social capital to economic growth, productivity and investment ratios. The work of Irma Adelman in the 1960s was the first in which that showed up.

There are other factors. I won't go into them in great length, other than as x, w, and z—however you want to run them out. But I would just point out that some of this includes the state of the play of the economy. Quite frankly, in Canada, for the last roughly 25 years, we have been operating well below the potentials of this economy. We have been operating in a world Leibenstein at one stage would have referred to as X-efficiency. We aren't doing what we could do with the smarts and the capital we have; i.e., we have high unemployment and unutilized capital.

• 1640

In that environment, the notions of allocative efficiency are relatively minor issues compared to the huge dead-weight losses associated with operating well below what you could be doing. And that strikes me as the major feature.

A final point is I suspect that throughout your discussions over the last two and a half days, the left-hand side of this whole productivity function, in terms of outputs, has been left. People talked about it as GDP or the value-added or gross output, or something like that, but I have to tell you that this is probably a mistake. Things are produced jointly by corporations, by governments, and by other organizations, other than the output for which they earn money or get credit for.

Let me give you a very simple example. In the United States, if you take the electric power industry in the post-war period and examine, in the framework that you were using on the first day, and ask whether they had any productivity growth, the answer is no, basically. If, however, you add to the output of the electric power industry in the United States in a negative way, if you penalize them for their pollution, created air pollution, particularly on SO_x, NO_x, VOCS, all of the local pollutant gases, and value those, as we are now doing, at the prices that are being generated by environmental taxes in that area, or trading permits, then you find something very interesting. It is that this industry, in the post-war period, has gone from one that was polluting a lot to one that today is polluting a lot less. And if you value this as part of its output, as society is saying they want to do now, then you find the productivity growth on that basis in electric power is on the order of 1.5% to 2% a year.

What does that mean? It means before we get all worked up about a single measure of productivity growth, we really need to step back and ask what the whole picture we're looking at is. If, for example, in the last 10 or 15 years Canadian businesses, with very low productivity growth being measured as we now are doing, are all becoming much better in terms of their environmental progress, if they were producing skilled people well over and above their own requirements, as they were learning by doing, if they were participating in their local economies and societies in a way that was strengthening those and not being measured in their output, then we might ask, why are we all upset about this productivity side?

Of course we don't know what they've been doing because we don't measure those kinds of things. And if we have any suspicions at all, it's that probably such an augmented productivity measure might look worse rather than better from the recent performance.

I'll skip the social capital slide and I'll talk a little bit about another view, which, again, is that of a chap by the name of Harberger. I'll simply leave with you a reference to him. Your people here on the research side can get the information. A recent article of his—his presidential address to the American Economic Association last year—hones in on this notion of productivity as a firm-level concept. It also says start thinking of it in a much more mundane way; don't waste your time trying to figure out this technology and all this other stuff. It basically comes down to whether you are or you aren't getting real cost reductions from any source. And if you use that framework, you may find that it's easier to say you understand why that would cause a real cost reduction, even if it's not some high-tech product.

What do you do? The simple measure I would suggest, if you're concerned about productivity, as I've defined it at the firm level, is to then recognize that it is where you're focused; you're trying to improve productivity through changes in the behaviour in the organization of work at the level of the firm. Reducing slack would help a lot. If you have a 10% output gap in the economy, closing this gap quickly would provide you a big boost to productivity growth, in my view, to investment, and certainly to the prosperity of the economy. Remember, infrastructure does matter. Worry about the societal effects, social capital, as much as you worry about technology, and don't forget about the other factors that are at work.

• 1645

If we ask how we have done, we come away with not a very happy picture, because it's the transmission from productivity through competitiveness to prosperity where in fact disappointments are large. Real wages themselves have not kept up even with the slow productivity growth we've had. A large gap has opened from labour's perspective on what they have obtained from working. So this has, in some sense, held back income gains and consumption in society.

However, from business' viewpoint they don't see it quite the same way. This chart here gives you some illustration. You have a copy of all of these charts in the back there as well. I will not go through all of the charts, but essentially what's happened is a gap has opened up from 1981 forward between real wages and productivity of about 8%. And even in our forecast out through 2006 this narrows only shortly, although that's assuming current policies are continued.

However, when you look at it from the employers' viewpoint and deflate those wages by the prices the producer gets, they're roughly in line. And this is where, in some sense, there is a disconnect between the prices that are seen by business and the prices used in the consumer price index. The other reason is you might say there's poor productivity growth, yes, but at least it's still growing, but in fact if you look at what I think people are more conscious of, which is real disposable income, on a per household basis today real disposable income is about 6% below the level of 1981. It is down from the 1990 peak of about 104% by about 10%.

That's a very large reduction in real disposable income per household. So it's not surprising that people are unhappy. It's not surprising we have a retail sector in this country that's not doing well. On a per capita basis the story isn't quite as bad, but it nevertheless still shows us today well below the levels of 1989-90.

What about investment? We hear about the wonders of investment. But if we take a look at the investment effort in Canada—the top line is total investment—from an investment ratio up around 25% in the 1960s and early 1970s, this has been declining to below 20% from about 1990 on. If you look at the components you see that the business investment, business non-residential, is down; you see housing is roughly stable at about 5%; and you see that perhaps the biggest percentage relative drop has been in government fixed investment from about 5% down to about 2%. And this has been steady erosion in the provision of roads, highways, airfields, ports, infrastructure spending in the information sector, etc.

If we look at another factor that is part and parcel of this whole exercise, which is the degree to which income distributions are affected, the basic story is one in which we have been getting a less even income distribution in Canada since 1973 on both the before tax and the after tax and transfer.

On the unemployment rate, I mentioned earlier to you that after tracking with the United Stated for the period from 1945 on this chart up through 1980 roughly, in 1981-82 we opened up a two-percentage-point gap with the United States. We now have managed to open it up to a total of 4% in the last recession. In my view, this is a choice that's being made by policy-makers in Canada and one that is costing us quite dearly. A rough estimate is we're losing about $80 billion per year—per year—in forgone output by not being at the same unemployment rate as the United States at the present time.

Let me not go too much on. I'll skip on the participation rate, employment ratio. On the social cohesion indicators, just so you get a sense of how some of those measures show up, one interesting one is what's called the bureaucratic burden. This is a ratio of people who are in the management and administrative sector to the total employment in Canadian industry. This has risen from about 7% in the early 1970s up to about 14% today. When you compare this to Europe, these numbers are about three times higher than the European numbers and Japanese numbers, about the same as the U.S.

• 1650

The other line indicated on the chart is the same movement among the women managers as a share of the total. It has risen, although somewhat less rapidly.

Another indicator is the circulation of daily newspapers per person, and I'm using here age 15 and over. Again, there is a steady trend downward. This measure across many countries is used as a sign of social capital or social cohesion. It's a proxy for interest in political and civic matters. This circulation has been declining in Canada, absolutely on a per capita basis, for some time. All of this of course is without any adjustment for quality of those newspapers. I won't get into the sign on that.

One indicator you may find interesting is that in some countries they consider an increase in the number of lawyers per thousand as a sign that the people cannot handle relationships on their own, and that there is less trust or social cohesion in that society. I have only the data here from 1985 forward, but the number of lawyers per thousand population in Canada has risen from 1.7 to 2.2 per thousand.

Finally, an indicator of how much people are involved is simply the voter turnout in federal elections, a number some of you will be familiar with. One of the things we can observe since 1972 has been a marked decline. Note that the pattern in some of those years is when you have an election call with a short lag between an earlier election, you tend to get a lower number as well. But the general trend has been downward. I understand this is also reflected in most provincial breakdowns.

So there is a sense of what's been happening over the last 10 to 20 years, and there are a lot of other measures in the same vein, that our social capital and social cohesion have eroded. And if that is an important variable in your production function, then it too could be explaining this productivity slowdown, and would suggest these are the kinds of things that may be more amenable to fixing by governments than by some policies dealing with upper income tax brackets.

Thank you.

The Chairman: Thank you, Mr. McCracken.

We'll now hear from Mr. McMahon.

Mr. Fred McMahon (Senior Policy Analyst, Atlantic Institute for Market Studies): Thank you very much, Mr. Chairman.

I don't know if your staff mentioned to you how I travelled here, but I'm not sure any committee studying productivity should be hearing from someone who came up to Ottawa from Philadelphia by train, and plans to return to Halifax by train. I guess I'm just lucky the old carriage routes are closed; otherwise I'd still be outside New York.

In that kind of a perverse sense I'd like to describe to you an instance where an increase in productivity can actually lead to a decrease in productivity. And I'm going to recommend a policy that will actually lead to a decrease in productivity.

Imagine there has been, perhaps through technology, some spontaneous increase in the productivity available out of low-skilled workers. That enables employers to hire more low-skilled workers. It enables them to pay more, perhaps bidding them off social assistance. Now their productivity as low-skilled workers has increased but it's still below the average level of productivity. So that increase in productivity, by bringing more low-skilled workers into the workforce, actually lowers your per capita productivity.

Now, the same sort of effect can be done controversially, through cutting back on social assistance, so being on social assistance is less remunerative than work, or less controversially through the tax code, through earned income tax credits or just raising the personal exemptions.

By bringing more low-skilled workers into the workforce, as I say, you actually lower per capita productivity. This may be—I missed the scintillating session on methodology earlier this week—one of the reasons why U.S. productivity seems at odds with what's actually going on in the economy. In effect, many European countries have excluded a whole class of low-skilled workers from their economy, where the United States is absorbing more and more low-skilled workers into their economy.

• 1655

Having made that point, I'm going to veer off and talk about largely Atlantic Canada, but it has national impacts. Let me explain why. You can consider Atlantic Canada as something of a test case. Researchers feed rats megadoses of various substances to see if they're toxic at lower doses. I think Atlantic Canada has had megadoses of various perverse policies that are doubtless toxic at lower levels.

To tell you that, I have to explain how poorly Atlantic Canada has been doing. I was one of the first to point out that over the last 35 years Atlantic Canada has slowly caught up with the rest of the country, with the exception of the early period of the 1970s before the oil crisis, when we were shocked by a whole bunch of economic development efforts in Atlantic Canada, which as it turns out lowered our growth rate.

There's a vast literature developed on something called the convergence effect. That's the ability of lagging economies to catch up with advanced economies. All that seems to be required is that you share a market system, various institutions, and the rule of law. Comparing Atlantic Canada's convergence with areas that do not have our regional programs, we aren't lower than them, we're so much lower it's embarrassing.

Atlantic Canada has caught up to the rest of Canada at one-third to one-half the rate you would expect with no regional programs at all—one-third to one-half the rate of U.S. states where there are no regional programs—some people say the military is, but when you examine the numbers that disappears; one-half to one-third the rate of Japanese prefectures; one-half to one-third the rate of European regions so diverse as a region in Spain compared to a region in Britain.

Europe does have regional policies, but these policies are dwarfed by what goes on in Atlantic Canada. For instance, the wealth transfer from the EU to Ireland is about one-tenth the level of the wealth transfer from Canada to Atlantic Canada. If you take out EU agricultural subsidies, it's about one-twentieth the level.

Atlantic Canada is the only place I know of that gets a similar level of aid as that other star performer, Corsica. Aid to Atlantic Canada on a per capita basis dwarfs U.S. aid to Israel, and they got a pretty nifty army out of it. What we got was Sydney Steel and Sydney Coal. What this vast flow of largely politicized resources has done is enable government to act upon a negative-sum view of the economy. Notice I didn't say zero-sum view, but negative-sum view. In other words, when any job disappears it's never going to be replaced unless some government activity is involved. Thus we hang on to declining industries, we bloat the fisheries, we do all sorts of perverse things.

Hanging on to outmoded industry only suppresses job creation and productivity. One of the reasons the United States is probably doing so well right now is that wave of hugely politically unpopular lay-offs in the late eighties and early nineties. Firms were showing large profits and everyone was asking how they could lay people off when they had such large profits. They said it would reduce employment. It was a negative-sum view of the economy. Nobody intervened, and what this allowed U.S. firms to do was move into new economic activities, spark a powerful rate of growth in the U.S. economy, and, by letting outmoded jobs go, bring unemployment rates in the U.S. economy down to near historic levels.

The trouble with the negative-sum view of the economy is it has a devastating impact on economic organization, both on the management side and on the labour side. It encourages rent-seeking, looking for grants and favours in which productivity is almost out of the equation, rather than profit-making through market competition.

• 1700

Profit-making is a path to both greater productivity and job creation. Profit-making gives you the resources and the incentive to invest and create new jobs in new areas.

Considering the largeness of the market economy, it is almost infinitely larger than what's available through various rent-seeking activities, which are very much like a negative-sum game. Government has a certain pot of money, and as outmoded jobs become more and more expensive to maintain, you can maintain less and less of them with the government funds.

The negative-sum view of the economy is clearly wrong, demonstrably wrong. If it were not, Halifax and Ottawa would have been devastated by the vast civil service cuts. In fact, Halifax is on an historic roll that, up to this point anyway, has very little to do with the offshore. So we're doing rather better after the federal government withdrew money from the Halifax area economy. If this were true, this negative-sum view, Pittsburgh would be the pits after the collapse of its steel industry. In fact, unemployment in Pittsburgh is almost vanishingly low, whereas in Cape Breton, where we held on to the steel industry, employment seems almost vanishingly low.

I'll just take a moment to describe a study of competitiveness in Nova Scotia versus New England. It found out that the New England products were much less costly than the Nova Scotian products. You may think the New England firms paid their workers less than Nova Scotian firms, particularly the low-skilled workers. In fact, the biggest differential between New England firms and Nova Scotian firms was that they paid their low-skilled workers more. Perhaps it's that the U.S. was producing shoddy goods. In blind tests before experts the Nova Scotia products were rejected. Maybe it's that big bugaboo that we just don't have capital flows to Atlantic Canada and therefore our equipment is outmoded. In fact, in almost all cases the equipment in Nova Scotian firms was more modern than that in New England firms because they got government grants to buy it. In some cases the New England people were buying second-hand Nova Scotian equipment. So here's what you had: New England firms producing cheaper and better quality goods with older equipment while paying their workers dramatically more than Nova Scotian firms. In other words, the Nova Scotia productivity was horrible.

What did the study say that was due to? It was due to rent-seeking, as I've just described, and looking to government for grants and favours, not just economic development grants but contracts and so on. So this large government presence severely suppressed productivity in Atlantic Canada. Now, this study wasn't produced by a far-out, right-wing group, unless you consider the Atlantic Canada Opportunities Agency a far-out, right-wing group.

So what can government do, then, to spur productivity? We need to depoliticize the economy as much as possible. I agree with Mike and Dr. Kesselman that government investment can increase productivity, but it has to be depoliticized, sensible investment. For instance, with regard to the millennium fund, I read with horror about the politicians from my region going down and shaking hands with people and doing absolutely nothing worth while when we should be building roads, schools, and hospitals. Those things increase social betterment, but they also lead to economic improvement. As a matter of fact, when government money flowed at its peak through Atlantic Canada, our investment and infrastructure went down. We were spending it on political stuff.

If you want to spend on things that improve productivity, the international research fairly strongly suggests that infrastructure, particularly transportation infrastructure, is about your best investment. It also suggests that post-secondary technical institutions, smaller-level ones, also have a great spurt of productivity.

• 1705

You notice I left out lower levels of education, because studies going back to the 1960s show that output in education, the standard school system, is completely unrelated to expenditures. In fact, there's some evidence that the more you spend, the worse the output on education. So you need a reform of the structure of education, as opposed to putting more money into it.

Finally, on taxes, clearly, if government focuses on things that actually do Canadians good, rather than do politicians good—the negative-sum view of the economy is a great view for politicians, because you get to protect existing interests and then go around with job-creating projects that everybody gives you credit for—leaving more money in the pockets of Canadians, particularly lower-income Canadians, will help spur productivity growth, even if it creates a paradox in the United States. Leaving more money for firms to invest will not just leave them more money to invest, but will increase the incentive to invest.

Thank you very much.

The Chairman: Thank you, Mr. McMahon.

Before we go to the question and answer session, I noticed, Mr. McCracken, that you were taking notes while Mr. McMahon was speaking. Perhaps you would like to express your point of view on what Mr. McMahon has just stated.

Mr. Mike McCracken: Regional growth in Canada is a very complex issue. It's a rural issue, and it's an urban issue. It also hinges very much on a question of what are you going to take as a given. One of the debates in Canada, which has not been answered and which is an ongoing one, is with regard to the distinction between place prosperity and people prosperity. Is our focus only to improve the incomes of people, regardless of where they live, or are we very much concerned about also maintaining people's well-being and the societal structure we have in different parts of this country?

Those who suggest that the answer is the market only and that we ought to in some sense let things work out, let people move, tend to put greater emphasis on people prosperity. That is also, I would say, the default view of the United States. One talks, for example, about Pittsburgh today having a low unemployment rate. I can tell you that there were many decades during which Pittsburgh was under great strain, and it did not happen that Pittsburgh became prosperous solely by market forces.

Now, there are many parts of the United States that are in decay and are being allowed to decay. Stop and finish, that's their choice.

I tend, though, in the Canadian context to think that at least in a relative sense we probably put more weight on place prosperity than on people prosperity alone; that is, we want people to be able to be making progress where they are, and this means we have a much more complex problem in terms of how we want to do it. That may have some trade-offs in productivity levels or productivity growth. We should be cautious also in distinguishing between these two. You may make certain choices that have a difference in productivity level, but that may not necessarily mean you're going to grow less rapidly.

I think these would be the main comments I would make.

I would make just one other comment, which is that there are measures we produced many years ago and that we continue to look at that can avoid the simple-minded view that if you employ people at lower productivity rates than the current average, it somehow is going to lower your numbers.

Let me give you a simple conceptual way to do things. You can say that we will put everyone who is currently unemployed on government employment at a social wage equal to the unemployment insurance benefit. If we did that tomorrow, the GDP would be higher by unemployment insurance benefits, and the total employment would equal our total labour force. It would be employment plus unemployment today. So then you would be looking at a measure that is our gross domestic product plus the unemployment insurance benefit over the total labour force. That sort of augmented view of labour productivity is then not going to be befuddled by changes in the unemployment rate. What it does, however, is it really focuses your attention in another direction.

• 1710

If you were to then disaggregate the economy into a bunch of sectors, you would observe, aside from our traditional twelve or thirteen sectors, this fourteenth sector, which is the unemployed sector, which is producing very low output; it's producing just the UI benefit per person who is unemployed. You would see that the challenge in our society is moving people out of low-productivity jobs into higher-productivity jobs. It's that sectoral movement that you want to do. You want to have less weight, fewer things being produced in a sector with low productivity, and more being produced in higher.

I think if you go through that, you won't fall into the trap of worrying about damaging productivity growth as a result of lowering unemployment. If in fact that were the dominant arithmetic, we would expect in Atlantic Canada, of course, the highest productivity in the nation, given that it has the highest unemployment, and we know that's not the case.

The Chairman: Mr. McMahon.

Mr. Fred McMahon: Sure, and in fact drawing lower-skilled people into the labour force was not something that I feared would lower productivity. In fact when you do bring more lower-skilled people into the labour force on a per capita basis—and I'm not sure Mr. McCracken understood that—it will lower the overall productivity on a per capita basis but increase the economy's overall production. Furthermore, the best way to move people into higher-productivity jobs is to first get them into any job at all, because the path to higher productivity is largely through employment experience. That's terribly important.

As for place versus people views, as I've said, Atlantic Canada has converged on the rest of Canada at one third to one half the rate we would have normally expected without any regional programs. Mr. McCracken is quite right: a large part of that question is the rural-urban spread. That too has a lot to do with government policy. One of the great drivers of productivity after the end of the Second World War, believe it or not, was the depopulation of the farms—people moving from agricultural activities into higher-productivity urban and so on activities. In fact that surplus farm population that was soaked up around the early 1970s is one of the reasons for the slowdown in productivity growth throughout the western world at that place.

While that was happening to improve productivity everywhere else, in Atlantic Canada government programs were shovelling more and more people into rural, low-productivity activities. For instance, while agricultural employment in Canada climbed by about a third—a third, two thirds, I forget which—between 1961 and the mid-1970s, employment in Atlantic Canada's fishing industry in the late 1980s was two and a half times what it had been in 1961. Most of those were marginal, non-productive jobs supported by various forms of subsidy. So in effect we maintained an overly large rural sector in Atlantic Canada through a whole number of quite perverse government programs. That slowed our productivity growth, and that in large measure created the urban-rural question, which Mr. McCracken referred to.

The Chairman: Thank you.

Now we'll proceed to the question and answer session. Mr. Epp.

Mr. Ken Epp: Thank you, Mr. Chairman.

Thank you for your presentations.

I'm really curious about the role of government when it comes to wealth distribution. We have governments in this country that are very eager to take money from those who earn it and give it to those who don't. This is done on a personal scale, and it's also done on a provincial scale, with the federal-provincial transfers. It seems to me that even though it redistributes the wealth, and hence the effect of the economy is spread out over the whole country by practices like that, our overall productivity is affected because of the fact that those who actually earn the income have a disincentive. And those who aren't earning anything—in other words, who are not actively producing, actively participating in our economy—are encouraged to remain inactive.

How would you respond to that? I'd like a response from both of you.

• 1715

Mr. Fred McMahon: First off—and I guess this is putting on my left-wing hat—if you had to take a single measure of society's success, fairly low income distribution would be perhaps the best measure to look at. Now, that said, just as you mentioned, you have to very carefully balance policies that redistribute income with policies that generate income.

The other side, and going a little bit further, policies that generate income—and the evidence isn't fully in on this yet—at first seem to increase inequality, and then as the economy adjusts begin to lower inequality again. That happened in Margaret Thatcher's Britain about seven, eight, nine years after she became prime minister and starting reorganizing society. Income distribution actually began to lower again. It's happening now in the United States over the last two or three years. So wealth generation itself is very important in resolving inequalities.

Mr. Mike McCracken: I guess the one common area of agreement we would have is that if we were running a fully employed society, we would be in a much better position. Quite clearly, if we were so doing, we would find that probably income distribution would not be as maldistributed, would not be getting as bad as it has been.

That would happen primarily because of access to employment by low-income Canadians. It would also include perhaps some relative strength of bargaining for people who are employed vis-à-vis their employer. They might get something approximating the productivity gains that are occurring in their firms. It would also probably occur for everyone in that kind of an environment where people have some security in their lives and some hope that they will be more willing to improve productivity where it's in their control, through better organization of work changes and through suggestions on how to improve work.

The evidence I have seen, both internationally and in Canada, suggests that an improvement in the income distribution, meaning a more even income distribution, has a positive effect on the economy, on economic growth, on productivity, on its performance, on social cohesion. So it perhaps is not what you want to hear, but that seems to be the evidence.

We also have been talking about income distribution, not wealth distribution. I'm sure it was just an oversight by Mr. Kesselman, but as part of his overall package, the ultimate conversion of income taxes to consumption taxes should end with a substantial, if not 100%, inheritance tax at the end of it. I think he just didn't have time to get to that particular issue in his comments.

We're one of the few OECD countries without that, by the way. So we ought to think of the full package if we go down that road. That might help provide governments with assets for redistribution elsewhere.

In terms of the incentive or disincentive effect, I've been before this committee for a number of years and talked to people for many years, and we have two schools of thought in the world. One is that you have to provide more after-tax income so people will work harder. There's another view that you have to sort of cut wages so people will work harder. It tends to be somewhere around the average income that these two effects seem to go in opposite directions. So when I hear we need tax cuts for the rich, it's always so they'll work harder. When I hear we can't afford wage increases, it's so that we make sure that these people at the lower end are adequately taken care of. So be cautious in terms of these effects.

By and large, people everywhere want to work. It's a social activity. They want to earn their way. The view that somehow people out there, generally other people out there, are happy with social assistance and the degradations that go with that, are happy on unemployment insurance benefits, or the two-thirds that don't have any are happy with all that leisure time, I think is just not correct. You might want to talk to some of them.

• 1720

The Chairman: I have a question. You said that there are people out there who say you have to pay people lower wages so they work harder. Can you tell me one person who said that?

Mr. Mike McCracken: Yes—anyone who says we can't afford to increase minimum wages because if we do we're not going to be able to hire any of these people, no one will hire them, so we cannot have at the low end any increase in minimum wages. That tends to be the standard of the BCNI approach to all of these things. But when it comes to adequate wages for them to work, it's preferably something like $100,000, $500,000—some 350 times the lowest employee's average income in their firm, for CEOs.

It just seems to me there's a bit of a schism in all of this discussion. We don't talk about the importance of income for survival. We don't talk about basic income. We don't talk about minimum standards. All the evidence the United States has produced, and some other countries, on minimum wages is that they don't in fact cause the unemployment of low-skilled and entry-level firms, but rather in fact that this serves as a useful base, provides in fact the positive income effect, particularly insofar as that stimulates consumption by that group, who usually spend it all.

So there's a whole tendency to say give me more money and I'll do better, but don't give anyone else any money because it will be bad for them.

Mr. Fred McMahon: Mr. Chairman, could I straighten something out here? No one has said that lowering wages increases the work effort. The actual argument is that lower wages enable employers to hire more people and this therefore creates an overall larger work effort in the society.

I disagree with Mr. McCracken on his reading on the literature of minimum wages, but that would get quite complicated.

The other thing I would very quickly add is I don't think people like living on social assistance, but the trouble is that it does show up in the research. People seem to be willing to take the road of least resistance.

In Atlantic Canada during the peak of UI, whatever, there were in many months twice as many people collecting UI as were actually unemployed, and about two-thirds more people collecting regular UI than were actually unemployed. The statistical agencies were reporting labour shortages throughout Atlantic Canada when we had double-digit inflation, and twice as many people collecting UI as unemployed in some months.

In The Netherlands, where they had a similar sort of system, except it was their disability system, in one of the healthiest countries in Europe you found one million of six million workers classified as disabled and able to collect 80% of their previous pay, I think it was, for the rest of their lives.

I don't think people like social assistance, but the evidence shows that if you create a generous social program it builds up more and more people. This might have been one of the things Lars Osberg was talking about yesterday, looking at ten, twenty, forty years down the line. Unfortunately, social assistance seems to get passed on through the families, so it becomes almost a family business. To break that chain, it's going to affect the next generation or even the following generation after that.

The Chairman: Mr. Epp.

Mr. Ken Epp: Thank you.

I think that generally speaking, if people were told they would continue to have the same income as they have now but they didn't have to come to work any more, probably 80% or 90% would opt to say they're not going to come to work.

We're talking here unemotionally, and I know we have to bring that social aspect into it. That is part of our society. But if you deal only with the empirical values of productivity, I believe that the imposition of this redistribution of wealth is a negative for our total productivity. Mr. McCracken, would you not agree on that?

• 1725

Mr. Mike McCracken: No. I think if you talked about offering people the same salary as they have today, perhaps some would. That tends not to be the generosity levels of any of our social programs or any of the proposals for a basic income.

What we do see in fact is a change in our society in the last 30 years, where increasingly people have entered the labour market in order to sustain an adequate family income in the face of great difficulties, with two people working rather than one. We've gone from a society in which about half of the families were single-earner to one in which now single-earner families are about 15% of the total, about the same number as our single-parent families. The dominant type of family now is the dual-earner family. Even with that, we see this group having great difficulty—in fact not able to, on average, get an increase in real disposable income per household, for the last 18 years.

Mr. Ken Epp: Have you analysed why that is?

Mr. Mike McCracken: Sure. Essentially, high unemployment and low real wages are the principal culprits over this period, partly offset by tax and income policies up through about 1994-95, and more recently further hurt by cuts in transfer payments both by federal and provincial governments. So the after-tax, real disposable income per household of Canadians continues to decline even in a recovery period in this country.

Mr. Ken Epp: Are you then saying that the reduction of income equates in your mind to a reduction in productivity?

Mr. Mike McCracken: No. I'm saying that's what the income story is. Productivity is a firm-level concept. In a firm, you have an entrepreneur who tries to organize a group of people and some capital to produce something. The productivity measure is essentially what those outputs that he produces are relative to the inputs, and is there anything magic happening—i.e., is there any additional output being produced with the same input. If people are insecure, if people are not trustful of their management, not trustful of the society in which they operate, they tend not to contribute toward improving that productivity in that firm, and that shows up as less rapid productivity growth.

It also means they themselves are going to have great difficulty in making progress because their real wage is not likely to get increased by that employer. That's how it comes in and affects the outcome. But as I say, we have had some productivity improvement over the last 10 or 15 years, and nevertheless we still haven't been able to translate that into increases and real disposable income per household. So there's obviously something else on top of that, and that is of course the obvious—the slack that's been created in this economy deliberately as a choice in policy to run with higher unemployment rates, and then more recently a withdrawal of governments from the unemployment insurance system, from social assistance, and cuts in the levels of benefits in those programs.

Mr. Fred McMahon: There's another obvious reason why Canadian disposable income hasn't risen, and that's the increasing tax burden.

Mr. Mike McCracken: Yes, but it's not just there. If you look at the tax as a share of the earned income, that's not where the action is. It's on the transfer side. You can decompose it and look at the parts and it's just not part of the story. Now, yes, you could have cut taxes instead, but that's not the issue. And indeed, we've had tax cuts in some of the provinces—Ontario, Alberta, etc.

Mr. Ken Epp: I want to know what your response is to the role of capital and the role of technology in improving production, because it seems to me it's much more significant than we acknowledge. I used the example yesterday, and for my colleagues here my apologies for the repetition.

When I was a youngster, my dad with his two boys farmed 10 quarters of land, and now my brother with his two boys farms the same land plus another 40 quarters. And it's producing about twice as much per acre as what we did when I was a youngster. There's no doubt in my mind that productivity-wise my family now is doing just an awful lot better than they did when I was a youngster at home many years ago. So productivity has gone up, but their income seems to be less. The difference is due primarily to bigger machinery, better technology, use of fertilizers and all those other things. So technology has had a great impact on that.

• 1730

The overall wealth of our nation, distributed over our population, should then be better if our productivity is better, but in fact it appears not to be. Everybody seems to be worse off than they were when I was young—or have I just forgotten because I'm old?

Mr. Mike McCracken: First off, just as a rough approximation, I think you're using a somewhat longer time period for your comparison than has been typical of some of the productivity discussions we've been having here, which have been on just the last decade. I would think, looking back, in the post-war period we've done pretty well on the productivity growth front. We've certainly had some slowdown in the last decade or decade and a half. In some sectors, such as agriculture, productivity gains have continued. It's an interesting sector because you made the side comment that you didn't really feel your income had improved all that much in that process.

Mr. Ken Epp: They're making half as much.

Mr. Mike McCracken: But making it up in volume is the old story. When you have a productivity gain in a competitive industry, then who gets it is less clear. Often it goes forward in lower prices. The fact you're still around in farming in Canada, for example, would mean you were able to achieve productivity gains sufficient to still be able to produce goods at record low commodity prices in the world.

The commodity prices are affecting your incomes, but productivity is real output over real inputs, and that's where you've made it. It's an efficiency gain, and that's what productivity is about. Whether it is something you can capture depends on the state of the markets you're operating in. One of our interests in making sure productivity gains get to the rest of society is we operate in markets that are competitive, so prices are lowered by those actions. Otherwise, I will never see the benefits of the productivity gains from your farm through any other mechanism.

If you capture them as a productivity gain in pharmaceuticals, what does the pharmaceutical company do with the increased profits from whatever step they used to get cost reductions? If they put it into R and D, I might see the benefit of that five or ten years later in a better medicine. If they remit it abroad in dividends to their parent company, then it becomes a little more difficult to trace the benefits that come back to me. If they use it for a gold-plated building in Toronto, then it's not clear I'll ever see it unless I go to Toronto and ooh and aah at the building. So we have to make sure we also understand these gains from productivity and how they are shared.

That essentially means it has to show up as investment or as something like investment—R and D, etc. It has to show up in higher wages for the workers, dividends being paid to the owners of the company, or lower prices. Those are essentially the channels through which the productivity spreads through your economy. All of those channels have positive effects on the economy, but also redistribute income, at the same time, to different groups.

That's sort of the process by which it happens. Of course, by the way, governments often benefit from that productivity as well because they have a tax rate applied to some base, that base goes up, and they receive more income. That's the other way there is a return to society. Governments are in better shape and can, in turn, if they choose, recycle that to people in lower taxes, greater transfer payments, or more infrastructure.

The Chairman: Thank you, Mr. Epp.

I have just a very short question. Can you identify one component of your equation that is more important than others?

Mr. Mike McCracken: Keep in mind what you have in the equation are the things you are in some sense explaining the output by, so the productivity is essentially what you can't explain by those factors. So the additional factors I bring to bear are the ones that are often omitted.

• 1735

In my own view, the explanation of so-called disembodied technical change or the residual factor productivity growth, or what have you, probably has most to do with things like infrastructure of government. It has a lot to do with the social cohesion of the country. Certainly the evidence I've seen piling up in that area is quite interesting. It probably has a lot to do with—if you haven't adjusted for it already—the human capital of your management and the kind of relationship management has with its workers. In other words, it's the quality of the working place. Those are the kinds of factors that work.

What probably aren't on the list in a major way, and certainly aren't on my list, are things that are derivative of the kinds of incomes and the way you treat them from all of that—i.e., the income tax system, the GST, or any of that type of stuff. Certainly the belief that if we could change the saving rate it would somehow have some magic effect has the whole thing backwards, in my view. We should focus on investment and its later effect on saving. We can't affect investment by changing the saving rate through some policy. We've demonstrated over the last 25 years that doesn't work.

The Chairman: You're saying it's quite difficult to isolate and give value to the inputs.

Mr. Mike McCracken: Any one factor. It also depends on the industry. For example, in the biotech industry in this country today, probably the single most important thing to determine its future productivity is some sorting out of the regulatory environment in which it's going to operate. Without that, nothing will happen.

In some other sector, like road transportation in New Brunswick, it may be completing the highway system in a form that will allow full use of a full load of a car or truck, in moving goods and services.

In some other industry, it may be another problem. Sometimes it won't even be where you thought it was. There was a huge productivity gain four years ago in rail transportation in this country, when a tunnel was enlarged in Ontario that allowed containers to move from Halifax to Chicago non-stop, double-decked. The investment was made in going under the St. Clair River in Ontario, but the whole productivity improvement was very large in rail transportation. So it's sometimes not always obvious, when you're dealing with these sorts of networks, as to where and how you can get a gain out of them.

The Chairman: So we have to be quite careful looking at it from sort of a sectoral productivity initiative.

Mr. Mike McCracken: In each sector you need something. There are some general senses. Someone has to say “I'm going to make that investment. I want to make an investment because I have some sense that five years from now in this country, I'm going to need it.” With the kind of slack economic performance we've had for many years, many business are now saying “I don't really need to expand. I don't really need to take that gamble. I think I'll wait a while.” That cautious mode is not very helpful for productivity growth.

The Chairman: We're going to go to Ms. Jennings and then to Mr. Brison.

Ms. Marlene Jennings (Notre-Dame-de-Grâce—Lachine, Lib.): Thank you, Mr. Chair.

I apologize for missing part of your presentation, Mr. McMahon. The questions I'm going to ask you may be redundant or non-pertinent because you may have addressed them in your presentation.

You talked about human capital, social capital, and the various safety networks in place and how they can impact negatively on productivity growth in a society. You used the Atlantic provinces as an example, where governments have poured money in there and it's had an negative effect, according to the studies you're basing your comments on.

• 1740

You also went into the issue of welfare, social assistance, and how that has just created a cycle of families. I'm perplexed, because the studies I've seen, which appear to be longitudinal studies on the whole issue of social assistance and whether or not it creates a dependency that goes from generation to generation, show that it's actually a very small percentage of the group that happens to. The overwhelming number of people who actually use social assistance come in and use it for what it was meant to be; that is, as a temporary aid because, for example, you've lost your job and you have no right to unemployment benefits, that kind of thing.

A woman who has left an abusive situation has no job skills because she hasn't been in the job market, and she has no income support. She moves in and, particularly now, is able to get the training that's required because we have all kinds of programs that do assist with this, and then she moves out. Generally, she moves out into a low-paying job where she may actually have less income than what she was making under the social assistance, if I'm just going to use that as an example.

According to the studies I've seen, which are long studies that have been around for a long time, you do have a percentage where it is a generational issue, but I don't believe it goes even to 25%. In the majority of cases people move in and people move out. How have you taken that into effect when you talk about government policies and assistance having a negative impact on productivity?

Mr. Fred McMahon: Everything you've said is quite correct. In fact, it is a minority of the people who use social assistance or most other programs who become trapped. That doesn't mean it's not a problem. I can't recall the numbers, but if, as you pointed out, it is 25%, then that's a horrendously high number.

Ms. Marlene Jennings: It's not. I'm just throwing that out.

Mr. Fred McMahon: Yes. Most people pass in and out, and if they're only on it for a few months, they just take up a small amount of income. That's not the problem.

The problem, as you pointed out, is beginning to develop the intergenerational transfer. Ireland, for instance, never had an unemployment problem until about the early 1970s. There was little social assistance. The Irish moved away if they couldn't get work. They came to North America or England. Since the 1970s and the establishment of a more or less generous social assistance program, in the inner cities of Ireland, such as Dublin and Cork—and this is what the labour union leaders told me when I was over there—you have families with no tradition of work for two generations now.

So you're quite right that people move in and out, but that's not the problem. The problem is when it becomes a pattern of life. The community—

Ms. Marlene Jennings: I'm going to interrupt you for a second. I'm glad you raised the issue of Ireland, because I am familiar with Ireland. You may be right. There was no social assistance.

Mr. Fred McMahon: It was low.

Ms. Marlene Jennings: It was very, very low. Basically what happened is that there was no work, and as they grew up and became educated—and it's a highly educated population—people simply stayed at home. Their parents, who had some kind of income support, supported them in many cases. Now they are eligible. Oh, yes.

Mr. Fred McMahon: They tended to leave home, and the Irish—

Ms. Marlene Jennings: Some did, but a lot remained there. You didn't have a complete exodus of the young population. There were a lot who remained there, and they lived with their parents.

We see the same thing happening in other areas of the world, such as the United States and Canada, where people are unable to move into the work field because there are barriers. Their parents, who have some form of income, whether it be retirement income or their own wealth they've been able to acquire, are helping their children live if there is no other assistance available to them.

Mr. Fred McMahon: Immigration actually seems to have been the main outlet. In fact, until fairly recently the Irish did not have a well-educated population. It was only in the late 1960s when secondary school was made free—

Ms. Marlene Jennings: I'm talking about the last 30 years. I'm sorry, I didn't make that distinction.

Mr. Fred McMahon: Okay. As I say, immigration was the main outlet. I've not seen a lot of evidence about the stay-at-home, though I'm sure it played a role.

• 1745

Ms. Marlene Jennings: It's significant in the same way that if we're talking about the generational problem in terms of social assistance, as you said, whether it's 10%, 5%, 15%, or 20%, it's a problem that needs to be addressed. In the same way, using the example of Ireland, whether it was 10%, 15%, 20%, or 25%, it was a reality.

Mr. Fred McMahon: I'm not really sure where this is leading us. As I say—

Ms. Marlene Jennings: The point I wanted to make was did you take into account the social capital and the fact that having social safety programs and a social safety net can in fact assist in productivity, because it allows people to move into the net when they are having difficulty and then to move back into the workforce?

Mr. Fred McMahon: So you would approve of the type of welfare reform in the United States, where it's strictly restricted so that people can only move in and out and not develop a long-term dependence on it.

Ms. Marlene Jennings: I think that's something that could definitely be looked at. But the point is that right now the overwhelming majority of people who do use social assistance in Canada do not use it on a long-term basis. Is that correct?

Mr. Fred McMahon: Yes. As I said before, I agree. I think you have to be very careful when you develop your safety net programs. I approve of the safety net. I don't think—

Ms. Marlene Jennings: From what I heard, it didn't sound as if you did.

Mr. Fred McMahon: I approve of the safety net. You have to be very careful in developing it so as not to set up a perverse program that gets passed on through generations. I have complete sympathy, as I say, for the safety net.

I think we have troubles when it gets perverse, as it did in Atlantic Canada where in some communities 100% of two-income families were collecting UI and where people were refusing work because they were on UI. It got terribly perverse in The Netherlands with their disability system. By the way, the way the labour unions and the Dutch government are handling that is to privatize—and this is a left-wing government—large parts of the disability system. It should be there for those who are disabled; it should not become a way of life. And you have to take great care in designing policy in order to avoid that. I think you and I roughly agree.

Ms. Marlene Jennings: I agree with you on that.

Do I still have some time left, Mr. Chair?

The Chairman: Yes, and what is the final question you were going to ask?

Ms. Marlene Jennings: Thank you, Mr. Chair. I'm glad you've made that clear.

The last question I was going to ask was you were talking about conversion effect—

Mr. Fred McMahon: I said convergence.

Ms. Marlene Jennings: Convergence effect. You used the aid to Atlantic Canada as an example. Do you have other examples related to Canada, either regional or at a more micro level?

Mr. Fred McMahon: I've obviously focused on Atlantic Canada. That's where I'm from.

As I say, I have looked at the evidence from the United States, Europe, and Japanese prefectures. Also, I've looked at somewhat similar evidence on international foreign aid, which is really revealing, with regard to the impact of wealth transfers to developing countries. Foreign aid does no good and may even do damage when it's transferred to countries with bad policy regimes.

By the way, if you transfer $1 million to a foreign country for education, you find absolutely no impact on education spending. It's just fungible all the way through. On the other hand, when it comes to transfers to nations with good policy regimes, which focus on infrastructure and not on politicized spending or rewarding the elite, you find very powerful effects from foreign aid.

I think the problem in Canada has not been the wealth transfer to the Atlantic region but the highly politicized way it has been spent and the distortion and support of industries that make no economic sense.

The Chairman: Thank you, Ms. Jennings.

Mr. Brison.

Mr. Scott Brison: Thank you, Mr. Chairman.

Thank you, Mr. McCracken and Mr. McMahon, for your presentations. I appreciate both your perspectives. In fact I think there's a fair bit of common ground in terms of where the rubber hits the road and practical policies that couldn't in fact work. But then again, I like The New Republic and The National Review as well, so perhaps I appreciate that kind of diversity.

• 1750

The disincentives I feel exist on a micro level involve, in a lot of cases, sometimes overlap and inconsistencies between federal and provincial programs. I know in my own constituency there is a widespread case where there are disincentives for those who are currently, for instance, receiving social assistance, a direct disincentive to taking a minimum wage job. To me, it seems perverse that we're.... The decision by one of those individuals to stay on social assistance, as opposed to work, is a perfectly rational response to an irrational policy. They're making a decision not to deprive their family, and I understand their response. But my question to both of you would be, what form of government policy would best address the issue of disincentives that exist at this level? And I do believe on a larger level it becomes a productivity issue. That's my first question.

Secondly, I'd appreciate your feedback in terms of the brain drain issue, and particularly as it seems to be affecting disproportionately those in the high-tech sector. We are seeing some of our best and brightest young people, particularly those in relatively high income levels, who are choosing to leave because of opportunities elsewhere. How can that affect productivity, particularly if the IT sector is one of the sectors that should be playing a more dominant role?

In terms of the Canadian dollar, some argue that the Canadian dollar is a reflection of lower productivity, or a nation's dollar is a reflection of lower productivity and the exchange rate mechanism operatively reflects productivity. Some other people would argue that it in fact also can create a self-perpetuating prophesy, in that companies may in fact not be making the types of investments in technology because of the fact they're hiding behind the low dollar policy that exists now. I'd appreciate your perspective on the impact of the decline in the Canadian dollar on Canadian productivity.

Lastly, Mr. McCracken, you were mentioning that productivity is best applied to the workplace. The Statistics Canada presenters a couple of days ago said they had intentionally carved out education and health care when measuring productivity in Canada, and I see that as a bit of a problem, because if we carve out the areas of education and health care, it's a fairly large segment in terms of our workforce. They are also both areas that can impact productivity in terms of output in the long term, particularly if knowledge-based industry is going to be the growth area.

So I would appreciate either or both of your feedbacks on how best we can measure productivity, or perhaps improve our measurement by in fact measuring public-produced goods, as opposed to purely market-produced goods, because I think that's something we have to get our heads around.

Mr. Fred McMahon: I think you're right, that Mr. McCracken and I agree actually on most things. We put on that show of disagreement just for your amusement.

The Chairman: We gathered that. Thank you.

Mr. Fred McMahon: I'm sorry, I meant to respond to this when you raised it, because it's a very difficult question, what you were talking about, the disincentives to enter the workforce.

We tend to believe that the highest tax rates in Canada are on high-income people. That's wrong. The highest tax rates in Canada are on people moving from social assistance into the workforce, and oftentimes it's well over 100%.

You face two problems there. One is the employment trap, which says that you don't move into work because you actually lose income when you move into work. And then once you address that, you face the poverty trap, because what happens if you start rewarding people to move into work is you begin to tax it away at a higher level as they go up the scale, so improvements in income don't translate.

• 1755

There are two ways to address this. One, which has happened a lot in the United States, has been cutbacks on social assistance. The initial evidence there is—actually it wouldn't be politically correct to say it in Canada—quite promising. It seems that about a third—don't hold me to that—of the people on social assistance will move into the labour force when you cut back or limit benefits.

The kinder way is to do it through various tax credit programs. Our personal exemption for low-income people is criminally low, much lower than in Britain, much lower than in the United States. I don't know why we're taxing somebody who's earning under $20,000, but we do. That's absurd.

The brain drain is not something I particularly studied, so my comments on that will be very quick. Obviously the tax regime has a fair amount to do with it. The evidence I've seen suggests that a lot of people go to the United States because they find it a more dynamic and interesting place. So it's just not low income or high taxes; there are other things mixed in.

Something Mr. McCracken said earlier I would pick up on here. He talked about firms generating trust and enthusiasm on the part of their employees. The United States business sector, from the studies I've seen, has been far more effective at that than Canada through various profit-sharing and stock-sharing plans and by moving decisions down the scale. Canadian business still tends to be too hierarchical and so on. Those factors—more employee involvement, more decisions down the scale—seem to have as significant an impact as the actual income and the high taxes. So it's a problem that's difficult to address through policy, because it may be a failure of the Canadian business section.

As for the low dollar, I really wish I was able to tie these three things together in some way to make a thread, but I can't.

Mr. Scott Brison: I'd like to have a book about it.

Mr. Fred McMahon: The low dollar, continuing depreciation, is a fool's path to prosperity. Just as you said, people, the manufacturing sector, for instance, will look at it and say “We can compete at this level, and when we can't the dollar will probably fall again”, rather than making the necessary investments in not just physical capital but human capital, which by the way is another area where the United States firms are much better than Canadian firms.

So the low dollar may have saved us to some extent, but it's a path to poverty in the long term. And that path is tied to our weak productivity performance.

The Chairman: Mr. McCracken.

Mr. Mike McCracken: I don't know what we agree on. Let me just say what I think and then you can decide whether there's any overlap.

In terms of the disincentives for employment and the anecdotes of people refusing to go off social assistance to take a job, too many times that job is one at minimum wage, unknown hours, insecure in terms of its duration, maybe just part-time, and with usually lousy benefits. You wouldn't move off social assistance to take that kind of a job.

So you want to make a change there. It comes down to a society in which there's sufficient forward motion and demand for workers, whereby in fact decent jobs at decent wages with decent benefits are available. Anything else is certainly not the kind of move that people should be making.

On the brain drain, in terms of the macro-picture, we should not forget that Canada today brings in 200,000 people from the rest of the world, net. So if there is a brain drain, I think we are the drain. We're the receivers of human capital from around the world. Countries all over the world are educating their people, sending them off sometimes to Canada even at their cost to be educated, and then having them stay here. If we want to do something about it, maybe we should pay back the countries from which we take their best and brightest.

• 1800

In terms of the high-tech companies who are perhaps having some challenges maintaining certain of the people, they do have options if they want to keep them: pay them more, challenge them more. And if your concern is whether Microsoft is going to move forward sufficiently rapidly to dominate the world, then look at world productivity. Maybe it is better that they go down there to help them do that.

On the exchange rate, there are a number of different issues, but let's recognize what an exchange rate depreciation is in the first instance. It is a transfer of a huge amount of income from the personal sector to the corporate sector. Essentially, consumers pay more for both their imported goods as well as for all of those domestic prices in Canada that are set relative to foreign prices. And the companies receive that: import-competing sectors get higher prices, and exporters obtain higher revenues. So that's sort of what's happening.

Then the question comes down, what do they do with it? If they invest and expand and use it for hiring additional people, and if they're able to pass on those gains in lower prices in competitive markets, then in fact there's a hope that out of all of that there will be an employment improvement for Canadians. So there will be some payback to the personal sector. But if they sit on it, or if they take the profits and send them abroad, then in fact there's no gain, from the viewpoint of the Canadians who have made that transfer.

In terms of its effect on behaviour of companies, there is very much a two-edged sword, a carrot-and-stick kind of an effect. If you have a depreciated currency, you have more profit, so you should be able then to invest more and to sell more in open and competitive markets. But many firms have squandered that benefit over time. And certainly when we see a substantial appreciation of a currency, in Canada as well as in other countries, we see that many companies' feet are put to the fire. They essentially have to adapt.

At one time there was a substantial appreciation of the Swiss franc, so much so that they were concerned they were going to lose their entire manufacturing sector. They lost a lot of it, but the parts that remained were highly productive. They were forced to adapt to change to become extremely modern.

So if your focus was only on productivity growth, you might find that what you want to do with business is a two-by-four between the eyes, and that's a good strong appreciation. It has a by-product of also improving real income of people in that process.

Unfortunately, we seem to have little capacity to move the dollar around as we want, from a viewpoint of policy, but rather have to live with the consequences of whatever happens.

On the more general issue of measurement, when you leave out sectors in calculating your productivity measures—like the public administration sector, like education, like health care—essentially what you are doing is recognizing that we are not able at the present time, or have not so chosen, to put in a productivity growth element to those measures in our national accounts. So by leaving them out, we are implicitly saying we will assume their productivity growth is not unlike what's happening in the rest of the sectors, focusing on the business sector, for example.

Indeed, though, it would be very useful to contain it, because for example in public administration, an area that of course some of you think has no productivity, are in fact some of the best documented improvements in productivity growth that have ever occurred. For example, look at cheque clearing: it's a very simple process, but if we look at the number of people required to clear a certain number of cheques today, there's been a phenomenal improvement in that productivity. The capacity to monitor, for example, a whole series of functions on the stock exchange by regulatory authority—the productivity of that operation has been enhanced immeasurably by computer.

So any measures of productivity growth that you would look at in the public administration area might well show major gains, and certainly in health care as well, and in some parts of the education system, with perhaps a lot more to come as people expect increased use of computers, Internet, and distance learning in that area. But we still have this problem of valuing the outputs of education, valuing the outputs of health care, and valuing the outputs of good public administration. Until we solve that problem, we're going to continue to leave them on the side, at roughly 20% of the economy. If the other 80% does very well, then that's a good start.

• 1805

The Chairman: Thank you.

I have one final question. As we engage in this debate about productivity, what becomes apparent of course is the fact that you can look at any factor in society and say that it's related to productivity, obviously. If you're looking at a breakfast program for children who will go hungry, of course that is related to productivity. If you're looking at taxes, that is related to productivity. If you're looking at international trade and fiscal monetary policy and human resources development and so on and so on, that is related to productivity.

One of the challenges of this committee will be to perhaps isolate some areas where we can in fact give some advice to the government as to areas we perhaps should focus on that would have some kind of impact on productivity. Some of it of course is short term, other issues we raise are medium term, and others will be in the long term. Can we get a sense from both of you as to what areas you would move quickly on to have a quick impact on productivity?

Mr. Fred McMahon: The first thing I would do would be to increase the personal exemption and study other ways to move income to lower-skilled workers. As I say, while that might reduce per capita productivity, the social benefits are huge, and it increases the productivity over all of society by bringing people back into the workforce. It can make some of these marginal jobs more attractive by leaving more income with the people.

The important thing to understand about marginal jobs is that when somebody first enters or re-enters the workforce, very often their income goes up thereafter as they get labour market skills and so on.

I would like as well to second Dr. Kesselman's overall thrust without going into the details. We do need lower tax rates on capital to encourage capital formation. Referring to both The Netherlands and Ireland, in both cases the labour unions took a lead in talking about wage moderation to improve profit margins for companies. This is labour unions saying they have to hold wages down so companies can get more profits, so there would be more investment and more incentive to invest.

Now, that's not going to happen in Canada. I can't imagine the recently retired Bob White saying we need higher profits here. But government can have an impact through the taxation rates on capital. Mr. McCracken was right earlier when he said it's both investment and savings. Causality flows both ways. You have to make capital less expensive to use.

I would encourage government to focus, as I said before, on those things government does best. Get rid of all the fancy frills, which cost the Canadian taxpayer billions of dollars every year, and focus on things like infrastructure, health care, education, things that have been shown to bring benefits to all Canadians, both economic and social benefits, rather than what all too often happens, which are fancy titles in search of a program.

So those are the three things I would do: focus government spending; widen the personal exemptions for low-income people; and work on the tax on capital.

The Chairman: Thank you.

Mr. McCracken.

Mr. Mike McCracken: I'll give you a complementary list, with no tax measures.

Essentially, let's think of two issues. One is the focusing on productivity. I think the other thing that as a committee you will no doubt have as a result of these three days, if nothing else, is an awareness of the effects of other programs, policies, etc., on productivity. So I think it will serve you well to be thinking, as you talk about tax systems or other issues you'll be dealing with, bank mergers and so on, that they may also have side effects on the productivity side.

• 1810

Let's focus just on the productivity side. My sense of the priorities in some relative sense of importance is that perhaps all-important is that we must first say that what we're trying to do as an objective is to get to a full-employment economy. Without that, we're going to be in some sense continuing to talk about the difficulties of productivity but we'll have none of the adjustment mechanisms in place working that in fact help improve productivity. We can't move people from sector A to sector B if we're not in a fully employed economy. It's very difficult. It's very easy if you can get a job in another sector that pays more; then the signal's very clear, and you make the move. But when you're unsure about whether you're going to have a job in the future, and when you have large degrees of unemployment in your society, and uncertain employment, as we have currently, then it's a very tough sell.

Part of that strategy is to go to full employment, lower real interest rates, increase infrastructure spending by governments, train people in business.... We keep talking about the long lags from education to improve human capital, but you could much more directly work on the existing stock of human capital if you could get business in this country to provide adequate training. Well, they don't, and the reason they don't is there's no incentive to do so. They can hire someone who's well trained right off the streets. But if they couldn't, they would have a stronger incentive to do that training internally.

You can also make some further steps, I think, on the post-secondary education side, and particularly in the more broadly based trainings, ones that do bring together the sciences and humanities. That's the kind of world I think we increasingly need to have.

Finally, focusing on social capital, social cohesion, building trust in the institutions in this country, including trust in government, I think would go a long way toward improving the performance of our society and the capacity for it to in some sense pull on the rope in the same direction.

I note that comments have been made about Ireland. Ireland's also I think dealing increasingly in an environment where there is trust among the partners—business, capital, labour, and government—some of that perhaps through the relatively newly formed Irish Economic Council.

Certainly one minor thing we could do in Canada is what we did back in 1963 and 1964—to establish a national productivity council and the next year fold that into the Economic Council of Canada as a consensus organization. We've lost that. We lost that in 1991 and 1992, for a variety of reasons. Let's just say that historically it's no longer here. It does, however, leave us without a place to talk. It leaves us without a research basis on an ongoing basis on such issues as productivity, employment, corporate concentration, and so on. So it well might behoove us, if we did nothing else, to revisit the need for such an institution on an ongoing basis to focus on productivity as well as many other issues.

Thank you very much.

The Chairman: Thank you very much, Mr. McCracken and Mr. McMahon. We certainly appreciate your comments. I'm sure we'll be reviewing them as a committee as we prepare to write a report to the Minister of Finance on our findings.

This is indeed a very challenging issue, one that will require a lot of thought and analysis. I think the committee feels we're up to this challenge. This will become, of course, an issue the public will debate, not just this year but I think for many years to come. Thank you very much.

The meeting's adjourned.