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Door opens to fundamental tax reform

Hey there, time traveller!
This article was published 12/2/2014 (1287 days ago), so information in it may no longer be current.

"Some people will say this budget is boring," Finance Minister Jim Flaherty remarked after unveiling the federal budget on Tuesday. A careful look, however, suggests the minister might be understating the future significance of his budget.

After running six consecutive deficits totalling $156.5 billion, Flaherty has been clear that balancing the budget in 2015-16 is his top priority. This budget reaffirms that commitment.

Minister of Finance Jim Flaherty is applauded as he arrives to table the budget in the House of Commons on Parliament Hill in Ottawa on Tuesday, February 11, 2014.


Minister of Finance Jim Flaherty is applauded as he arrives to table the budget in the House of Commons on Parliament Hill in Ottawa on Tuesday, February 11, 2014.

The big surprise is the projected deficit for 2014-15 has decreased to $2.9 billion from the $5.5 billion reported in November's fiscal update. The improved bottom line includes a $3-billion contingency reserve, which means the budget could effectively be balanced a year earlier than planned. For 2015-16, the government is now projecting a $6.4-billion surplus -- up from $3.7 billion -- which also incorporates a $3-billion cushion. If the government's plan comes to fruition, it could have a sizeable surplus in 2015-16. The question then becomes, what will the Conservatives do with it?

But first remember there are reasons to be cautious about the government's projections, particularly as they pertain to revenue expectations, which are expected to grow strongly over the next two years.

Consider that the budget projects average annual revenue growth of 5.4 per cent for 2014-15 and 2015-16 -- including a 6.2 per cent increase in 2015-16. These projections seem ambitious even after accounting for increased tobacco taxes, tax-loophole closures and potential asset sales.

For perspective, last year's budget estimated total revenues would grow by 3.8 per cent in the current year, but this budget lowered this projection to 2.9 per cent. With reliance on strong revenue projections, a blip could result in a larger deficit or chip away at future surpluses.

On the spending side, the Conservatives have exercised spending restraint in recent years, but there are also potential risks here. Last year's budget estimated program spending will grow in the current year by 0.8 per cent. But a series of unforeseen events such as the Alberta floods and Quebec rail tragedy partly led to program spending more than doubling to 1.9 per cent.

Although Flaherty limited new spending initiatives in the budget, he did set aside $500 million over the next two years for more corporate subsidies to the auto sector and a smattering of other items such as new boutique tax breaks.

If Flaherty manages to deliver a balanced budget in spite of revenue and spending risks, the story from budget 2014 will ultimately be the government's reticence about how it will use future surpluses.

Besides a couple of references to "further tax relief for small businesses" and a commitment to "examining ways to provide further tax relief for Canadians," the government was largely silent about its top post-deficit priorities.

The Conservative party's 2011 election platform made a handful of tax-related commitments conditional on eliminating the deficit. Most notable is the plan to bring in income splitting for families with children. They also pledged to introduce new or augment existing tax credits for children's fitness and other activities. Expectations have been that the government will use a portion of future surpluses to enact these measures in next year's pre-election budget, assuming it remains on track to eliminate the deficit.

But Flaherty recently seemed to back away from the income-splitting commitment and instead encouraged "a fulsome debate about that issue" which -- when combined with the potential for a significant surplus in 2015-16 and beyond -- opens the door to a discussion about how best to use future surpluses.

To set the foundation for strong future economic growth, and to attract skilled workers, entrepreneurs, and investment, Flaherty should consider an ambitious personal tax reform package. While previous tax reforms enacted by both the Liberals and the Conservatives have improved the business tax regime, Canada remains decidedly uncompetitive on personal income tax rates and the income levels at which they apply.

Bold personal tax reform would broaden the tax base by eliminating ineffective tax credits, deductions and other special privileges. In exchange for closing special loopholes, the government could reduce marginal tax rates for the broader population.

Here's the real upside: Fundamental tax reform would not only improve Canada's tax competitiveness, it would also encourage productive activity such as increased work effort, saving, investment and entrepreneurship, while reducing the complexity of the system and the unproductive costs Canadians spend on tax compliance. The federal government could use part of future surpluses to this end.

Despite risks in Flaherty's plan, his budget signals a return to balanced budgets may soon be upon us. This presents an opportunity for a rigorous debate on how best to use future surpluses. Directing a portion to personal income tax reform would be a positive plan for the country.

Sean Speer is associate director of fiscal studies at the Fraser Institute. Charles Lammam, resident scholar in economic policy, and Milagros Palacios is a senior research economist at the institute.


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