Less Debt, More Growth: A Shadow Federal Budget for 2019 - CD Howe Institute
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In s t i t u t C.D. HOWE In stitute
commentary
NO. 531
Less Debt, More Growth:
A Shadow Federal
Budget for 2019
This Shadow Budget ensures the competitiveness and dynamism of the Canadian economy in the
near and medium-term, while setting the stage for a return to surpluses during the next Parliament.
William B.P. Robson and Alexandre Laurin
The C.D. Howe Institute’s Commitment
to Quality, Independence and
Nonpartisanship
A bout The The C.D. Howe Institute’s reputation for quality, integrity and
Author s nonpartisanship is its chief asset.
William B.P. Robson Its books, Commentaries and E-Briefs undergo a rigorous two-stage
is President and CEO of review by internal staff, and by outside academics and independent
the C.D. Howe Institute. experts. The Institute publishes only studies that meet its standards for
analytical soundness, factual accuracy and policy relevance. It subjects its
Alexandre Laurin review and publication process to an annual audit by external experts.
is Director of Research at
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C.D. Howe Institute staff and authors provide policy research and
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Institute does not take corporate positions on policy matters.
Commentary No. 531
D. HOWE
February 2019 .
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Fiscal and Tax Policy
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issn 0824-8001 (print);
issn 1703-0765 (online)The Study In Brief The C.D. Howe Institute’s Shadow Federal Budget for 2019 looks past the overspending and deficits the federal government has adopted as its fiscal signature since its election in 2015. Instead, our focus is on ensuring the competitiveness and dynamism of the Canadian economy in the near and medium-term, setting the stage for a return to surpluses during the next Parliament. This Shadow Budget would improve tax competitiveness in the near term and lay the groundwork for a much-needed modernization of the tax system in the years ahead. It would enhance Canadians’ educational, labour-market and retirement prospects. It would facilitate international trade, invest in core federal infrastructure and reduce red tape. And, critically, it would improve fiscal accountability, contain spending and assure Canadians that their federal government is on a return to budget balance. C.D. Howe Institute Commentary© is a periodic analysis of, and commentary on, current public policy issues. Michael Benedict and James Fleming edited the manuscript; Yang Zhao prepared it for publication. As with all Institute publications, the views expressed here are those of the authors and do not necessarily reflect the opinions of the Institute’s members or Board of Directors. Quotation with appropriate credit is permissible. To order this publication please contact: the C.D. Howe Institute, 67 Yonge St., Suite 300, Toronto, Ontario M5E 1J8. The full text of this publication is also available on the Institute’s website at www.cdhowe.org.
2
Until now, rapid spending growth – virtually across the board
– and exceeding revenues has been a signature policy of this
government.
Ottawa has embraced red ink and undermined have done. This prospect is unwelcome to talented
its ability to resist spending demands from its individuals wondering where to live and work and
would-be beneficiaries and those who advocate to businesses considering where to invest. Allowing
living for today. The 2017/18 fiscal year is a case in debt to accumulate is also imprudent at this time in
point. The 2018 budget, which anticipated five- the economic cycle. Central banks are getting their
percent-plus growth in both revenue and expense, policy interest rates back to more neutral levels,
underestimated the strength in the economy. asset prices have been volatile, growth has flagged
Revenue came in $4 billion above projections. The in Europe and Asia, and the US expansion looks
government spent the bulk of this bonus, so the vulnerable.
deficit came in almost as projected. In contrast, this Shadow Budget contains
The government’s chronic borrowing would be a number of measures to enhance Canada’s
less concerning if accompanied by tax and program attractiveness as a place to work and invest, while
changes that enhance Canada’s ability to create restraining less productive expenses. Together, they
and retain talent and investment, and to grow should set the stage for a return to surpluses.
in the future. But the rationale for the Liberals’ Parallel with the promise to give Canadians
election campaign commitment to run modest confidence in the federal government’s fiscal
deficits – about $10 billion annually – in order to framework and the longer-term prospects for
finance infrastructure investment made no sense. Canada’s economy should be a commitment to
No conceivable amount of federal infrastructure greater transparency and accountability in the
spending, let alone the small amount that has budgeting process. The C.D. Howe Institute’s latest
actually occurred, could produce a $10 billion fiscal accountability report (Robson and Omran
addition to annual spending in the near term, 2018) gave the federal government an A-. Good,
because the federal government expenses capital but not the top-rank position appropriate to the
assets over their useful lives, which can be decades. national government. Obscure presentation of key
The commitment to return to budget surplus budget numbers, estimates that do not match the
in 2019/20 also turned out not to be reliable. The budget projections and late production of the Public
government has added considerably more debt Accounts were the defects that kept the government
than Canadians were led to anticipate during the from achieving a top grade.
campaign. The cost of servicing this additional debt They are also easy to fix. As detailed below,
means Canadians ultimately will pay more taxes for the Estimates will from now on reconcile
fewer federal services than they would otherwise straightforwardly with the fiscal plan in the budget.
We thank Daniel Schwanen, Don Drummond, Ross Hagemeister, Michael Horgan, Kenneth McKenzie, William Molson,
Tom Wilson, members of the C.D. Howe Institute’s Fiscal and Tax Competitiveness Council, and anonymous reviewers for
ideas and comments on earlier drafts. Responsibility for the ideas and numbers presented here, and for any errors, is ours.3 Commentary 531
Table 1: Near-Term Fiscal Projections with Shadow Budget Initiatives
2018/19 2019/20 2020/21
($Billions except as noted)
Baseline Projections
Revenues 328.9 339.2 352.1
Expenditures -344.0 -355.8 -367.2
Budgetary Balance before Initiatives -15.1 -16.6 -15.1
Shadow Budget Initiatives
Environmental and Efficient Taxation 2.3 2.3
Better Opportunities -0.5 -0.5
Fostering Growth 0.9 0.6
Achieving Fiscal Sustainability -0.1 0.3
Total 2.6 2.7
Lower Debt Changes 0.0 0.1
New Budgetary Balance -15.1 -14.0 -12.3
Accumulated deficit 687.7 701.7 714.0
as % of GDP 30.9 30.3 29.8
Sources: Tables below; authors’ calculations.
The federal government will publish its financial economy working flat out. As previously noted,
statements before the end of June, matching the strong economy yielded higher-than-projected
the best performance among Canada’s senior revenues, which the government used mainly to
governments. As for straightforward presentation, finance higher-than-promised spending.
unlike the 2018 Budget, which buried the key This Shadow Budget uses as its baseline the
numbers on page 319 in an annex, this Shadow economic and fiscal projections from the October
Budget moves the fiscal plan summary to the 2018 Fall Economic Statement (Canada 2018a).
document’s front (Table 1). The average of private-sector economic forecasts
used by Finance Canada puts real growth of gross
Econom ic a nd Fisc a l domestic product (GDP) at 2.0 percent for 2019
Fr a mewor k and 1.6 percent in 2020. Allowing for inflation, the
corresponding figures for nominal GDP growth
2018 marked the long-awaited closing of the are 4.1 percent in 2019 and 3.3 percent in 2020.
gap between Canada’s economic activity and the The private sector projections show short-term
productive potential of its workforce and capital interest rates rising by 1 percentage point from
stock. Inflation came in close to the Bank of 2018 to 2020 and long-term interest rates rising by
Canada’s 2 percent target, the unemployment rate 0.7 percentage points over the same period.
hit a record low and business surveys revealed The projections show revenue increasing
pressures and capacity constraints typical of an 7.1 percent in total over the next two fiscal years,4
Table 2: Shadow Budget Assumptions and Projections
2018/19 2019/20 2020/21
($Billions except as noted)
Economic Growth (percent)
Real GDP growth 2.0 2.0 1.6
GDP inflation 2.2 2.1 1.7
Nominal GDP growth 4.2 4.1 3.3
Revenues
Taxes on incomes, payroll, consumption and other
299.1 307.3 318.3
transactions
User fees and charges for government services and products 15.6 17.4 19.1
Investment income 14.2 14.5 14.7
Total Revenues 328.9 339.2 352.1
Expenses
Direct program expenses 149.0 149.6 150.6
Transfers to persons and governments 171.2 178.7 186.7
Gross debt charges 23.8 27.5 29.9
Total Expenses 344.0 355.8 367.2
Summary of Revenue, Expense and Balance
Taxes, fees, and other charges 314.7 324.7 337.4
Program spending and transfers -320.2 -328.3 -337.3
Debt charges net of investment income -9.6 -13.0 -15.2
Budgetary Balance -15.1 -16.6 -15.1
Notes:
Totals may not add exactly due to rounding.
Investment income projections include interest income, net income from enterprise Crown corporations, foreign exchange revenues and other
returns on investment.
Sources: Canada (2018); authors’ calculations.
reaching $352.1 billion in 2020/21, and expenses rate. Based on these projections, our Shadow
excluding debt charges rising 5.3 percent over Budget planning baseline starts with a $15.1 billion
the same period, reaching $337.3 billion. Debt deficit in 2018/19, followed by a $16.6 billion
charges, however, are expected to rise steeply, by deficit in 2019/20 and $15.1 billion in 2020/21
25.6 percent, over the next two years, reaching (Table 2).
almost $30 billion in 2020/21 despite benefiting An economy at full capacity can only grow as
from a still relatively advantageous effective interest fast as growth in the workforce, the capital stock5 Commentary 531
and productivity allow. In 2019 and beyond, Since 2010, provincial governments have raised
potential for positive surprises that further their tax rates on higher-income earners, and
buoy federal revenue is limited. While negative the federal government did the same after 2015.
surprises are possible, this Shadow Budget uses The combined federal/provincial top tax rate is
the economic and revenue projections from the currently close to 50 percent – a threshold typically
2018 Fall Economic Statement as given. The growth seen as psychologically, and perhaps economically,
forecasts from the private sector used by Finance important – in the three western provinces and
Canada in this economic statement have tended to more than 50 percent in the other seven.
be reliable over the medium term. With no near- In the short term, high-income taxpayers can
term commitment or pressure to achieve a balanced respond to tax-rate increases by converting their
budget, moreover, the long-standing practice of income to different, lower-taxed forms and by
building a contingency reserve – lately termed an realizing that income at different times and in
“adjustment for risk” – into each year’s fiscal plan different jurisdictions. These responses shrink
has little justification. Indeed, these reserves or the tax base and reduce tax receipts – a key
adjustments increase the real risk of unbudgeted reason for New Brunswick’s decision to reverse
spending when potential downside problems do not a change that would have taken its top marginal
materialize (Busby and Robson 2017). tax rate to 60 percent (Laurin 2015). In the long
The Fall Economic Statement included $3 billion run, tax increases on high earners could depress
annually for such contingencies. This Shadow entrepreneurial activity and private investment.
Budget ceases this practice and uses the private Excessively taxing the talent that fuels a more
sector’s baseline projections without modification innovative, creative and successful economy can be
(Table 2). counterproductive. Responding to these concerns,
the Quebec Taxation Review Committee in March
R esponding to the Ta x 2015 recommended that the maximum federal/
Competiti v eness Ch a llenge provincial tax rate should not exceed 50 percent
(Quebec 2015).
Canadians pay relatively high amounts of personal This Shadow Budget would reduce the number
tax due to a combination of relatively high rates of people subject to the highest tax rate by doubling
and relatively low thresholds at which taxes become the threshold at which it applies from the current
payable. Meanwhile, lower corporate income tax $210,371 to $420,742. The net cost to the federal
rates in other developed countries, and especially budget would be around $364 million annually
in the US, have eroded a long-standing Canadian in the short term after accounting for changes
advantage in corporate income-tax rates. This in taxpayers’ decisions about when and how
Shadow Budget address both challenges. they report taxable income and higher levels of
activity. The positive responses to the lower rates
Personal Taxation: Lower Rates, Better would expand the tax base for both the federal
Structure government and for provincial governments. The
revenue dividend for provincial governments would
Reducing Punitive Personal Income Tax Rates be around $767 million – $300 million more than
the reduction in federal government revenues.1
1 This estimate uses the same methods as described in Laurin (2015); i.e., the median taxpayer response-elasticity coefficient
of 0.62.6
The resulting provincial tax-revenue windfall to registered charities, the determination of their
would provide timely help for provinces and relieve incomes for tax purposes excludes any capital gain
provincial pressures for more federal transfers. on those shares. In contrast, donations of private
company shares and non-environmentally sensitive
More Generous Tax Treatment of Nondiscretionary land may leave donors with a capital gains tax
Medical Expenses liability.
Extending favourable tax treatment to the
A key principle in taxing personal incomes is that donation of private company shares and real estate
people who would be equally well off without would unblock major new support for Canada’s
taxation should be equally well off with it. If people charities. There is no good tax-policy reason to treat
who face unavoidable costs related to, say, children, the donation of shares of publicly traded securities
health status or deductions from employment differently from privately held ones (Aptowitzer
income, pay tax on the income that covers those 2017). This Shadow Budget proposes to amend the
costs, they will end up with lower discretionary Income Tax Act to exempt donations of privately
incomes than people who do not face such costs. held securities from tax. To maintain the incentive
For this reason, most personal income tax systems to donate environmentally sensitive land to
– including Canada’s – provide exemptions, charities dedicated to its conservation, only a partial
deductions or credits related to non-discretionary exemption would apply to donations of other real
expenses. Many medical expenses fall into this estate. The cost of this measure is likely to be small.
category: people incur them because they are or
may become sick, and the income they need to More Competitive Business Taxation
cover them is not available for enjoyment.
Although Canada’s personal income tax does The recent reduction in the US federal corporate
recognize this principle in part – employer-paid income tax rate from 35 percent to 21 percent and
premiums for health and dental plans, for example, the provision – albeit temporary – for 100 percent
are exempt from a person’s taxable income – in expensing of many capital investments have boosted
general, its treatment of health-related expenses is the attractiveness of the United States for new
overly restrictive. The current medical expense tax equity-financed business investment. The United
credit applies only to expenses exceeding 3 percent States has also adopted a quasi-territorial system
of net income, or $2,306, whichever is lower, and for the taxation of foreign affiliates’ profits. These
is calculated at the bottom tax rate. This Shadow changes have many growth-friendly elements
Budget would lower the threshold on such expenses with positive implications for Canada. At the
to 1.5 percent of net income, or $1,150, whichever same time, however, they make the United States
is lower. This change would help people who pay for relatively more attractive as a place for investments
healthcare directly, or pay health-related insurance in productive facilities intended to serve the
premiums not covered by their employers. The North American and world markets, and pose a
fiscal cost of this measure is $400 million per year. competitive challenge for Canada.
Employer-paid health premiums would continue to In Canada, successive reforms during the 2000s
be untaxed. lowered the marginal effective tax rate (METR) on
new capital investments. The result was a significant
Facilitating Donations of Private Company Shares METR advantage over the United States. However,
and Real Estate Canada’s tax burden on new investment has lost its
competitive edge over many developed economies
When philanthropists donate publicly traded shares in the current decade (Bazel and Mintz 2016), and7 Commentary 531
in particular with the United States following the US rate reduction likely induced multinational
recent changes (Bazel and Mintz 2017; McKenzie firms to realize more of their profits in Canada than
and Smart, forthcoming). they would have otherwise (McKenzie and Smart,
The 2018 Fall Economic Statement responded forthcoming). Differences in average effective tax
to these pressures by introducing, on a temporary rates (as opposed to METRs) also drive location
basis, an immediate full tax deduction for some decisions with respect to new corporate investment,
investments in new machinery and equipment whereas the METR drives the intensity, or quantity,
– basically replicating a similar US provision – of investments.
plus a temporary accelerated tax deduction for This Shadow Budget would reduce the corporate
other forms of capital investments. As a result, income tax rate by two percentage points, from
Canada’s aggregate-industry METR on new 15 percent to 13 percent, effective immediately.
capital investment is now down to a level just This change would provide additional locational
under that of the United States (McKenzie and incentives for investments and profits in Canada,
Smart, forthcoming). This is a good, although while a more comprehensive review of the tax
late, temporary first step to improve Canada’s system is underway.
competitive position, but still far from fully Unlike a structural reform proposed below, which
restoring the advantage Canada enjoyed before the would apply only to new investments and can be
US reforms. designed to be revenue neutral, a rate reduction
This Shadow Budget responds to these pressures would come at a cost, at least in the short-term.
with additional measures to improve the incentives Some have argued that this cost is excessive because
in Canada’s business taxation regime. Firstly, it it rewards “old” capital investments and just not
launches a comprehensive tax system review for the the new investments it is intended to spur. We do
best way to remove human and capital investment not think that this argument should be decisive,
disincentives while respecting the tax principles of any more than concerns about rewarding “old”
equity, efficiency and adequate revenue yield. On investments in human capital should discourage
the corporate income tax side, a move to cash-flow lowering personal income tax rates.
taxation would be front and centre (McKenzie and Indeed, concerns about rewarding old capital
Smart, forthcoming). investments were not decisive in the discussion
Comprehensive reviews take time and consensus over tax-rate reductions during the 2000s. After
is difficult to reach. In the meantime, lower those reductions, corporate tax revenues increased
corporate income tax rates would make Canada a as a share of profits (McKenzie and Smart,
more desirable location for capital investment. forthcoming). While this experience is consistent
with more formal research that shows how positive
Lower Corporate Income Tax Rates reactions from investors and business managers can
offset the fiscal cost of corporate income-tax rate
Taxes are a cost of doing business and can influence reductions, it is fiscally prudent to plan for a short-
the location of economic activity and profits of term revenue loss. Based on the Parliamentary
multinational corporations. The large tax-rate Budget Officer’s net cost estimate of about $1.6
differential that existed between the United States billion per percentage-point reduction (PBO
and Canada prior to the recent 14 percentage-point8
2018),2 the revenue cost of the 2 percentage-point result (McKenzie and Smart, forthcoming). The
rate reduction would be $3.2 billion per year. comprehensive tax review would consider these
options among the range of possible reforms.
Comprehensive Tax Review: Modernizing Business
Taxation Rationalizing Taxes and Transfers
This Shadow Budget calls for a comprehensive Greening Canada’s Taxes
review of the tax system with a view to making
Canada has committed to reducing greenhouse
Canada more attractive to human and capital
gas emissions to 30 percent below 2005 levels
investments. With respect to business taxation,
by 2030. Many provinces have since put in place
the review would explore different ways to lower
systems – cap-and-trade or “carbon taxes” – that
Canada’s METR on business investment on a cost-
discourage carbon-dioxide (CO2) emissions. The
neutral basis. Two promising possibilities are taxing
federal government has recently set a floor for a
above-normal returns through a cash-flow tax, and
national carbon price. For provinces not meeting
providing an allowance for corporate equity (ACE)
these standards, namely Ontario, New Brunswick,
in calculating taxable profits.
Manitoba and Saskatchewan, Ottawa will impose
An ACE provides a deduction for shareholders’
a carbon pricing backstop starting this year. For
equity multiplied by an appropriate interest rate.
these provinces subject to the backstop, the federal
It thus exempts returns equal to the opportunity
government promises to transfer 90 percent of
cost of equity financing from taxation. Such an
all revenues from the surcharge on fossil fuels to
approach would make Canada more attractive for
households in a “climate action incentive payment.”
domestic and foreign investors alike (Milligan 2014,
Industrial emitters will not be subject to the
Boadway and Tremblay 2016, Laurin and Robson
carbon price on fuel but instead will pay a carbon
2012, IFS and Mirrlees 2011). Eliminating tax on
charge on the portion of their emissions that are
normal profits would greatly reduce or eliminate
above a limit, which will be determined based on
the METR on new investment. The ACE would
relevant output-based standards (emissions per unit
also reduce the tax advantages of debt over equity
of output). The regulations governing the output-
finance.
based pricing system are to be finalized later this year.
Achieving an ACE on a revenue-neutral basis
However, these measures are unlikely to reduce
is possible through offsetting changes such as
sufficiently the CO2-emissions-intensity to achieve
restoring the corporate tax rate to its 15-percent
the 2030 targets. The carbon levy will apply at a
level and broadening the base of investment
price that is equivalent to $20 per tonne of CO2
income subject to personal taxation. In addition,
in 2019, increasing annually until it reaches $50
applying the ACE to new capital investments
per tonne by 2022. Most studies of the response
only – a phased-in approach, as Italy did – could
of households and businesses to higher prices
lower its initial costs. Alternatively, a cash-flow tax,
estimate that CO2 emissions will have to become
which provides an immediate deduction for the
much more expensive to reduce them by amounts
full cost of all capital investments combined with
sufficient to hit such targets. For example, a recent
no interest deductibility, would achieve the same
2 This cost estimate includes consideration of integration mechanisms between corporate and personal income taxes leading
to personal income tax revenue increases. This comes from a decrease in dividend gross up and tax credits to maintain
integration (PBO 2018).9 Commentary 531
study estimated that a carbon tax of about $175 per that have no fiscal offset, raising costs throughout
tonne would be necessary to reduce emissions by the economy and making Canadian exports less
about 10 percent in the transport sector (Rivers and competitive. An aviation fuel excise tax also induces
Wigle 2018). airlines to fuel their aircraft where taxes are lower
The bulk of greenhouse gas emissions are rather than minimize their fuel use. This response
ultimately the result of consumer choices, and works against the tax’s intended impact on fuel
most governments have, to date, been reluctant to consumption, making air transportation less
steer those choices as forcefully as the greenhouse- efficient and further damaging the environment.
gas targets require. The federal government’s Aviation fuel would be subject to the same
assumption of authority to determine which higher GST rate that applies to other motive fuels,
provinces are meeting its standards is, moreover, with rebates through the same invoice-credit system
certain to be the cause of continuing inter-regional that relieves intermediate users of tax. The revenue
and inter-governmental acrimony. cost of this change would be less than $100 million
Instead of putting all of its carbon reduction eggs per year.
into one unpredictable basket, this Shadow Budget
sets a new course by increasing the Goods and Levelling the Playing Field in the Digital Economy
Services Tax (GST) rate applied to transportation
fuels. Raising the GST (5 percent) on The Internet is revolutionizing how people access
transportation fuels is preferable to raising existing entertainment, order taxis, find accommodations
excise taxes or imposing a new carbon levy because and shop for goods. Consumers can now make
GST is only effectively paid on net value-added many purchases from a supplier located outside
when goods and services are purchased by the Canada just as easily as if the company were
final consumer. While this feature attenuates the domestic.
incentive to reduce CO2 emissions on intermediate Domestic providers of digital products and
activities, it protects Canada’s international services must charge 5 percent to 15 percent GST/
competitiveness and avoids the distortions that HST on their sales. Foreign providers of like
occur when taxes “cascade” on intermediate inputs products and services need not collect and remit
bought and sold but do not cascade on internal firm sales tax if they are not “carrying on business” in
transactions. Establishing a new GST rate of 15 Canada. Consumers are responsible for remitting
percent on motive fuels, starting in the next fiscal the taxes on these items, but most do not. The
year, would provide consumers with a strong price impracticality of enforcement means significant
signal to discourage CO2 emissions and generate amounts of potential tax revenues go uncollected,
about $4 billion in additional revenues that would which gives foreign providers a competitive
help finance a return to budget balance in the advantage over domestic competitors in services
medium term. such as video streaming, digital books, games
and myriad fees for digital platform and network
services. Requiring suppliers to pay GST/HST
Eliminating Excise Tax on Aviation Gasoline and
based on the location of consumers could help fix
Jet Fuel
this problem.
This Shadow Budget would abolish federal aviation Provinces have begun addressing these revenue
fuel excise taxes because they are inferior to value- and competition issues. For example, Quebec’s
added taxes such as the GST for several reasons. 2018 budget created a requirement for non-Quebec
By taxing an intermediate input, levies such as suppliers of digital goods and services to register
the aviation fuel excise tax impose business expenses for, collect and remit Quebec Sales Tax, starting10
Table 3: Tax Competitiveness: Fiscal Impact of Shadow Budget Initiatives ($Billions)
2019/20 2020/21
Reducing Punitive Personal Income Tax Rates 0.4 0.4
More Generous Tax Treatment of Nondiscretionary Medical Expenses 0.4 0.5
Facilitating Donations of Private Company Shares and Real Estate s s
Lower Corporate Income Tax Rates 3.2 3.2
Comprehensive Tax Review n/a n/a
Greening Canada’s Taxes -4.0 -4.0
Eliminating Excise Tax on Aviation Gasoline and Jet Fuel 0.1 0.1
Levelling the Playing Field in the Digital Economy -0.2 -0.2
Scrutinizing Tax Preferences -2.2 -2.3
Total -2.3 -2.3
Notes: n/a = not applicable; s = cost is small or negligible.
Sources: Authors’ calculations.
in 2019. Already, 76 digital providers including benefit, this measure would increase annual revenue
Apple, Google, Netflix, Spotify, Expedia and by about $200 million annually.
LinkedIn have registered and started to collect the
9.975 percent provincial sales tax.3 Saskatchewan Scrutinizing Tax Preferences
has also begun taxing some digital services. Apple is
now charging Canadian sales taxes on downloads. The federal tax system contains many exemptions,
Meanwhile, British Columbia has reached an deductions, rebates, deferrals and credits. While
agreement with Airbnb whereby the company will some attempt to recognize differing capacity to pay
collect the 8-percent provincial sales tax and other among taxpayers, others are effectively disguised
taxes that apply to short-term rentals. spending programs (Laurin and Robson 2017).
This Shadow Budget would amend the Excise A number of these disguised spending programs
Tax Act to apply to all businesses that supply might not pass muster if accounted for and voted
digital goods and services for consumption within on as federal expenses.
Canada, regardless of where the supplier is located, For example, the Age Credit provides a tax
in compliance with the International VAT/GST subsidy to seniors who already benefit from a
Guidelines. The main goal of this reform is to level number of federal and provincial transfers and
the playing field for domestic and foreign providers in-kind benefits. The amount is clawed back on
of digital products and services. As an added incomes between $37,790 and $87,750, which
3 La Presse. 10 January 2019. « Taxe Netflix » québécoise: 76 entreprises étrangères ont dit oui.11 Commentary 531
increases the METR on these seniors. This Shadow retirement. This Shadow Budget addresses all
Budget contains a number of measures to improve these areas.
retirement security for Canadians (see next section)
by relaxing limits on saving and mandatory Enhancing Canadian Education
drawdown of income. It makes sense to accompany
those improvements with a rationalization of the Measuring Results in Elementary and Secondary
Age Credit subsidy: this Shadow Budget proposes Education
to reduce the base amount for the age credit from While the provinces deliver elementary and
$7,494 to $4,000, closer to the amounts most secondary education services, the federal
provinces use for their old age tax credits, for a government plays a key supporting role by
saving of about $1.9 billion annually over the next supporting the benchmarking of student
two years. achievement across the country and internationally.
Another contentious spending program is the This benchmarking promotes the spread of
tax credit for first-time homebuyers. This is a effective practices and highlights areas that need
problematic subsidy, given the disproportionate improvement. This Shadow Budget proposes
amount of Canada’s capital investment that flows measures to enhance this federal role.
into residential construction (Robson 2017a) and At the national level, the Pan-Canadian
the evidence that many younger and less well-off Assessment Program (PCAP) evaluates
Canadians are financially overcommitted. This performance in reading, writing, mathematics
Shadow Budget proposes to phase it out for a and science. Its evaluations currently look at
saving of about $100 million annually. achievements three grades apart, but its value
Meanwhile, the federal credit for investment would be far greater if it measured performance at
in labour-sponsored venture capital corporations each grade level. Year-by-year measures are better
(LSVCC) notoriously distorts saving and for judging value added, and a shorter cycle would
investment. In general, venture capital funding spurs improve the chances of spotting and responding
innovation, but among the various venture capital to problems while the students affected are still
funds in Canada, LSVCCs are among the least in school.
efficient in this respect (Fancy 2012). In addition, At the international level, the Program for
LSVCCs crowd out alternative private-venture International Student Assessment (PISA)
investments and favour portfolios unsuitable for benchmarks the performance of Canadian students
retail investors. For this reason, this Shadow Budget in math, science and reading against peers abroad.
would eliminate the LSVCC federal credit for a Canada supports over-sampling to also allow
saving of about $200 million annually. comparison among the provinces.
Table 3 summarizes the revenue and expense The Shadow Budget would augment funding for
implications of these measures to improve Canada’s these student assessment programs over the next
tax competitiveness. five fiscal years. The estimated cost of this measure
is small.
Bet ter Opport unities
Enhancing Canada’s human capital is a multi- Supporting Education for Indigenous Children
pronged effort. We need to promote high-quality Indigenous Canadians, especially on reserve, tend
education, improve labour-market performance to complete secondary education at much lower
and ensure that Canadians can prepare for a secure rates than other Canadians. In Budget 2016, the12
federal government proposed spending $2.6 billion employers about the characteristics they seek would
over five years to support on-reserve primary and also be useful.
secondary education programs and infrastructure. This Shadow Budget proposes an additional $25
Indigenous students on reserves do not benefit million annually to implement the Advisory Panel’s
from the measures of achievement that benchmark recommendations to address continuing gaps in
performance and spur improvement in most labour market information and expand existing
provincial schools. Therefore, this Shadow Budget surveys where necessary.
proposes to fund the PCAP and PISA assessments
for on-reserve schools and offer bonuses for schools Treating Unemployed Canadians More Fairly
whose students participate in sufficient numbers to
benchmark their performance. Related spending Currently, regional differences in the EI program
would amount to some $200 million annually – encourage dependency for many workers and
funds that can help on-reserve Canadians assess discourage migration to areas where job prospects
whether they receive educations as good as those are brighter (Busby, Laurin, and Gray 2009).
available to their peers off reserve. Shorter qualifying periods and longer benefit
periods in areas with higher unemployment
subsidize industries and regions where prospects for
Improving Canada’s Labour Markets
long-term, stable jobs are poor. This Shadow Budget
Canadian workers and employers will find and proposes to phase out EI’s regionally differentiated
engage better with each other if they have access entrance and benefit provisions. Tying the new
to better information about job opportunities and uniform provisions to the national unemployment
worker qualifications. They would also benefit rate would preserve a countercyclical income
from Employment Insurance (EI) reforms that stabilization element in the program.
reduce distortions that promote pockets of high In the short term, the desirability of accelerating
unemployment. EI access for workers in regions where past low
unemployment rates impede access justifies easing
Better Labour Market Information the stringent requirements ahead of tightening the
looser ones. To cover these transitional costs, the
The 2009 report of the Advisory Panel on Labour Shadow Budget includes $300 million in 2019/20
Market Information identified priority data gaps and a further $300 million in 2020/21.
with respect to vacancy rates, employment figures,
Aboriginal peoples, immigrants and education. In Enhanced Security for Canadian Seniors
the decade since, some advances have occurred.
For example, Statistics Canada launched its Job Revising Tax Rules to Accommodate Target-Benef it
Vacancy and Wage Survey in 2015, providing Pension Plans
information on in-demand occupations, job
Sharing risks related to retirement income between
openings, the duration of job vacancies, average pay
employers and employees fosters more durable
and educational requirements.
pension plans than traditional defined-benefit (DB)
However, data gaps remain. The Labour
plans. Target-benefit plans (TBP), often known as
Force Survey still does not cover the on-reserve
shared-risk plans, are already common in multi-
Indigenous population. Canada has no consistent
employer environments. Canadian policymakers
data tracking people as they move from formal
and regulators are updating their pension laws and
education to work. A survey asking potential
standards to accommodate single-employer TBPs13 Commentary 531
(Steele et al. 2014), but uncertainty over their tax This Shadow Budget proposes to let group RRSP
treatment is impeding progress (Gros et al. 2015). sponsors and/or participants deduct some of the
This Shadow Budget proposes new tax rules administrative expenses currently levied against
to accommodate single-employer TBPs, whether plan assets from outside income. Since employer
new, or conversions from existing DB or defined- contributions to these plans are likelier to be locked
contribution (DC) plans. The default approach in – more like pension plan contributions than
would treat TBPs like DB plans. An alternative employee contributions that might be withdrawn
approach would be more suitable for TBPs that before retirement – this Shadow Budget also
more closely resemble DC plans – for example, proposes to relieve employers’ contributions to group
plans with fixed or capped contribution rates. Either RRSPs from payroll tax (Robson 2010).4 These
way, the new rules would reduce uncertainties about changes would help put different retirement savers
tax provisions related to saving and accrual limits, on a more level footing, and would have little effect
types of benefits and funding requirements. The on federal revenue during the projection period.
fiscal impact of this measure would be negligible.
Increasing Age Limits for Tax-Deferred Saving
Levelling the Field for Savers in Group RRSPs
Life expectancy in Canada has risen by more than
Most working Canadians, and the vast majority two years per decade since the 1960s, but current
who work in the private sector, do most of their age limits related to retirement plans and benefits
retirement saving through RRSPs. Many employers do not reflect this new reality. Currently, Canadians
support such saving by organizing group RRSPs, (and their employers) must stop contributing to tax-
and many match at least part of their employees’ deferred retirement saving plans at age 71, which
contributions. Approximately 3.1 million Canadians is also the age at which contributors must start
participated in an employer-sponsored group RRSP drawing down their wealth. This Shadow Budget
in 2018, more than the 2.2 million participants in would increase the age at which contributions to
DC pension plans. In that year, the top 10 suppliers tax-deferred retirement saving schemes must end to
of group RRSPs held $93 billion in assets, only 72 on January 1, 2020, and increase it one further
slightly less than the $97 billion in assets held by the month at six-month intervals thereafter. This
top 10 DC plan providers (Benefits Canada 2018). change would reduce the likelihood that Canadians
DC pension plans and pooled registered will outlive their wealth and should encourage older
pension plans help their participants prepare for Canadians to stay in the workforce longer. The
retirement by allowing sponsors to deduct some cost implications are small on an annual basis, and
administrative expenses from outside income. By negligible on a present-value basis.
contrast, participants in group RRSPs pay these
expenses from their assets inside the plan. Limits on Later Eligibility for Public Pension Benef its
tax-deferred saving mean these participants cannot
contribute to offset these expenses, which means Low fertility rates, rising life expectancy and the
that savers in group RRSPs who have identical aging of the baby boom are pushing up the ratio of
work histories and contributions will retire with less retired to working Canadians, creating many fiscal
than those in DC or pooled registered plans. strains. Other countries with aging populations,
4 To address concerns about potential withdrawals of employer contibutions by employees simply seeking to avoid payroll
taxes, the government will consider imposing an additional tax penalty on such withdrawals.14
including Finland, Sweden, Norway, Poland and the pension plans or limits for RRSPs are badly out of
UK, are responding by raising the age of eligibility date, putting people with DC plans and/or RRSPs
for social security benefits. at a major disadvantage relative to those in DB
One straightforward way to mitigate the impact plans (Robson 2017b).
of longer life on old-age benefits is to calibrate the This Shadow Budget would update the
age of eligibility for public pension benefits such assumptions underlying the equivalency factor
that the proportion of an average person’s adult life – currently a factor of nine – to reflect current
spent in retirement stays constant (Brown and Aris demographic and economic realities. This updating
2017). To keep that proportion at its current level of would raise the tax-deferred savings limit for
34 percent, Canada would need to raise the normal capital accumulation plans from 18 percent to 30
age of eligibility for OAS and CPP from 65 at the percent of income. The tax deferred on additional
beginning of 2023 to 66 in 2025. Future changes contributions would be paid when invested funds
in the eligibility age would also trigger changes in and income are withdrawn. Since the rate of return
the range of ages over which people can choose to on assets in these plans is likely to be equal to, or
commence their benefits. exceed, the government’s cost of borrowing, and
The same actuarial adjustments that penalize or since the average effective (inclusive of benefit
reward early and later commencement of benefits clawbacks) tax rates affecting people when they save
would apply from the new age. This flexibility and when they draw down are not very different,5
would ensure that people who cannot work past the fiscal cost of this measure, on a present-value
the current earliest age of commencement can still basis, is small.
collect benefits, while further encouraging later
receipt by people who wish to work and save for Eliminating Mandatory Drawdowns from RRIFs
longer. This change would have no implications over
the budget-planning horizon. Tax rules should not prevent retirees enjoying the
lifelong security they are striving to achieve. The
2015 federal budget’s reduction of mandatory
Increasing Tax-Deferred Saving Limits
minimum withdrawal amounts from registered
Canadian income-tax rules limit the amounts retirement income funds (RRIF) and similar
of retirement wealth Canadians can accumulate tax-deferred accounts reduced the risk that many
without paying tax at the time they save. Longer Canadians would outlive their savings. Yet, with
lives and, even more important, low yields on longevity increasing and yields on safe investments
investments suitable for retirement saving have as low as they now are, the risk is still material
raised the amount of saving needed for every dollar (Robson and Laurin 2015a). The calculations of
of annual income in retirement. The current rules the new RRIF mandatory minimum withdrawal
for calculating equivalency between DB and DC schedule’s impact in the 2015 budget assumed real
5 Total personal income contributed to registered retirement plans in 2017 reduced current federal income tax receipts by
about 22.0 percent of contributions in aggregate, and increased federal income-tested benefit payments by about 2 percent
of contributions – for an aggregate effective rate of 24 percent on registered contributions. Total personal income paid out
of tax-deferred registered plans in 2017 – pensions, RRIF withdrawals, or RRSP withdrawals – garnered new income taxes
representing about 15 percent of that income federally, while reductions in benefit entitlements, such as GIS benefits, GST
credit, or OAS clawbacks, represented about 8 percent of total income paid out of tax-deferred registered plans – for an
aggregate effective rate of 23 percent on registered retirement income. These estimates were computed by the authors using
Statistics Canada’s Social Policy Simulation Database and Model (SPSD/M), v.26.0.15 Commentary 531
Table 4: Better Opportunities – Fiscal Impact of Shadow Budget Initiatives ($Billions)
2019/20 2020/21
Measuring Results in Elementary and Secondary Education s s
Supporting Education for Indigenous Children 0.2 0.2
Better Labour Market Information s s
Treating Unemployed Canadians More Fairly 0.3 0.3
Revising Tax Rules to Accommodate Target-Benefit Pension Plans s s
Levelling the Field for Savers in Group RRSPs s s
Increasing Age Limits for Tax-Deferred Saving s s
Later Eligibility for Public Pension Benefits n/a n/a
Increasing Tax-Deferred Saving Limits n/a n/a
Eliminating Mandatory Drawdowns from RRIFs n/a n/a
Promoting Longevity Insurance n/a n/a
Broadening Access to Pension Credit and Income Splitting s s
Total 0.5 0.5
Notes: n/a = not applicable; s = cost is small or negligible.
Sources: Authors’ calculations.
investment returns of 3 percent. Re-running those new opportunities to obtain secure incomes for
projections with real returns on safe investments life – the kind of incomes longevity insurance
closer to current levels suggests that most seniors can provide. However, Canadian insurers do not
still face a material risk of outliving their tax- currently offer pure longevity insurance on a
deferred savings – which increases the likelihood of standalone basis. Among the reasons for this are
future seniors depending on government benefits the income tax rules just discussed that require
because they depleted their own resources. minimum distributions from registered funds after
This Shadow Budget would launch a age 71 and a requirement that owners of permanent
consultation on two options: regular adjustments life insurance pay tax on returns above a specified
to keep the minimum withdrawals aligned with level, even when the insurance company has not
returns and longevity; or eliminating the mandatory paid them the money (Ezra 2018).
minimums. The new regime would be in place for This Shadow Budget would change the tax
the 2020 taxation year. rules to ensure, so long as RRIF minimum
withdrawals exist, that single-premium, standalone
Promoting Longevity Insurance deferred annuities are exempt from the drawdown
requirement. It would also relax current age limits
Increasing numbers of Canadians who have to make deferred annuities available later in life.
accumulated retirement wealth in capital And it would require tax to be paid when, and only
accumulation plans are nearing retirement or have when, the individual receives an annuity payment.
already retired. Many of them would benefit from16
The government would initiate consultations Rationalizing Tariffs and Sales Taxes on Small-
to encourage capital accumulation plans like DC Value Imports
pension plans to offer partial standalone longevity
The de minimis threshold (DMT) is the maximum
insurance for voluntary member purchase at
value of a product imported by mail or courier
retirement. It would also work with insurance
that is exempt from HST/GST or custom
regulators to ensure that solvency rules for
duties. Canada’s DMT is currently $20. The
standalone, single-premium longevity insurance
administrative costs and frictions at the border
contracts are adequate to protect both consumers
created by attempting to charge taxes and duties
and the industry.
on small shipments above the $20 level exceed the
value of the revenue collected. As well, the fixed
Broadening Access to Pension Credit and Income costs of dealing with these taxes and duties loom
Splitting particularly large for small- and medium-sized
The Pension Income Tax Credit and pension Canadian businesses using imported inputs, whose
income splitting are currently available to pension shipments tend to be smaller (McDaniel, Schropp
annuity recipients before age 65. However, and Latipov 2016). The CUSMA will raise the
recipients of funds from other retirement saving DMT that applies to shipments by private courier
vehicles, such as life-income funds, RRIFs and from the United States and Mexico to $40 with
RRSPs, can use the credit and split income only at respect to HST/GST and $150 for customs duties.
age 65. This Shadow Budget would make these tax This change will reduce some administrative
provisions available to all recipients of income from costs and border frictions. Extending this treatment
retirement saving. to cover imports from all trading partners would
Table 4 summarizes the fiscal impact of these reduce them further. This Shadow Budget would,
measures to improve opportunities for Canadians. therefore, apply the same DMT to all shipments
by private courier from abroad. Especially in
view of the accompanying proposed phase-out of
Foster ing Grow th
import tariffs (see below), the revenue impact of
The 2019 Shadow Budget puts forward measures this measure is negligible. Since imports near the
that would enhance Canada’s international lower limit produce most of the administrative
trade performance, rationalize and modernize costs and border frictions, the Shadow Budget also
infrastructure, and improve regulation in key announces the beginning of consultations with the
sectors. provinces and other stakeholders about raising the
threshold for HST/GST to match the threshold
Improving Canada’s International Trade for custom duties.
Performance
Simplifying International Trade for Small
Notwithstanding the conclusion of the Canada- Businesses
US-Mexico Agreement (CUSMA), protectionist
threats put countries with smaller internal markets Rules of Origin are a key component of any free-
at a disadvantage when businesses are considering trade agreement, because they determine which
where to produce. This Shadow Budget introduces goods and services qualify for lower or no customs
several initiatives to reduce friction at the border duties. But compliance can be onerous, and small and
and enhance Canada’s ability to expand domestic medium-sized firms – whose shipments will typically
production to serve markets at home and abroad. be smaller relative to the fixed costs of compliance –17 Commentary 531
often prefer to pay customs duties at Most Favoured 1 percent to Canadian GDP – a larger effect than
Nation (MFN) rates. Their decision to pay the MFN any preferential trade agreement available (Ciuriak
duties clearly indicates that these frictions raise the and Xiao 2014).
costs of those who do trade internationally and it is This Shadow Budget would phase out all
straightforward to infer that they reduce the gains remaining import tariffs. On its own, this reduction
from trade liberalization by deterring some firms would eventually reduce federal revenue by more
from trading internationally at all. than $5 billion annually. The offset in lower
Very small shipments – typically with values administrative costs and additional tax revenue from
of $1,000 or less – are exempt from these MFN a higher GDP, however, reduces the net fiscal cost
rules. An elegant way to mitigate the bias against to about $2 billion once the phase-out is complete.
smaller firms would be to calculate the exemption
not with respect to the value of the shipment, but A New Framework for Infrastructure
to the value of the MFN duty (Ciuriak 2015). Investment
This approach would be consistent with the
trend by customs agencies to move to risk-based Although infrastructure investment figured strongly
enforcement and would require minimal changes in the current federal government’s 2015 election
to the wording of existing free trade agreements. platform, follow-through has been disappointing.
Canada would seek to make this change in its The Parliamentary Budget Officer (PBO 2018b)
current trade agreements and add it to its objectives observed that about 60 percent of committed Phase
in negotiating new ones. 1 infrastructure money in the 2016 Fall Economic
This proposal has no fiscal implications over the Statement was not spent as planned by the end of
budget-planning horizon. 2017/18. Large greenfield projects require extensive
planning and assessment of their economic and
environmental benefits and costs, much of which
Eliminating Tariffs
occurs at the provincial and local level, and is
Import tariffs increase costs to Canadian consumers therefore out of the federal government’s control
and businesses. Since they vary by countries and – and the federal government’s prospective Impact
product, they distort purchasing decisions. When Assessment Act will add further delay and uncertainty
a Canadian buyer chooses a product from a to major projects. Moreover, many proposed
preferentially treated trade partner over a superior projects require coordination with other levels of
product affected by a tariff, Canadian businesses and government, a further obstacle to completion since
consumers suffer. Rankings of Canada’s openness they have their own responsibilities for use of funds,
to foreign products place us below counterparts to users of infrastructure and for environmental and
such as the Scandinavian countries, Germany and other impacts.
the UK (World Economic Forum, 2016 – pillar 6
Competitiveness index). Prioritizing Infrastructure under Federal Control
While lowering our tariffs through negotiations
that induce trading partners to lower their tariffs Accordingly, this Shadow Budget prioritizes
also has straightforward benefits, it takes time direct funding for projects that fall under federal
– and at the moment, the momentum of trade government control and can move relatively
liberalization is weak. Under these circumstances, quickly. This Shadow Budget would devote fresh
Canada can benefit from unilateral action. infrastructure spending to federal projects where the
Eliminating all import tariffs would add about national interest makes government involvementYou can also read
