It’s time for spending control and tax cuts

With Canada’s federal election just weeks away, the combination of the financial crisis in the US, volatile commodity prices, and troubled sectors such as manufacturing may yet make this an “economic issues” election. Unfortunately, economic uncertainty is often used as a platform for increased government spending and more activist economic policies. What Canada really needs to weather uncertain economic times is spending constraint and tax relief that improves Canada’s productivity and competitiveness.

The single most important priority for Canada’s next federal government should be to slow the rate of growth in spending. Sadly, Canadians can take little solace in the spending records of the two main political parties and past three federal governments (two Liberal and one Conservative).

Consider that federal program spending increased by an average of 5.0 per cent annually from the time the federal government balanced its books in 1997/98 to Prime Minister Chrétien’s departure in late 2003. Under Prime Minister Paul Martin’s tenure (2003/04 to 2005/06) federal program spending increased by an average of 7.1 per cent annually.

Worse still, since 2005/06 the Conservative government has increased program spending by an average of 7.2 per cent per year. This is well beyond the average annual rate of population plus inflation growth of 3.1 per cent – the goal proposed by the Conservatives during the last election.

Had any of these governments held spending in check, there would have been billions of dollars available for additional tax relief. The same holds true going forward, applying the spending brakes will create the fiscal room needed to provide incentive-improving tax relief.

The key to improving incentives for productive behaviour is reducing marginal tax rates. That is, the government must reduce the tax rate people and businesses face on the last dollar of income earned.

Of particular concern are Canada’s high marginal personal income tax rates on middle and upper income Canadians that apply at relatively low levels of income. For instance, Canada maintains among the highest marginal personal income tax rates on middle and upper income earners among the G7 countries.

In addition, Canada’s combined federal and provincial marginal personal income tax rates are materially higher than our closest competitor and neighbour the United States. Specifically, Canada’s top marginal personal income tax rate on income over $75,000 is 43 per cent compared to 31 per cent in the United States, and 46 per cent compared to 34 per cent for income over $150,000.

The new federal government should make it a priority to reduce the personal income tax burden on middle and upper income Canadians to harness the productive energies of skilled workers, business owners, and entrepreneurs across the country.

Canada also continues to maintain among the highest tax rates on investment in the industrialized world. While the Conservative government did enact some important business tax relief (i.e. the reduction in corporate income tax rates to 15 per cent over the next four years), significantly more needs to be done to decrease the tax burden on investment.

Specifically, the new government should further reduce the corporate income tax rate from 15 per cent to 11 per cent by 2012. The reason for the reduced target rate is to eliminate the difference between the small business tax rate (11 per cent in 2008) and the general corporate income tax rate. As a number of studies have shown, the enormous increase in the tax rate borne by businesses as they grow and develop results in a significant barrier to growth.

The new government should also allow investors and entrepreneurs to defer capital gains taxes if they reinvest the proceeds. Canadians continue to bear the damaging economic costs imposed by capital gains taxes including stifled entrepreneurship and the considerable barrier the tax creates for the movement of money to new businesses and growing industries.

Additionally, the federal government should facilitate the harmonization of provincial sales taxes with the GST in British Columbia, Saskatchewan, Manitoba, Ontario, and Prince Edward Island. Harmonization with the GST would exempt business inputs from provincial sales taxes and improve the incentives for business to invest in productivity enhancing machinery and equipment.

While economic uncertainty calls for increased prudence, it’s not an excuse for failing to cut taxes. With increased constraint on spending, there is ample fiscal room for tax relief. Reducing personal and corporate income tax rates and eliminating the capital gains tax would significantly improve Canada’s competitiveness. Most importantly, it would put Canada in better stead to weather uncertain economic times.