You Have to Make It First

During the past few weeks, federal politicians of all stripes have been busy making promises to Canadians in an effort to make sure everyone gets something. Unfortunately, the reality that the money to pay for these promises comes from a productive economy seems to have been completely lost. Little discussion has taken place about how to increase the productiveness of the Canadian economy and the incomes of Canadians, which produce the resources used to finance social programs. In order to pay for the promises made as well as the existing social programs that Canadians hold dear, the party that forms the next government will need to immediately and meaningfully address Canada’s productivity challenge.

Productivity, the ability of our economy to transform inputs like raw materials and labour into valuable goods and services, is admittedly a complicated matter. Recent polling data collected for the Federal Department of Finance showed that Canadians were not motivated by the term “productivity” and did not generally understand it or its implications. The lack of comprehension cannot, however, be an excuse for neglect. Canada requires leadership on this issue if we are to secure and even improve upon our current standard of living.

Economists across the political spectrum agree that Canada is facing a serious productivity problem. International rankings consistently show Canada amongst the lowest performers: Canada ranked 18th amongst 24 industrialized countries in terms of average labour productivity growth over the last ten years. Specifically, Canada’s average annual labour productivity growth of 1.5 percent between 1995 and 2004 was less than one-third that of Ireland, the top ranked country with average annual labour productivity growth of 4.7 percent.

A broad measure of living standards, namely the value of all goods and services produced in an economy on a per person basis (GDP per capita), reveals a marked decline between Canada and the United States over the last two decades. Canada’s GDP per person was 87.9 percent of the US’ value in 1985,but has since dropped to 84.7 percent in 2004. Narrower measures of living standards, such as average after-tax income per person have experienced sharper declines: 80.4 percent of that in the United States in 1985, dropping to 66.9 percent in 2004. In other words, our inability to transform inputs into outputs has meant a marked decline in our standard of living.

Given the impact that productivity has on incomes and living standards, it’s unfortunate that little has been proposed to address the problem. The Liberals have offered some small but nonetheless important measures like a 1-percentage point drop in the middle personal income tax rates and a 2-point reduction in the corporate income tax rate. Unfortunately, these measures do not take effect until 2008. The Conservatives have matched the Liberal’s business tax cuts and offered a reduction in capital gains taxes for those who reinvest the gains. While both plans offer important improvements, they are too little and/or too late.

In order to reverse current productivity trends, significant changes must be made immediately. In a study published last week, we recommended a $59.1 billion five-year provincial-federal plan for business tax relief aimed at spurring investment and productivity growth. The plan would significantly reduce business income tax rates and eliminate the corporate capital tax at both the federal and provincial levels. Doing so will reduce the level of taxes applied on capital investment and will substantially improve the incentives for both Canadians and foreigners to invest and develop businesses in Canada.

While promising more government spending and popular tax relief might be good politics during an election, the next federal government will soon have to face reality. If we do not improve our productivity, our current standard of living and our ability to fund social programs like public pensions and healthcare will be at risk. One reform must be to make our business tax system more competitive in order to ensure that Canada is more attractive to investors. Unfortunately, none of the proposals offered by any of the federal parties go nearly far enough.