Ontario Budget Advice

Last Monday, I testified twice to the Ontario legislature’s finance committee: as an “expert witness” and then on behalf of the United Steelworkers.

I emphasized the provincial deficit’s manageability, the folly of trying to reduce it through cutbacks or privatization, the importance of maintaining tax rates to bolster future revenues, and the advantage of targeted measures to create jobs rather than across-the-board tax cuts.

The transcripts are now available online. Lightly edited versions of both presentations follow.

First Presentation

I will focus on the question of the provincial deficit. Specifically, this presentation will:

– Examine the significance of projected deficits.

– Comment on some things that the provincial government should not do in response to the deficit.

– Suggest some things that the government should do with respect to the deficit.

I encourage members of this committee to step back from the hysteria surrounding the provincial deficit and recognize that Ontario has experienced major recessions and large budget deficits before. The history has been that, within a few years, the economy returned to its long-term trend of growing at about 2% annually above inflation and the provincial budget returned to balance.

The current recession is significantly worse than previous recessions, but current deficits are less worrying than previous deficits because interest rates are far lower. The recessions of the early 1980s and early 1990s were largely caused by high interest rates, which meant the deficits incurred during those periods greatly increased future debt-servicing costs. Conversely, interest rates are now at rock-bottom levels and will remain relatively low for some time, so today’s deficits can be financed relatively cheaply.

The government’s fall economic statement projects that between 2008-09, the last fiscal year, and 2010-11, the next fiscal year, the provincial debt will rise by 40%. However, it projects that over this same period, debt-servicing costs will increase by 23%. In other words, borrowing will increase interest costs by little more than half as much as the overall debt.

Even after this increase in debt-servicing costs, the Ontario government will still be paying less to service the debt next year than it did as recently as the 2000-01 fiscal year. The provincial deficit is certainly not Ontario’s worst problem. Reducing the deficit is less important than reducing unemployment.

The second issue I will examine is what the provincial government should not do in response to this deficit. The government and some outside commentators have floated the ideas of reducing the deficit in the short term by cutting provincial expenditures and/or by selling provincial Crown corporations. Both policies should be rejected. If implemented, they would risk increasing deficits in the long term.

It is neither feasible nor desirable to balance the budget through cutbacks. As committee members will know, the projected annual deficits in the next couple of fiscal years are approximately $20 billion. Cutting that amount of money out of the provincial budget would involve completely closing down the Ministry of Health or eliminating the entire public school system as well as all social services. Cuts on that scale are simply not realistic.

Also, as noted in chart 3 of the government’s fall economic statement, Ontario has the second-lowest program expenditures per capita of any Canadian province. The Ontario government is already investing too little in many important public services, so there is no room to cut further. If the public sector were cut, it would compound the contraction that has already occurred in the private sector, prolonging Ontario’s recession and jeopardizing the economic recovery that will increase provincial revenues and balance the budget in the long run.

Another proposal has been to raise money by selling provincial assets. This proposal would worsen future deficits by removing the more than $4 billion of annual revenues that Crown corporations currently contribute to the provincial treasury. In exchange, as privatized enterprises, they would pay about $400 million in provincial corporate income tax. They would pay a further $600 million in federal corporate income tax, leaving about $3 billion of after-tax profits for the private owners.

The net loss to Ontario’s treasury from privatizing all Crown corporations would be $3.6 billion per year. If we assume that provincial bonds pay approximately 5% interest, to save $3.6 billion in annual interest charges, the Ontario government would need to reduce its borrowing by $72 billion. In other words, just to break even on privatizing Crown corporations, the Government of Ontario would need to sell them for $72 billion.

I submit to this committee that it would be extremely difficult to sell Ontario’s Crown corporations for anywhere near this sum of money. In particular, it is unlikely that private investors would be willing to pay $72 billion to gain annual after-tax profits of only $3 billion. That transaction would imply a price-to-earnings ratio of 24, very high for mature enterprises.

Having discussed what the Government of Ontario should not do in response to the deficit, I will suggest a strategy to balance the budget over the long term. First, the government should help the economy recover by investing in infrastructure, especially the green infrastructure that will be needed to reduce Ontario’s carbon emissions going forward. These investments should be combined with proactive procurement policies to maximize the amount of investment and jobs that they generate in the province’s private sector.

Second, the Government of Ontario must maintain appropriate tax rates so that provincial revenues will rebound as the economy recovers. In particular, I would advocate maintaining the provincial corporate income tax rate at 14%, rather than cutting it to 10%.

Table 2 in the government document entitled Tax Plan for Jobs and Growth indicates that the corporate income tax cut will reduce revenues by $2.4 billion per year when fully implemented. The implication is that maintaining a 14% corporate income tax rate would increase future revenues by at least this amount. It would eventually increase provincial revenues by more than that amount after corporate profits begin growing again.

This policy would drain very little money out of the provincial economy during the recession because corporate profits are depressed and businesses are currently paying very little corporate tax. In any case, corporate tax cuts are a very ineffective form of economic stimulus. In Finance Canada’s last Budget Plan, it estimated that each dollar of corporate income tax cuts adds only 10 cents to Gross Domestic Product this year and 20 next year. By comparison, each dollar of additional infrastructure spending adds a dollar to Gross Domestic Product this year and $1.50 next year.

These numbers do not come from me. They come from a federal government that is cutting its own corporate income tax rate to 15%.

So, if Ontario were to keep its provincial corporate income tax rate at 14%, the combined federal-provincial rate in Ontario would be only 29%. By comparison, the U.S. federal corporate tax rate is 35% and American state corporate income taxes typically bring the combined total up to about 40%. So, Ontario does not need provincial corporate income tax cuts to be competitive with the United States.

When American-based corporations repatriate profits from Ontario to the United States, they pay the American federal corporate tax rate minus taxes already paid in Canada. The effect of reducing Canadian corporate taxes further below the 35% American federal rate is not to give more money to the Ontario operations of American corporations, but rather to redirect their tax payments from the Government of Ontario to the U.S. Government. Maintaining the 14% provincial corporate income tax rate would retain more of these revenues in Ontario.

Finally, I suggest that Ontario should maintain a corporate capital tax for financial institutions. Table 2 in the Tax Plan for Jobs and Growth indicates that removing the capital tax from banks will cost about half a billion dollars per year. That is one-third of the total cost of eliminating Ontario’s corporate capital tax.

Most Canadian provinces have also eliminated their corporate capital taxes, but several have retained corporate capital taxes for banks. South of the border, President Obama is introducing a new tax on bank liabilities.

Other jurisdictions have recognized that it is legitimate to tax banks somewhat more than other industries because government regulation provides banks with several special privileges and protections not enjoyed by other industries. I encourage Ontario’s government to apply this principle, particularly because it could use the extra revenue.

Thank you.

Second Presentation

This morning, in my role as an expert witness, I explained why the budget deficit is not the most urgent problem facing Ontario. This afternoon, in my role as a witness for the United Steelworkers, I will focus on the more pressing problem of unemployment and policies to create jobs.

Throughout this committee’s deliberations, you will undoubtedly hear many depressing statistics about the grim state of Ontario’s labour market. I will provide only two numbers that are particularly important for my union. Since the financial crisis hit the labour market in October 2008, Ontario has lost 116,000 manufacturing jobs. Since manufacturing employment peaked in November 2002, Ontario has lost a grand total of 327,000 manufacturing jobs.

The appropriate policy response is to enact measures that are directly targeted toward creating jobs. In this context, I will examine Ontario’s Tax Plan for Jobs and Growth. It includes input tax credits through the Harmonized Sales Tax of $4.5 billion annually. It also includes a corporate income tax rate reduction of $2.4 billion annually.

Provincial policymakers must ask whether these tax cuts are the best possible use of nearly $7 billion per year. I will argue that these across-the-board tax cuts are not the best way to create jobs.

A more targeted use of nearly $7 billion, or less money, could create many more jobs. In particular, I will make the case for tax credits for new investment and new hiring in Ontario. I will develop this case with three different concepts of targeting:

– Targeting the economic outcomes that we want.

– Targeting new or incremental economic activity, as opposed to economic activity that would have happened anyway.

– Targeting the industries that are most vulnerable to international competition and most able to move to other jurisdictions.

Ontario’s Tax Plan for Jobs and Growth provides tax breaks for the use of inputs and for the generation of corporate profits. However, the goal of public policy is presumably not to encourage the use of more inputs or to increase profits. I think all members of this committee would agree that the goal is to increase investment and employment in Ontario. So, why not instead institute tax credits that are directly related to investment and/or employment in the province?

A second aspect of targeting is concentrating on new economic activity rather than on activity that would have taken place anyway. Most of the $4.5 billion of input tax credits provided through harmonization will reduce the cost of inputs that Ontario businesses would have purchased in any case. Similarly, most of the $2.4 billion of corporate income tax reduction will be on profits that would have been generated in Ontario anyway. Very little of this funding will go to inputs for, or profits from, new investments.

Of course, I must acknowledge that tax credits for new investment or hiring would provide some money for investments or hiring that would have been undertaken anyway. But at least these types of targeted tax breaks would be directed toward new investment and new workers rather than toward existing facilities and existing employees.

A final aspect of targeting is focusing on those industries that are most vulnerable to international competition and most able to move to other jurisdictions. Some industries, like manufacturing, are completely exposed to foreign competition and very mobile between different parts of the world. For example, it is possible for a factory to close down in Ontario, reopen in China, and continue selling its output into the North American market.

Other industries, like construction, are much more sheltered from international competition and are inherently based in the local economy. For example, it is impossible to construct a building in China, put it on a barge, and move it to Ontario.

Economic policy should be more concerned about the first type of industry. If Ontario can retain a good share of internationally mobile industries like manufacturing, then the provincial economy will prosper and locally-oriented industries will do well as a consequence.

From this perspective, Ontario’s Tax Plan for Jobs and Growth is quite poorly targeted. I draw your attention in particular to table 2 in that document, which indicates that most of the Harmonized Sales Tax’s input credits will go to the construction industry. Specifically, construction will get $2.3 billion out of $4.5 billion. Most of harmonization’s input tax credits are targeted at an industry that is not very exposed to international competition and has very little capacity to relocate to other jurisdictions.

Much has been made of these input tax credits being a boon to manufacturers, who often use inputs multiple times throughout the production process. But I draw your attention to the same table, which shows that manufacturing will get $510 million of input tax credits. That is only about 11% of the total being spent on input tax credits. By contrast, the most recent available Statistics Canada figures indicate that manufacturing accounts for 17% of Ontario’s Gross Domestic Product.

So, the input tax credits delivered through the Harmonized Sales Tax will provide disproportionately little support to manufacturing, an industry which I would argue is disproportionately in need of support. In fact, manufacturing would have been better served had the provincial government simply distributed the $4.5 billion according to shares of Gross Domestic Product.

The corporate income tax reduction in this same tax plan is also very poorly targeted. The single biggest beneficiary will be the financial services industry, excluding insurance. In other words, banks will gain the most from the corporate tax cut.

Thank you.

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