National Post
Saturday, February 19, 2000

Mr. Speaker, my shoes and I propose ...

This will be Paul Martin's seventh budget, and the most important since his second, in 1995, which began the Liberals' assault on the deficit. This time the challenge is less obvious; there is no immediate crisis, rather a need to define the government's fiscal direction up to and beyond the next election.

This the finance minister has been strangely unwilling to do. He was still pretending last year that the budget was merely balanced, give or take a couple of billion dollars. By last November's economic statement, however, the swelling surpluses in the treasury could be hidden no longer. On current economic trends, and with no change in tax or spending, the forecast surplus will grow to $23-billion in five years -- $30-billion, if you add back his built-in margins for error. It could be used to repay debt, cut taxes, or increase spending (above adjustments for inflation and population growth, already pencilled in).

His dilemma is that the deficit no longer overwhelms debate about the proper size and role of government. With surpluses, that argument can resume, for good or ill. A flat "no," from the finance minister does not suffice. Choices about spending increases, tax cuts or debt repayment must now, alas, be made on their merits -- whatever those are.

THE CASE FOR DEBT REDUCTION

There is no iron rule to guide Mr. Martin -- certainly none so simple as the one on which the government campaigned in the last election: that half the surplus would be spent, leaving the other half to be divided between tax cuts and debt reduction. This remarkable pledge committed the government to spend a fixed sum of money, before it had any idea of what to spend it on.

There are no rules, only tradeoffs. How much debt, for example, is too much? Dollar figures tell us nothing. The only meaningful way to measure the national debt is in comparison with national income -- that is, the debt-to-gross domestic product ratio. It's 60% now, which is less than at its mid-1990s peak of 70%, but more than at any time before then. Is 60% too high? How do we know?

Short of hitting the "debt wall," where a country hasn't enough money to pay debt interest, there is no bright line separating "happiness" from "misery," as in Mr. Micawber's famous dictum. What we can say, however, is that the lower the debt-to-GDP ratio, the less the likelihood of crisis. A smaller debt means lower servicing costs, leaving more money for other, more fulfilling purposes.

Should we pay debt down to zero? Not necessarily. As debt shrinks, the urgency of further reductions diminishes. Indeed, it's not self-evident that we should pay down the debt at all. Merely balancing the budget would reduce the debt-to-GDP ratio over time, so long as the economy continues to grow. Why not just blow it all on tax cuts, or higher spending? True, by forgoing tax cuts (or spending increases) today, we could have even bigger tax cuts (or spending increases) in future, thanks to the interest we'd no longer be charged on all the debt we'd have repaid. But maybe people would prefer jam today.

All the same, I propose that we put a large proportion of the surplus toward the debt, at least for the next few years. Indeed, I would give the debt first claim on surplus dollars, by setting aside a fixed amount for debt repayment at the start of each budget year. Taxation and spending decisions would then vary according to the required annual debt repayment, rather than the other way around.

Why pay down debt first?

- Our debt-to-GDP ratio is still very high, relative to other countries and our own past. A couple of bad years, a prolonged rise in interest rates, and we would be back on the exponential escalator.

- Interest costs put an immovable floor beneath Canadian tax levels. Taxes are so much higher in Canada than in the United States not because of the cost of our social programs: the United States spends more per person than we do on health, education and social security. It's the 6% of our GDP we pay in public debt charges. To close the tax gap, we have to close the interest gap. That means paying back some of what we borrowed.

- However plentiful today's surpluses are, they won't last long. There's the chance of a recession, and besides, the first Baby Boomers will start retiring in just 10 years. We have not begun to grapple with the costs of an aging population's pensions and health care. If the debt is not down to manageable proportions before then, it will quickly become unmanageable.

- There is also the question of intergenerational equity. We ran up all that debt, mostly to pay for current spending. It's only fair that we should bear the burden of repaying at least some of it, rather than leaving it all to our children.

That doesn't mean all the surplus should be put toward debt. Past a certain point, the marginal benefit of a dollar of debt reduction is less than that of a dollar put to other uses. I've no idea where that point is. But here are a couple of fairly arbitrary benchmarks. First, the amount set aside for debt repayment should provide enough of a cushion to ensure that the budget does not slip back into deficit even in a recession. Running a deficit in any given year may not seem to matter much, but at present debt levels it would damage our credibility in the bond market -- which would exact its usual price.

Long term, we might aim to stabilize the debt-to-GDP ratio at or below 20%, the level that prevailed in 1975, before it began its dizzying climb. We might give ourselves 20 years to do it -- the same 20 years that it took to dig ourselves into this mess.

What would it take to get us to "20 in 20"? Not all that much -- an annual payment equal to 2% of the outstanding national debt. It is an appealingly simple formula, and would commit us to making the biggest payments up front, gradually scaling down the surplus in line with the dwindling debt: from a starting point of roughly $11-billion a year, or more than 1% of GDP, to about $8-billion, or roughly one-third of 1% of GDP, in 2020.

MY FIVE-YEAR PLAN

Now, as it happens, $11-billion is precisely the surplus projected for fiscal 2000-2001. (The $9.5-billion predicted in the fall economic statement was almost certainly an understatement, given better than expected growth since then.) That would suggest there's no room for either tax cuts or spending increases: the whole of the surplus would go to reducing the debt.

Actually, there's room to cut taxes and increase spending, so long as the overall figures remain the same. There is lots of room for reallocation within those boundaries.

Unless it is contended that every last dollar is now well spent -- a difficult case to make, in view of the revelations coming out of the Human Resources department -- then any spending increases in priority areas can be funded out of spending cuts elsewhere. In a reversal of Gresham's law, good money might then drive out bad.

Similarly, on the revenue side, tax cuts need not lead to a reduction in overall revenues, so far as they are offset by measures to broaden the tax base. Rather than simply cutting taxes, we should seize this opportunity for comprehensive tax reform, eliminating those deductions and preferences -- and there are many -- that have no social or economic justification

Until we have hard evidence that the possibilities of reallocation have been exhausted, I think we should continue to hold total spending steady in future years. That is, we should increase spending, but only enough to offset increases in prices and population. If all goes well, that would open up room for tax cuts over and above those made possible by broadening the base. By fiscal 2005, the surplus is projected at $30-billion. Subtract debt repayment of about $10-billion, and that still leaves $20-billion in net tax cuts.

And if things don't work out as forecast? Unless something truly terrible happens, the surplus should be large enough in any given year to make the debt repayments. If the surplus is larger than predicted, taxes can be cut by more than planned. But if the surplus is smaller, tax cuts will have to be limited accordingly.

THE DETAILS

But what about the fine print? For the sake of simplicity, assume that all of the spending cuts and base-broadening measures are imposed in the first year, exactly offsetting spending increases and tax cuts. But in fact these could be phased in over three years, or five, or any schedule you liked.

Here, then, a budget that pays down debt, rationalizes spending, and reforms the tax code, all at one go. Hold tight.

SPENDING

The federal government spends only a small part of its own budget: mostly it gives it away to others to spend.

Operating and capital expense, across all 23 federal departments (including defence) amount to only $31-billion, barely a quarter of the total. Five years ago, it was still possible to carve major savings out of departmental budgets. Public sector wages had grown out of line with private sector equivalents. Staffing levels had ballooned. But with 35,000 fewer employees today, and salaries just emerging from a multi-year freeze, it will be enough just to keep these budgets at current levels. Savings: nil.

The rest, $82-billion in all, is transfers -- to other levels of government ($22-billion), to individuals ($37-billion), to Crown corporations ($4-billion) and to that vast, uncharted archipelago called "other" ($19-billion), a dizzying array of subsidies, grants, zero-interest loans, and other means of spiriting federal cash to thousands upon thousands of corporations, agencies, advocacy groups and native friendship centres, by means of any number of federal programs, all with identical names. Or so it seems.

The biggest transfers, to governments and individuals, are the most difficult to change. Ottawa has only just extricated itself from a political spat over how the $13.5-billion Canada Health and Social Transfer (CHST) is divided among provinces, and would be loathe to get back into it. If Ottawa is to maintain its leverage over the provinces in the social policy field, it can scarcely spend less than this, and is already committed to spend more: the CHST is scheduled to increase to $15-billion over the next two years. Savings: nil.

Equalization, at $10-billion, is too fiendishly complicated to make much sense of. Ideally, the definition of a "have-not" province would be narrowed -- seven of the 10 now qualify -- but whatever savings might result would be offset by another necessary reform, allowing provinces to keep more of their equalization payments as their own revenues increase. At present, they are penalized financially for bettering their lot. Savings: nil.

What about persons? A couple of years ago, the government made a stab at reforming elderly benefits, combining Old Age Security ($18.2-billion) and the Guaranteed Income Supplement ($4.9-billion) into a single, income-tested Seniors Benefit. The reform ran aground on the confiscatory marginal tax rates implied by a steep "clawback" of benefits from seniors on higher incomes, which encouraged the old not to work and the young not to save for their retirement. With the bill for elderly benefits rising by 3.3% a year, even before the baby boomers retire, this is yet another area where it will be enough just to keep the lid on. Savings: ?

Employment Insurance costs $13-billion, less than five years ago, partly owing to the sharp fall in unemployment and partly because of 1996 reforms that modestly restricted the availability of benefits. A system based on international norms -- two weeks' work for one week's benefit, a minimum of 26 weeks of work and a maximum of 26 weeks of benefits, with benefits standardized across all regions and premiums set by "experience rating" -- would cut the cost by about $6-billion, according to government estimates in 1996. Surely we could save half that amount today. Savings: $3-billion.

That leaves us with transfers to private and public groups. When sifting through these, it is useful to bear in mind two axioms on the proper role and function of the state. One, "government should only do what only government can do." A corollary is that taxes should only pay for what only taxes can pay for. As a rule, the users of a service should pay for it. Taxes should be reserved for pure "public goods," such as defence, which cannot otherwise be financed.

The second axiom: "the only moral basis of redistribution is need." There is a well-developed case for transfers from rich to poor. There is none for transfers from city to country, from west to east, from service industries to manufacturers, from young to old, or any of dozens of other surreptitious schemes for reshuffling the nation's wealth. Apart from the cost and the economic distortion, these subsidies are immoral. We must ensure no one falls below a decent living standard. We are not obliged indefinitely to maintain anyone in the business or profession or region of his choosing.

The immediate task, then, is to desubsidize the economy. A quite remarkable proportion of transfer payments are into the hands of private businesses. Sometimes the businesses go by other names, such as fishermen, or farmers, or culture. But they are all people who earn their livelihood not by persuading others to pay for their goods and services, but by demanding that they be paid whether their product finds a willing buyer or not. This should stop.

Here is a list of the more obvious subsidies that could be wound down over time.

Agriculture. Federal contributions to farmers under the Farm Income Protection Act, include crop insurance ($223-million), the Net Income Stabilization Account ($213-million) and Agricultural Income Disaster Assistance ($600-million). Savings: $1-billion.

Fisheries and Oceans. Licence retirement programs for East and West Coast fishermen under the Canadian Fisheries Adjustment and Recovery Plan. Savings: $0.2-billion.

Industry. The regional development agencies, including the Atlantic Canada Opportunities Agency ($280-million) and the Economic Development Agency of Canada for the Regions of Quebec ($314-million), the Western Economic Diversification initiative ($195-million). Also, Technology Partnerships Canada, a contribution to Canadian "competitiveness," is ruled illegal by the World Trade Organization ($253-million). Most of the rest of the $500-million doled out through the Industry Sector Development program should also be scrapped. Savings: $1.2-billion.

Foreign Affairs. The Export Development Corporation ($130-million). Ditto that portion of the Canadian International Development Agency's budget that goes to business -- sometimes in the recipient countries, but as often as not to Canadian businesses through "tied aid" agreements. The agency's "Canadian Partnership" program is particularly full of pork. ($256-million). Savings: $0.4-billion.

Canadian Heritage. Public libraries, museums and galleries are a legitimate concern of government. But goodbye to the Canada Council ($116-million), the Canadian Film Development Corporation ($79-million), the National Film Board ($60-million), the Canadian Television Fund ($100-million), and the Book Publishing Industry Development Program ($32-million).

More is doled out under the "Canadian Identity" program. The recipients might be called professional grant-seekers: advocacy groups, trade associations and non-profit agencies, whose raison d'etre is is often to lobby governments for money. Ours must be the only government in the world that pays people to lobby it to pay them to lobby it. It is surely possible to reduce the $350-million budget by a third. Savings: $0.5-billion.

Human Resources Development. If there isn't at least $500-million of pork mixed in with all those worthy schemes to train the disabled, I'll be Jane Stewart's press officer for a month. Just shutting down the Canada Jobs Fund and the Targeted Wage Subsidies scheme -- the source of so many recent headlines -- would save $200-million. Reforming student loans, with its massive default rates, could recoup hundreds of millions more. Savings: $0.5-billion.

Indian and Northern Development. The department hands out more than $4-billion every year, mostly in grants to native bands. Much of is lost, misspent or goes into the pockets of band leaders. But with the aboriginal population growing as fast as it is, and given the appalling conditions on many reserves -- whether in spite of or because of federal largesse -- it's unlikely progress can be made quickly toward reducing this dependence. But a start must be made. Chop 10%. Savings: $0.4-billion.

There is also the money the government gives itself, in the form of subsidies to Crown corporations. They are no longer the sinkholes of old -- Canadian National, Petro-Canada, Canadair and de Havilland have all been privatized, while Canada Post seems content exploiting its statutory monopoly -- but they are still an unnecessary drain on the public purse. Atomic Energy of Canada Ltd. ($110-million), Via Rail ($170-million), Marine Atlantic Inc. ($40-million) and the Cartier and Champlain Bridges ($38-million), should either recover the full cost of their services in fees, or close.

The same for the CBC, at least the English and French television networks. Convert these to pay channels, and save at least a third of the CBC's $904-million parliamentary appropriation. The Canada Mortgage and Housing Corporation, finally, puts most of its $1.9-billion budget into subsidies to social housing. As a rule, this is bad policy: better to subsidize the people who need housing. Converting subsidies for bricks and mortar into income-tested shelter allowances is no easy matter, but savings might be had by charging higher rents to the better-off residents of the mixed-income co-ops. Savings: $1-billion.

All told, that's $5-billion in subsidies that could be saved without harm to essential services. Throw in $3-billion from Employment Insurance reform, and you have $8-billion for other purposes. We could put $2-billion into daycare subsidies and early childhood development. We could extend medicare to cover drugs and home care, at an initial cost of $3-billion. We could start to refurbish the military and the RCMP, help settle immigrants and refugees, and much more. And we could do all this within existing spending.

REVENUES

As much as high tax rates or distortionary tax preferences might harm the economy on their own, their combined effect is more than the sum of their parts. The higher the tax rate, the greater the value of an exemption, and the more that economic decisions will be governed by tax avoidance rather than by fundamental economic factors. If lower rates were paid for by eliminating deductions and credits, the economic gains are twice what they would be if either were pursued separately.

How much could rates be cut? Warning: You can't actually do what I'm about to do, which is to add together Finance department estimates of the value of a number of different "tax expenditures." Each interacts with the others, and the value of one would change if another were removed. Still, we can get a rough idea of the revenues available. As before, these could be phased in over five years or less.

Suppose we taxed capital gains as income, on the usual reformist grounds ("a buck is a buck is a buck"). Eliminating the $500,000 lifetime capital gains exemption for farms would scoop up $295-million; scrapping a similar exemption for small business shares would reap another $620-million, while including all gains as income, instead of the present 75%, adds $355-million. (We should, however, index capital gains for inflation, which would give back some of that revenue.) Savings: $1.2-billion.

Now suppose we taxed those benefits, public and private, which we now get tax free. These are, after all, income: if ability to pay is the criterion, they should be taxed. The big one here is employer-paid health and dental benefits, a tax expenditure worth $1.7-billion. Taxing workers' compensation benefits would add another $625-million. Savings: $2.3-billion.

There is no good reason why lottery winnings should be exempt from tax ($1.4-billion), nor is it unfair to ask contributors to charities to do so on their own dime ($1.3-billion). The tax credit for labour-sponsored venture capital funds ($85-million) is of dubious social value, as is the deduction for union dues ($545-million). Businessmen could get just as much business done without deducting meals and entertainment ($105-million). Investors, likewise, could do without an investment tax credit ($55-million), while it is surely possible to move house without claiming a deduction ($63-million). Savings: $3.5-billion.

Finally, what is the argument for retaining the age credit, on top of the Canada Pension Plan, OAS, GIS and any number of provincial programs? And why is the first $1,000 of pension income tax free? It's one thing to help out people who are in need. But why pay people simply for being old? Savings: $1.9-billion.

Together, these measures would expand the personal income tax base by roughly $9-billion. But wait, there's more.

The corporate tax system is also riddled with preferences, many expendable. The largest is the special 12% tax rate for small businesses, versus the 28% standard rate. If small businesses are the world beaters everyone says, they don't need special treatment. If they do, all the more reason not to give it to them. Raising the small business rate all the way to 28% would save $3.1-billion. Let's compromise at 21%. Savings: $1.7-billion.

Other needless preferences for corporations include, again, the capital gains exclusion ($700-million -- less if gains were indexed to inflation); deductions for charitable donations ($155-million) and meals and entertainment ($230-million); and tax credits for investing in Atlantic Canada ($100-million), in film and video productions ($40-million), and in logging ($35-million). The Mintz committee, which looked into corporate tax reform, found lots more. Savings: $2-billion.

The GST also has its own list of preferences, of which the largest and most indefensible is the zero-rating of groceries. Not only does this lead to ludicrous definitional problems -- how many doughnuts do you have to eat before a "snack" becomes a "grocery"? -- but it blows an enormous hole in federal revenues: $3.3-billion. Ostensibly, this was to insulate the poor from the tax. But we already have a mechanism to do that: the GST tax credit. Enriching the credit by about $100 for a family of four would relieve those on low income of any additional tax burden, at a cost to the treasury of a half a billion dollars. Savings: $2.8-billion.


THAT'S nearly $16-billion in base-broadening measures: money that's available for reallocation now, without depending on future economic growth. What kind of tax cuts could it buy?

First, let's raise the basic personal and spousal deductions to $10,000 apiece, from their current levels of $7,131 and $6,055. That would take hundreds of thousands of poor people off the tax rolls entirely, at a cost of $8.3-billion. Then, let's bring back the basic child deduction for all families, regardless of income: since children are not a discretionary expense, that's only fair. At $2,000 per child, the cost would be $1.7-billion.

Third, suppose we set, as a short-term goal, a top federal rate of 25%. According to Finance, it would cost $650-million to eliminate the 5% high-income surtax. Cutting the 29% top rate by four percentage points would cost another $2.2-billion, while a one-percentage-point cut in the 26% middle rate costs $1.1-billion. A 10% cut in EI premiums would use up the remaining $2-billion. There's your $16-billion tax cut. And all without taking a dollar out of overall tax revenues.

Now the real fun starts. By year five of our baseline forecast, remember, revenues are projected to exceed spending by $20-billion, after setting aside $10-billion as a payment against the debt. How much further could we cut taxes by then? This gets tricky: the revenue loss from a given reduction in tax rates would be larger five years out than in Finance's estimates. Nonetheless, we might tentatively divide up that $20-billion windfall as follows:

- $5-billion to index the tax system for inflation (that's the cost in year five, if we started in year one). Since 1986, the system has been indexed only to that part of inflation in excess of 3%. Over time, even 2% inflation erodes the purchasing power of tax credits and reduces the real value of thresholds separating higher from lower tax brackets -- that's why they call it "bracket creep."

- $1-billion to raise the ceiling on RRSP contributions to $20,000, from $13,500 (it's already scheduled to rise to $15,500 by 2005). RRSPs don't count as "tax expenditures" because saving should not properly be taxed in the first place. Taxing savings means that the income earned by investing those savings is, effectively, taxed twice. Ultimately, the aim should be to exempt all savings from tax.

- $7-billion to cut the top rate of personal tax another four percentage points, to 21%.

- $2-billion to cut the general corporate tax rate from 28% to 21%, the rate now levied on manufacturers, plus $1-billion to abolish the 4% corporate surtax and the large corporations tax.

- That leaves $5-billion to play with -- just enough to make some much-needed improvements in federal support for families on low income.

There are two problems with the present system. First, the Canada Child Tax Benefit does not pay enough to put the working poor on the same footing with parents in provincial welfare programs. This presents a serious discentive for parents to leave welfare to take a job. Second, the CCTB imposes too severe a "clawback" of benefits as earned income rises: more than 20% in some cases. In combination with other federal and provincial programs, each with its own clawback, this means families with incomes in the $20,000 to $35,000 range can lose 70 cents in benefits and taxes for every extra dollar they earn, with obvious effects on incentives.

The Caledon Institute of Social Policy has put forward a plan to increase the CCTB from its current maximum of $1,800 a child, to the average $2,500 a child available to families on welfare. It would also reduce the clawback to a much gentler 5% to 10%, and only start to apply it at a family income of $25,000. It reckons the cost of its proposal at just under $5-billion.

THE END

The budget would:

- Cut the debt by $52-billion over five years, slashing the debt-to-GDP ratio by a third, and lowering annual interest charges by at least $1-billion.

- Cut the top rate of income tax to 21%, and equalize it across the board: for wage earners and stockholders, persons and corporations, manufacturing and services, small businesses and large.

- Abolish deductions for items that should be taxed, like lottery winnings, while increasing deductions for those that shouldn't: basic personal needs, children and savings.

- Cut or eliminate spending on things that governments should not touch, like bailing out business, and increasing spending on things it should do, such as protecting public health and safety, underwriting basic research, helping people in need.

It would not, however, address the cost of public pensions, the distressed conditions of aboriginals, or the tensions in fiscal federalism. But hey, I can't do everything.


THE COYNE BUDGET PLAN:
(Based on November economic update)
In billions of dollars

00-01
Program spending 113.0
Debt service 41.0
Debt repayment 11.4


01-02
Program spending 118.0
Debt service 40.5
Debt repayment 11.2
Net tax cut 2.8


02-03
Program spending 121.5
Debt service 40.0
Debt repayment 11.0
Net tax cut 7.5


03-04
Program spending 124.0
Debt service 39.5
Debt repayment 10.8
Net tax cut 13.7