Cut spending; don't just slow its growth

With federal Finance Minister Jim Flaherty poised to unveil his 2014 budget on February 11th, early signs point to a business-as-usual budget with his government staying focused on eliminating the deficit in 2015 and creating the fiscal room to provide tax relief in next year's budget conveniently right before the 2015 federal election campaign.

But Flaherty could take a different approach and positively surprise Canadians. First, he could put the plan to eliminate the deficit on firmer ground. And second, he could announce a revenue-neutral tax reform plan that forms the basis of a bold, pro-growth policy agenda.

Let's start with the federal government's current plan to eliminate the deficit in 2015-16 which largely rests on strong revenue growth coming to fruition. Revenues for next year and 2015-16 are projected to grow by 4.6 per cent and 5.9 per cent. These rates far exceed actual revenue growth in the two previous years which came in at 3.0 per cent and 3.4 per cent, respectively.

In a still uncertain global economy it is a risky plan to rely on such robust revenue projections. Past forecasts have already and consistently been lowered.

A more prudent plan would use conservative revenue projections. Doing so would reduce the risk of further downgrades altering the government's timeline for eliminating the deficit which has shifted many times in recent years.

The government would also be wise to cut spending, rather than merely slow its growth. While the Conservatives have slowed spending growth since 2011-12, past stimulus spending has never been fully withdrawn. Program spending is currently $11.6 billion above the pre-stimulus trend level and it is still projected to increase to $259.4 billion in 2015-16 approximately $13 billion or 5.3 per cent higher than the latest actual number.

There are many areas where the government could cut spending without negatively impacting the government programs that Canadians rely on. Some low hanging fruit includes corporate welfare spending and subsidies to inefficient Crown corporations such as Via Rail.

Bringing government employee compensation more into line with private sector norms is another option. Government workers in Canada currently enjoy a 12 per cent average wage premium for comparable positions. This is on top of more generous pensions, an earlier average age of retirement, and greater job security.

Further action on the spending side would lower the risk that a revenue blip causes the government to deviate from its balanced budget timeline.

With more prudent revenue forecasts and lower program spending, the Conservatives would better position themselves for actually delivering on their commitment to balance the budget in advance of the 2015 election.

They previously 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 are that the government will enact these measures in next year's budget assuming it remains on track to eliminate the deficit.

But there is a better way and it does not require delay. Rather than proceed next year with tax relief measures that aren't broad-based, have little positive economic effect, and add complexity to the system, the government could use this year's budget to introduce fundamental personal tax reform.

That means broadening the tax base by eliminating tax credits, deductions, and other special preferences in exchange for lower marginal tax rates. This type of tax reform could be implemented in a revenue neutral way without affecting the government's budgetary position or its plan to return to balance.

And here's the real upside: fundamental tax reform would encourage productive activity like increased work effort, saving, investment, and entrepreneurship, and at the same time reduce the complexity of the system and the unproductive costs that Canadians spend on tax compliance.

With relatively weak economic growth expected for the foreseeable future, tax reform could provide a real economic boost and ultimately contribute to higher living standards for average Canadians.

Flaherty could defy conventional wisdom with a bold, pro-growth agenda including fundamental tax reform that positions the country well for long-term economic growth. This would be a welcome surprise.