STANDING COMMITTEE ON FINANCE
COMITÉ PERMANENT DES FINANCES
[Recorded by Electronic Apparatus]
Thursday, December 2, 1999
The Chair (Mr. Maurizio Bevilacqua
(Vaughan—King—Aurora, Lib.): I'd like to call the
meeting to order and take this opportunity to welcome
everyone. This is the final session before the
committee meets to write the report and make
recommendations to the Minister of Finance. So we'll
be sharing with you some of the thoughts and ideas that
we heard as we travelled across the country, and of
course we'll be looking for your input as to what type
of recommendations you would like to see in the budget
This afternoon we have the pleasure to have with us
the following individuals: David Rosenberg,
vice-president and senior economist, Nesbitt Burns;
Professor Pierre Fortin, Department of Economics,
University of Quebec in Montreal; David Laidler,
Department of Economics, University of Western Ontario;
Jim Stanford, economist, CAW Canada; John McCallum,
senior vice-president and chief economist, Royal Bank
of Canada; Joshua Mendelsohn, vice-president and chief
economist, Canadian Imperial Bank of Commerce; Tim
O'Neill, executive vice-president and chief economist,
Bank of Montreal; William Robson, senior policy analyst
from C.D. Howe Institute; Andrew Jackson, chief
economist, Canadian Labour Congress; and Professor Marc
Van Audenrode, chair, Department of Economics, Laval
We're waiting for two or three more individuals, but
Many of you have appeared before the finance
committee. You know how this works. You get 7 to 10
minutes to make your introductory remarks, and
thereafter we'll engage in a question and answer
We will begin with Mr. David Rosenberg. Welcome.
Mr. David Rosenberg (Vice-President and Senior
Economist, Nesbitt Burns): Thank you, Mr. Chairman.
At the outset, I would like to put forward
a question to the government side.
What is so sacred about allocating 50% of the so-called
fiscal dividend to new spending and the remainder
divvied up between tax and debt reduction, and why
should we feel compelled to divide the fiscal pie in
such a preordained way, as if fiscal policy were on
Fiscal policy, in my view, always involves tough
choices over what to do with programs that have
outlived their usefulness, what new spending
initiatives are needed to serve the public good, and
how the tax system can be altered to best maximize our
economic potential and standard of living.
I want to go back to last year's budget just for
a minute. While the government responded to the polls
showing health care to be at the top of Canadians' list
of concerns, nearly $4 billion of new expenditures were
earmarked for the ensuing four years toward “building
a stronger economy”.
At the same time, the tax relief that could achieve
that goal that was contained in last year's budget was
tiny, to say the least, amounting to a negligible
0.2% of GDP for this year, and left top marginal rates
for individuals at a still burdensome level of just
under 50%, depending on the province.
So if 1999 was the health budget, 1998 the education
budget, and 1997 the child benefit budget, the one we
see in February hopefully will be dubbed the tax relief
budget that aims, for a change, at strengthening family
incomes and bolstering confidence in an economy that
has relied far too long on riding the coattails of the
Members of Parliament should be aware that future
economic historians will note that real disposable
income per capita in the 1990s fell almost 5%—a legacy
few other industrial countries share, and a decade
without precedent in recorded Canadian history.
Adjusted for inflation, population growth, and taxes,
personal income is no higher today than it was in 1988,
and that is a haunting statistic.
Accordingly, I would make the case strongly that from
here every dollar possible from the so-called fiscal
dividend be allocated toward reviving household incomes
for everyone, and after this decade of lost income
growth, this should be the government's number one
Thank you very much.
The Chair: Thank you very much, Mr. Rosenberg.
We'll now hear from Professor Pierre Fortin. Welcome.
Professor Pierre Fortin (Department of Economics,
University of Quebec in Montreal): Mr. Chair
and members, my remarks will
touch basically on three subjects: first, the
prospective economic environment in which fiscal policy
is likely to operate; second, the broad split of the
projected economic surplus between debt reduction, tax
reduction, and expenditure increases; and third, the
potential contribution of fiscal policy to accelerating
I think first the basic economic and fiscal
projections of the economic and fiscal update are quite
reasonable, including the setting aside of an
additional economic reserve of prudence. What will
determine whether the economic assumptions are
fulfilled or not is whether an economic slowdown will
occur over the planning horizon.
I want to point out to the committee in this respect
that there is no rule in scientific business cycle
analysis that sets a maximum length for an economic
However, there's a major fact that describes very well
the occurrence of recessions in the last 50 years of
macroeconomic history in North America, and that fact
is that without exception, all major recessions—in
1960, 1975, and 1982 in the United States; and 1960,
1982, and 1991 in Canada—have been engineered by
central banks fighting inflation.
At this time there is no high level of inflation to
fight either in Canada or in the United States. A
burst of inflation related to an explosion of world
commodity prices is not impossible, but very unlikely
So the worst situation we could face is some central
bank action in the United States or Canada, not really
to reduce inflation but to prevent inflation from
rising. That could generate a short pause in economic
growth, but nothing like the big setback that hit us in
1990 to 1993.
So put me in group O, the group of
optimists, concerning economic prospects for the next
five years. It is my view that very likely the average
economic scenario presented in the update will unfold
as projected, and that the contingency on economic
reserves will not be needed and therefore can
contribute to debt reduction.
In the very short run, one particular cloud hanging
over the Canadian economy is that our central bank
could increase short-term interest rates prematurely.
No one knows for certain where the lowest sustainable
non-inflationary unemployment rate is in Canada. It
could be 7%, but it could also be 6% or 5.5%.
Apparently, the bank has determined that the current
unemployment rate of 7.2% is close enough to the
critical, but unknown, non-inflationary level that
interest rates must begin to be raised again.
There is a big risk that the bank is wrong. Until two
years ago it believed that Canada's unemployment rate
could not fall below 8.5% without generating ever-rising
inflation. It was wrong then, and it may be
just as wrong now if it believes that the unemployment
rate cannot decline under 7% without launching
As the experience in the United States in this decade
has shown, the key to good monetary policy is to keep
testing and probing lower and lower unemployment as
long as there's no solid evidence that inflation is
really threatening again. The pre-emptive attack
approach is the wrong way to go, because it means
fighting inflation in advance of really seeing it, and
taking the risk of keeping unemployment higher than
really needed. We should remember that one point of
lower unemployment is that it means 225,000 more jobs
in Canada and some $20 billion more output.
What rule of thumb should the government follow in the
split between debt reduction, tax reduction, and
expenditure increases? I think the update has set the
right framework for thinking about this question. As
many have emphasized, federal finances are still
currently in a fragile situation. A 1%
across-the-board increase in interest rates would soon
add $5.7 billion to interest charges on the federal
debt, and hence to the fiscal deficit. So I think it
is wise to continue to set aside the contingency
reserve grossed up with an additional economic prudence
factor, and to apply it to debt reduction if it is not
needed during the fiscal year.
But I do not believe the government should go further
and make additional instalments to repay the debt. At
three percentage points per year, the current pace of
reduction in the debt-to-GDP ratio is quite
respectable. It is well understood by the public and
allows the government to pay attention to other
pressing needs on the tax expenditure side of the
How, then, should the fiscal surplus for planning
purposes be split between tax reduction and expenditure
increases? I think the answer once given by the Prime
Minister, 50-50, is the correct answer. This would
imply that program expenditures would increase by just
about the same percentage as current dollar GDP, on
average, so that the weight of the federal government
in the total Canadian economy—which has recently
fallen back to its level of 50 years ago, as shown on
page 86 of the update—would essentially be maintained.
I do not think it would be a good idea to have program
spending grow faster than nominal GDP again if we're
not to forget the hard lessons learned from the budget
horrors of the last two decades. But I do not believe
it would be a good idea to keep program spending
growing more slowly than GDP either. I must admit that
this advice, on my part, is based on personal values. I
think it would be absurd to throw overboard the kind of
Canadian society our parents and grandparents have
taken a decade to build with the somewhat higher, but
not exaggeratedly higher, level of public services
rendered in Canada than in the United States, and the
top rank on the United Nation's development index that
goes with it.
I will add that my first priority for program spending
growth would be that government return to the health
care sector the funds it has withdrawn by cutting
transfers to provinces over the past decade. This
could be done by increasing the transfers or by
imaginatively spending more federal money directly in
the health sector to relieve the provinces from
their current financial straitjacket.
My key point is that our health care sector is
deteriorating outrageously by the day, and something
must be done about this quickly. This is not the time
for Canada to start spending again in every direction,
but it is the time to improve the way we do what we already do.
Now, given the economic and fiscal assumptions of the
update and my preferred 50-50 split between tax
reduction and expenditure increases, some $12 billion
to $15 billion of tax relief could be offered to
Canadians by 2005. There are major political and
economic reasons that tax relief is necessary. The
stakes are the basic credibility of our democratic
institutions and the international competitiveness of
our private sector. The need for tax relief is nowhere
more evident than in the areas of personal and
corporate income taxes.
I think here the government should take advantage of
the prospect of tax cuts to review the structure of
taxation so as to spur productivity growth—this is my
third and final point—which has been seriously
lagging in this country over the last 20 years. The
great thing with tax reduction is that it makes changes
in the structure of taxation possible without making
losers. We may have here the opportunity of the
century to do so.
Fiscal policy cannot be everything for productivity,
but it could certainly do a lot by encouraging saving
and investment. There are many ways to generate more
savings in Canada. One of the most effective is to
exempt all savings from personal taxation, thus
actually making personal income tax a consumption
Two such schemes have been proposed: the flat
tax advocated in Canada by Mr. Dennis Mills, and the
progressive consumption tax advocated by Senators
Domenici, Nunn, and Kerrey in the United
According to the latter proposal, all new savings
would be removed from the personal income tax base, and
all old savings disposed of and brought back into the
consumption flow would become taxable. This would
amount to putting all Canadian savings in a mammoth
RRSP. I think the committee and the minister should
focus on the potential such a progressive consumption
tax would have for promoting savings in Canada.
We also know for sure that Canada is seriously lagging
behind the United States in the area of business
investment. Here the policy tool is the corporate
income tax, and the bottom line is that the effective
rate of taxation on business capital is 31% in
Canada, 22% in the United States, and 10% in Ireland.
Based on these numbers, guess who got the highest and
lowest rates of foreign direct investment and the
fastest and slowest growth rates of income per head in
the industrial world over the last decade?
In this light, I think taxes on business capital
should be reduced by a large amount in Canada. This is
the only point on which I would differ with the update.
I think that in the area of business capital taxation,
the department plans to move ahead too slowly and too
Thank you very much.
The Chair: Thank you very much.
We'll now hear from David Laidler of the Department of
Economics at the University of Western Ontario.
Professor David Laidler (Department of Economics,
University of Western Ontario): Thank you, Mr.
Let me begin with the last question that was posed to
us: what can we do about productivity with economic
policy? I'm not one of those who believe in picking
winners and micromanaging innovation. It seems to me
that a stable background of macroeconomic policy and a
microeconomic structure of taxes that doesn't distort
the incentives that confront the private sector are the
two things the government can provide that really will
help productivity, if anything is going to.
On the monetary front, I think things are in
relatively good shape at the moment. The inflation
targets are working well. I would note that over the
last couple of years they, if anything, helped to keep
monetary policy accommodative, and appropriately so at
a time when many people were calling for tighter money
to support the exchange rate. The inflation targets
are up for renewal in 2001. That has to be discussed,
but I don't think this is the time to discuss it.
On the matter of the macro stance of fiscal policy,
clearly we're in pretty good shape, but I am among
those who think that the current level of debt is
outrageously high, that $40 billion per annum spent on
interest is ludicrous, and that the faster we can get
that down, the better. I would give very high priority
to continued debt reduction.
On the matter of the microeconomics of fiscal policy,
let me just utter two sentences about health and
education. I speak as an interested insider. I think
these two things are national disgraces, but I'm not at
all clear that the solution either to health care
problems or to education problems lies in more federal
expenditure on them. There are much more complicated
issues that need discussing there, but again, not here.
As far as the microstructure of the tax system is
concerned, it's a dog's breakfast. I would suggest
that instead of thinking in terms of piecemeal tax
relief, the committee think instead in terms of an
overall reform of the tax system, with an eye to
evening out the many perverse incentives that currently
lurk within its structure.
As Pierre Fortin has just remarked, we really do have
a once-in-a-generation chance of doing something about
the structure of taxes. Because tax reform doesn't
have to be revenue neutral, we can compensate the
losers this time around.
I've made a brief list of things that I would like to
see in tax reform. Let me just go down the list.
I was very impressed with the report of the Technical
Committee on Business Taxation. Given that we have
this report, which has looked into the highly
distortionary field of corporate taxation in this
country and has already provided us with a blueprint
for getting out of that mess, that would probably be
the place to start with tax reform.
Once you are reforming company taxation, you have to
look at the personal income tax, because dividend
taxation and capital gains taxation do have to be
integrated with the structure of corporate taxation.
The next think I would be looking for is a restoration
of full indexation to the personal income tax. The
lack of full indexation of the personal income tax
seems to me to be economically indefensible. The only
possible excuse for it was that it was a good way of
helping to get the deficit down quietly. Those days
are past and gone. I would give high priority to
getting indexation back into the PIT.
I would say the same thing about the 5% high income
surtax. That was there for deficit reduction purposes.
I would just note that the income tax is not a tax on
being rich, it's a tax on getting rich, and if you're a
young person who wants to get rich you're probably
going to go to a jurisdiction that doesn't tax you high
on the margin. I am one of those who think high
marginal income tax rates potentially create a brain
drain problem. I am concerned about it, though I
certainly agree that there's much more to the brain
drain issue than the level of taxation.
Then I would go to the clawbacks of income support
measures that are built into the income tax structure
at the moment. We have an extraordinary sawtooth of
variable marginal tax rates, depending upon when the
GST tax credit is clawed back, on when the child tax
credit is clawed back. I would want to reduce the
progressivity of those clawbacks to iron out the
incentives in the structure of the personal tax. I
didn't note this in my written submission, but of
course there are all sorts of perverse incentives that
come from the structure of provincial taxes and
benefits and that need to be looked at as well.
Finally, I'm going to be an academic and
put two things on the table that are not politically
very popular. It seems to me that for payroll taxes
overall the academic evidence is that they're not
terribly distortionary as far as the overall supply of
labour is concerned. I'm not terribly concerned about
the level in Canada, except at very low levels of
income where they start to interact with minimum wages
and welfare benefits and create problems for people
with very low skills.
So I'm not much in favour of an overall lowering of
the level of payroll taxes, but may I just enter a plea
for reconsideration of experience-rating the EI system
in order to get some of the distortions out of the
allocation of the labour force, which it currently
Finally—I think it will be the only time this is
mentioned this afternoon—the base of the GST is rather
narrow and its rate is rather high. It would be
possible to broaden the base and lower the rate, and
that would be economically desirable. I do recognize
that it's politically very difficult, but I am an
academic and I felt that I just had to say that.
Finally, if one is thinking in terms of tax reform
rather than piecemeal tax relief, that's going to take
thought, time, and careful planning. That means
proceeding slowly. Given my concerns about the high
level of the public debt, I wouldn't be the least bit
concerned if we started planning now for meaningful tax
reform in two or three years, in the centre, when we
really did have the debt-to-GDP ratio a fair way
The Chair: Thank you very much.
We will now hear from Jim Stanford.
Mr. Jim Stanford (Economist, Canadian Auto
you, Mr. Chair.
Thanks for the invitation to appear. I'm glad I got
here, along with everyone else who was on the 1 o'clock
Air Canada flight from Toronto. If we'd had a suicidal
pilot or anything like that, the economics profession
would have been dealt a serious blow. Luckily, the
pilot didn't know that I worked for the CAW. Air
Canada pilots have a thing about the CAW these days, so
that was kept under wraps.
Anyway, I'll do three things here in my presentation,
which is in the green booklet.
First, I'll give my take on the fiscal forecast, my
interpretation of the finance minister's fiscal update
and where it's going. I think his projections of the
latent surplus and hence the amount of fiscal room for
initiatives, either on the tax side or the program
side, is a bit conservative.
I applaud his efforts this year to extend the planning
horizon to five years and incorporate, I think, a
greater degree of transparency and honesty into that
forecasting exercise, but I crunched the numbers, and
even using the same consensus forecasts about
inflation, growth, and interest rates, I come up with
surpluses that are about one-fifth bigger.
In terms of that fiscal planning exercise, I do
applaud the initiatives he has made this year, but I do
still express my view that there are some conservative
assumptions, combined with the $3 billion contingency
fund in that exercise, that impart a conservative
bias. I think there's even more room for initiatives
on the program side and the tax side than his update
suggested. I looked at a latent surplus of something
close to $12 billion in the fiscal year you're looking
at, fiscal 2000, and something close to $18 billion in
the second year.
In terms of priorities for what to do with that latent
surplus, I put the full weight of my remarks on the
need to rebuild program spending. It was reductions in
federal program spending that bore the brunt of the
fiscal transition of the mid-1990s. It is quite
wrong—and I think most members of the committee would
agree with me on this—to argue, as many do today, that
we taxed our way out of that deficit. Higher taxes as
a proportion of GDP accounted for less than one-fifth
of the change in the final federal balance expressed as
a share of GDP, whereas reductions in program spending
as a share of GDP accounted for something close to
two-thirds of the shift in the final balance.
Federal program spending has been cut by one-fifth as
a share of GDP since 1994. Most worrisome in my view,
it's still falling as a share of GDP despite the much
improved fiscal situation we have. That suggests that
not only are we not going to repair the damage that has
been done to infrastructure, public programs, and
social benefits, we're in fact going to see that damage
In terms of David's question at the beginning—what's
so sacred about the 50-50 rule?—in my books, the only
thing sacred about it is that it is a key element of
the platform the existing government was elected on. I
don't know what democracy and accountability count for
any more, but if they count for anything, that 50-50
rule should be a guidepost for you.
I point to the results of the seven provincial
elections that have been held within the last two
years. Tax cuts were an issue in every one of them,
and only one government succeeded with a radical tax
cut package. I think that's because the majority of
Canadians recognize the value they get from public
services. That feeling is still there.
In terms of my two bits about a top priority for
rebuilding program spending, in the portfolio of items
you have to look at I would put in a plug for
significant investment in a national public early
childhood development program. That has been a major
priority of our union. This year we made some progress
we're very proud of in our bargaining with the major
automakers around child care accessibility for our
members. We think the cost of a public national
program, including child care, is well within the reach
of the government, and that would be an important thing
to do, not just for enhancing the future prospects of
those children but also for maximizing the labour force
participation of their parents.
Finally, in terms of the tax cut issue, I range from
being skeptical to viewing with alarm what I see as
increasingly shrill and often extreme calls for tax
cuts—especially personal income tax cuts—coming from
many business and financial lobbyists and economists.
I find the contrast quite startling between the
alarmist words we're getting—like “cut taxes now or
our economy will fall apart, all the smart people, all
the wealth creators will leave, all the incentive will
be gone”—and the real evidence we're getting about
what's finally happening in our economy.
For the first time in the 1990s, we're seeing
sustained economic progress and a sustained rise in
living standards for people like the members of my
union, thanks to falling unemployment and thanks to a
modest rise in earnings. At the very moment when
finally the typical Canadian is going to feel that
things might be getting better, we get the alarm bells
ringing that the world is falling apart in Canada
because of our taxes.
I just do not accept that there is significant
evidence for it. Much of the evidence that's advanced
is clearly shallow, ranging to false. I'll just pick a
couple of examples. The Financial Post this
week—they employ me to write a column, so I have to be
a little careful here on what I say—ran as a cover
story a poll of CEOs calling for personal income tax
cuts as the most important initiative.
Well, this is a group of individuals whose average
income is over $1 million, so I don't think any of us
should be surprised that they would identify cuts to
the personal income tax system as a priority.
mentioned the need to compete with the stock market
millionaires in the U.S., with the huge gains people in
some companies make through stock options in the
technology field ad so on.
We could cut our personal income tax rates in Canada
to zero and we still wouldn't compete with the stock
market millionaires in the United States, so I don't
see the value of that argument. If we start to design
important programs in our economy to try to keep up
with those who are winning from what is clearly an
unsustainable paper lottery in the U.S. stock market,
then I think we'll be making major mistakes.
It's quite wrong—the evidence is there—to blame
higher personal taxes for the decline in disposable
incomes in Canada. Personal taxes have increased
marginally in the 1990s but they're starting to
decline now. They fell at an average rate in 1997 and
probably again in 1998, once we see the data.
The decline in personal disposable incomes in Canada
is driven almost exclusively by a decline in pre-tax
incomes in Canada as a result of our poor macroeconomic
performance and, significantly, as a result of the
retrenchment in public transfer payments, an important
component of personal incomes.
I would prefer to see all of the surplus reinvested in
public programs. I doubt that's saleable politically
for your government, so I'd consider it a step in the
right direction to stick with the 50-50 rule you were
I would certainly like at this point to highlight the
view from the other side of the tracks, if you like,
for those Canadians who earn $40,000, $50,000 or less,
for whom personal income taxes are moderate in Canada,
more moderate than they are in the United States, and
for whom the consumption of public services makes up a
very important share of their standard of living.
For those Canadians, a reinvestment of the surplus
funds in program spending should be the top priority of
your government. I think that's justified on both
ethical and efficiency grounds.
The Chair: Thank you very much, Mr. Stanford.
We'll now hear from Mr. McCallum. Welcome.
Mr. John McCallum (Senior Vice-President and Chief
Economist, Royal Bank of Canada): Thank
you, Mr. Chairman. It's a pleasure for me to be here,
although I'm not sure if I'm not in a dangerous
position between these two gentlemen.
I think the fundamental challenge for Canada in the
coming years is to balance two possibly conflicting
objectives. On the one hand, there is our desire for a
distinct national identity—a kinder, gentler society,
to use that cliché—and on the other hand, there is our
need to be competitive.
I hope Jim won't say I'm one of these shrill people,
but I do think there's some evidence that the costs of
becoming uncompetitive are becoming more severe in this
globalizing world. It's all very well for Canada to
have higher taxes than the U.S., and it always will
have—we are kinder and gentler, which I buy into
altogether—but we cannot afford, although this is what
we'll get under status quo policies, a tax gap
vis-à-vis the U.S. that keeps on getting bigger and
bigger. That's what we're seeing in the personal tax
side and that's what we're seeing in the corporate tax
side. Therefore, I think we do have to assign a pretty
high priority to lower taxes.
What importance should be attached to debt versus
spending versus taxes? I know the government is
committed to 50-50 now, but if one looks into the next
mandate, that might change. We're talking in terms of
five-year planning these days. I would favour
approximately half for lower taxes and a quarter each
for debt and spending. Let me go very briefly into
each of the three areas.
On the debt, I think I would do what essentially the
government appears to be planning to do, which is to
have a never-ending string of balanced budgets, but
with very substantial contingency reserves. In the
event those are not used, they would go to pay down the
debt. It seems to me that under that policy we'd get
an adequate rate of debt reduction relative to GDP.
On the spending side, I would suggest spending going
up at the rate of about 3.5% per year, relative to an
assumed GDP growth rate of 4.5%. That's allowing real
per capita spending to rise somewhat, but it's not
rising as fast as GDP.
I'd mentioned three areas of spending. One, it's true
that our national infrastucture is in a state of some
disrepair. Whether one looks at the Mounties, the
armed forces, or the state of our roads, more money is
Second, I would certainly put more money into what one
might call the areas of greatest or most pressing
social need: homelessness, aboriginals, foreign aid,
and things of that nature.
Third, in the new economy, information-based
industries are critical. Those are areas where Canada
has been lagging rather badly behind the U.S. I would
put some money into basic research and things of that
nature. However, I'd keep the total spending growing
at not more than 3.5%.
With regard to taxes, I will mention primarily
personal income tax and business tax and give you three
reasons for assigning a high priority to lower personal
The first is the very simple point of putting more
money back into the pockets of Canadians after a very
dismal decade in which the average household has seen
declining take-home pay.
The second is the idea that marginal tax rates higher
than 50% are bad. They add to the underground economy.
They constitute disincentives. I'd agree with the idea
of getting rid of the surtax, as David Laidler
mentioned, but I'd also emphasize that high marginal
tax rates are not just the domain of rich people. Some
of the highest marginal tax rates of all are for those
earning between $25,000 and $30,000, who might lose,
for every extra dollar they get, up to 70¢ because of
the clawback of various social programs in combination
So I would assign a high priority to reducing those
clawback-induced high marginal tax rates by extending
the period of the clawback so it is much more gradual,
rising to a higher level of income.
Last but not least, we stick out like a sore thumb
in this country in terms of our very high level
of personal income tax as compared with other
countries, including, but not only, the U.S. We're
about 30% higher than they are.
It's true that the brain drain numbers today are not
huge, but I think we are really facing the tip of an
iceberg if we don't take action. The United States has
surpluses like we do, they have a Republican Congress,
and they are going to be cutting taxes. If we stay
where we are, the gap, as I said earlier, is just going
to get larger and larger. I don't think that can be
sustained in a world where U.S. corporations are
scouring the globe for talent, in a world where the
Canada-U.S. border is coming down, and in a world where
anti-Americanism among younger Canadians is definitely
on the wane.
So it's not just a brain drain issue. I think there's
a threat of that if we stay where we are in a world
where the U.S. is coming down in taxes, but it's also
the other two reasons I gave you at the outset in
favour of a large attack on personal income tax. You
need a lot of money to do that, because almost half of
government revenue is personal income tax. Any
sizeable tax reduction will take quite a lot of money.
Finally, I agree with Jack Mintz, who paraphrased Bill
Clinton in saying that the business tax is stupid if
your idea is to produce a more prosperous, competitive
Canadian economy. In terms of the location of economic
activity, I suspect you'll get more bang from the buck
through reforms to the business tax system than you
would in personal income tax. Another advantage is
that it costs a lot less. Mintz estimates it would
cost, I think, $2 billion to get a one-third reduction
in the corporate tax rate. I think you could get quite
a sizeable increase in economic activity if you did
that. As Pierre Fortin mentioned, Ireland is an
I think I'll leave it at that. I don't want to sound
alarmist, but if we look forward a period of five
years, with the Americans not standing still, I think
there is an element of urgency to take some action on
both personal and corporate tax. That is why I would
put somewhat greater emphasis in that area.
Thank you very much.
The Chair: Thank you very much, Mr. McCallum.
We'll now hear from Mr. Mendelsohn.
Mr. Joshua Mendelsohn (Vice-President and Chief
Economist, Canadian Imperial Bank of Commerce):
Thank you, Mr. Chairman, and thank you for the
invitation to appear this afternoon.
I'm going to try to avoid repeating some of the things
others have said, although I clearly will be taking
exception to some things. It's a bit unfortunate that
I follow John McCallum, because he and I are pretty
much on the same wavelength, I think.
I want to focus on a couple of things. One, despite
the fact that both I and many others in this room are
focusing on tax reductions, we do not live in a dream
world where we believe taxes are the only element
hurting the Canadian economy or the only element that
will fix the Canadian economy.
It is clearly part and parcel of a broader set of
issues, but to deny that Canada's high tax structure is
doing damage is also being very disingenuous. And there
are numerous issues here.
Secondly, I raise some questions about what makes
public sector spending so holy and beneficial. It's
not necessarily beneficial. What we need to do is
evaluate public spending on an ongoing basis, and—as
I'll talk about in a few moments—for any program that
is put in place, have a sunset clause on it where it is
reviewed periodically, whether it's five years or
whatever the normal period, so that we can determine
whether it's meeting its objectives, and if not, how we
should alter it, or in fact if it needs to be
Let me go back a bit. In the context of the fiscal
projections and the fall economic statement of the
finance minister, I found that statement, that
assessment, more heartening than I have in past years,
certainly. Many of the issues I'm concerned
with...including the fact that it's the taxpayers'
money, it's not the government's money. I think that's
a very clear statement that needs to be repeated: it is
There is also the fact that we are paying some of the
highest taxes in the G-7 economies. Bracket creep
is clearly an issue. Even if we were to reduce taxes,
we still do not have full indexation, so progressively
we are still eroding the income base until we go back
to full indexation, and I believe that needs to be done
Now, in view of Canada's high and very progressive tax
structure, my belief is that it has contributed to poor
productivity performance and the long-term depreciation
of the Canadian dollar, which in turn reinforces that
poor productivity performance.
As for the evidence, obviously there's mixed evidence. But
I want to make a couple of observations on the
There's been an ongoing debate about whether the
measurements are right, whether we're a tenth of a
point higher or a tenth of a point lower than the U.S.,
or whatever. That to me isn't an issue; that to me is
a red herring. Over the long term, sure, the rate of
growth of productivity is important, but productivity
gaps in many, many areas do exist in wide scale. The
issue is how do we maximize Canada's productivity
performance and our long-term competitiveness without
relying on a cheap currency? In point of fact,
that's the only thing that's giving us our
competitiveness these days—in many industries, not
While I'm on this issue, I want to note that while I'm
focusing on personal taxes—again echoing what
some of the other speakers have said, partly because of
the political imperatives of the day—there is also a
clear need to reform Canada's corporate tax structure
and the resulting distortions that we face from that.
Now, I find it interesting that the OECD, the IMF, and
a whole host of international bodies have come back to
Canada.... In fact, in the 1999 IMF review of Canada,
it says that the staff believe priority should be
given to reforming income taxes in order to improve
incentives to work and save, and that restructuring
these taxes would leave a permanent legacy of higher
growth and prosperity in Canada.
Now, the IMF is not the be-all and end-all. They
clearly have made mistakes in numerous areas. But
having said that, I think what is also important about
the tax system is the incentive system.
Unfortunately—I'm just speaking for myself, but I do
know I've heard this sentiment reflected more and more
often—we tend to disparage success. When is the time
going to come when we start applauding it?
When are we going to say, fine, it's great to become
wealthy and successful—although obviously, in a
socially responsible and legal fashion, of course?
When are we going to do that? We are not doing that.
In fact, we are saying that if you're successful, somehow
you've done something wrong.
One of the elements I keep being concerned about
here is that when we talk about renewal of government
transfers back to the original numbers, and spending
here, spending there, what we're effectively saying is
to continue to protect the Canadian system as it is
There are many, many good things about the
Canadian system, many things that the Americans would
love to have that we have up here. But not everything
is perfect, and the issue is that we need to move forward
through an incentive process that restructures this
Let me go back to productivity. There are some
numbers that come out. When people talk about U.S.
productivity in manufacturing, they often point to the
fact that the high growth of productivity is in two or
three sectors: information technology, computers, and
commercial and industrial machinery. That's true, but
the U.S. has changed its manufacturing output so that
these sectors are increasingly important sectors of
that economy and they reap the benefits of the changing
technologies and the changing world demand structure,
while we still have not really tapped into that in a
very big way. And the tax structure certainly does hurt
Let me go back to the issue of disposable income. It's
interesting, we're all using similar things. I have a
chart in front of me that shows U.S. real disposable
income from 1983 through June of this year, and from
1989 on, the year in which Canada and the U.S. were at
roughly the same level—and this is in local
currency—the U.S. income is up about 17%, and of
course Canadian income has gone nowhere; in fact
it has gone down.
Recent reports saying that we're going to finally catch
up to 1989, rather than making me feel comfortable, scare
me, because it reinforces the lost decade, if you will,
and we need to get off that kind of process.
But it's true, it isn't taxes that have done most of
this. The charts show, even if you take off the taxes,
it isn't just the taxes. It's employment. But to what
extent has our tax structure and our approach to
subsidies and the like supported a system that doesn't
allow for the creation of jobs—and for the creation of
high-value jobs—and productivity, that hinders the
future development of this economy?
That's really where I'm coming from in terms of the
tax cuts, that we do need them. I'm looking at it as
much from an incentive process as anything else. That's
why the 5% surtax becomes important, because it's a
very visible image of penalizing a group despite the
fact that the reason for the tax is now totally gone
and there's no justification for it.
Finally, let me just talk about the 50-50 issue. I
mentioned earlier on that I don't know what
is sacred about public spending. Certainly there
are good things and there are areas.... The health
care system certainly is one that we need to support.
The educational system is one that I strongly believe
should be supported. But—and I think David Laidler
raised the issue—putting money into it isn't
necessarily the best answer. In fact it may be the
I'm not going to deny the fact that if one puts more
money into health care and it reduces or eliminates,
hopefully, the need for various patients to go hundreds
of miles or down to the States to get treatment that
they should be getting closer to home, that certainly
is necessary and desirable. But one can also look
within the system and see where the cracks are and where
the fixes have to be, so that we don't just paper
over the cracks by putting more money into it.
Education is another one, and I'll leave the higher
education out for a moment, but simply deal with
the elementary and
high school levels. Canada is one of the highest per
capita spenders on education, and yet we all know that
the results are far from ideal. What is in the system
that we need to look at and revamp, rather than just
throw money at?
So to me the spending is not God-given, it's one I
would look at as doing judiciously.
In regard to the 50-50 rule, it may be necessary for
the next two years, because the government has
committed itself to it. I still don't believe that. I
think it's how you define the 50-50. There are a lot
of issues of where the base is, and so forth. So I
leave that for some questions.
At the end of the day, what I'm really getting at is
that there are no free rides in international commerce.
The social programs and amenities that we enjoy as a
country don't arrive as manna from heaven, but are
fully paid for by the strength of our economy, or not
paid for by any weakness. If that strength erodes
further, those social programs will be at risk, and so
will Canada's standard of living in the future.
The Chair: Thank you, Mr. Mendelsohn.
We'll now hear from Mr. O'Neill.
Mr. Tim O'Neill (Executive Vice-President and Chief
Economist, Bank of Montreal): Coming at this position
on the list, you feel a little bit like Zsa Zsa Gabor's
seventh husband—you know what to do, but you're not
sure how to make it interesting. But I have a couple of
First of all, the cost of the debt burden in Canada is
still significant, and I would agree with David Laidler
that a greater focus on that ought to be part, at
least, of our contemplation of what should be done with
the surpluses. Higher real long-term interest rates,
reduced fiscal flexibility in situations where you hit
an economic air pocket that you hadn't anticipated,
and, quite frankly, the continued use of resources to
service the debt that could be better allocated
elsewhere are key components of that cost.
It's clear that Canada's tax system has a higher
burden than is the case in the U.S., and it is
uncompetitive in that sense with respect to our major
trading partner. Structurally, it also contains—as
I've already mentioned—important disincentives to
work and I think, as a consequence of those two
things, impaired productivity and investment growth.
My third point would be that the relatively lower
level of program spending does not appear obviously in
any way to be adversely affecting the economy—if I
could turn the argument around the other way—and as
has been mentioned by international standards, we
compare fairly well in major areas of spending like
health and education. It may even be true that the
lower level of spending has engendered a salutary
effect on the efficiency with which money is spent in
the public sector.
So my recommendations in brief would be that a larger
proportion of the surplus be allocated to debt
reduction than what's currently being contemplated; that
program spending be allowed to grow no faster than the
rate of inflation plus population growth; that economic
considerations dictate that corporate tax cuts and tax
reform take priority over personal income tax cuts; and
that where we reduce personal income tax, they should
focus on two key areas—the disincentive effects of the
high effective marginal tax rates at low income levels
and the high marginal tax rates that kick in at modest
levels of what is regarded as “high income”.
Where spending initiatives above those I've just
suggested are going to be contemplated, they should
encompass investment, not consumption spending.
Our economic outlook is that the economy is not going
to be facing a recession over the next five years, but
I think there is a legitimate risk. And here I may
differ somewhat from Pierre's view on the U.S. economy,
and the Federal Reserve in particular. I think there's
a very significant risk that the Fed will have missed
the boat and will have to be fairly aggressive in
tightening next year. It's not in our forecast, but
it's a real risk, in which case we'd be looking at a
very weak 2001—not necessarily a recession, but
certainly a very weak growth level below the 2% we're
Let me come back to several policy principles that I think
ought to guide the discussions. Some of this has
already been said, but it strikes me that the mix of
debt reduction, tax cuts, and spending has to begin
with choosing that mix that contributes most to
productivity, and through that, to economic growth and
improvement in living standards, while still serving
equity considerations—the efficiency-equity trade-off.
Secondly, the allocation within those three
categories, particularly taxes and spending, has to
be based, it seems to me, on their effectiveness in
solving whatever economic and social problems are
deemed to have the highest priority.
One of the things that public policy often suffers
from is the law of unintended consequences. You
have to be sure you have the right solution to the
problem, not the one that people feel most sincerely is
the right one.
Secondly, this presumes that the problems that are
identified are ones for which a solution is required.
To put it in a somewhat different fashion, if you have
a solution to offer, you'd better make sure you have a
problem that actually needs solving. And I'm not sure
the debate we have seen in a number of key public
policy areas actually reflects clear evidence that
there's a problem that needs solving, or that the
solutions being offered are precisely the correct
One other point I'll make here is that the choices in
fiscal policy—and this is not an issue that seems to
be getting a lot of attention—have to consider the
implications for other policy areas, most notably that
the more stimulative fiscal policy is, whether that's
through tax cuts, spending increases, or both, the more
restrictive monetary policy will inevitably be. That
reflects the fact that the Bank of Canada will be
targeting a particular rate of economic growth that's
consistent with its inflation targets. So let's keep
that trade-off in mind as well as some of the other
ones that have been discussed.
With regard to specific recommendations, let me go
back to debt reduction. I've referred to the costs in terms
of high real long-term interest rates, high debt
servicing requirements, and the fact that we're still
relatively vulnerable to flights of quality.
We certainly saw that through the Asian
crisis, where the U.S. became the country of choice for
those looking for a safe haven.
I've made reference to the trade-off between the two
macro policy levers. The fact is that debt reduction
will be a neutral policy choice with regard to its
stimulus effect on the economy in the short term, at least.
With regard to the fiscal flexibility that's available
if in fact we hit a more severe economic air pocket
than I'm expecting, the financial market response to
having to go off the fiscal program is obviously going
to be less severe in an environment where we've already
established that we're going to allow debt-to-GDP to
decline not only by allowing the denominator to grow but
also by reducing the numerator.
The final point I'll make in that regard, and then
I'll move on to tax cuts, is that the cost of the tax
burden, which is obviously there, is, in my view,
relatively less critical at this stage.
There are two things.
First, the brain drain to the U.S. is in fact
low, by any historical standard one would want to use,
despite the fact that we've had a decade-long
underperformance in the economy relative to the U.S.
Second, some people point to the weak growth in
investment, particularly foreign direct investment. I
again would attribute that to the weak cyclical
performance, not to a structural impediment in the tax
Having said that, I think tax cuts are important and
ought to be second in choice to debt reduction but
overwhelmingly preferred to higher real per capita
program spending. I would focus my efforts more on
business taxes because of the negative impact they have
on both investment and productivity.
If the government
were to contemplate increasing real per capita
expenditures, that is, increase spending faster than
the rate I'm suggesting, let me offer, finally, a
couple of points in that regard. First, the focus of spending
ought to be what will increase the economy's capacity
and/or what will increase its productivity. In other
words, in the very conventional way in which economists
look at this, it should be an investment rather than a
Second, I think we should avoid sector-specific
spending—for example, on R and D in the high tech
sectors. We have had a number of attempts at developing
an industrial strategy in this country. I think a new
one, however it's guised or disguised, isn't likely to
be as unsuccessful as previous attempts.
Where spending is earmarked for infrastructure—and
here I would argue that really is an investment as
long as it's real infrastructure and not roofs on
skating rinks—the target ought to be solving the
highest priority problems and avoiding regional balance
I have two final points. Let's distinguish clearly between
investment spending in the way I've just described it
and what is now being called strategic spending.
That's a concept that I think is far too vague and
elastic to be really of much functional use in making
Finally, distinguish between spending that is good
and spending that is essential. I think spending
might be argued to be essential if in its absence
economic growth, productivity, living standards, and/or
the quality of life would clearly deteriorate, and if the
evidence is available that in fact that would be the
We've had a lot of discussion about the need for
spending because we need to get back to levels we had
previously. It begs the very critical question of
whether the allocation of
those levels was in fact the most effective way for
society to allocate its resources.
If we're going to seriously consider spending in areas
that have been referenced, let's be clear
that we have evidence that such spending
is necessary and that the type that's being
suggested is actually going to be effective in solving
the problems that are deemed to exist in
The Chair: Thank you very much, Mr. O'Neill.
Mr. William B.P. Robson (Senior Policy Analyst,
C.D. Howe Institute): There are worse
things than being Zsa Zsa Gabor's
seventh husband. You could be Henry VIII's fifth wife,
I also want to thank you for the opportunity to
appear—again, in my case. I don't know if that's true for
everybody. But just because you're willing to see
some of the same faces, I won't presume you're
willing to hear the same old words.
Nevertheless, for the sake of those who missed
those riveting sessions in Mississauga, I will
very quickly recap a couple of points about the $23
billion in cumulative room to move that was identified
in last month's fiscal update. Echoing Pierre Fortin,
I support the process that produced that number.
I think it is a realistic and useful estimate of how
much room to move we have, while maintaining very strong
confidence we will still have budget surpluses.
But I would emphasize that this number is one that
deducted prudence cushions and
neglected dynamic effects, so in that sense there's
not a lot of downside risk in it, but there is a lot of
upside opportunity. If we were to meet again in five
years' time, in December 2004, smart moves in upcoming
budgets could leave us well ahead of where the fiscal
update envisaged us being at that point, and we could have
a payoff that's bigger than $23 billion, thanks to lower debt
and a more buoyant economy.
In the rest of my 10 minutes, I want to say a few
things about how we might make that happy result more
likely, in the hope that it will be of some use to you
as you finish your report.
First, following on what
some other members of this group have said, I hope you
will recommend dropping the commitment to spend half
the projected surpluses. It makes a nice sound bite and
certainly maps easily on polls where people are
asked what they would do with an extra federal dollar.
But as was hinted at just now, if you don't have any
indication of what your baseline or timeframe is, it
can be very misleading.
I'm not going to drag you
through the math here, but if you're in a situation
like we are now where you're looking ahead and seeing
a surplus expanding every year, and you increase your
spending every year by half the amount of the expected
surplus, you're going to ratchet spending up.
In a very simple example, you could end up at the end
of five years' time having spent 80% of the surplus
you forecast at the beginning. So I worry about
that type of rule.
Some of us at
the table may argue that you could boost that $23
billion to a much larger number by spending 80% of it,
but I wouldn't come down on that side of the argument.
That brings me to the second reason for disliking the
50% rule, and that is that it short-circuits what ought
to be a fairly serious discussion of how
various changes in the federal budget can enhance our
future prosperity. At every stage we really have to
ask, what impact can we expect this to have in the future
jobs, investment, and incomes? How
certain are we of that impact?
The third issue—and perhaps an awkward one
in this room—is whether the federal government is the best agency,
the best place to look, to carry out those things.
I think straightforward answers to those
questions can lead you in a different direction than the
rule saying we should spend 50%.
At this table I may be a minority voice on using
unneeded prudence cushions to pay down debt, so I'll
make a very brief pitch on its merits.
As far as
impact goes, it will reduce federal interest costs, and
that expands the capacity of every subsequent budget to
deliver lower taxes, more programs, or a healthier
bottom line. How sure are we of those effects? We're
dead certain. It's simple.
Is the federal government
the right agency? We're talking about the federal
budget, but that aside, I do want to point out that the
federal government has the fiscal capacity, as
provincial and local governments don't, to get the
country's balance sheet in better shape as we go
forward. We have demographic pressures that are
looming not all that far away any more. The federal
government has the greatest capacity to prepare us to
deal with that.
The reason for pointing this out, though, is that
this isn't necessarily some abstract question for far
off in the future. We face it right in the current
fiscal year. In the fiscal update there was a $3
billion contingency reserve shown for this fiscal year
and also a $2 billion surplus on top of that. The
economic news lately has been better than otherwise,
so we may even come in a little better than that
total of $5 billion.
What I'm wondering about is what are we going to see
at the end of this year? Are we going to see a repeat
of last year's almost $7 billion spending overrun that
erased a very healthy surplus, a lot of that spending
backdated? Or are we going to reap the fruit of good
luck and good management and pay down the debt? The
benefits, as I said, of paying down debt are dead
certain, but equally certain is that you have to
actually pay the debt down to get them.
When it comes to spending, asking those three
questions about the impact, your certainty, and your
confidence that the federal government is the right
place to do it often delivers some sobering answers. I
could go through a long list, but in the interest of
time, I won't.
EI benefits are a good one to subject to that kind of
scrutiny. As I say, I'm not going to go through all
the reasoning, but there is one thing I do want to
point out, because I know that area is under pressure.
We're getting into the steepest part now of the Canada
pension plan premium hike. We're going to go from 7%
to 7.8%, employer plus employee, next year. The
federal government is the only government with the
capacity to offset that in any significant way when we
look at the total burden of payroll taxes in Canada.
To offset it completely, you'd have to cut the
employee rate in 2000 by 35¢, not the 15¢ that's
planned—that would be $2.6 billion roughly next
year—and you'd have to do it the year after and you'd
have to do it the year after again, because those taxes
are going up. That's a huge bite out of our budget
room, and I wouldn't recommend going the whole hog
necessarily, but to the extent you raise the benefits
in ad hoc ways on the grounds that there's a lot of
money in the EI account, you're making that task of
offsetting those tax increases that much harder going
On transfers to the provinces, again, I won't go
through the whole list here. Just quickly cutting to
the end, as far as the federal government's role is
concerned, I'd recommend that as you look at tax cuts
in the upcoming budget and especially going forward as
the extra money that was earmarked for the CHST runs
out, earmark part of the tax cut you recommend as room
for the provinces. If they need the revenue, let them
move in and take it. They keep saying they need more
money. Make that room available. See if they take it.
When it comes to some other areas such as defence,
remuneration of civil servants—particularly top-level
ones—and research, some of the hard infrastructure
that's been mentioned, those are areas where those
positive impacts I was talking about are more
reasonable to expect. In many cases they're more
certain, and the aptness of Ottawa being involved is
But I do worry that the sense that there's money to
spend is prompting a bit of an overexpansive mood among
many federal bureaucrats and perhaps among many of your
colleagues as well. Asking and answering these
questions is more than just going through the motions,
and I really would like to see the Department of Human
Resources Development, for example, held to a standard
in justifying the money it's beginning to splash
around, as the Department of Finance seems to be when
it advocates tax cuts.
Let me touch on tax cuts now. I'm very encouraged by
the tone of much of the fiscal update and many of the
discussions there have been around this table on the
importance of getting taxes down.
I'll turn to those three questions. What impact ought
that to have? Economic theory has emphasized for a
long time the costs of high taxes on labour and on
returns to saving.
How certain are we? I've always had a
double-barrelled uncertainty on this score. First of
all, some of the estimates of how important these
effects are in real life have tended to be imprecise.
Second, there's no guarantee of course that any federal
tax cut that's actually going to happen will address
some of the worst problems economists tend to identify.
Lately some of the fog on both those fronts has
lifted. There's been some very careful cross-country
work on government budgets and growth, and in those
cross-country studies, the effects of taxes on income
and return to saving do tend to show up strongly.
This is a bit unfair, but Andrew Jackson is going to
have a chance to rebut me when I talk about the murky
evidence you have, this diagram in front of you. Select
your beginning and end years with a bit of care, select
your sample of countries with a bit of care, neglect to
look at the whole government budget and the different
types of taxes, and you can prove just about anything
with a scatter plot like this. But the longer the
timeframe you look at, the more countries you include
in your sample, and the more careful you are to take
the whole government budget into account—the fact that
taxes pay for things and there are surpluses and
deficits implied by certain levels of taxes and
spending—you start to see those effects coming through
quite clearly. And actually, as a footnote, some
beneficial effects of government spending on certain
types of things come through from those studies as
well. But the negative effects of taxes on work and on
saving are pretty clear.
The other reason for my saying some of the fog is
lifting is that I think I'm detecting in this
committee's deliberations and in the fiscal update a
strong and appropriate focus on getting the rates of
tax on work and saving down. So I would say getting
our personal taxes down and our business rates down as
part of a package looks like a good bet for making that
$23 billion budget payoff grow.
As for the federal role, the third question on taxes,
Ottawa should take the lead. Despite the presentation
in the fiscal update, the federal tax load is still
growing. When you count taxes properly instead of
netting the various transfer payments out and just
forgetting about them as though they weren't there, but
when you add them in and look at them as part of the
personal tax burden, our tax burden as a share of GDP
is scarcely down. When you look at it in absolute
amounts, it's still going up. The next fiscal year,
federal taxes, with the status quo policy, would top
$22,000 for an average family of four. That's a
record, even after you allow for population growth and
So I hope you'll be aggressive in your report. I
hope you'll be aggressive in calling for higher
personal tax brackets, lower rates, the removal of the
personal and corporate surtaxes, and ultimately, though
maybe not right away, improving the tax base by moving
to a more sensible set of deductions. Make the
advocates of spending fight you and each other for
every extra dollar, and keep your eye on that $23
billion payoff and make it grow.
The Chair: Thank you very much, Mr. Robson.
We'll now hear from Mr. Jackson.
Mr. Andrew Jackson (Chief Economist, Canadian
Labour Congress): I'm glad to be following Bill,
because I'm going to cover some of the same ground.
I'll begin by saying I actually very strongly agreed
with one thing Bill said, which is that a criterion for
looking at these issues, particularly the division
between spending and taxes, should be the impacts on
investment and on jobs and how certain we are about
One thing that's been a bit unfortunate about the
debate leading up to this budget is it has tended to be
cast in terms of equity versus efficiency issues.
There's a way of setting up the issues where social
advocates want spending on social programs while
business is calling for tax cuts to promote growth. We
get a counter-position of growth to fairness.
The key point I really want to make is that the
linkages from tax cuts to economic growth are a lot
thinner and more tenuous than you would believe from an
awful lot of what you read in certain newspapers these
days, and also a lot weaker and more tenuous than the
economics literature that's available would have us
It's particularly important to bring this forward as
an issue when you look at the kinds of tax cuts that
are being advocated, for example, by the BCNI and the
Chamber of Commerce and indeed people around the table.
They are tax cuts that would be quite regressive in
terms of their impacts on income distribution: getting
rid of the high-income surtax, cutting top income tax
rates, easing the burden of tax on capital gains. All
these, as I pointed out to the committee before, would
produce much larger tax cuts for high-income earners
and very little—indeed, in many of these formulations,
absolutely nothing—for people at the bottom of the
The only really morally defensible basis for calling
for tax cuts now is indeed that they will stimulate
growth and expand the pie.
How to approach that question? I'm not sure whether
I'd get much debate from my colleagues. Let's look at
the relative impacts of a public spending increase, as
opposed to a personal income tax cut, on economic
growth over the next one or two years. Most of the
macroeconomic models around would in fact show that we
get a bigger impact from the spending side than the tax
cut side, because of leakages to savings and imports.
The proposition that's really being put forward is if
we cut taxes and get the incentive structure right,
we're going to raise the long-run rates of economic
Just to be clear on whether there are
areas of agreement, I think we can all agree that high
rates of both public and, I would argue, private
investment in machinery and equipment, research and
development skills, and so on are extremely important
for long-term economic growth. So the question is how
do we raise the investment level in our economy? How
do we raise efficiency?
When it comes to taxes on personal income, I think it
was Tim O'Neill who talked about disincentive effects
on work. I think frankly, if you dig into that literature,
almost all of it found that the so-called disincentive
effects of high marginal tax rates on willingness to
work just evaporate on examination, and particularly for
prime income earners.
Just to unpack it in English, the
proposition is if that if there are high marginal tax
rates, people are going to be cutting on their hours of
work and sitting around slacking.
The reality is that Canadians are working longer and
harder than ever before. You could just as plausibly
argue that high tax rates in fact are leading people
to work longer and harder in order to achieve the same
amount of after-tax income.
So it's theoretically
ambiguous in any case, and there's very little evidence
for the impacts of taxes on work incentives. There used to
be more solid evidence for women, but in the case of
Canada the research has shown that women and men are
When it comes to the brain drain story, which is the
other one.... Tom d'Aquino accused me the
other day of just sticking my head in the sand. There
are a lot of anecdotes around, but the fact of the
matter is we have no data to support the anecdotes.
The Halliwell study for Industry Canada, which is
the most recent data available from the U.S. current
population survey, shows that the proportion of
Canadians resident in the United States is at an
all-time historic low for the century. We had a
recent survey of university graduates in Canada showing
1.5% leaving for the U.S., a trivial proportion, most
of whom will in fact come back. A very large chunk of
them were nurses moving because there were no jobs.
It's also actually and implicitly a fairly racist
proposition, because when we look at emigration, it's
obviously greatly eclipsed by immigration. In fact we
we have four university graduates come to Canada for
every university graduate who leaves. Even if you go
to the PhD level, we have a balance of immigrants and
emigrants. So I think the idea that we're suffering a
large brain drain itself is problematic. To blame it
all on high tax rates is doubly problematic.
Next, we have the alleged linkage between personal
taxes and savings rates. The argument is if we tax
incomes, and particularly property income, we're going to
be eating into national savings rates and thereby into
investments. So without even venturing onto the
terrain of the linkage between savings and investments,
I'll just quote from a review of a recent OECD study on
taxation and economic performance:
Empirical studies for OECD countries have generally
found it difficult to establish a statistically
significant and robust role for after-tax real
interest rates in estimates of savings functions. On
balance, it appears that taxing capital income reduces
savings, but not by very much.
So impacts on savings are low. The studies in the
United States show that the effects of the 1980 tax
reforms, the great supply-side revolution, had no impact on
savings. Indeed, I think anybody who argues that low
taxes are going to generate high savings runs
up against the fact that the U.S. has an incredibly low
and, indeed, negative savings rate. In fact
what's keeping the U.S. boom going is that they're
spending like crazy. They're not saving any of this
income. So I think that's a complete non-starter as an
Indeed, people made the observation, and I think it's
dangerous, coming from the CLC, to make it, but I
think if there is an argument for tax cuts leading to
growth and investment, it would be more on the
corporate side than on the personal tax side. I think
it certainly comes out of the literature that there's
a stronger impact.
However, again, I think the evidence, when you survey
it closely, shows—scarcely surprisingly,
when you think about it—that by far the largest
influence on rates of business investment is output
growth as a whole. Businesses will invest primarily
when they see the opportunity to sell products from new
investment—products or services. The after-tax cost
of capital does insert a kind of wedge into that
decision, but most studies have shown that effect to be
really very small. Just to quote from a study by
Philip Gerson of the IMF, in a recent working
paper—the IMF is being quoted here on numerous
occasions, but unfortunately in a lot of their
recommendations they don't read their own working
While many of these studies find that investment is
negatively related to the cost of capital, most find
that the size of the effect is rather small.
In this OECD study on the effects of taxation on the economic
performance, they go through ten recent econometric
studies on the effects of the after-tax cost of
capital on investment. Three found no effect at all.
Four found small negative effects.
Recent studies done of the impacts of
different tax rates in the United States between
different states in the U.S. have generally found very
little impact on investment depending on capital tax
rates between states.
It is true that the Mintz report has argued, to
quote from them, “that taxes do have a significant
investment on business decisions”. Actually, I think
on close examination this is like Donald Macdonald
and the royal commission and the leap of faith for free
trade, because in the Mintz report, when you
look at it, he only cites three studies, which were
themselves quite ambiguous for that statement.
The major background study that was in fact done for
the Mintz committee by Mckenzie and Thompson
found that the changes in the relative cost of capital
between Canada and the U.S. had “a small, but
statistically significant, impact on relative investment
levels...for equipment investment, although not for
It went on to argue that the major
ingredient in the cost of capital between the two
countries was in fact interest rates rather than the
effect of taxes.
They came to the conclusion that a 1% increase in the
Canadian cost of capital overall would lead to a 0.03%
decrease in the rate of growth of the Canadian capital
stock, which is a small impact. Indeed, I'm struck by
the fact that my friend and colleague, Jim
Stanford, if you look at Paper Boom: Why Real Prosperity
Requires a New Approach to Canada's Economy, actually
finds a rather more robust impact from profit rates on
investment than in fact most of the literature around.
I wouldn't dispute his finding, which was that 11% of
the fall in business investment in Canada is explained
by changes in profitability as opposed to these overall
I think the important point—and it's not just a
debating point—is that if you proceed on the basis that
you're going to get significant output and growth, and
efficiency and productivity effects, from tax cuts, that
might be an interesting experiment to run; however, you
might just sacrifice large chunks of tax revenue for
very little payoff. So you have to subject these
proposed changes to a cost-benefit analysis.
I again commend to people's attention that we did run
one big experiment under the previous governments on
giving incentives to saving and to investment, the
lifetime capital gains exemption. There was a whole
range of studies done of that measure, edited by one
Jack Mintz and published in a special issue of the
Canadian Public Policy, which found there
was a very regressive impact from those changes in
terms of income distribution, and an absolutely negligible
impact on growth.
So it's believed, I think, that cutting corporate taxes
and personal taxes is going to result in significant
impacts on investment. In honesty, there are studies
that point to some modest impacts in that direction. I
don't dispute that profitability is an important
consideration in investment, but you have to go through
an awful lot of channels to get, for example, from higher
after-tax profits to increased rates of investment. A
lot of corporations are buying up their shares today
rather than investing them.
So I come to the other set of studies, which again
Bill mentioned, and I think he fairly said that a
growing number of studies in fact show quite
significant growth effects from certain categories of
public expenditure. So to flag those very
quickly—and again, I think they're quite unsurprising
if one thinks about it for a moment—there are quite
robust impacts from investments in public education on
growth, and particularly from primary education. I
think when Jim rightly points to the importance of an
early childhood education program, we shouldn't see that
solely as a “social measure”. And I think a
lot of research done by Fraser Mustard
and others has shown that in fact in terms of impacts
on “human capital”, investments in early childhood
education have a very significant payoff.
There's a lot of evidence of quite significant impacts
on private sector productivity of investments in
public infrastructure, particularly transportation and
communications. I think it's also worth noting that
there's beginning to emerge now a kind of interesting
literature, which is drawing a link between having a
relatively equal distribution of income in after-tax
terms and growth rates, and Danny Roderick from
Harvard is one of the major authors of that work.
Again, I think the key link is that if you have a relatively
equal income distribution, relatively low rates of
poverty, you're going to have positive impacts on
“human capital”, lower social costs in terms of issues
like crime, higher rates of health and so on.
You saw my “scatograms” here, which were done
hurriedly this morning and were passed around.
Really, the main point I'm trying to make here is that
if you're trying to draw any kind of close correlation
between the overall tax burden and growth as measured
by per capita income, or for that matter in productivity
as proxied by labour productivity in manufacturing, you're
going to get a pretty weak relationship overall.
I'll commend Bill's attention to the OECD study, where they
actually take more or less the same tax period and the
same measure in order to derive their estimate of
the impact of tax cuts on GDP. The main
difference I made here was to convert GDP growth to GDP
growth per person, which seems to me a reasonable
change. Part of the reason the U.S. has been
growing faster than other countries is that its population
growth has been growing faster.
Anyway, I think one can produce different studies with
somewhat different results. Again, if you take the
taxation and economic performance study from the OECD
and recent surveys by the IMF, which do argue the case for
tax cuts, actually the efficiency impacts are really
very small and modest. The bottom line for the
OECD is that if you cut taxes by 10% of GDP you
“may” get an increase in the long-term growth rate of
as high as 0.5%. That's not a terribly strong
relationship, although of course if we could
increase growth rates by half a percent, that's not to
be sneezed at.
Also, that study doesn't offset against that what
would be the impacts of cutting taxes by 10% of GDP in
terms of income distribution, in terms of the level of
public investment. We'd pretty well have to gut
huge areas of program spending in order to do that.
So I'll just conclude by saying I think these economic
efficiency impacts of tax cuts, particularly on the
personal income tax side, are greatly exaggerated by a
reasonable reference to the literature. And I
really reiterate what Bill said, which is that I think
in fairness—and debate does become polarized—if
you pressed all of us, we should all concede
that there are positive impacts on growth and
productivity from both the possible measures on the tax
side and on the spending side. Just to get into
a spending versus taxes thing really isn't a terribly
intelligent discussion, because one could do many
different things on both sides.
I would stress it's not an argument where
those for tax cuts are the only ones taking economic
efficiency and growth issues seriously.
The Chair: Thank you very much, Mr. Jackson.
We'll now hear from Mr. Van Audenrode.
Professor Marc Van Audenrode (Chair, Economics
Department, Laval University): Thank you, Mr.
At this point nobody believes it's
possible to add anything to a very long shopping list
that my colleagues have presented you with, but it is
possible and I'm going to show you.
Let me start with a general remark on something some of
my colleagues have raised. I would insist a little bit
about how fragile the equilibrium in public finances
and the equilibrium with the federal government
finances are still. There essentially are two sources
of danger for this equilibrium. One is a recession,
and the second is a sudden rise in interest rates.
Let's talk about the recession. There's no recession
forecast for the immediate future, but we have to
recognize the fact that the growth of our economy is
being strongly sustained by our exports, which in turn
have been strongly sustained by the strong growth of
the U.S. economy. Nobody has been able to predict such
a long period of growth for the U.S. economy, and
nobody has been able to explain why it has lasted so
long. That therefore raises a doubt about our ability
to predict when it's going to end, so we should be very
careful at that level.
I'm not going to insist a lot on the problem of
interest rates, but nobody can predict when the Bank of
Canada is going to embark on another inflation
ghost-busting operation that could cost a lot of money.
I would say this advocates for being prudent probably
for one more year, while trying to pay a big chunk of
the debt in order to try to start a very strong reverse
snowball effect that would clearly solidify the state
of our public finances at this point.
Okay, getting to the shopping list, I would say the
single most important and identifiable source of
surplus for the federal government has been and is
going to be the surplus in the EI account. It was $7.5
billion last year, and it's going to last for many
years. Many economists have criticized European
countries for years for just financing their general
programs through payroll taxes. It's clear these taxes
create a wedge between wages and labour costs, and this
is linked to persistently high unemployment.
It is clear that our labour market could do without
that tax for another few years. It is also clear that
at some point we have to look at a strong reduction in
EI contributions. This is even more required in that
as a tax, EI contributions are strongly regressive. The
existence of maximum insurable earnings and maximum
contributions can be justified when EI contributions
are just contributions to an insurance system. When
they are a tax, they become strongly regressive, and at
least this will have to be taken into account. A very
small part of low-wage-earning people are contributing
disproportionately to deficit reduction and to the
creation of that surplus. That will be taken into
account when looking at the general balance of the
progressivity of our income tax system.
That's the first thing. The second point I wanted to
raise—and I haven't heard this enough—is the fiction
that Canada's public finances are good and healthy just
because the public finances and the finances of the
federal government are healthy. There are still quite
a few provinces and territories that are hurting.
There are still many municipalities, school boards,
universities, and hospitals that basically have been at
the receiving end of the giant game of snow shovelling
that this federal government started a few years ago in
order to bring its finances into order. They are still
hurting, so one of the things this government should
probably do is restore some of the funding towards
these institutions and levels of government, because,
in addition, these levels of government are providing
the services that are the closest to the people.
A third point that I really want to raise, which
nobody else has raised, is the horizontal equity aspect
of our tax system. I'm surprised that nobody has
talked about this. Families, especially families with
children, have been hit over the last few years by all
the measures of cost-cutting and spending reductions.
They basically have had to absorb many increases in the
hidden costs of education and school transportation.
They have been at the receiving end of
the reduction of municipal subsidies into social,
cultural and sporting activities. I have paid for
that, and I've been hit disproportionately by all these
At this point, if you look at the tax break that the
federal government gives to a family with two children
and earning $50,000, which is not rich, and if you
compare it to a family earning $50,000 with no
children, and if you look at what the U.S. federal
government does—basically, these are two comfortable
families earning around $50,000 Canadian dollars—the
Canadian government gives a tax break to that family
that is around $850 a year, while the U.S. federal
government gives a tax break of close to $1,300 a year.
That's 50% more. And we are not talking about Norway,
France, eastern European countries, etc. We're talking
about the U.S. The Americans are doing much more to
help families at a very middling and reasonable level
of income. If I put these figures not at an absolute
level but at one proportional to the level of taxes
that these families have to pay, the difference is
I would say the poor level of help that families
receive from the federal government is a national
disgrace, and we have to correct that very quickly.
I'd say it is time that you say you don't have to be
poor for the federal government to care about your
kids. Our system has become very inequitable recently,
and this is much more obvious than the vertical
inequalities that all my colleagues have been talking
about in this round table.
That's all I have to say.
The Chair: Thank you very much.
That was the final presentation, and I feel everything
is so clear now. I understand which way to go.
We'll have a ten-minute question and answer session,
beginning with Mr. Epp, who will be followed by Mr.
Mr. Ken Epp (Elk Island, Ref.): Thank you.
I feel like I'm very far away, but I was anticipating
being called away to other duties.
This has been very interesting. I remember last year,
when it was my first year on the finance committee.
After having heard a whole bunch of witnesses in our
committee, we finally came to this one, where all the
guys who came in knew what they were talking about for
sure. I remember being amazed at how much diversity
there was then, just as now. I guess it's true that if
you ask twenty economists what to do, you should have
about thirty opinions. You delivered today.
I have a couple of questions. First of all, with
respect to tax rates, all of you are talking about tax
rates costing the government money. Do any of you at
all buy into the idea that if we were to cut the tax
rates, government revenues might actually go up?
Mr. David Rosenberg: I think all you have to
do is take a look at Ontario's experience. Here you
have a government that cut personal taxes aggressively,
and here we are today with personal income tax revenues
that are 7% higher than they were at the time when the
Tories took power back in 1995. So, go figure. There
is also a situation in which program spending
is actually up by more than that
amount. So I think when you are as overtaxed as Canada
is, you can certainly build an argument that those
multiplier impacts are minimally a third.
I'd take a look at the U.S. tax situation. What was
the last thing the U.S. did? Amazingly, a Democrat cut
the capital gains tax rate a couple of years ago. When
you take a look at the tax revenues from capital gains
now, that cut has more than paid for itself.
So notwithstanding what the textbooks would tell you,
when you take a look empirically, around the world you
can find examples of where, when you cut taxes, you
certainly get back more revenues than you otherwise
would have by stimulating risk-taking investment
and economic growth. I
think actually, just taking a look at the Ontario
experiment, that is probably the best case in point.
The Chair: Thank you, Mr. Rosenberg.
Mr. McCallum, followed by Mr. Laidler.
Mr. John McCallum: Mr. Chair, I'm afraid
you're not going to get unanimity, because I don't
believe for one moment that if you cut personal income
you'll get more revenue than you otherwise would have
gotten. I mean, this is a free lunch that's just too
free to be imaginable. It would suggest that you cut
income tax by 20%, so why not 80%? Why not take it to
close to nothing, because then your revenues will
explode? I think there's some payback, but I don't
think you'll find that you'll more than make up the
revenues, especially in the case of personal income
On other kinds of taxes, it might be closer—and here
I think I'm quoting Jack Mintz again. On certain
kinds of business taxes, you could get your business
taxes to a level lower than those of your neighbours.
You'll then create an incentive for corporations to
shift income into your country and also perhaps to
shift economic activity into your country. In the case
of corporation tax, then, I could conceive of your
statement being correct. But for a big, broad tax like
personal income tax, I find that very hard to believe.
Mr. Ken Epp: If I could just enlarge on it before
another person speaks, I have no problem with saying
that if you cut your rate to zero, everybody knows your
revenue from income tax is then going to be zero. But
if you put it at 100%, your income tax revenue would
also be zero. Who would keep working if they had to
send everything they earned to the government? There
is a place in between, and if you visualize that—as I
know economists love to do, so I'll do this from your
point of view—you have this curve where the income tax
revenue is zero or zero at either end. In between,
depending on where you are on that heap, you may have
passed the point of maximum revenue at a given rate.
I guess I'm exploring whether or not we're over that
rate, because the message we keep hearing from
Canadians is that they feel they're taxed to death. It
therefore seems to me that we might really give the
economy a boost if we did give them a really good cut.
Anyway, carry on, please.
The Chair: We have Laidler, Robson, Mendelsohn, and
Prof. David Laidler: I'm one of those people
who believes we're well in the wrong side of the Laffer
curve from the point of view of supply-side
economics in Canada. I lived in England before I came
to Canada in 1975. I'm prepared to believe that when
the top rate of income tax was cut from 96% to
somewhere around about 50% and then 40%, revenue went
up because people moved back to Britain from
Switzerland and the West Indies and started declaring
their income. But we're nowhere near that here.
I would caution as well about evidence from studies of
the capital gains taxes alone. If you cut capital
gains taxes and leave income taxes alone, smart
accountants will convert income into capital gains very
quickly. The revenue from capital gains taxes will go
up, but the revenue from income taxes will go down.
So there's no doubt that it's a mistake to read from a
proportional cut in a tax rate to a proportional cut in
revenue. I'd be absolutely astonished if, in Canada,
we were on the wrong side of the Laffer curve and we
could rely on tax cuts to generate an increase in
revenue. I think Alan Greenspan has had more to
do with the revenue from the Ontario income tax than
Mike Harris has.
Mr. William Robson: It's just too
bad that that same effect didn't wash over into
Ontario's neighbouring provinces, I suppose. I just
can't help pointing that out. Nevertheless, I'm
fundamentally in agreement with David Laidler.
It's not usually respectable for economists to argue
in favour of the more-than-offsetting revenue
effect that you're talking about, but such situations
clearly do exist. We have a great example here in
Canada with the foreign property rule. That's a tax.
There's a special tax levied on people who own too much
foreign property in their pension plans. It's levied
at a prohibitive rate and it raises very little
revenue. If it were actually levied at a lower rate,
we might actually see some revenue from that tax.
There would be a more-than-offsetting impact. As it
happens, though, I'd like to see that particular one go
On business taxes, I think the tax base is probably
getting to be more elastic all the time. Therefore,
that's one area in which you're certainly not looking
at one-for-one decreases in revenue if you cut your tax
On capital gains, David makes an important point
about the possibility of translating income, but at a
point in time there are people who are locked into
situations they'd like to get out of, and certainly in
the short run from releasing that situation alone you
can end up reaping some additional revenues.
So the very unexciting answer is that it depends, but there
are certainly examples where the cheat sheet in the
fiscal update that shows those revenue impacts has to
be taken with a grain of salt, for the reasons you're
The Chair: Mr. Mendelsohn.
Mr. Joshua Mendelsohn: I guess I'm going to muddy
the waters a little bit more for you.
I would agree. The problem we're facing here—and
I think it goes back to some of the issues
Andrew Jackson and some others were talking about—is
you point, there is evidence, there isn't evidence.
There is the attempt to measure one variable against
another, a direct impact or a reasonably direct impact.
I don't have the answer here, but I think the problem
is that the economies we live in today are
increasingly complex. The reaction functions, the
behaviour patterns are more complex perhaps because
people are more knowledgeable. They've been attuned to
different reactions. They respond differently.
In the short run, my inclination would be to say that if
you're just going to reduce taxes marginally, no, you're
not going to recapture it in added revenue; in fact
you lose. But the question becomes—and that's where my
focus is—what happens in the long term if you change
an incentive system, if you change the returns that are
available, by whatever tax structure you want to
change? I don't have the answer to
this one, but at that point I expect you will get a
different answer, a different result.
It is true, as was said before, that taxes are
not going to generate necessarily in the short run
additional investment, for example, and therefore
I was responsible for a study—I'm going way back now
to the mid-seventies at C.D. Howe—on tax incentives to
boost investment. The end result was that it's demand, it's
the ability to sell their product, which was noted
before, that is going to create that investment. The
question is what creates the demand? It's the
employment. It's the income. It's the ability to
spend. It's an integrated system.
So I think the notion that it's a one-to-one is one
we have be very careful of, because we're going to get
all sorts of different answers.
Ontario is an interesting case because, I would also
have to concede there, it owes more to Greenspan than it
owes necessarily to the taxes. I think the Ontario
government itself basically shies away from taking all
the credit on the tax side as being the source of the
growth. They do recognize very strongly that the U.S.
has been a source of that growth.
The Chair: Mr. Fortin? No? Anybody else?
Mr. Epp, you have one question.
Mr. Ken Epp: I want to ask just one quick question
about debt. Several of you mentioned it, that it
should be a priority. It seems to me that at times
when our economy is really rolling along reasonably
well and the interest rates are low, that would be
an excellent opportunity to reduce the principal amount
of our debt. Yet some of you were tentative or you
didn't even mention it.
Those of you who didn't, can you tell me why you'd
like to keep the debt high?
The Chair: Mr. Mendelsohn.
Mr. Joshua Mendelsohn: I don't think I didn't
mention it because I want to keep it high; I think it
was mentioned by others, so I skipped it.
To be quite fair about it, I think the question is
how much are you going to lower it by? If you take the
entire unanticipated surplus, as I tend to refer to it,
the sort of year-end piece that's left there, I would
most definitely say there's only one thing to do with
that, and that is put it toward the debt reduction.
At the minimum you've got the $3 billion, yes; I would
say if you go to $4 billion or $5 billion, I'd be quite
happy with that. But I also have to balance in my own
mind what my own feeling is about the longer-term
contribution to some of the beneficial effects of
growth as opposed to what you might save by just another
$1 billion, let's say, in debt reduction if you did it
at the front end. If you did it at the back end,
question in my mind, and the quicker it's done away
with, the better.
The Chair: Thank you.
Mr. Yvan Loubier (Saint-Hyacinthe—Bagot, BQ): Thank you, Mr.
The Chair: Oh yes, of course, sorry. Mr.
Mr. David Rosenberg: I gave a fairly quick
preamble at the beginning. I would just say that to me
the key measure of fiscal stress is not the debt level,
but debt-to-GDP, and we're at a stage now where that is
coming down. Even if you're not paying down the
mortgage, it's coming down just through economic growth.
But I would fully agree that the contingency
reserve at the least should be used as the down
payment. The debt-to-GDP ratio, which has already been down
10 percentage points in the past couple of years, is going
to continue to decline.
The question is why is this debt-to-GDP ratio
overly high? What is the symbol that's
showing us that? I would argue that we have this very
rare situation in Canada where our interest rates out
the yield curve, out to the 30-year bond, are below
those of the
U.S. So the markets are certainly not telling you
the level of debt in this country as it stands
right now is unacceptably high. It's expectations that
It was back in the late 1980s and early 1990s, when our
bond spreads out the curve were 200 basis points or
higher, that the market was signalling the policy-makers
that the debt situation was dire. We managed to
turn that around. So the fact that our interest rates are
below the U.S. and it's not an inflation story, because
our inflation is pretty well the same, is I think a
symbol that investors are comfortable with the progress
Canada is making on the fiscal balance sheet. I
mean, what better indication of that is there than that last
week Newfoundland got upgraded by Standard & Poor's
to single A-minus from triple B?
I think the fiscal progress has been a good
story. When I take a look and I see that GDP is down,
that total public sector spending as a share of GDP, while
off its peaks, is still higher than it was 10 or 20
years ago, what sticks out like a sore thumb is the
fact that federal government revenue as a share of GDP
is still over 17%—at the high end that it's been in the
past 20 years, and two percentage points higher than
when the Liberals took office. That's next to a
$1,000 extra bill for the average household.
I'm not saying the debt isn't high and shouldn't
be addressed, but the fact of the matter is that it's
already down 10 percentage points and will continue to
go down. The question for the government is what is
really the number one priority from this day on? The
reason I chose to focus on the tax side is that this is
where I think the more pressing need is at this time.
The Chairman: Thank you, Mr. Rosenberg.
Professor Wilson, go ahead.
Professor Thomas A. Wilson (Director, Policy and
Economic Analysis Program, University of Toronto):
I'd just like to argue that
I share the view that in the medium term, tax
reductions are terribly important. I'll say a few
words later on, if there's an opportunity, about which
taxes should be cut.
But I think in the short run, the priority clearly
should be on debt reduction. I say this for a number
of reasons. The economic outlook has strengthened over
the last two months since the original fiscal dividend
exercise; the projected surpluses are higher now in
the first couple of years. This is exactly the time
when the good news should be translated into higher debt
paydowns. We should have a medium-term plan, but then
the debt paydown really should be the residual. I
think when we see good times, that's the time to pay
down debt more rapidly.
I also think we should be planning to have sufficient
debt reduction so that, given the minister's and I think
the government's commitment never to run a deficit ever
again, we've got to have a big enough cushion there to
avoid the risk of perverse fiscal policy in the event
of a recession. So if we were to have a recession in a
year or two from now—even though it looks unlikely in
terms of the current outlook, things can
change—and if we were to have the worst-case kind of
recession, an inflation acceleration in the United
States, the Federal Reserve tightening up, so we'd face
both declining real demand and rising interest rates,
we want to have a big enough cushion there so the
government's commitment to not running deficits would
not force us into cutting spending in the recession or
raising taxes. The other thing of course is that
running a larger surplus now eases the burden on the
Bank of Canada in its need to control inflation.
The Chairman: Monsieur Loubier.
Mr. Yvan Loubier: I would like to continue this discussion on
taxation bearing certain comments in mind and then I would like to
move on to another topic.
Although the analyses presented today do not acknowledge the
consequences of lower taxes, reality has nevertheless shown that
the impact is quite dramatic. For example, whereas the general
individual tax burden has jumped 40%, particularly since 1993, the
GDP has risen by 27%. These two figures therefore indicate that
some individuals have grown poorer.
As for the imbalance that exists between income categories and
tax contributions, once again, certain facts are clear. For those
earning between $30,000 and $70,000 per year, which includes
approximately 27% of all taxpayers, the federal tax rate is more
The other fact that I consider quite important, and I believe
that Mr. Mendelsohn and Mr. Van Audenrode alluded to this earlier,
is this whole issue of equity of the tax structure. It is quite
surprising that some of you are not convinced about the impact that
lower taxes would have on average income earners in particular,
whereas the absence of full indexation alone results in flagrant
imbalances between federal and provincial taxation, particularly in
We just saw such an example this afternoon at the Finance
Committee: the zero tax threshold for families with two children is
much higher at the federal level than it is at the Quebec
government level, for example. A family with two children is taxed,
at the federal level, starting at an income of $10,700, whereas the
province does not start taxing until the income reaches $30,200, if
memory serves me correctly.
When you see such imbalances, such as the growth of GDP in
comparison with individual income tax, you can understand that
reducing income tax for taxpayers in this category would have a
definite impact. Perhaps we should not reduce taxes for all income
categories, but do so for this category of taxpayers in particular,
particularly since this category is the one assessed to have the
highest marginal propensity to consume. Consequently, any tax
savings resulting from a measure contained in the next budget could
be totally spent or invested and this would have a significant
I would like to hear what you think about this because, with
only a few exceptions, you do not seem to be convinced about the
impact that reduced taxes would have on economic growth.
I'm going to ask you my other question right now in case I run
out of time. I would also like to hear your opinion on anything
pertaining to the debate on integrating the currency of North
America and even that of the three Americas. I do believe that Mr.
Robson and Mr. Mendelsohn spoke earlier about the productivity of
businesses and the fact that we could not continue basing the
performance of our businesses on the devaluation of the Canadian
I would, therefore, like you to talk about the possibility of
integrating first the currency of North America and then of the
three Americas in terms of stability and then in terms of increased
productivity for Canadian businesses.
Mr. Joshua Mendelsohn: Let me respond this way.
I'm not one who's in favour of the common currency,
because I don't think common currency is the answer. I
think common currency is often used as a mechanism to
try to force or bring about change to some degree,
abstracting the political pressures within Europe that
brought about the introduction of the euro.
The process was that if we have a common currency, we
can in fact use that as a straitjacket to bring down
fiscal deficits, to bring down debt loads, to
restructure our economies. It is a reflection of their
failure amongst the various countries to in fact, in
many cases, such as Italy, where there has been
traditionally a lack of strong effort or capacity to do
this, that this is more a mechanical exercise. At the
end, it may prove very fruitful.
I think the same challenge faces us in Canada, which
is why I raised some of the other issues I did. That
is, if in fact we move forward and introduce policies
that promote our economic competitiveness on grounds
other than the currency, or improve our productivity,
improve our competitiveness, those industries that rely
on the cheap currency are going to lose, because they
need to move forward. That currency will move up of
its own and will stabilize at some level.
I don't know what the proper level is.
The challenge I have with a fixed rate is this: at what
rate do you fix it? If you fix it at 50¢ U.S. per
Canadian, you're worse off, because in fact you're
adding even additional protection to Canadian industry.
If you fix it instantly at 80¢ or 85¢, I suggest that
many Canadian industries will not survive.
What is the proper rate, then? The purchasing power
parity number is a long-term concept that I don't think
holds in this case.
I would prefer to see us undertake policies to reach a
higher level of stability and a higher level of overall
performance through choice and election rather than
mechanically. When Margaret Thatcher tried that, it
worked to a degree when she shadowed the Deutschmark
with the British pound. But that was an inflation
issue, trying to prevent business from giving in to
labour demands. So there are different reasons for
We do need, however, some flexibility in our exchange
rate. No matter how far out we look, the structure of
the Canadian economy will certainly be different to a
degree from the structure of the United States economy.
It is more resource-oriented. It is more regionally
diverse in that respect. Consequently, we will need
some flexibility in there.
So I'm not in favour of a fixed currency or a fixed
The Chair: Mr. Laidler or Mr. Fortin.
Prof. David Laidler: With regard to the issue of a
common currency, I think the major objection is
political, frankly. I can't conceive of a common North
American currency that would not be the United States
dollar run by the Federal Reserve, which is accountable
to the U.S. Congress. I can't imagine the Americans
giving that up, and I don't see why we should create a
hierarchy of political power within North America.
The next one down the line is some type of fixed
exchange rate arrangement. They have worked really
badly in the last 15 years. They've been the source of
all manner of instability. It's difficult to hold a
pegged exchange rate.
Moreover, in this discussion I think there has just
been insufficient attention paid to the fact that there
is a border between Canada and the United States that
most members of the labour force find very hard to
cross. Asymmetric shocks have to be absorbed within
the Canadian economy. I agree with Josh Mendelsohn
that a little flexibility in the exchange rate to help
absorb those shocks is well worthwhile.
That's not a plea for soft monetary policy. I don't
recall hearing many people complaining that the Bank of
Canada has been soft in its monetary policy in the last
decade. I don't give much credence to the argument
that soft money policy has been responsible for lagging
The Chair: Mr. Fortin.
Mr. Pierre Fortin: I would like to answer the question about
lower taxes. First of all, I think that contemporary literature
analyzing the American experience from the early 80s, where
individual and corporate taxes were reduced by 20 to 25 percent,
proves that this idea that North America was sitting on the wrong
side of the Laffer curve was just a crackpot notion. In France,
this curve is referred to as the Colbert curve. It was, in fact,
Colbert who had developed this idea. This is a crackpot idea
because we are far from being there. I think that the reaction of
the committee members, earlier, was the right signal to give.
And then, the reason why we intuitively do not feel prepared
to say that a significant reduction in income tax will, in itself,
stimulate exceptional economic growth, is that... The real reason
which prompts us to ask for tax reductions is that, with the
elimination of budget deficits, the percentage of GDP representing
interest will gradually decrease. We are, therefore, simply
suggesting that we replace this amount with tax reductions and
offset the decrease in interest to be paid in order to balance
everything. In practical terms, that means that the money that
would have been spent on interest will now instead be spent by
people who will have it in their pockets and use it as they wish.
In a nutshell, this will not change buying power whatsoever.
The country has a capacity to produce goods and services on a
short-term basis and this capacity cannot be overshot without
triggering inflation. Should this happen, even if decreased taxes
were to boost the economy, making it inflationary, you would
immediately see a jump in interest rates which would prevent this
reduced taxation from having an expansionary effect.
Furthermore, it is just as ridiculous to say that the recent
drop in taxes in Ontario—and this is how colleagues in general
appear to be reacting—contributed significantly to the economic
growth of this province. Indeed, that would be like saying that the
sale of peanuts during the weekends in Italy caused an increase in
car accidents in Scotland, because the frequencies of the phenomena
both increase over the weekend, as everyone knows. There is really
no link between these two things.
What happened is that the interest rates dropped in North
America, particularly in the United States, our exports climbed and
Ontario benefited. Furthermore, Ontario's economy was the regional
economy that declined the most in Canada during the recession. It
is therefore logical that, in times of growth, its economy recovers
faster than the others.
There is, however, one area where significant tax reductions
would have an impact. This would be in the corporate sector, in
conjunction with the competition that exists throughout the world
to obtain direct investment from international corporations. It is
obvious that Ireland's decision to reduce the capital tax burden
which was, I believe, sitting at 22%, as compared to 10% 10 or 15
years ago, had a major impact on the flood of foreign investment in
Obviously, if Canada were to do the same thing, there would be
a flood of investment, but this would not be the result of any
savings from Canada, or additional work or effort coming from
Canada. It would essentially be the impact of the decision made by
foreign or Canadian corporations who wish to expand or set up shop
Consequently, if we want investment in Canada to really climb,
we are either going to have to remove corporate tax or change the
way that individual income tax is structured so as to remove taxes
on savings to the maximum. In order to do that, we may have to
analyze the system suggested by Mr. Mills, and also the system
suggested by American senators such as Mr. Domenici, who has
suggested the USA Tax.
Mr. Yvan Loubier: I would like to ask a supplementary question
in conjunction with what you have just said. Do you find that it is
just as, as you say, ridiculous that since 1993-94, it has been the
income category I mentioned, namely, those with average incomes
earning between $30,000 and $70,000 per year, who are contributing
the most, all things being equal, to the campaign to put public
finances back in order, when in fact we are in a situation where we
have forecasted surpluses, for the next five years, of between $95
and $150 billion?
This morning, economists from Toronto agreed with you: they
felt that Mr. Martin had once again underestimated the surplus we
would have in the next five years. This is becoming a habit. We
can't seem to change it. Would you find it a crackpot theory that
we should give some respite to these categories, to these middle-
income families who made most of the sacrifices when we tried to
put our public finances back on a sounder footing?
Mr. Pierre Fortin: I'm not saying it's a crackpot theory in
that case. The government has a decision to make. It can go one way
or the other. What I called crackpot was saying that we were on the
wrong side of the Laffer curve. But I think we know where we stand
However, I feel it is a good idea to squarely target the
middle class for massive tax cuts across Canada in the next 10
years. Personally, I think there should be at least $30 billion in
overall tax cuts over the next 10 years, and on the whole the
middle class should benefit. At the same time, though, I would make
a particular effort to bring down the maximum marginal tax rate in
Canada, and bring it closer to that in the United States, as John
McCallum suggested a few moments ago.
Mr. Yvan Loubier: Thank you.
The Chair: Mr. McCallum.
Mr. John McCallum: I have just two quick points to
supplement what's been said about the common currency.
By the way, I agree with David Laidler. North
American common currency is a euphemism for Canada
using the U.S. dollar, so politically that's not
likely to happen any time soon. I think what we're
really talking about is a pegged exchange rate or a
The two points are...for a country like Argentina,
Mexico, or Brazil, with a history of gross monetary
instability and hyperinflation, there's a certain
appeal to just dumping their rotten system and using
the U.S. dollar, though even then I don't think it's
going to happen any time soon, if only because they
wouldn't have any lender of last resort and their banks
are not exactly stable.
In Canada we went through considerable pain in the
early 1990s to get our monetary house in order. We
went through further pain more recently to get our
fiscal house in order. Arguably we have at least as
much monetary and fiscal discipline as the Americans,
and the proof of that, as was pointed out a few minutes
ago, is that our interest rates today are lower than
the American rates. So we don't have that same
incentive as point one.
For point two, I think the best example to illustrate
the benefits of a flexible exchange rate was the Asia
crisis. When the Asia crisis occurred, commodity
prices around the world tumbled and the resource-based
countries like Chile, Australia, New Zealand, and
Canada experienced significant currency depreciations,
which offset in part the impact of that Asia crisis and
which depreciations were at least partially temporary.
My argument is that you have to take the hit from the
Asia crisis somehow, and far better to take the hit in
these temporarily weaker currencies, which permitted
continued growth and job creation, rather than take the
hit in defending the currency by higher interest rates
and arguably putting us into a downturn.
To look at fixed rates, which haven't done very well,
there are only two major countries in the world that
have true pegged exchange rates today. They went
through that experience. Those countries are Argentina
and Hong Kong. They are not in good shape today. I
would argue that our flexible exchange rate has served
us well. Nowhere has that been more apparent very
recently than in the consequences of the Asia crisis in
The Chair: Thank you.
Mr. Jackson, followed by Mr. O'Neill.
Mr. Andrew Jackson: Very quickly, I agree with
just about everything John said. The point I wanted to
make in terms of the positive impacts from the flexible
exchange rate is this. In certain quarters the recent slide
in the Canadian dollar is seen as a terrible thing, but
I think it's absolutely clear that the recent growth
we've had in our economy has been driven in a very
important way by that change in the exchange rate, the
cushioning impact following on from the Asian crisis.
The point I wanted to make...and I was really glad to
see it made yesterday by the new dean of the business
school at U of T, who I heard took a 90% pay cut to
come back to Canada. The point he was making, which I
think really gets overlooked a lot in the debate, is
that Canadian businesses, particularly businesses
selling into the United States, which is the case for
an awful lot of the high tech sector calling for tax
cuts so vocally...I mean, they have an incredible deal
at the moment. They're selling in U.S. dollars and
they're paying people in Canadian dollars.
If you're paying people in Canadian dollars...I think
most people would agree that the purchasing power of a
Canadian dollar is about 80¢ U.S. The exchange rate is
67¢. That's an incredible incentive, in fact, for
companies selling into the U.S. to locate in Canada.
It's an incentive effect that greatly outweighs any
possible tax reduction.
I mean, it's just absurd...not that people here are
falling into that trap, and certainly not John, because
he's far too sensible. It's absurd for people like
Sherry Cooper to call for major cuts and fixing
the Canadian dollar. They're policies that run in
completely opposite directions. We should be
maximizing the leverage that we have from the
depreciation of the exchange rate.
The Chair: Mr. O'Neill.
Mr. Tim O'Neill: I have one small caveat there.
One of the consequences of a lower-valued currency, of
course, is that your purchasing power internationally,
at least in the short term, is declining. It's not
something you'd look forward to. It nonetheless does
have similar effects. I think one of the key points,
though...and I'm in the group that feels that a common
currency or fixed exchange rate is conceivably the
worst possible policy we could find. I'll make a long
list of what I think would be silly policies, and that
would be at the top.
One of the arguments—there are other good ones that
have been made, I think—that are often made is that it
protects against the volatility in currency and the
problems that creates.
In fact, if you go back over the last 20 to 25 years,
the Canadian dollar is one of the least volatile
currencies. I would argue, in fact, that it may well
be the case that the Bank of Canada has been too
focused on and too concerned about the currency, rather
than insufficiently concerned. It may be criticized on
those grounds, and certainly all of the points that
have been made about why you would want a flexible
exchange rate are appropriate ones.
Let me also pick up on something that Pierre
mentioned. Hopefully this is not grossly
oversimplified, but in looking at the stimulative
effects, in the longer term, of tax cuts, we have to
make a distinction between personal income tax and
business taxes, as I think Pierre pointed out. Both of
them are going to stimulate
spending in the short term—sort of a demand-side expansion.
The key point, though, is that investment has two
other impacts. One is that it's a capacity-expanding
expenditure, so in the long term you are going to
improve your trend growth rate in the economy. Your
capacity to grow in the future is enhanced because of
that. That's not the case when you increase the
capacity for consumption spending. Reducing personal
income taxes doesn't, in that sense, expand your
economy's capacity to generate output in the future at
a higher rate than you've hitherto been able to. And
to the extent that investment spending has embedded in
it technological change, it also has a
productivity-enhancing role to play.
While it may be true, as Andrew Jackson pointed out
earlier, that the size of the impact looks relatively
small, I would argue that a half a point increase in
the trend growth rate in the economy is a very
significant long-term improvement. The effect of
compounding that over 20 or 30 years is very
significant. I don't think that even the most
optimistic literature about the impact on private
sector productivity from infrastructure spending would
claim anything remotely close to that kind of impact.
The Chair: Mr. Robson, then Mr. Mendelsohn.
Mr. William Robson: Since everybody is picking up
on the currency union point, I'd just like to amplify
one thing, if I may. The machinery at the core of a
monetary system—the central bank,
lender-of-last-resort facilities, and the regulatory
and legal powers that go along with that—is very
difficult to pick apart.
One of the things that bothers me about the debate
about North American monetary union is that no one has
told me why we could expect the U.S. Federal Reserve to
provide us with the same types of services that we now
get from the Bank of Canada without an extension of
legal and regulatory power into Canada, which no one
seems willing to contemplate. This is a topic that has
also come up in a different context that I believe is
of some interest: the question of whether Quebec, as
an independent country, would want to use the Canadian
dollar. I tend to think that the same difficulties
arise, and I have the same reservations about the North
American monetary union idea.
In your first question about personal income tax
burdens and families, you mentioned the specific
example of families with children. I was wondering if
Professor Van Audenrode was going to come in on that
point. I neglected it in my presentation.
Mr. Yvan Loubier: Two children—
Mr. William Robson: Or three.
Canada's tax system is almost unique now in the world,
I think, in providing no recognition of the existence
of children for many families.
At the end of my presentation, I sneaked in a quick plea
for the re-establishment of a sensible system of
deductions, because that's how you do it and that's how
you get the horizontal equity that was referred to
here. In Canada we have had a very big problem with
sorting out the issue of defining the tax base in a
sensible fashion and then putting your social policy
transfers on top of it as a separate issue.
We have tried to make up for problems in the tax base,
like the lack of deductions, for example, with further
complications of our system of transfers, and we're
making a worse mess. We have to get the tax base
right. I think the deductions that would put a family
with two or three or four children into the situation
you're describing—where they don't start paying taxes
until a higher income level—are the way to go.
The Chair: Mr. Mendelsohn.
Mr. Joshua Mendelsohn: I just want to pick up on
one point. I just don't want to leave the wrong
impression; I mean, we all seem to agree that we don't
want a fixed exchange rate, but then there were some
comments from Andrew Jackson, and maybe some others,
that somehow it's “I'm all right Jack, we have a low
exchange rate, it's great, we sell everything”. What
we have to understand is that there is a price to it.
Whether you lower wages or you lower the exchange
rate, there is a cost to the standard of living of
every Canadian as a result of that. Increasingly, to
the extent that you have companies or firms that don't
export and don't have export earnings and need to buy
capital equipment, that capital equipment becomes more
expensive to them.
So there is a cost in all of this, and to presume that
somehow.... I'm not in favour of artificially raising
the exchange rate. I don't believe in that. But at
the same time, to leave the impression that if the
exchange rate were to go down another 2%, 3%, 5% or 7%
it would be fine, I think, is very misleading. It has
a cost, a very expensive cost over the long term.
The Chair: Mr. Rosenberg.
Mr. David Rosenberg: I would tend to second what
Mr. Mendelsohn had to say.
Of course Mr. Jackson decided to take a shot at my
boss, who isn't here, but I'll take the high road and
just say that everybody's been talking about what a
great antidote the lower Canadian dollar was during the
Asian crisis and for our beleaguered resource
producers. Nobody's talking about what's happened this
year. The Canadian dollar is up, and yet it's still the
disappointment of the year on the upside.
Someone would have to explain to me what the Bank of
Canada's policy really is. When you consider that
commodity prices were going up in the spring—oil
prices were already going up to $16, $17 or $18 a
barrel—and the Canadian dollar hit 69¢ on May 3, the
peak for the year.... The very next day, the Bank of
Canada independently cut interest rates 25 basis points
to lean against the currency going to 69¢, when the
terms of trade were telling you we should be over 70¢.
So what is the Bank of Canada's policy with respect to
the Canadian dollar if they suppress it at a time when
the fundamentals are telling us it should be going up?
That's the big question, not what happened last year.
But why is the Canadian dollar trading as if oil
prices were at $16 or $17 a barrel instead of $24 or
$25, where they currently are right now? There's a
serious mismatch between where the Canadian dollar is
and where it should be, based on the fundamentals. And
that's a question that hasn't be addressed.
The Chairman: Mr. Laidler.
Prof. David Laidler: Yes, there are two things.
The Bank of Canada's policy is to keep the inflation
rate between 1% and 3%, and that's what it's been
The second point is that it is very misleading to
refer to the price of oil as having a positive effect
on the fundamentals of the Canadian dollar. The
empirical evidence and the theoretical work that has
been done in the Bank of Canada over the last decade
shows that the price of oil has a negative effect upon
the value of the Canadian dollar, because Canadian
manufacturing exports are extremely intensive in their
use of oil and other energy products, and that indirect
effect outweighs the direct effect of the price of oil.
The commodities you must look at as drivers of the
Canadian dollar are non-oil commodities that are
produced in and exported from Canada.
The Chair: Thank you.
Mr. Paul Szabo (Mississauga South, Lib.): Thank
There seems to be a consensus that the 50-50
discussion is really quite academic, that 50-50 is not
appropriate for all time. It seems to be some sort of
reasonable starting point when you're moving out of a
deficit scenario into modest surpluses that are small
enough dollars to work with. But obviously once these
surpluses get up to higher levels, all of a sudden you
may find yourself having to spend where the need is not
justified, but you still have to match the formula.
So I think you got some consensus on that one, Mr.
I got the distinct impression from everyone that
really productivity was what we were all talking about,
that we're really looking for ways to improve
ultimately the quality of life for Canadians, and that
there are many ways to deliver that improvement in
quality of life. Some are direct, right to the
individual. Others are through things like improving
the corporate side, so that we grow the pie, whether it
be tax cuts or whatever.
I'm very interested, though, in how all this
translates into the size of the debt. We've heard
often from people who have come before us, “Isn't it
outrageous that we have this large debt and we're
paying $40 billion a year on debt servicing?” It
reminds me of the initial reaction to a fiscal
dividend, that the real fiscal dividend was the
interest savings on debt repayment.
It's a very interesting argument. I always thought
that since the national debt is basically the
accumulation of our past deficits, there's good
argument to say you have to pay it all down—but not if
you have other opportunities to grow the pie or to
improve quality of life at a greater rate than you
would from the benefits of paying down
I guess the question really is, do you agree
that we need tax cuts to continue so that we get in the
ballpark or into the middle of the pack again? Do we
need spending to directly address quality of life
issues? And I'm pleased to hear all the talk about
children and families generally, especially those who
maybe aren't fully participating in the quality of
The balance of debt: is debt really bridge financing
at a time when it's the cost of capital to provide
those tax cuts that are going to provide pie growth...or
strategic spending, where that also is going to
stimulate the growth of the pie? Is the debt really a
floater, or is it something we really have to get down,
ignoring the debt-to-GDP, to some extent because there
is some empirical level at which it must drop simply
because Canadians feel it's absurd that we have a
The Chair: Mr. O'Neill.
Mr. Tim O'Neill: Obviously the choice on mix, as I
said in my presentation, has to do ultimately with what
its impacts are on productivity, quality of life, and
so on. So what role does debt reduction play in that?
One role it plays, I think, is in reducing real
long-term interest rates in Canada. That has to be one
of the biggest benefits that come out of reducing the
debt-to-GDP faster than is, say, currently being
contemplated. Canada is still a high-debt economy,
still a high-debt country. As I indicated, we're still
about 20 basis points in terms of percentages above the
average for triple-A-rated countries. Is that the
right benchmark? I don't think any economist could
tell you what the optimal debt-to-GDP is. What they
can tell you is that we don't have it. We're above it
Secondly, it buys a lot of room—Tom Wilson made
reference to this, and I did at my presentation—if we
hit a shock to the economy that's externally generated,
let's say in this case, from the U.S. If the Federal
Reserve were forced to be far more aggressive than most
people are currently forecasting, you could be looking
at a significant growth recession, or even a real
recession, in Canada, say, in 2001.
In that environment you want to have lots of room for
two things. One is to move off your fiscal track and
get acceptance from financial markets. Let's not
forget that the problem in the mid-1990s was not
related to the specific deficits in any given year; it
was the rising debt-to-GDP that was causing so much
heartburn in financial markets. The second thing it
does is allow you more room to use, if necessary—even
instead of just passive—actual active counter-cyclical
fiscal policy. We didn't have the room to do that in
the 1990s. We could buy more room in the future with
It seems to me those are the three biggest benefits
you get from using more of the surplus to pay down the
debt directly and to reduce the debt-to-GDP faster than
we're currently contemplating.
The Chair: Mr. Wilson.
Prof. Thomas Wilson: In the handout I gave you,
and I'm sorry I had to come so late, we have a package
of policies that involve personal income tax
reductions, business income tax reductions—I'm
including corporate and capital gains there—payroll
tax reductions, spending increases, and debt paydown.
The orientation of the package is heavy emphasis on
debt paydown in the first couple of years, then much
heavier emphasis on tax reduction in the later years.
We did look at the effects of each of these policies
relative to a benchmark in which all of the so-called
fiscal dividend, except for the contingency reserve,
was allocated to spending, to non-taxable transfers to
persons. So we were evaluating what each of these
Now, it turns out that the measures that are most
favourable to growth—growth of output, growth of
productivity, and growth of employment—are the
combination of debt reduction, business tax reductions,
and payroll tax reductions. I want to just emphasize
that when you look at something like a PIT cut, its
effect is very similar to a transfer payment increase.
We're not taking into account possible effects of
selective cuts of certain people on brain drain
effects. These may be important. In a broad context,
the big payoffs were from the reductions in the other
taxes and the debt paydown.
The reason you get these results is in part that
there's a very important interaction with monetary
policy. If we look at an initiative such as cutting
personal taxes, we can't just view that in isolation
and say there are going to be these wonderful demand
effects, people will spend more on consumer durables,
and so on. Because what will happen is the Bank of
Canada, looking at the path it wants for inflation
control, will be offsetting those demand effects.
We really have to focus on what the supply effects
are, because if there are favourable supply effects,
which the three policies I mentioned have.... The debt
reduction and corporate income tax and business income
tax cuts have very important long-run effects in
improving productivity. The payroll tax cuts have very
important short-run effects. They're like favourable
supply price shocks. Those are how we can get some
gains, because there the interaction with monetary
policy can be quite favourable.
The Chair: I have the following: Laidler, Van
Audenrode, Stanford, McCallum, and Jackson.
Prof. David Laidler: I have one very brief comment
on the debt. There are huge dead-weight losses
involved in collecting the taxes to service it. If we
had the debt-to-GDP ratio now that we had in around
1984, you could abolish the GST and still have change.
That's a measure of the order of magnitude of the
fiscal burden the current debt outstanding puts on
Prof. Marc Van Audenrode: On the debt, the last
thing we want to do is corner ourselves with another
magic number, like the debt-to-GDP ratio has to be 40%
and inflation at 1%, with a deficit of zero. Then we
get cornered and we can't do anything.
The message several of us have tried to pass on is
that we want to make sure that should the Canadian
economy hit some troubled times, we won't have to start
the 1990s all over again, with tax hikes and program
cuts and all these kinds of things. The impression we
have is that at this point the debt-to-GDP ratio is too
high to be sure this won't happen. That's the message.
The Chair: Mr. Stanford.
Mr. Jim Stanford: I have a couple of points, Paul.
I think we would all agree the debt ratio needs to
fall, and it is falling. It's falling quickly by any
historical standard, and it will continue to fall,
under any of the forecasts or programs we've put out.
The fiscal burden associated with serving that debt is
going to fall in step with it.
Here's an interesting experiment. Take your consensus
outlook on GDP growth and then plot some scenarios.
Plot the reduction in the debt burden with balanced
budgets, plot the reduction in the debt burden with $3
billion contingency funds that are used to pay down the
debt, plot the reduction in the debt burden with $10
billion contingency funds that are used to pay down the
debt, and the three lines are virtually
indistinguishable. The notion that financial markets
would know the difference between our debt burden four
years out, having paid $3 billion a year off or having
paid nothing off, is fantastic to me.
If Tim were right that paying down the debt would lead
to a sustained reduction in long-term real interest
rates, that would be a powerful argument for me to pay
down the debt. But I've seen no empirical evidence of
a systematic or predictable link between a country's
debt burden and its long-term real interest rates,
including in the Canadian case.
In terms of the argument several have made that it's
good to have a sizeable surplus as a cushion so that in
the event of a downturn, you don't have to cut program
spending and increase taxes, that's all based on the
starting point that we accept the notion that Canada
can never run a deficit again in any circumstance.
That's what the finance minister in essence has stated.
Then yes, we should have a surplus, because having a
surplus to avoid the pro-cyclical changes in fiscal
policy that would be required to live up to that
promise would be much worse.
But we can also question that promise in and of
itself. It isn't at all clear to me, despite our
headache from the 1980s and 1990s, that if we have a
cyclical problem, the government should not run a
deficit. In fact running a deficit would seem to me
to be exactly the appropriate thing to do in the event
of a cyclical problem.
So for all of those reasons, I would put debt
reduction at the absolute bottom of the list of
priorities for what to do with this surplus.
The Chair: Thank you.
Mr. McCallum, do you agree?
Mr. John McCallum: Well, strangely enough, I find
myself closer, in what I said, to Jim here than to Tom
Mr. Jim Stanford: I told you it would rub off if
you sat down here, John.
Voices: Oh, oh!
Mr. John McCallum: Not quite as much. What I said
was put about a quarter of the surplus into debt
reduction, which is not that much different from my
interpretation of what the government is now doing.
But having listened to Tom, not having heard him for a
while, I'm starting to waver a bit. Let me tell you
two reasons I might be wrong and they might be right.
One, if you look at the demographics, we have about a
ten-year window of opportunity before the baby boomers
start to retire en masse. By that time, the burden on
them of supporting all us old people will become much
higher and health care costs will be higher. So one
way of helping out demographically is to get that
debt down as fast as we can in that ten-year window
that now exists.
The second reason I might be wrong is that we might
look back two years from now on this year as the best
of times. I was part of this process with Paul Martin,
and it seems to me, as Jim just said, that even if we
just have balanced budgets, the debt ratio will come
down to less than 50%. That's pretty good, given that
it was 72% a couple of years ago. But as Tom said, all
of that is predicated on the assumption of smooth,
continuous growth over the next five years. What if
there's a stock market crash? What if the interest
rates go through the roof south of the border and we
have a recession? All of those future surpluses we
talk so freely about, in that circumstance, simply
won't materialize. They'll be a mirage; they won't
So to the extent you believe we are now in the
best of times—and we're not doing badly, with
employment growth, 7.2% unemployment, etc.—you can
certainly make a case on the grounds of prudence for
putting more into debt reduction than what I just
expressed a view on.
The Chair: Thank you.
Mr. Jackson and then Mr. Robson.
Mr. Andrew Jackson: I just wanted to clarify what
I was saying about the dollar. All I was trying to
argue was that macroeconomic policy recently, including
the depreciation of the exchange rate, being
appropriately stimulative, and that basically present
growth rates were a reflection of that past policy with
a lot of impacts....
I do agree that constant depreciation is not a viable
long-term economic strategy for Canada. I wrote a
paper last year where I said part of the weakness in
the dollar over time can be attributed to our
productivity performance vis-à-vis the U.S.
But the important point I was trying to make—and I
hope it wasn't a cheap shot at your boss—is that there
is a continued need for macroeconomic policy now to be
maintaining the pace of the expansion rather than
tightening up. As was mentioned, that's why it was
appropriate for the Bank of Canada to cut interest
rates earlier, rather than to maintain an exchange
rate. So I was in agreement with that.
People are throwing out these scenarios for the next
year or two. The big question is hanging there: what
is going to be the overall course of macro policy? I
personally found it disappointing that the Bank of
Canada did decide to match the American rate increase.
I don't think there was much in the monetary policy
report that really justified that decision.
I'm bothered by the notion that was thrown out that if
we have a stimulative federal budget, monetary policy
is necessarily going to have to tighten in response to
that, and that would wipe out some significant part of
the impacts on growth. It is an interesting question.
With the size of the surplus we now have, we can all
quibble about whether it goes to taxes or spending, but
that's a lot of money that's going to go back into the
economy, and it is going to have a stimulative effect.
There is clearly some danger that that impact on growth
could be offset by monetary policy.
I would just throw out in that context the observation
that everything we've learned from the U.S. over the
past couple of years does suggest that our potential
for growth free of inflation pressures is much stronger
than used to be believed, that the case for pre-emptive
tightening is a lot weaker
than used to be the case.
Also, I think it's important to underline that if we
look at Canada at the moment, indeed the unemployment
rate has fallen—and that's very welcome—back to the
1989-90 rate. It's also true that in the last year or
so we've seen significant growth of full-time paid
jobs. But I think it's also really important to
underline how much underemployment continues to exist
in Canada. We've see fairly significant shifts out of
self-employment into paid jobs, and there are still a
lot of part-time workers who would like full-time jobs.
So I would argue that we have a lot more capacity to
grow than many people believe, perhaps including the
Bank of Canada. But I think it is an important issue
for the committee to reflect on.
The Chair: Thank you, Mr. Jackson.
Mr. William Robson: Just as a quick comment,
I'm afraid I want to take exception to Jim Stanford's
argument that zero, $3 billion, $10 billion a year
doesn't make any appreciable difference.
Let me just mention the Canada Pension Plan. A
few years ago, we went through quite a bit of
difficulty. We were faced with a situation in which
the Canada Pension Plan looked like it was going to run
out of cash, we were going to see contribution rates go
up to 14% plus, and it was looking unsustainable. We
fixed that with a package of benefit changes and
contribution hikes, and we put it into something that
looks like it's probably going to be sustainable at a
9.9% rate for as long as any of us is going to be
The difference that package made was much less than
$10 billion a year. It wasn't much more than $3
billion a year, really, when you're looking at things
over the next few years. Those differences really do
add up to a lot, and if we're going to look out over
the long term, I don't think it's at all defensible to
say that a few billion dollars a year this way or that
doesn't make any difference. When my children grow to
adulthood, it'll make a big difference to them which
choice we make. That's why I like the idea of
including a bit of debt paydown in the fiscal package.
The Chair: Thank you, Mr. Robson.
Mr. Lorne Nystrom (Regina—Qu'Appelle, NDP): Thank
you very much, Mr. Chair.
I want to shift gears just a little bit this afternoon,
if I could, and ask Mr. Stanford the following
question—and anybody else who wants to comment can do
so, because everybody's welcome. We've heard an awful
lot today about the creation of wealth and capacity,
competitiveness and productivity, and so on. The
creation of wealth is extremely important. If we don't
have a bigger pie, we're not really going to have more
people working and money for social services and the
like. But we've heard very little about the
redistribution of wealth this afternoon.
As public policy-makers, we have to look at both sides
of the equation and think about the common good.
Committee members have heard me often talk about how I
represent the inner city in Regina, where there's an
awful lot of poverty and all the other problems that
you have in the inner cities. The inequity, the gap
between the rich and the poor, seems to have been
growing in the last few years. We went through a
number of decades when equality was actually increasing
and the gap was narrowing, but now the gap seems to be
An example of the inequity occurred just in the last
few days, when our six large banks—we have a lot of
bankers here—announced that their profits in the last
year were $9 billion. Those were some of the largest
ever, if not the largest in the history of our country.
About a year ago, the top 24 executives had an
accumulated compensation package, between salaries and
bonuses and stock options, of over $250 million. That's
about $10 million apiece, Mr. Stanford, and that's
equivalent to the salary of about 12,000 bank tellers.
Once again, that shows the tremendous inequity that
there is in our society.
In light of that growing trend, what would you
recommend to the finance committee or to the Minister
of Finance on redistribution on the income side, so
that the people who have been really paying for the
reduction in the deficit the last few years because of
cutbacks and transfers in health and education, social
services and so on, can get more of their fair share of
Mr. Jim Stanford: Thank you for that question,
I did not pay Lorne to ask that question of me. I'd
like to make that clear.
Mr. Lorne Nystrom: Mr. McCallum did.
Voices: Oh, oh!
The Chair: Is he paying you for the answer? That's
Mr. Jim Stanford: In terms of the distribution of
income, I think there's probably no more powerful force
promoting a better distribution of income than growth,
job creation, and the tightening of the labour market
that we've seen in the past couple of years. And
perhaps I'd have agreement from some of my more
conservative colleagues here, but when you get the
unemployment rate coming down as it has been, and when
you get jobs created as they have been, you're
inevitably going to get rising disposable incomes and
falling poverty rates, and that's good all around.
So I put a real emphasis on the macroeconomic
ingredients in redistribution, but I also put a lot of
stress on the role of federal and provincial
governments, and the role of the tax transfer and
public programs. I do have a few numbers that I didn't
mention in my presentation—they're included in my
handout here—about the impact of the role of
government on income distribution, based on the most
recent Statistics Canada survey of income distribution
The data goes up to 1997 now, and the interesting
thing in 1997 was that the average effect of personal
income tax rates fell for the first time during this
recovery. This meant that the tax burden on individual
households declined marginally, from about 20.2% to
just below 20%. But the data is quite shocking in
terms of who benefited from that decline in personal
income taxes. In fact over 100% of the dollar value
of that personal income tax was concentrated in the 20%
at the top of the income ladder. The bottom 80%
actually had a slight increase in their average
effective tax rate. What that reflects is the
overwhelming bias of the income tax cuts in Ontario and
Alberta, and now in other provinces. Those cuts reward
the high-income earners who collect the lion's share of
Shockingly, in 1997, even though it was a good year
for the labour market and should have been a good year
for income distribution, the result or impact of the
tax cuts on the distribution of after-tax income
actually outweighed the progressive effects of the
labour market. You actually had an increase in
inequality during 1997 when it was measured by the ratio of
the top to the bottom.
There's another experiment that I did with that
same data. If you look at the distribution of market
income—that's what you supposedly earn before
transfers—the ratio of the top fifth to the bottom
fifth is roughly 24:1 as of 1997, and that ratio has
grown steadily. After taxes and after transfer
payments, the ratio falls to under 8:1, at about 7.9:1.
Immediately, right there, you get a major impact in
terms of the tax and transfer system leading to a much
more egalitarian society.
But then there's an
additional step if you consider the value of public
services that are consumed across the board. If we
assume each individual Canadian consumes a proportional
share of the public services such as health care,
education, roads and so on—and I don't think that's
too far off the mark, because I think the distribution
of public services is something that everybody benefits
from—the ratio of income inequality in Canada falls to
less than 4:1. For the poorest fifth of the
population, the consumption of public services
effectively doubles their standard of living relative
to their actual cash income, even including the
In a riding like yours, Lorne, or in terms of
inner-city ridings elsewhere in Canada, where you have
tremendous poverty and so on, the collection of taxes
and then the spending of those taxes on valuable public
services—whether that spending is on early childhood
development, health care, education opportunities, or
other forms of public consumption that everyone has
access to regardless of their income—is an absolutely
crucial ingredient in what we've been able to preserve
in terms of equality of opportunity and access to
Now, I know folks like David will have questions about
the efficiency of public spending and the value of it,
but even under very reasonable assumptions I think
that's a very important part of their standard of
The Chairman: McCallum, Fortin and Laidler.
Mr. John McCallum: As I said at the beginning
of my comments, I do think it's a question of balance,
because I buy into the idea of our having a more solid
safety net. I don't aspire to U.S. taxes. I don't
like the huge increases in inequality that we see south
of the border. And they are huge. On the other hand,
we have to be competitive, so if we go too much in that
direction, we won't have the jobs and the people and
the wealth created in this country. So it is balance.
My argument is that we have to tilt that balance a
little bit. I'm not arguing for any cuts. I'm arguing
for some measures that favour low-income people, but we
have to look a little bit at the high end as well,
because I think the U.S. is becoming more and more of a
Let me just give you one illustration of Saskatchewan.
A report was done for the NDP government in
Saskatchewan, and I thought it was excellent, because I
think the problem that Saskatchewan has vis-à-vis
Alberta is like the problem Canada has vis-à-vis the
U.S. Saskatchewan will never have its taxes as low as
those of Alberta, and Canada will never have taxes as
low as those of the U.S.
But don't let that gap get too big, or activity
will move from Saskatchewan to Alberta. Saskatchewan
is responding by big cuts in income tax to preserve its
competitive position and wealth, and that's what I
think we in Canada have to do as well. But it's always
going to be a question of balance.
Finally, a lot of the problems in Regina, it seems to
me, are related to problems of aboriginals. I said in
my remarks that I put a high priority to areas of
pressing social need, and nowhere is that need more
evident than in the aboriginal population. It's not
just a moral or social issue. It's an economic issue,
because it's a ticking demographic time bomb. The only
thing I don't know—there are lots of things I don't
know, but I mean on this topic—is whether we know how to
spend the money wisely. We've already spent $6 billion
plus. I'm all in favour of more if we know how to do
it. But it's not evident to me that Indian Affairs
knows all the answers.
The Chairman: Mr. Fortin.
Prof. Pierre Fortin: Thank you very much.
I think one thing that should be said here is that
income inequality in Canada is very much less than that
in the United States, first of all. Our poverty rate as
measured by international standards, meaning the
percentage of people in Canada living below the 50%
median, is 12%, compared to 20% in the United States.
This doesn't mean we should not do more to improve
income equality, to reduce income inequality. The
first thing to do is to push the monetary authorities
so they continue to explore lower and lower
unemployment rates. It is stupid to say that because
the unemployment rate in Canada now is 7.2%, and that
it is the same as it was in 1989, we should be happy with
that, because we know that structural unemployment has
fallen, and if we can reach 6%, we should do it as
quickly as we can.
The third point I would like to make is that one
way to directly help is to stop cutting EI benefits.
I'm not saying anyone is considering this, but I think
we've done enough.
Another measure that could be considered would be to
fold the entire Canada health and social transfer into
equalization payments. In other words, include this
spending side of the equation, by the provinces, into
the equalization formula. The problem is that the
provinces that are poorer not only have less money to
attend a given level of poverty through welfare, but
they also have more poor. In other words, their
responsibilities are higher than average. Therefore,
there would be an argument here to put the CHST under
The Chairman: Thank you.
Prof. David Laidler: Yes, if I were concerned
about inequality, which I am, I wouldn't look at annual
income distribution data at all; I would look at
lifetime inequality, which is very difficult to
measure. But we do know how to get at that through a
tax system—we tax consumption rather than taxing
income. My ideal tax reform would tilt the Canadian
income tax structure much further toward a consumption
tax. I'd be willing to look at inheritance taxes as
well. Those are under provincial jurisdiction in
Canada. But if you're really concerned about
inequality you want to get at the wealth and not the
income, because as I said in my presentation, a
progressive income tax is not a tax on being rich, it's
a tax on getting rich, and you don't want to discourage
people who want to get rich if you're interested in
productivity growth in a market economy.
Finally, if you think that bank executives are
overpaid, that's a problem for the shareholders. And
if you think there's something the matter with the way
the shareholders police the banks, you might look at
the rules. And I would look at the 10% ownership rule.
The Chair: Mr. Van Audenrode.
Prof. Marc Van Audenrode: I just want to make the
point that inequality is actually the result of many
things, and there are many tools to answer the problem
of inequality. As Pierre has noted, they seem to be
working relatively well.
Now, my impression is that if inequalities have
increased in Canada in the last few years, it's not a
problem of the tax system. It's more a problem of
these other tools, like the reduction in EI and social
welfare spending. So we should first look at these
programs before looking at taxes to solve the problem
That being said, I don't deny the fact that there
are some annoyances and some things that are bad in
the tax system. One has been already talked about,
and it's the minimum taxable income for families, which
definitely should be raised a lot. There are many
other examples that we could think of, these small
things that annoy a lot of people and that are
Another example is—I'm sure I'm not going to be
popular with my colleagues—that I have an employer who
pays for a very generous retirement package, and I
still get to deduct thousands of dollars to put into my
RRSPs. I don't think that's fair. I'm very happy to
do it, but I don't think that's fair. So all these
small examples of annoyances should be taken care of.
The Chair: Mr. Wilson.
Prof. Thomas Wilson: I just want to make a couple
of brief points. One is that the thing I'm
most concerned about with low-income Canadians is that
many of them face the highest effective marginal tax
rates in the country. I sometimes joke that we should
have a constitutional amendment that no one pays a
higher marginal tax rate than the richest Canadian.
If you look at people in the $15,000 to $20,000
bracket, with clawbacks of cash transfers, child tax
credits, and sales tax credits they can be pushed into
marginal rates above 50%. If you take into account
in-kind types of clawbacks—people losing access to
social housing, subsidized child care, and so on—these
effective marginal rates can be very high.
So one of the things I think should be looked at is
how the tax system, the transfer system, and the
welfare system interact to make sure that low-income
families have adequate incentives to work and save. In
the short term, I think what you can do to help is to
increase the personal amount—as has been noted—and
also reduce the EI contribution rate. This is a heavy
tax on employment and on job creation in the short run.
Finally, I come back to business taxes. I think
Pierre mentioned Ireland, but the Scandinavian
countries have all cut their corporate rates. I think
they now have a two-stage tax, with investment income
typically being taxed at a flat 30% rate. These are
not viewed as right-wing countries.
The Chair: Are there any further comments? Thank you.
Mr. Scott Brison (Kings—Hants, PC): Thank you. I
was pleased to hear Andrew Jackson say earlier that in
fact reducing corporate tax rates would probably lead
to the best economic growth of any tax reduction. I'm
expecting to hear Herb Grubel say that increased
levels of social spending would probably be a good idea
at this time. But I was pleased to see on the road to
Damascus that we're seeing some conversion and
convergence on some of these issues.
I have a question for Mr. Stanford. You've said that
we should now focus on reinvestment in social spending
because of the fact that a large part of the balancing
of the budget has come as a result of cuts to social
spending. Isn't that a specious argument from an
economics perspective? Isn't how we got to where we're
at irrelevant? Shouldn't we be focusing on what would
be the best decisions we could make now relative to the
allocation of this fiscal surplus for the future?
Isn't that an irrelevant argument that we got here by
cutting social spending?
Mr. Jim Stanford: I think that's a fair point to
some degree. The reason I make that argument is
One is to debunk the claim that is
made very loudly that we got to where we are by
increasing taxes. The economic evidence is clearly
contrary to that. Yes, taxes increased in the 1990s,
but they increased modestly. The bulk of the
turnaround fiscally was achieved by program spending
Secondly, I would emphasize that there have been
significant and long-lasting, but often invisible and
underreported, costs to that reduction in program
spending. It's showing up in all kinds of ways and
all kinds of places, to suggest that what we've done is
not necessarily sustainable in terms of the decline, as
John mentioned, in many components of the public
infrastructure, which have suffered.
I've looked at public investment—I know Tim is
interested in this subject as well. In Canada we are
barely investing enough in the public real capital
stock to offset depreciation, which means we're not
growing that infrastructure in line with the economy.
You just have to look around at the state of much of
that public capital stock to see that's the case.
Then of course the social costs, the increases in poverty
that we've seen, ironically even during what should be
good times, are to a large extent the result of
reductions in unemployment insurance and other transfer
That being said, I accept the point that others made
that at this point you've got money to spend and you
have to look at what's the best way to spend that. I
think on that ground there's a very strong argument in
favour of social reinvestments as well.
Mr. Scott Brison: Well, if you go back about
20 years, there was a relationship
between taxes paid by Canadians and the services
they received. That was largely due to the fact that
they weren't paying such an egregiously large amount of
their taxes to debt servicing. If you compare our
debt-to-GDP ratios in the 1970s to those of the U.S., for
instance, the U.S. had a higher debt-to-GDP ratio than
Canada did, I believe. If you compare
Canada to the U.S. and in fact to other countries in
terms of spending as a percent of GDP—let's just focus
on the U.S. for a moment—spending on health care,
spending on the military, spending on any range of
services or public spending, those numbers are not
grossly out of whack with the U.S. Our taxes as a
percent of GDP are actually out of whack. They're at
about 28%, we're at about 30%. But the debt servicing
charges we're paying in Canada are where you see a
Shouldn't we be focusing on
getting those fundamentals more in line with those of
our largest trading partner and also with some of the
other countries? The Scandinavian countries have been
mentioned. Mr. Jackson and others have acknowledged
the importance of corporate tax reduction. When
social democratic countries like Germany are reducing
their corporate taxes and we see the Scandinavian
countries reducing these, shouldn't we be focusing on
public policy dealing with these realities as opposed
to some of the other perceptions that may be out there?
The Chair: Mr. Jackson.
Mr. Andrew Jackson: I just want to clarify a
little what I was saying about corporate taxes. When I
was talking about impacts of taxes versus spending
cuts, I was trying to be quite clear that in an
immediate stimulative sense to the economy, in terms of
growth and job creation, spending has the greater
impact. I was saying that in terms of studies of impacts of
tax levels on long-term economic growth, there are a lot
of studies that speak to significant impacts again on
the public spending side. Of the studies on the tax
side, I did make the point that it would appear there
are stronger impacts on the business tax side than by
It is within a narrow frame that I would make
that point. I just did it to make the interesting
observation that I think so much of the corporate tax
cut is from the business side. The BCNI and the
chamber have been so
heavily focused on tax cuts for high-income earners,
and I think that's at odds with the message they're trying
to send in terms of the impacts of growth. I'm
certainly not myself saying corporate tax cuts
should have any sort of immediate priority.
The Chair: Mr. Mendelsohn.
Mr. Joshua Mendelsohn: I just want to correct one
element. I know I speak here as an economist
representing a financial institution, but I also happen
to be the chair of the economic policy committee of the
Canadian Chamber of Commerce. By no stretch of the imagination is
the chamber focused on high-income taxes only, on
high-bracket individual income taxes only. It's across
the board. I just want to make that clear.
The Chair: Any further comments?
Mr. Scott Brison: On the corporate tax side or
even on the personal side, there are strong arguments
for significant tax reform as a vehicle for tax
reduction at this time. Somebody made the argument
that we have such a brilliant opportunity now for tax
reform and using tax reduction as a way to ameliorate
the impacts for some of them. We could eliminate a lot of
the distortions in our tax code. I thought Mintz did
a very commendable job in pointing out some of
those distortions on the corporate tax side in areas of
taxing capital or the profit-insensitive taxes, and also
the degree to which we are taxing in a
discriminatory way those sectors we should be
trying to encourage—technology, the service sectors,
etc.—and actually favouring the older resource-based
sectors that we should probably be trying to grow from.
Wouldn't this be a great opportunity for us to be
pursuing an aggressive tax reform strategy as a vehicle
for tax reduction at this time?
The Chairman: Mr. Wilson.
Prof. Thomas Wilson: I couldn't agree with
you more. In the tax reduction package we have,
there's $2 billion allocated to corporate income
tax cuts and capital gains tax
cuts. Most of that is the corporate. But one
important thing is that that magnitude of cut, which would
finance about a three-percentage-point reduction in the
large corporate rate, would facilitate the
implementation of the Mintz committee report. So you
could actually get the statutory rate down a lot more
because you could put in place all of the base-broadening
measures of the Mintz committee's report by combining
reform with reduction.
I mean, the
reduction means you don't have to gore too
many oxen as part of the reform process. I think
that's another plus for allocating a certain amount to
these cuts, and it's not large. We're talking
here, say, in the fifth year of the analysis, where the
fiscal dividend is at least $30 billion to allocate,
and where you might want to allocate half or 60%,
something like that, to tax cuts, you're only allocating
a small percentage of the cuts to the business income
tax cuts. But I think those are the ones that have the
greatest payoff, particularly when combined with the
implementation of the Mintz committee reforms.
The Chairman: Mr. Laidler.
Prof. David Laidler: Very briefly, I agree entirely.
I would go further and say the emphasis should be
on tax reform, and the fiscal dividend should be
seen as providing the opportunity to provide the tax
reductions that will make the reform politically
The Chairman: Mr. O'Neill.
Mr. Tim O'Neill: Just to add, you have the
interesting problem that you have some large companies
in this country who started out as
manufacturing companies in, say, computer manufacturing
who basically become service industries, and as a
consequence of that, their effective tax rate has gone
up just because they've changed the nature of the
business they're doing. It's hardly an incentive for
companies of the same sort as IBM to invest significantly
in a country where their effective tax rate has gone up
simply because they've changed the nature of their
I think the Mintz report clearly points to a
significant need for tax restructuring. The political
economy reality is that you probably can't do
that restructuring in a neutral way. You
have to do it in the context of lowering rates and just
doing it more for some than for others. I think
there's a fairly significant benefit coming from that.
The Chairman: Mr. Fortin.
Prof. Pierre Fortin: At this time, I think I'm going
to simply suggest that I fully agree we should
take advantage of this situation to reform the tax
structure and not only reduce taxation overall. I
would suggest the committee read the recent book by
Larry Seidman, who is a professor at the University
of Delaware, on the unlimited savings account
tax, entitled The USA Tax: A Progressive
Consumption Tax, published at MIT
Press. It describes exactly what elimination of all
savings from income taxation would mean, and the return
then of all savings to be consumed
into the tax base. I think the results are
pretty interesting to study. I'm suggesting you
go fishing and look at this.
I think it's a very good
idea at least to explore this possibility.
The Chair: This will be your final question, Mr. Brison.
Mr. Scott Brison: Just before I ask my final question,
I'd like to say that my party wasn't positively reinforced
the last time we engaged in meaningful tax reform in
this country, but we're not trepidatious about pursuing
With regard to capital gains taxes and their impact
particularly on the high tech sector, given the
increasing rate at which stock options are used as
compensatory assets, I'd appreciate your feedback on
the priority we should be placing on reducing personal
capital gains taxes. To reduce our personal capital
gains inclusion rates to levels that would be roughly
equivalent to those of the U.S. would cost the federal
treasury $247 million per year. Again, this is a
matter of public policy sometimes being built around
perceptions as opposed to realities.
appreciate your feedback on that.
The Chair: Mr. Mendelsohn.
Mr. Joshua Mendelsohn: On the capital gains tax, I
think that over time we probably should lower them, but
I think we could achieve part of the process by
attacking the more general income tax structure, because
that in itself will automatically lower the capital
Also, when you're speaking about the
United States, you're talking about a two-tier capital
gains tax. There are the long-term capital gains and
the short-term capital gains, and the rates are
substantially lower than they are here. I would argue
politically and in every other which way—even though I
argue we should do it for economic reasons, but I think
in this one it's going to be a really tough row to
we're going to put our political capital into anything,
it should go into the more generalized tax structure. I
think that will offset some of it.
The Chair: Mr. Rosenberg.
Mr. David Rosenberg: I think that is vital
in terms of promoting the future growth industry, which
is the high tech sector. This is happening around the
world. We just saw Australia cut their capital gains
taxes, and it's hardly a bastion of conservatism. In the
U.K. Chancellor Brown, just a couple of weeks ago,
announced a huge reduction in capital gains tax rates,
and again that is a Labour government. I think there's
a growing awareness outside of Canada's borders as to how
important stock options are in terms of compensation in
this sector and how important lower capital gains taxes
are in terms of boosting the stock market and the access to
capital that ends up providing to businesses.
I should just add that if you're looking at a supply-side
impact that raises the growth potential of the
economy, I know that the Department of Commerce put out a
study suggesting that lower capital gains taxes
ultimately would give the U.S. an additional percentage
point of non-inflationary growth potential, which is one
of the reasons the Democrats were able to go
on-line in terms of the capital gains tax of 1996.
Mr. Scott Brison: The unlocking of capital
would be significant.
Mr. David Rosenberg: Right.
The Chair: On my list is Laidler, Fortin,
McCallum, and Jackson.
Prof. David Laidler: I'm going to disagree
A voice: You're the academic.
Prof. David Laidler: Yes, I'm the academic. But
this sounds to me exactly like the half-thought-through,
winner-picking tax scam that got the Canadian
tax system into the mess it's in.
I really do urge you
to stand back and think about how you want to tax
businesses. Then go through the implications of that
for how you want to tax dividends, and go through the
implications of that for how you tax capital gains.
Stop trying to pick winners through the tax system,
because it's going to be a disaster.
The Chair: Mr. McCallum.
Mr. John McCallum: I'm an ex-academic, but I think
on this one I might be a bit closer to David Rosenberg.
It's not necessarily a pick-a-winner strategy. You
don't have lower capital gains just for the high tech.
It would be across the board. If you look at the
productivity debate, it's the high-tech information,
computer-related industries that explain more than all
of the gap in productivity growth between Canadian and
U.S. manufacturing. We really are lagging behind in
those industries, and I think those industries are
So I think it would be a good idea, in a well-thought-out,
deliberative manner, to devise certain policies,
perhaps the ones you've mentioned, that would give a
boost to those industries.
I think sometimes the optimal tax rate for Canada is
not the optimal tax rate you'd get if Canada were an
island unto itself, but it sometimes is closely related
to the U.S. tax regime. It's not entirely driven by
it, but we cannot afford to ignore it even if it is, in
some sense, sub-optimal.
The Chair: Mr. Wilson.
Prof. Thomas Wilson: I think we could have an
immediate reduction in the capital gains tax by
decreasing the inclusion rate to two-thirds. I think
you can make a strong case for that, because that would
effectively bring the marginal tax rate on capital
gains and dividends into rough equivalence. Right now
for top-bracket taxpayers the marginal rate on capital
gains is above the marginal rate on dividends. I don't
think you want to ever go below the marginal rate on
dividends, because then you'll open up all of the
surplus-stripping problems that led to the
establishment of the Carter commission many years ago.
If you want to do something on the incentive side, I
would suggest revisiting the existing $500,000 capital
gains exemption. The Mintz committee recommended
getting rid of that and replacing it for farmers and
small business by having a more liberal rollover into
RRSPs, which would save some revenue. If you want to
then provide some incentives of a general type, not a
winners-picking type, I would say that would be the
source of the revenue. Don't draw on the fiscal
dividend for that but use reform of the existing
provision to generate a more effective incentive.
The Chair: Very quickly, Mr. Jackson.
Mr. Andrew Jackson: I have just two points.
First, distributionally, any move towards easier
taxation of capital gains is really perverse. Over
half of all taxable capital gains goes to people with
incomes of more than $100,000. A very huge chunk,
actually, goes to those with more than $250,000. So I
think people's political antennae should be twitching
if those are the candidates for tax reductions in the
Second, it strikes me that there's quite a lot of
emerging literature that it's not a particularly good
thing to be heavily tilting the compensation of senior
executives towards stock options. Actually, The
Economist, of all places, had a major article on this
a couple of months ago.
You really have to pose this question: do you want
senior executives to be personally driven by short-term
appreciation of shares as opposed to longer-term
corporate performance? I think there's significant
evidence that this type of short-term thinking can lead
to all kinds of unproductive corporate behaviour.
I guess the third point, just to repeat myself, would
be that the studies done on the lifetime capital gains
exemption showed almost no positive impacts on real
I think it's bad policy, then, from three different
The Chair: We're running a little bit late here,
but I'd like to very quickly go through some questions
for which I need some very quick answers.
Assuming the 50-50 formula for the allocation of the
fiscal dividend is abandoned, what would your split be?
Some of you have already stated it, but I'd like to
get a sense of that.
Mr. Fortin, I know you agree with the 50-50 split.
Prof. Pierre Fortin: I agree with it because it
means for the next five years, for this planning
horizon, it's exactly what would turn out to be the
case if you simply increased expenditure at the same
rate as GDP. In another period, it might not be 50-50.
I support 50-50 only because it turns out, by chance,
that it falls exactly where it should to maintain the
The Chair: Mr. Wilson.
Prof. Thomas Wilson: I have to leave, so perhaps I
can just say my piece.
I don't usually disagree with Pierre, but I think we
should be keeping spending, in the five-year window,
lower than that, and putting a higher priority on debt
reduction in the short run and on tax reductions in the
I didn't add them up in the handout I gave you, but I
think you'll see that I have a higher allocation to
taxes than to spending, and I think spending is
slightly higher than debt. So I have a spending
proportion that's roughly 30% of the available fiscal
dividend. This is with the fiscal dividend measured
against the base of constant and real per capita
The Chair: Mr. Laidler.
Prof. David Laidler: The Department of Finance is
full of smart people who can convert expenditure
increases into tax cuts and vice versa, so I don't
think it's worth arguing about.
The Chair: Mr. McCallum.
Mr. John McCallum: I originally said half
for taxes, and a quarter and a quarter for spending and
debt. That's still my position. I was a bit
persuaded by Tom. It might change to a third, a third,
a third; but right now I'm a half, a quarter, and a
The Chair: Anyway, there seems to be a departure
from the 50-50.
Mr. Joshua Mendelsohn: In a sense, we answered this
before, because the key is not the ratio. Fifty-fifty
is clearly too much because it opens up too many doors.
The key is, whether it's 15%, 20%, 25% or 30%,
what you spend it on. And if you can make a strong case
for contribution to growth and performance, whether it
be public infrastructure or whatever, then so be it.
It's when you get into these rather loose-ended,
very touchy-feely kinds of areas that it becomes very
difficult, and my concern with the 50-50 is that it
creates a barrier or a threshold you have to hit
whether you have good projects or not.
The Chair: Mr. O'Neill.
Mr. Tim O'Neill: If you use as your baseline for
each of the next five fiscal years constant nominal
spending levels and then look at what the “surplus”
is—which is the exercise Jeff Rubin and and his
colleagues went through that was reported in the paper
today, so there's no difference between their views and
our views on what the size is, it's just how you use
the baseline—what you end up with is about 150. Of
that, about close to 50 is taken through just
increasing spending at the rate of population plus
inflation. So in a sense, through that mechanism, you've
allocated, using current spending as your baseline, a
third to spending. Then you divide the other 90,
whatever it is, 92, 93, 95.
I would argue for a bigger split. We've argued in the
paper that we provided to use about three-quarters of a
percent of GDP for debt reduction. Five years out
that gives you around $8 billion, and then you get about
a $15 billion tax cut, divided among a number of
different categories. A fair chunk of it, bigger than
Tom's, would be on the corporate tax side. So that
gives you obviously a much different allocation from 50-50,
The Chair: What do you think is a healthy mix
between corporate and personal?
Mr. Tim O'Neill: I think the answer to that
question from an economist should always start with the
phrase, it depends on what you are trying to do. If
what you're trying to do is increase long-term capacity
and productivity in the economy, in my view there's no
question that the initial focus is going to be far
better placed on business taxes because of the impact
it will have on creating incentives for investment,
both in terms of reform and in terms of levels. So in
that context, then, if that's what you're trying to do,
you give personal income tax lower priority.
If you're in Jim Stanford's position and you really want
to put a lot more emphasis on equity, then you do it
differently. Obviously you would either put far more
into personal income taxes or ramp up the public
spending distribution side of things. I don't think
that's a particularly effective way of doing it, but
certainly it depends on your priors.
The Chair: Mr. Robson.
Mr. William Robson: On that
second one, the other “it depends” is that
it depends on how you classify
some of this stuff with regard to capital gains and
employment insurance cuts. Is part of that corporate,
or do we assume it all comes out of the employee's hide in
the long run?
Giving the most expansive definition of the personal
side, I think you'd probably end with about one-tenth in
the terms of corporate, maybe a little higher than
that, but you'd get more bang for those bucks,
In terms of the 50% rule, taking prices and population
growth as the benchmark for spending, I would fight
like crazy to give three-quarters of everything extra
to tax cuts and one-quarter to debt, knowing that I was
going to lose, even if I budgeted for that. I don't
mean to express any kind of cynicism about the way
spending actually develops in the wake of budgets, but
I know that as a matter of fact, once the public
accounts are published, there will be spending there that I
didn't budget for. After
the fact, a good fifth to a quarter will be spending.
That's just how it's happening. Even as we speak,
there's spending happening that wasn't in the budget.
So I would fight like crazy for three-quarters tax and
one-quarter debt, knowing that only by doing that would
I keep spending down below a third.
The Chair: Mr. Stanford.
Mr. Jim Stanford: In the same vein, knowing that
I'm going to lose, I would argue for 100% on program
spending, and that will be the line taken by the
alternative federal budget, which is a project that'll
come out early in the new year, for the fifth year.
It will obviously surprise Tim, but I'd put more of
an emphasis on corporate tax cuts before personal tax
cuts any day for the impact on real investment spending
and job creation.
The Chair: Mr. Jackson.
Mr. Andrew Jackson: I concur with that. I
want to make the observation—and I agree with David
Laidler—that it's a bit silly to be bandying this
around in the abstract. There are an awful lot of areas
that can be classified to either side. Is an increase
in the child tax credit a tax cut or a spending
increase? It counts as a tax cut, but it's basically
indistinguishable from a very targeted.... It's really a
transfer increase, but you can argue about which way to
On the business side, I would argue that if you have scarce
resources, you probably get quite a bit more bang
for your buck in terms of the very targeted kinds of
program spending that John Manley's pushing for, in
terms of increasing funding for the National Research
Council and Technology Partnerships Canada. Those will
show up as spending, but in essence they are a direct
reduction in the cost of capital to companies that are
investing in research and development. So in a sense,
they're analogous to an extremely efficient
corporate tax cut.
So it's not a very productive
debate in a lot of ways.
The Chair: Although it does give you a sense
of...this is what I believe. I think you have to
produce the best public policy you can, given your
ultimate goals. And percentages matter up to a point,
but the reason we have the 50-50 split is because,
quite frankly, symbolically it represents a balanced
approach. That's the reason—
Mr. Andrew Jackson: We voted for it.
The Chair: Yes. That's exactly why.
Mr. Tim O'Neill: Nobody agrees with the
The Chair: That's right.
Prof. David Laidler: I'd say one word on the corporate
versus personal thing. There's one good reason you
might start with company taxation, and it is that the
homework on the reform has already been done, in the
shape of the Mintz report.
The Chair: That's right.
Prof. David Laidler: So you're much less likely to
go off up blind alleys if you start on the corporate
The Chair: I had many more questions.
Unfortunately, as chair, I gave everybody else the
questions and didn't take care of my own.
Nevertheless, I really appreciate your taking the time
to come here. This is an all-star cast, and we're very
privileged to have you here. We certainly appreciate
the added value you brought to the debate.
We did get quite a number of answers. Of course, now
we have to reflect upon what everyone has said, but I'm
sure you'll see many of your points of views represented
in the recommendations we make to the Minister of
Finance. Thank you.
The meeting is adjourned to the call of the chair.