Federal Budget Redux

In the last couple of years, Relentlessly Progressive Economics delivered detailed analysis the evening after the budget by bloggers who had been in the lock-up. Last week, those of us who were in Ottawa dropped the ball. However, Marc picked it up by assessing the budget remotely from Vancouver.

My main excuse is that, after drafting USW’s press release, I had to go do TVO’s post-budget panel. My other excuse is that there was actually not much new material in the budget to analyse. Indeed, the TVO panel ultimately degenerated into an argument between Andrew Coyne and me about whether Saskatchewan should join TILMA.

While it was not a very dramatic budget, and although Andrew Jackson and Toby have since posted some excellent commentary, I think that a few elements of Budget 2010 warrant further attention.

Shrinking Government

Continuing previously announced stimulus will keep federal program spending at 15.6% of Gross Domestic Product (GDP) in the coming fiscal year: 2010-11. However, the Conservatives envision squeezing it down to 13.2% by 2014-15.

That is modestly above the 12.1% spent by the Liberals around 2000. But looking back before the late 1990s, 13.2% of GDP is the lowest level of federal program spending since 1949.

Furthermore, in 2000, the government was also paying more than 4% of GDP as interest on the national debt. Despite the hysteria surrounding current deficits, Finance Canada projects that debt-servicing costs will increase from 2% of GDP today all the way up to 2.1% in 2014-15.

So, total federal expenditures (programs plus debt servicing) will be 15.3% of GDP, in line with recent lows and a little below 1950. But even with expenditures at rock-bottom, the budget will not quite be balanced in 2014-15.

Why? Because federal revenues will be even smaller: 15.2% of GDP, the lowest since 1963-64. Of course, total federal revenues now include higher Employment Insurance (EI) premiums. But Finance Canada’s definition of “tax revenues,” which excludes EI and some other revenues, will be only 12.2% of GDP.

The budget boasted, “Canada’s federal tax-to-GDP ratio is at its lowest level since 1961.” That claim is based on Finance Canada’s Fiscal Reference Tables only going back to 1961. The Historical Statistics of Canada tell an even more extreme story: 12.2% of the economy is actually the lowest level of federal taxes since 1940!

Budget 2010 thus continues the Liberal-Conservative drive to reduce the share of Canada’s economic resources allocated to national purposes.

Cutting Tariffs

Budget 2010 declared Canada to be a “tariff-free zone” for manufacturers. In at least two respects, this declaration was more sizzle than steak.

First, after decades of trade liberalization, Canada does not levy many tariffs. Eliminating the few remaining tariffs paid by manufacturers will be of relatively little consequence.

Second, in September 2009, Finance announced its “intention to eliminate all remaining tariffs on imported machinery and equipment and manufacturing inputs used by Canadian industry.” Budget 2010 simply implemented that announcement.

I responded to the September 2009 announcement with an op-ed in The Financial Post. While the government has put out another press release re-announcing the policy, I do not feel compelled to repeat now what I wrote then.

Closing Loopholes

A genuinely positive but under-reported element of Budget 2010 was the closure of some tax loopholes. In particular, annual federal revenues will rise by about $300 million from taxing stock options and about $200 million from lowering the interest rate refunded to corporations on tax overpayments. (Unfortunately, these revenue gains pale compared to the billions lost by pressing ahead with scheduled corporate tax cuts.)

Taxing employee stock options like regular employment income, as proposed by the Alternative Federal Budget, would boost annual revenues by around a billion dollars. Budget 2010 does not do anything quite that sensible.

However, it does prevent the following scam: an executive exchanges his stock options for cash, counting the proceeds as a capital gain (only half of which is taxable) and enabling the company to deduct them as an employment expense in filing its corporate taxes. Budget 2010 mandates that either the employee may count the stock options as a capital gain or the corporation may deduct them as an employment cost, but not both.

At least the government has stopped the worst excess of stock-option tax avoidance. The Alternative Federal Budget deserves credit for having been ahead of the curve in putting the tax treatment of stock options on the table.

The other issue is that, when a corporation overpays its taxes, the government refunds the money with interest. However, the government was paying a higher interest rate on these balances than on federal treasury bills.

In other words, corporations could gain a higher return by overpaying their taxes than by investing in treasury bills. Budget 2010 quite appropriately brings the interest rates on overpayments into line with those on treasury bills.

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