Building whose better Canada? EFU preview

Swelling federal surpluses provide a real opportunity for the federal government to get serious about the priorities of most Canadians: for aggressive climate change action, including major new public transportation projects; fighting poverty and homelessness in our cities, including big investments in non-market housing; in building a world-class early learning and pre-school system. This opportunity will be squandered by the Harper government through a blind adherence to tax cuts and debt reduction.

Like the Liberal governments before it, the Conservatives have been greatly under-stating the size of available surpluses – a bias towards debt reduction. A look at the 2006 Budget is revealing. The projected surplus at budget time for 2006/07 was $3.6 billion (mostly earmarked for debt reduction). By the time of the 2007 budget, that number grew to $9.2 billion. And upon release of the year-end public accounts, it was revealed that the surplus was $13.8 billion (a new accounting rule makes it $14.2 billion, as some media have reported). This surplus is about 1.0% of GDP.

After posting this “surprise” surplus for 2006/07, the federal government is again on pace for another large surplus in 2007/08. At the time of the 2007 budget, the surplus was forecast at $3.3 billion, of which $3 billion is earmarked for debt reduction. Back-of-the-envelope estimates indicate that the 2007/08 surplus will be much higher, topping $13 billion for the third consecutive year, perhaps even higher if resource revenues maintain their early pace.

These surpluses will occur despite downgraded economic growth forecasts from the Bank of Canada’s October Monetary Policy Report. Over much of 2007, the Bank was primarily concerned about inflation above its target range, with a bias towards increases in interest rates. In the aftermath of a credit crunch in the  financial markets stemming from home mortgages in the US, and more importantly for the Canadian economy, the rise of the Canadian dollar to parity (and beyond), the Bank has shifted its stance to neutral.

Looking forward, the estimated surplus rises to $18 billion in 2008/09, and could hit $27 billion in 2009/10 (latter year is based only on the expenditures that have had commitments made in previous budgets). In other words, there is lots of money available for spending priorities given prevailing tax levels.

However, under the cover of “Building a Better Canada” the Harper Conservatives have set out a fiscal agenda that will continue the trend of the past decade to further shrink the size of the federal government. The two key planks of this agenda are broad-based tax cuts and proposed legislation to limit federal spending power in areas of provincial jurisdiction.

Federal program expenditures remain very low by historical standards. Program spending was 13.0% of GDP in 2006/07, up from the all-time low hit in 1999/2000 and 2000/01, but still well below levels seen over the post-WW2 period. In the 1960s and 1970s, program expenditures ranged from 15-18% of GDP. Even the 13% in 2006/07 is an overstatement due to an accounting charge of $2.8 billion (reflecting bad debts on the accounts receivable front and one-time costs associated with a change to public service pensions). Take out this adjustment, which exists only on the books, and the 7.5% increase in program spending is actually a 5.8% gain – it also would make the underlying surplus closer to $17 billion.

It is also worth noting that the Conservatives were actually well under its 2006/07 budget on expenditures, by about $5 billion, during the fiscal year, which provided the room to finance $4 billion of expenditures announced in the 2007 budget by billing it to the 2006/07 fiscal year. Only this late surge made expenditures come close to what was originally budgeted.

Federal revenues were 16.3% of GDP in 2006/07, also low by historical standards, and a reflection of the priority given to tax cuts in recent years. The final public accounts for the 2006/07 year recorded a large (19%) increase in corporate income tax revenues. Corporate profits have been booming in recent years, but this has not translated into substantially larger tax revenues because companies can write off prior year losses against current profits. It appears that those losses have now been fully utilized.

The diminished size of Canada’s government since the mid-1990s is revealed dramatically in a recent study published in Canadian Public Policy by Ferris and Winer (see this post). After making adjustments to national accounts frameworks in Canada and the US for better comparability, they find that the size of government in Canada and the US is virtually identical. There are some important differences in how funds are allocated (a much larger chunk of US expenditures go to defence) but nonetheless this is indicative of how much the public sector has been reduced by both Liberal and Conservative governments.

This backdrop is important when looking forward, as the Conservatives answer to almost every economic and social ill is a tax cut. Thus far the details remain elusive about what a “broad-based tax reduction plan” would look like, with the exception of the (already announced) further one percentage point reduction in the GST.

The second broad thrust of fiscal policy, the notion of limiting federal spending power in areas of provincial jurisdiction, amounts to short-term political opportunitism vis-à-vis the province of Quebec.  While it may appear that the federal government is moving ahead based on principle, this is at odds with other proposed moves that would exercise federal powers to harmonize provincial regulations.

In the recent Speech from the Throne, the government appeals to respecting provincial jurisdiction as a justification for restricting federal spending on social programs. It is not entirely clear how this would be implemented. But right after this, the Throne Speech invokes an often-repeated but highly dubious claim about interprovincial trade barriers in order to use federal powers to challenge provincial jurisdiction to meet local needs through public interest regulation. The Tories’ principles seem less about respecting federal and provincial jurisdiction and more about whatever measure will act to further reduce the size of government.

On reflection, in the decades after the Second World War, the federal government used its taxation power to set a national social agenda, including cost-shared programs in health care, post-secondary education, and social welfare. Much of Canada’s social infrastructure to this day is rooted in a few decades of productive cooperation between federal and provincial governments. While the federal government has retreated from that role in recent decades, it would be foolish to give up on use of federal spending power to forge a stronger nation.

A reduction in taxes and social spending will not build a better Canada for most Canadians, but rather will extend the gains made by the very top income earners in the country, and leave the federal government standing on the sidelines as the score piles up.