The case for raising taxes

Why sensible tax policy could help Canada build on its competitive advantages

Listening to Barack Obama’s state of the union speech I couldn’t help thinking that in surveying America’s problems he was, quite inadvertently, showing us where Canada should move to entrench competitive advantages.

I don’t mean just the obvious imperative to keep up the diligent efforts of recent years to improve our already manifestly preferable health care system. There’s also the broader matter of responsible government finances—with reasonable levels of taxation.

The U.S. president spoke of inheriting a trillion-dollar federal deficit when he took office last year. Prime Minister Stephen Harper waltzed into power facing only the pleasant task of deciding what to do with multi-billion-dollar surpluses.

Obama talked of how Washington, during the George W. Bush era, failed to pay for “two wars, two tax cuts, and an expensive prescription drug program.” Ottawa shucked off the nasty habit of passing along the bill to future generations in the mid-1990s. Or so we thought.

With this year, however, comes the troubling prospect that we might follow the Americans back into the corrosive cycle of perennial deficits. Credible experts tell us that even after last year’s gush of federal stimulus spending is done, the government is on track to keep spending so much, and taxing so little— against a backdrop of such modest economic growth—that a structural deficit of perhaps $20 billion looms.

So what to do about it? The gambler hopes for stronger-than-forecast growth to churn out tax revenues sufficient to balance the books painlessly. The believer in small government pounces on this a chance to permanently shrink federal programs.

There’s another option: increase taxes. The only problem is that tax hikes are what make voters maddest. Or at least that’s what they say. I’m not so sure. What about a long wait at emergency with a sick family member? Admit it—that’s more maddening.

Or if your kid’s classroom is an overcrowded portable. Parents get pretty mad. Or if the army is being nickel and dimed on vital hardware. Everybody was mad about that. Or if potholes go unfilled. Or if our Olympic athletes don’t get enough training funds to win medals…

Come to think of it, pretty much whenever government fails to perform up to snuff, we’re apt to forget, for a careless moment, that we’re supposed to be fed-up taxpayers. Instead, we respond as citizens who want spending.

And if we want it, we have to support the taxes to pay for it. Up to a point, of course. What’s reasonable? Consider an international comparison. Add up all taxes in Canada and they amount to 33.3 per cent of gross domestic product (in 2007, the latest OECD figures). In the U.S. taxes amount to 28.3 per cent of GDP and in Britain 36.6 per cent.

So compared to the countries we might reasonably benchmark against, there’s no tax-burden problem here. Lowering taxes has been a big preoccupation in Ottawa for a decade. The Liberals introduced deep, across-the-board reductions in 2000, and the Conservatives followed with a range of cuts after 2006. Their boldest move was the two-point GST reduction, and they’ve also cut individual and corporate income taxes, for a combined $45 billion a year in foregone revenue by 2014-15.

Some of that is still to come. A key part of Finance Minister Jim Flaherty’s plan for making Canada’s economy more competitive is reducing the general corporate income tax rate to 15 per cent by 2012 from 22.12 per cent in 2007. For this year, the rate is 18 per cent.

Until the fall 2008 financial meltdown, and return of deep deficits in 2009, cutting corporate taxes looked affordable. Not any more, at least not according to Scott Clark, the retired former deputy minister of Flaherty’s department, and Peter DeVries, Finance’s former top fiscal planner.

They don’t think it’s needed, either. “Canada already has a lower tax rate than in the U.S., and it is highly unlikely that the U.S. will be lowering their corporate rates in the near term,” Clark and DeVries write in a cogent budget analysis made available recently to Maclean’s, as well as to the government and the opposition parties.

Freezing the corporate income tax rate at 18 per cent, rather than keeping on with the planned cuts, would bring in more than $5.5 billion a year by 2013-14, erasing more than a quarter of the structural deficit. Look at it this way: if that money isn’t reaped in taxes, any responsible government will have to cut it out of spending. And saving $5.5 billion is an extraordinarily tall order. Let’s say, for instance, you’re hard-nosed enough to freeze all public servants’ salaries. Independent economist Dale Orr estimates that will net $500 million a year.

In other words, freeze government pay—and then impose nine other cost-cutting measures of similar magnitude—and you might nearly match the fiscal impact of just leaving corporate taxes at their present competitive level. (I look at what Clark and DeVries tell us about spending restraint here.)

Less obvious, for political reasons, is an even more sensible tax option: restore those two points the Conservatives shaved off the GST. “As a matter of principle,” Clark and DeVries write, “one should look at tax changes that favour economic growth. In other words, the balance should favour less tax on income and savings and greater reliance on consumption taxes.”

Raising the GST back to where it stood not so long ago would enrich the federal coffers by about $15 billion a year. That’s enough, combined with holding fast on the corporate tax rate, to balance the books again—assuming reasonable spending restraint. This is basically the plan Clark and DeVries outline in a proposed 2010 budget (their table is reprinted below).

The fact that these two highly credible, mainstream commentators can call for big tax increases without being shouted down is itself heartening. It doesn’t work that way in the U.S., where the need to accept responsible taxation is even more acute. As The Economist observed last week, “If America keeps its distaste for taxes, it will face fiscal Armageddon.”

I don’t wish that on the U.S. Here’s hoping Obama reforms health insurance, restores fiscal sanity in Washington, and presides over prosperity. Canada always does better when the U.S. thrives.

But if Washington remains mired in policy stalemates, all the more reason to make sure Canada strengthens its position as the North American jurisdiction that’s run right. That requires balanced books again soon in Ottawa, and the tax increases necessary to make it happen.

Proposed 2010 Budget: Scott Clark and Peter DeVries
2009-10 2010-11 2011-12 2012-13 2013-12 2014-15
(Billions of dollars)
A. Deficit: Parliamentary Budget Office forecast -54.2 -43.1 -27.9 -23.2 -19.0 -15.0
B. Source of Funds
1. Reduction in program expenses 0.5 1.0 1.5 2.0 3.0
2. Revenue Measures
1-percentage point increase in GST 1.7 6.8 7.2 7.6 8.0
1-percentage point increase in GST 1.7 6.8 7.2 7.6
Freeze general CIT rate at 18% 0.8 5.3 5.5 5.8
Other revenue-raising measures 1.3 5.3 5.4 5.4
Interest savings 0.2 1.0 2.4 3.8
Total fiscal actions 2.2 11.9 27.0 30.1 33.7
C. Use of Funds
1. Dept repayment reserve 2.2 11.9 16.9 18.9 20.0
2. Prudence reserve 10.1 11.2 13.7
3. Total 2.2 11.9 27.0 30.1 33.7

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