IMAGES

Peter Redman, National
Post

Finance Minister Ralph
Goodale is at the centre of criticism over the proposed Surplus Allocation
Act.

Goodale policy criticized: Productivity at issue: Slammed for
lack of clear vision of economic health
National Post
Fri 14 Oct 2005
Page: FP1 / Front

Section: Financial Post
Byline: Jacqueline Thorpe
Source: Financial
Post

When Ralph Goodale, the Minister of Finance, stands up in
the next couple of weeks to deliver his fiscal update, he will face a business
and economics community in near despair over federal economic policy.

It had been rumoured that Mr. Goodale may present a "beefed-up" document that
would focus on improving Canada's miserable productivity record. The document,
it was said, may even include those corporate tax cuts that were unceremoniously
dumped from this year's budget in favour of the $4.5-billion spending deal with
the NDP.

But after the latest initiative from Mr. Goodale -- the Surplus Allocation
Act -- economists aren't holding their breath. Some say he should avoid creating
a credibility problem by forgetting the notion of a productivity document
altogether and revert to the usual five-page update.

"How do you come up with a productivity paper when every single thing you're
doing is productivity-unfriendly?" said Don Drummond, chief economist at
Toronto-Dominion Bank. "Isn't that a little bit embarrassing?"

The SAA -- meant to answer criticisms of a budget process that regularly
spews out "unexpected" surpluses -- has instead turned into the latest policy
disappointment from a Liberal government that has displayed a singular lack of
vision on the economy file, analysts say.

From the surge in spending, to a refusal to do more than just talk about
improving productivity or make taxes more competitive, to continued delay on
bank mergers and the recent instability over income trusts, the frustration on
Bay Street creeps higher by the day.

Jayson Myers, chief economist at Canadian Manufacturers and Exporters,
perhaps summed up the feeling of many best: "The fiscal policy of the past four
years has been policy in terms of how to spend money and very little on how to
make money."

Introduced into the House of Commons last Friday, the SAA will see any
surpluses beyond the $3-billion contingency reserve divvied up in three ways.
One-third will go to further debt reduction, one-third to social spending and
the rest to tax relief.

At its best, economists liked the idea the $3-billion contingency reserve
would still be devoted to debt reduction. Beyond that, their view was almost
uniformly negative.

Clement Gignac, chief economist at National Bank in Montreal, said the
procedure of devoting surpluses to the national debt has helped drive Canada's
debt-to-gross domestic product ratio down to 40% -- lower than U.S. levels --
from 72% in the mid-1990s.

"One big plus: We are much less dependent on foreign capital," Mr. Gignac
said.

At its worst, economists say the SAA will provide Mr. Goodale with another
excuse not to overhaul the Canadian tax system when other countries around the
world are furiously cutting theirs to attract capital.

"What we need is meaningful tax relief for Canadians," said Nancy Hughes
Anthony, president and CEO of the Canadian Chamber of Commerce. "This Surplus
Allocation bill is just tinkering, trying to pretend you're slicing up a pie."

But slicing up the pie will give Canadians little in the way of tax relief
and will do even less to improve productivity, analysts say. (Assuming there is
a pie, of course: Last year's 15.1% increase in spending reduced the surplus to
$1.6-billion.)

Mr. Drummond does the math: "Let's say the surplus is $6-billion. So
$1-billion comes back and it gets distributed among 10 million people, so it's
$50. What do you think it will cost to administer that?"

Craig Wright, chief economist at Royal Bank of Canada, added: "In a world in
which we're hoping to focus on productivity, why divide things up that way? By
most measures, there's not a great deal of money available on a go-forward
basis, so you might as well get as much bang for your buck through focused
initiatives rather than a continuation of the scattergun approach."

The word "productivity" may make most taxpayers' eyes glaze over, but
productivity growth -- output per worker -- is crucial to raising income. By
squeezing more work out of fewer resources, more income can be distributed back
to workers in the form of higher salaries or benefits, to further investment or
shareholders.

The trouble is, productivity growth has flatlined in recent years. From 2000
to 2004, annual productivity grew an average 0.9% per year in Canada versus 3.5%
in the United States.

Canadian income per capita has tapered off in tandem. Dale Orr, managing
director of Global Insight, says Canadian real gross domestic product per capita
dropped to 85.3% of U.S. levels in 2004 from 86.9% in 2002 and is forecast to
drop to 84.4% in 2007.

Analysts say it is a bit of a mystery that Canada's productivity growth has
been so poor. Profits have soared in recent years -- though mainly in the oil
patch -- and the stronger dollar has made imported technology cheaper.

One thing they do agree on is that encouraging both corporate investment and
personal effort is key to improving productivity.

"There's a lot you don't know about what drives productivity, but one thing
that does tend to drive productivity is robust investment activity," Mr. Wright
said.

If Mr. Goodale is as serious about improving productivity as he says, then he
should reduce barriers to corporate investment by lowering corporate income
taxes, capital taxes, increasing the depreciation allowance, or increasing
investment tax credits. On the personal tax side, reducing the marginal tax rate
-- taxes paid on additional dollars earned -- would encourage people to work
harder.

"If you're simply giving people a rebate cheque, that doesn't change people's
behaviour," said Rick Egelton, chief economist at Bank of Montreal. "For
competitive reasons, we want to lower marginal effective tax rates: That
encourages businesses to invest, and for individuals, it encourages effort."

A recent study by the C.D. Howe Institute found Canada's marginal effective tax on
business capital -- combining such things as depreciation deductions together
with capital and corporate tax rates -- averaged 39% in 2005, second only to
China's among 36 industrial and leading developing countries.

Marginal effective tax rates are often higher for low-income workers. For
families with two children, for example, it can run as high as 60% in the
$25,000 to $35,000 income range because of clawbacks to such thing as the child
tax benefit.

Here, too, the options are obvious, analysts say: Cut the four personal
income tax rates across the board. "The advantage is that everybody wins," Mr.
Drummond said. "The disadvantage is that one point off each rate costs
$4-billion per year."

Less costly would be to raise the income thresholds for which certain rates
kick in or reduce the "clawback" rates on the child tax benefit or the
low-income GST credit, Mr. Drummond said.

But Bay Street has been pitching these ideas for years and they seem to be
falling on deaf ears.

Recent mediocre efforts on the personal tax front will not be enough to
prevent the overall burden from rising, Mr. Orr said. Without a tax cut of at
least $20-billion, personal income taxes will be the source of more than half,
or 50.7%, of all government revenue beginning in 2009-10.

As far as corporate initiatives go, most of the cuts that were slated in the
2005 budget were back-end loaded, with not much relief coming before 2008. Then
they were dropped altogether.

"Every once in a while, there's some kind of small measure -- like
recognition in the last budget on starting the slow road to reducing capital
taxes or improving the capital cost allowance -- but once again it's a half
measure," Ms. Hughes Anthony said.

While analysts understand a minority government makes it harder for the
Liberals to table policies that may not be sexy to most Canadians, some blame
continued disappointment on the economy front squarely on Paul Martin and Mr.
Goodale.

"I think this is an issue that goes to the Prime Minister's Office and to the
Minister of Finance that there is a lack of vision in terms of priority," said
Jason Clemens, director of fiscal studies at The Fraser Institute. "On the tax
front ... not only have we stayed stagnant, but we've moved backward because the
Surplus Allocation Act is a very strong incentive for the government to maintain
tax rates, particularly if people start to get used to a $100 rebate when they
file their income tax."

Mr. Clemens said every major economic achievement any government has won has
happened by single-minded focus on the issue: the Free Trade Agreement, slaying
the deficit and the 2000 tax cuts.

It is up to Mr. Martin and Mr. Goodale to make productivity salable in the
same way, analysts say.

After all, how difficult could it be to sell Canadians a tax cut?

A SURPLUS OF TAX POLICY CRITICISM:

Business leaders line up to call for reform of budget process

SURPLUS ALLOCATION ACT NUTS AND BOLTS

- $3-billion contingency reserve would still be devoted to deficit reduction.

- Surplus above $3-billion would be split three ways between debt reduction,
spending and tax relief.

- "Contingency spending" would be set out in the budget

- Tax relief would be delivered through a one-time tax credit when Canadians
receive their tax assessment.

- Tax relief could be made permanent through an adjustment to the basic
personal amount (amount of income Canadians may earn without paying federal
income tax).

- Effective for fiscal years 2005-06 to 2009-10; would have to be renewed
thereafter.

WHAT BUSINESS LEADERS DON'T LIKE

- Last year's 13.3% increase in program spending was the second largest on
record in inflation-adjusted terms, standing only after a 17.1% increase in
1974-75

- Even before last year's large increase, spending rose an average 7.3% per
year from 1999-2000 to 2003-04;

- Plans in last year's budget to cut corporate surtax and general corporate
income tax rates were dropped in favour of $4.5-billion spending deal with NDP

- No major personal income or corporate tax cutting initiative since the 2000
five-year plan.

- No decision on bank mergers

- Ambiguity over income trusts

- - -

"As somebody who's spent half of my life fighting the deficit, I'm thinking
what kind of beast did we create? It was one thing to be fighting a $42-billion
deficit but this has gone into the realm of the surreal."

Don Drummond, chief economist, Toronto-Dominion Bank

- - -

"It doesn't preclude them from doing serious tax policy because, to the
extent that the fiscal dividend is still a positive number....you can still make
longer term plans."

Peter Dungan, professor, Institute for Policy Analysis, University of Toronto

- - -

"This is not a piece of economic policy. It's a piece of public relations."

Dale Orr, managing director, Global Insight

- - -

"It seems difficult to interpret [the] announcement as anything other than an
attempt to purchase votes in the near term with surplus dollars."

Jason Clemens, director of fiscal studies, The Fraser Institute

- - -

"In the past ... we ended up with the phrase debt reduction by stealth. What
we've seen more recently is spending by stealth."

Craig Wright, chief economist, Royal Bank of Canada

- - -

"For me, it's more an accessory, it's not the core fiscal policy. The surplus
allocation act is an appendix ... to calm down the critics of the surplus
allocation process."

Clement Gignac, chief economist, National Bank of Canada

- - -

"If you're simply giving people a rebate check, that doesn't change people's
behavior. For competitive reasons we want to lower marginal effective tax rates,
that encourages businesses to invest and for individuals, it encourages effort."

Rick Egelton, chief economist, Bank of Montreal

- - -

"I think we need to rethink our whole budget process and go to medium-term
type budgeting that has been adopted by a lot of other countries."

Jack Mintz,
president and chief executive officer, C.D. Howe Institute

- - -

"What happens if that surplus is enormous? Why do you simply have to assume
that 1/3 will go to spending? Especially when we're already running at a
spending rate that is well over the growth in the economy and the rate of
inflation. Why again a limitation to a strict one-third in tax cuts?"

Thomas d'Aquino, chief executive and president, Canadian Council of Chief
Executives

- - -

"Every once and a while, there's some kind of small measure -- like
recognition in the last budget on starting the slow road to reducing capital
taxes or improving the capital cost allowances -- but once again it's a half
measure. None of the political parties seem to feel there's any sense of urgency
on economic issues."

Nancy Hughes Anthony, president and chief executive, Canadian Chamber of
Commerce

Illustration:
• Colour Photo: Peter Redman,
National Post / Finance Minister Ralph Goodale is at the centre of criticism
over the proposed Surplus Allocation Act.
• Colour Photo: (Don) Drummond
•
Colour Photo: (Dale) Orr
• Colour Photo: (Craig) Wright
• Colour Photo:
(Clement) Gignac
• Colour Photo: (Rick) Egelton
• Colour Photo: (Jack) Mintz
•
Colour Photo: (Thomas) D'Aquino
• Colour Photo: (Nancy) Hughes Anthony
•
Table: Federal program spending: (See print copy for complete table.)

Edition: National
Story Type: Business
Note:
Ran with fact box "A Surplus of Tax Policy Criticism" which has been appended to
the story.; [email-masked]
Length: 2108 words