Marc’s budget commentary (revised)

Usually when expectations are lowered it is so that they can subsequently be exceeded. So budget watchers were all wondering in the past few days what the surprise in this budget would be. Alas, the surprise is that there is no surprise. As expected we got a do-nothing budget, albeit one with a glossy cover of a child waving a Canadian flag looking out at an ocean that is conspicuously Tory blue.

This Budget has a title, Responsible Leadership, but if you thought that leadership meant taking action to address climate change, reduce poverty and homelessness, expand child care, or prepare for a downturn in the economy, you will be disappointed. But if you believe that paying down federal debt and making the rich pay less tax should be the overarching priorities of the country you will love this “prudent” budget (but I doubt that you are reading this blog).

Even some of the rumoured items in the lead-up are rather puny in size: $500 million one-time for public transit; $250 million over five years for “large-scale R&D projects” in the auto sector; $110 million for “demonstration projects” in mental health and homelessness. Stated in hundreds of millions of dollars, these are designed to sound big to the general public when they are rather small in the context of a $1.5 trillion economy (and $200 billion in federal expenditures).

Similarly, there are many bulleted lists in the budget under the key themes, making it look action-oriented but featuring trivial amounts of money. For example, there is a two-year $10 million advertising campaign to promote Canada’s forestry sector “as a model of environmental innovation and sustainability”. Take that, pine beetle!

The budget’s Table 1.1 shows the priorities of the government quite clearly. New measures in the budget plus the October Economic and Fiscal Update over three years (2007/08 to 2009/10) amount to $23.9 billion in tax cuts, $13.8 billion in debt reduction (this will likely be even greater due to restrained revenue assumptions) and $5.4 billion in new spending.

In other words, about seven dollars in tax cuts and debt reduction for every dollar in new spending. These guys really hate spending money on anything but defence.

It’s a budget not without its share of irony: the creation of a new crown corporation to peddle P3 projects; a No Child Without program to disburse $3 million for MedicAlert bracelets for children (this is the only initiative aimed at children). Interestingly, for a government that decried the use of federal spending power in the 2007 Throne Speech, most of these initiatives are in provincial jurisdication.

In terms of economic slowdown, there is a more realistic growth assumption for 2008 at 3.5% nominal growth from 4.8% in the EFU. Which underlines the fact that the government did not see the slowdown coming when it delivered its tax cuts. This shows that statements by the Finance Minister to the contrary since January that tax cuts were planned as a stimulus were just spin.

As a result, revenue forecasts have been downgraded. While revenues in 2007/08 are up $600 million from EFU, 2008/09 revenues are down almost $4 billion from EFU; 2009/10 down $3.4 billion. Both personal income tax and corporate income tax revenues are revised downwards for 2008/09 and 2009/10.

No radical departures in terms of expenditures – the budget looks more like an economic and fiscal update, while the October EFU looked more like a budget. Expenditures in 2007/08 are up $2.8 billion from EFU due to billing new spending to the past fiscal year, including the $1 billion for distressed communities previously announced, so expenditure for 2007/08 ends up being 6.9% higher than in 2006/07 (though it should be noted that the Tories are good at not spending all of the money passed by Parliament, so we will have to see where the year closes). But for 2008/09 the increase is drops to 3.4%, then 4.9% for 2009/10. Thus, expenditure growth is pretty much in line with nominal GDP growth, so a small victory in that program expenditures relative to GDP stay essentially the same over the next couple years.

That said, if the economy turns down the budget would move naturally into deficit, and this would likely lead to spending cuts in order to balance the budget because deficits are taboo in today’s Ottawa even though every other G7 country but Germany will run one this year and in the recent past. Spending cuts would only make any downturn worse, and are completely unnecessary given that federal debt to GDP at the end of 2006/07 was 32%, down from 68% in 1996/97, and lowest among the G7.

A debt paydown of $10.2 billion is billed as an automatic tax cut through the Tax Back Guarantee™. However, there is essentially no detail in the budget that ties the savings from debt reduction to specifics in terms of taxes. I asked Finance officials about this and they told me that because multi-year tax cuts have already been announced, part of these cuts would be “funded” by the TBG. So the good news is that new debt reduction does not trigger new tax cuts; the budget document merely exposes the TBG as a gimmick.

The major new initiative in the budget is the introduction of Tax Free Savings Accounts. Starting in 2009, individuals over 18 can contribute up to $5,000 per year (and roll forward any unused room). Funds can be withdrawn at any time without paying tax on any capital gains or investment income.

If this had existed for the past 20 years, the cost to the tax system this year would have been $3 billion. Even by 2012/13 this measure will cost the Treasury $385 million per year.

A table on page 278 shows that the TFSA is identical to the RRSP in terms of rate of return after a certain period for the same initial investment – that is, the new $5,000 per year TFSA is essentially equivalent to raising the ceiling for RRSP contributions by $5,000. The major difference is that this is not aimed at retirement – anyone with reserve cash over 18 can contribute and withdraw for whatever purpose they want.

This moves the tax system further towards one in which taxes on investment income or capital gains are not treated equally as taxes on work. This follows on reduced tax rates on capital gains and the RRSP system itself, plus similar vehicles in recent budgets such as the RESP (also expanded in the budget) and the Registered Disability Savings Plan (and BC just introduced a similar initiative for saving for home care and residential care in old age).

Bottom line: if you go out and work to earn a buck, you pay tax at the full legislated rates but if you get income from investments or the gain in the value of your assets, you pay no or little tax.

Few people will be able to fully avail themselves of these plans. They are essentially an upper-income tax cut in disguise. The notion that this will promote savings is not on for individuals who are already liquidity constrained. Low-income families have little in savings; in fact, many middle-income families have little in savings outside of RRSPs (only families with incomes over about $200K avail themselves of the full amount of the RRSP deduction). Average savings for families are down from $7,000 a few years ago to $1,000 last years (and that is the average, pulled up by those at the very top; the median is likely much lower), with the average family $80,000 in debt (according to Roger Sauve).

Furthermore, it is based on a model of the economy that is flawed. The “loanable funds” theory of (neo)classical economics (ie savings by individuals create a pool of capital that is then loaned out for new investment) was demolished by Keynes. Increasing savings leads to the “paradox of thrift” – it is bad for the economy when everyone saves more by reducing aggregate demand. Keynes stressed the importance of investment, but rather than financed by household savings saw it driven by retained earnings by companies or through the expansion of credit through the financial system.

On the unemployment front, after years of running big surpluses on the EI account, EI is now moved into its own account managed by a Crown corporation. But the accumulated surplus on EI to date, around $50 billion, is gone. Instead the new Canada Employment Insurance Financing Board will be endowed with $2 billion. In the event of a downturn EI premium increases are capped at 15 cents per hundred dollars of earnings (for comparison sake, the EI premium rate has fallen from $3 per hundred dollars back in 1994 to $1.73 today).

A final notable point is the creation of a new grants program for post-secondary students. This is not really new money per se as it is an equal dollar replacement for the soon-to-be-expiring Millennium Scholarships Fund that was funded out of a “surprise” surplus back when Martin was finance minister (1997/98 fiscal year).

All of which goes to show what might have been done with the $10.2 debt repayment out of the 2007/08 surplus. There seems little reason why debt repayment is a top priority for the government given the challenges facing the country. With this budget we will have to keep waiting.

3 comments

  • You make some interesting points but I’d have to disagree a bit about negative comments about the TFSA . It’s a bit of a gimmick , but in my opinion , a good one as it allows persons of all incomes , (except those at the very bottom of the scale) , to save for major purchases like a new heating system for the home , a new roof , a bathroom rebuild , new siding with insulation , a new car , an education savings plan ( RESPs are not for everyone), etc. We know that people will spend this money in nearly all cases and it may help to reduce personal debt that is now carried as credit card debt . Encouraging responsibility is never a bad thing .
    A word of agreement – TBG is clearly a gimmick – must have been thought up by the same policy wonk that spent the excess EI income .
    Finally , I see nothing wrong with trying to not go into deficit . If Federal spending were more realistically targeted , they would have enough of a cushion that 2% surplus would be 10% , until an economic slowdown came along , and they always do . If we cling too closely to the economic theories of the past ( Keynes ) ( who may have been correct for those times ) , we risk being out of touch with current reality . The world , and people’s thinking and priorities are constantly changing . So too must governments .

  • An addendum to my earlier comment re the budget – RRSPs are nearly useless to a great many low income Canadians – all they do is reduce the OAP Supplement and cause many to have to avoid enrolling in provincial drug coverage plans . Most low income Canadians will be better off using the newly announced TFSA , which should be started in 2008 , not next year .

  • I’m an “average” Canadian, now retired. Unlike many of our contemporaries, my wife & I didn’t use debt as a way to survive or enhance our lifestyle. If it didn’t fit into our budget, we did without it. Not to say we suffered unduly, we just lived a bit more simply, and, I suspect, less stressfully.
    Even so, we were never able to use all the “RRSP room” we had, because we weren’t wealthy enough, didn’t have the extra dollars to put into contributions, despite much advice that we do so. We did contribute what we could afford, but not all we were eligible to bank.
    Aside from the fact that both our kids have now graduated from university without the help a TFSA might have offered, it’s pretty unlikely we could have afforded to contribute to one, anyway. As Marc notes, yet another tax avoidance programme for the already-well-off.
    Another matter – I just did a rough cut at what the $10billion “debt reduction” might do if used for a good purpose. At the figures in current use, it would house and provide all needed support services to 2860 homeless people. Instead, the funds go to increase bank profits. Good, work, politicians!

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