Budget 2007 erodes the federal governmentâ€™s capacity to improve the lives of working people. Tax cuts will benefit profitable corporations without increasing investment in the Canadian economy. The federal government will continue subsidizing oil-sands extraction for nearly a decade. Increased transfers to provincial governments may serve important public purposes, but the Budgetâ€™s general thrust is to reduce the proportion of Canadaâ€™s economic resources devoted to such purposes.
The former Liberal government balanced the budget by reducing federal spending to its lowest level, relative to the economy, since the 1950s. It then held spending at this level, devoting almost all surplus dollars to tax cuts and debt repayment. Both of the subsequent Conservative budgets (2006 and 2007) continued this strategy of shrinking the Canadian state.
Budget 2007 proposes to reduce federal revenues, as a share of Gross Domestic Product (GDP), from 16.4% in 2004-05 to 15.5% in 2008-09. Federal program expenditure, including transfers to provincial governments, will be reduced from 13.7% to 13.2% of GDP during the same period.
Budget 2007 projects surpluses of $9.2 billion for 2006-07, $3.3 billion for 2007-08 and $3.0 billion for 2008-09, all of which will be devoted to debt repayment. The Canadian Centre for Policy Alternatives, which has been far more accurate than Finance Canada in forecasting federal surpluses, projects that tax cuts may eliminate future surpluses and require deep spending cuts. So far, federal revenues have grown faster than anticipated because the incomes of the rich, which are taxed at relatively higher rate, and corporate profits have been increasing more rapidly than expected. In this context, corporate-tax reductions may seriously undermine fiscal capacity.
Budget 2005 proposed to eliminate the corporate surtax and to reduce the Corporate Income Tax rate from 21% to 19% by 2010. The NDP stopped this cut, but the Liberals recommitted to it in the 2005 Economic and Fiscal Update. The Conservatives revived this plan in Budget 2006 and subsequently proposed another cut to 18.5% by 2011. Budget 2007 confirms these rate reductions.
Canadaâ€™s Corporate Income Tax rates were reduced from 28% in 2000 to 21% in 2004, placing them well below American rates. Since then, corporate profits have surged to record heights, but Canadian business investment has stagnated.
Rate reductions provide the greatest benefit to the most profitable firms. As a result, the financial sector will gain about twice as much as the manufacturing sector from such reductions. Specifically, each dollar of corporate-tax cuts adds about 25 cents to bank and insurance company profits, but delivers only 13 cents to struggling manufacturers.
Some of these funds will flow to the US government rather than to businesses in Canada. American-based corporations can deduct Canadian taxes from the US tax payable on their Canadian operations. For these corporations, reducing Canada’s tax rates further below US rates simply shifts tax payments from the Canadian treasury to the American treasury.
Rather than offering giveaways in proportion to pre-tax profits, the federal government should develop tax measures proportional to new investment in Canada and target them to those sectors that need support. Budget 2007 takes a limited step in this direction by allowing a two-year writeoff of investments in eligible manufacturing and processing equipment made before 2008.
This temporary measure connected to tangible investment is worth $0.7 billion over two years. By comparison, the Corporate Income Tax rate cuts already implemented since 2000, which are not linked to investment, already cost about $10 billion per year. The further cuts confirmed by Budget 2007 will cost billions more.
Budget 2007 proposes to slowly phase-out the Accelerated Capital Cost Allowance for the oil sands. This phase-out will not begin until 2010 and will not be complete until 2015. In other words, the government has committed to subsidizing the oil sands for almost another decade.
Former Alberta Premier Peter Lougheed, the Mayor of Fort McMurray, the Alberta Federation of Labour, and others are calling for a moratorium on oil-sands extraction. The federal governmentâ€™s decision to continue subsidizing this extraction contradicts its stated goal of limiting greenhouse-gas emissions.
Budget 2007 also provides an incentive for provincial governments to eliminate their Corporate Capital Taxes (CCT). These taxes are deductible in calculating federal Corporate Income Tax (CIT). The incentive payment is equal to the amount that the federal government would collect in additional CIT due to the elimination of the provincial CCT. There is little evidence that tax cuts for the existing stock of accumulated capital will stimulate new capital investment.
Contrary to expectations, Budget 2007 did not significantly cut capital-gains taxes. It simply increased the Lifetime Capital Gains Exemption for small-business owners by $250,000 at an annual cost to the federal treasury of less than $0.1 billion.
As promised in the 2006 Economic and Fiscal Update, Budget 2007 provides a Tax Back Guarantee that all interest savings from debt repayment will be used to reduce personal income taxes. At best, this policy is a harmless gimmick. At worst, it places an inappropriate constraint on future budgets.
If income-tax reductions would have been implemented anyway, then claiming to (partially) finance them through interest savings is meaningless. Because money is fungible, the distinction between â€œinterest savingsâ€ and â€œgeneral revenueâ€ is artificial. Using a dollar of â€œinterest savingsâ€ to cut income taxes simply frees up a dollar on â€œgeneral revenueâ€ for other purposes. Similarly, using a dollar of â€œgeneral revenueâ€ to cut income taxes frees up a dollar of â€œinterest savingsâ€ for other purposes.
However, given the pledge to repay at least $3 billion of debt annually, the Tax Back Guarantee effectively mandates a corresponding minimum level of income-tax cuts in every budget regardless of changing fiscal circumstances. If future revenues are less than projected, the government might â€œneedâ€ to cut spending in order to fulfill its â€œguarantee.â€
The largest personal-tax reduction in Budget 2007 is a $2,000 child tax credit that will provide families with up to $310 (i.e. 15.5% of $2,000) per child under the age of 18. Since this credit is non-refundable, low-income parents who do not pay taxes will not benefit from it. This credit will cost the federal government about $1.5 billion per year.
Budget 2007 introduces a Working Income Tax Benefit (WITB) to assist low-income workers and encourage people to move from social assistance into the workforce. While the notion of a â€œwelfare wallâ€ has been overstated, this initiative is worthy of support. However, the WITB should be combined with higher minimum wages to ensure that it supplements the incomes of the working poor, rather than subsidizing the labour costs of low-wage employers. The WITB will cost about $0.6 billion per year.
As announced on October 31, 2006, pensioners will be allowed to divide their incomes between spouses for tax purposes. As demonstrated by the Caledon Institute, this measure will deliver the greatest benefit to a small minority of wealthy seniors. Of course, it will provide no benefit to the poorest group of seniors: widows.
Budget 2007 does not extend income splitting beyond pensioners. However, it increases the spousal tax credit to the same level as the basic personal amount, saving single-earner families up to $209 annually. Following this change, single-earner families making $36,000 or less per year would not stand to benefit at all from further income splitting. Whereas an extension of income splitting would have cost $5 billion per year, raising the spousal credit will cost only $0.3 billion per year.
Other small personal-tax reductions, each costing about $0.1 billion per year, include: a Registered Disability Savings Plan, the elimination of capital-gains tax on charitable donations to private foundations, and a higher age limit for Registered Pension Plans and Registered Retirement Savings Plans.
Transfers to Provinces
Budget 2007 increases transfers to provincial governments to fix the â€œfiscal imbalanceâ€. From 2006-07 to 2007-08, transfer payments will increase by $1.5 billion for Equalization, $1.2 billion for the Canada Health Transfer, $1.0 billion for the Canada Social Transfer (CST), $0.5 billion for Labour Market Training, and $0.1 billion for Territorial Formula Financing.
Budget 2007 introduces a new ten-province Equalization formula including half of non-renewable resources. The Offshore Accords will fully compensate Newfoundland and Nova Scotia for any Equalization lost due to their oil and gas. However, non-renewable resources will count against the Equalization entitlements of Saskatchewan and British Columbia. While a ten-province standard is welcome, the differential treatment of provinces with respect to non-renewable resources will be a source of continued controversy.
The new Equalization formula uses market value to measure the property-tax base. This change will decrease the Equalization entitlement of British Columbia, which has expensive real estate, and increase the entitlement of Quebec, which has relatively cheap real estate.
The new formula also excludes user fees. This approach may encourage provincial governments to collect relatively more revenue through regressive user fees, which will not count against Equalization, and relatively less revenue through progressive taxes, which count against Equalization.
About $0.8 billion of the CST increase is intended for post-secondary education, but the details are murky. This increase is unlikely to address soaring tuition fees or the creeping privatization of our universities.
The remainder of the CST increase is intended to help provincial governments create childcare spaces. Under pressure from the NDP, the former Liberal government developed transfers to provincial governments to create childcare spaces. The new Conservative government cancelled these transfers, but introduced family allowances and tax credits for employers to create childcare spaces, which did not work. This Budgetâ€™s abandonment of tax credits in favour of transfers to provincial governments is a small step back in the right direction. However, these new transfers will provide much less funding than the cancelled transfers would have.
Specifically, the new childcare transfer will provide $0.3 billion per year. The development of a universal, accessible, and high-quality system would require about $1.2 billion per year, four times the amount provided.
Budget 2007 also provides infrastructure funding to other levels of government. It extends the gas-tax transfer of $2 billion per year to municipalities through 2013-14 and allocates $6 billion to a new Building Canada Fund. These investments will be tied to increased reliance upon public-private partnerships. The Budget claims that â€œCanada aspires to be a leader in public-private partnershipsâ€ and promises to establish a federal public-private partnership office.
The capital cost of public-private partnerships is higher because private borrowing and equity financing are appreciably more expensive than public borrowing. These partnerships may lower operating costs by replacing good public-sector jobs with lower-wage, contracted-out positions.
As part of its approach to the fiscal imbalance, Budget 2007 pledges to build a stronger â€œeconomic union.â€ In particular, the government is â€œcommitting to work with interested provinces/territories to examine how the Alberta-British Columbia Trade, Investment and Labour Mobility Agreement [TILMA] could be applied more broadly.â€
For further information on the â€œfiscal imbalanceâ€ and TILMA, please see:
Andrew Jackson, A Labour Perspective on the â€œFiscal Imbalanceâ€.
Marc Lee and Erin Weir, The Myth of Inter-provincial Trade Barriers and TILMAâ€™s Alleged Economic Benefits.
Budget 2007 proposes relatively little new spending on federal-government programs. In 2007-08 and 2008-09, measures announced in this Budget will amount to $6.4 billion of tax cuts, $5.1 billion of transfers to other levels of government, and only $3.2 billion of spending on federal programs. In other words, Budget 2007 contains two dollars of tax cuts for every dollar of new federal spending.
New spending initiatives for 2007-08 include income-stabilization for farmers ($0.6 billion), a program to combat cervix cancer ($0.3 billion), a Canada First Defence Plan ($0.3 billion), cultural programs ($0.1 billion), and conservation measures ($0.1 billion). Budget 2007 also includes rebates for the purchase of new fuel-efficient vehicles, the cost of which will be more than offset by a levy on the purchase of new inefficient vehicles.
In anticipation of a federal election, Budget 2007 unleashes a blizzard of tax cuts, increased transfers to provincial governments, and small spending initiatives. Many of these measures seem somewhat innocuous and lacking a clear sense of priority. However, the Budget also continues a schedule of deep corporate tax cuts combined with subsidies for the oil sands. Its basic direction, like previous Liberal and Conservative federal budgets, is to reduce the size of government and hence its capacity to serve working people. An ever smaller share of Canadaâ€™s economic resources will be devoted to making important public investments and providing crucial services to individuals, families, and communities.
Can you elaborate on the user fees statement:
“The new formula also excludes user fees. This approach may encourage provincial governments to collect relatively more revenue through regressive user fees, which will not count against Equalization, and relatively less revenue through progressive taxes, which count against Equalization.”
Thanks for this good reading (and for such hard and fast work).
It will be interesting to hear from Stanford on what he thinks the impact of the budget is going to be on the automotive sector. Specifically, how the capital write -offs will play with the surcharge on large vehicles?
The Expert Panel on Equalization and Territorial Formula Financing, which recommended excluding user fees, also summarized the case for including them:
Provinces have argued that all user fee revenues, including some $17 billion of fees collected by colleges, universities, hospitals, and housing authorities, should be fully equalized. In their view, these fees represent revenues used to finance the provision of public services and are equivalent to taxes as a source of funds.
Provinces point out that an Representative Tax System is supposed to mirror what provinces do. If they choose to deliver a service publicly, it is a public service and all revenues financing these services, whether user fees or general taxation, should be equalized. They argue that excluding some or all such fees from the Equalization formula could distort policy choices when it comes to collecting taxes or user fees. In other words, user fees are a source of revenue not distinguishable from any other source of revenue so they are a source of fiscal capacity.
Provinces noted that the inclusion of these fees, with Equalization payments determined by the current proxy base (and no fixed envelope), would enrich the program and raise Equalization payments to all receiving provinces. Provinces with the weakest non-resource fiscal capacity would receive the most benefit per capita.
Equalization payments fill the gap between a province’s fiscal capacity and the Equalization standard. If Ontario raises its taxes, this action raises the standard and increases Equalization payments to other provinces. If Ontario raises its user fees and these are excluded from Equalization, then this action would not affect Equalization payments to other provinces. In this example, the exclusion of user fees might bias Ontario against taxes and in favour of fees.
Thanks for a really professional summary reduced to staightforward language. I wish I had read this before commenting elsewhere, as I missed the date when the oil sands subsidy would be gone, 2016 which is not only hopeless but will not last even on paper for a year. The planet killers remain, then, a target. But are there not other subsidies for these interests, and do they not generate a lot of costs due to environmental destruction.
It is interesting that if you combine the built in requirement for PPPs and the bias towards user fees you have a key ideological plank of the conservatives put into practice. User fees play a key role in establishing estimates of potential revenue from government services which in turn creates the basis for contracting out government services.
Rather than offering giveaways in proportion to pre-tax profits, the federal government should develop tax measures proportional to new investment in Canada and target them to those sectors that need support.
Why? If you believe that firms will just pocket cuts to pre-tax profits without increasing investment, then why wouldn’t they decide to do the same thing with any other tax measure?
If the tax abatement were contingent upon new investment, then companies would not get it unless they increased investment.
If the tax abatement were contingent upon new investment, then companies would not get it unless they increased investment.
All investment is new.
I’m confused on this and I came looking for an anwser. Would the credit be for net investment per firm? Or just any investment, even if it is just replacing depreciated capital?
A Budget For Everyone???
What was in it for a self-supporting lady, over 50, adult kids, paying a morgage, making $17,000 /yr??? I can’t even use the benefit of the preventive cervcal cancer needle !!!! Instead of giving more money to families with kids, they should be giving out free birth control pills and condoms!!!! Might then there be something…anything in the budget for people like me???
Not sure again, but Corinne I think you may benefit from the working income tax credit.
Stephen and Molson:
If taxes are going to be reduced, I would prefer almost any reduction that provides a direct incentive for tangible investment over a reduction that just increases after-tax profits (which theoretically provides an indirect incentive for investment). As explained in the following note, I think that a tax credit for investment net of depreciation would be better than one for gross investment:
Jim Stanford discusses this issue in more detail in his book, Paper Boom.
Thanks Erin, I wasn’t sure would the tax credit covered….
No, that doesn’t address my original point: if you think that firms will pocket cuts to corporate taxes and carry on as before, why wouldn’t they just pocket the ITC and carry on as before?
Firms might indeed do that, but at least an ITC would provide a relatively stronger and more direct incentive to increase investment. I contend not that corporate ITCs are an economic panacea, but that they are preferable to corporate-tax-rate cuts.
I’m confused, if the tax credit was conditional only they increased investment, I don’t see how they would pocket tax reduction, if they are required to make investment inorder to recieve it?
Molson: firms invest all the time, if only to replace worn-out equipment.
Erin: Cutting the corporate tax rate increases the benefits to investment, and increasing the ITC reduces the cost. To the extent that we’re talking about changes of comparable size, the effect on the cost-benefit analysis would be the same.
The difference is that a corporate-tax-rate cut applies to all profits, whether generated by current investment, the existing capital stock or whatever. An ITC only reduces the cost of current investment. To have the same effect on current investment, the corporate-tax cut would have to be far larger and costlier than the ITC.
I discussed this “cost effectiveness” issue in more detail with respect to corporate-tax cuts versus R&D incentives:
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