IN SEARCH OF A DOMESTIC GROWTH STRATEGY
Last week the Governor of the Bank of Canada, Stephen Poloz, warned Canadians that they should get used to a low dollar, since this was a normal and, indeed, the necessary response to a global reduction in oil and commodity prices. The necessary adjustment in the economy from the resource sectors to the non-resource sectors could take at least five years, perhaps longer. Private sector forecasters are starting to recognize this. They are again cutting their growth forecasts for 2016 to below 2 percent.
This is not good news given that the economy has been operating below its potential for the last seven years. Business investment has been sluggish and has fallen as a share of GDP over this period; the long-term unemployment rate has risen and the labor force participation rate and employment rate have fallen. In these circumstances of sustained underinvestment and underemployment, potential output declines. This has been happening, not just in Canada, but also in most OECD countries.
For years, the IMF, OECD and the World Bank have reduced their forecasts of global economic growth. In a speech last September, the head of the IMF stated, “we see global growth that is disappointing and uneven. In addition, medium-term growth prospects have become weaker. The “new mediocre” of which I warned exactly a year ago – the risk of low growth for a long time – looms closer.”
In other words, the global economy is in a bad place going forward and that means the Canadian economy is in a bad place as well. If there was ever a time for a domestic based growth strategy, now is the time. We need a growth strategy that will sustain GDP growth in the short term and strengthen potential GDP growth in the medium term.
The government is committed to a major increase in infrastructure investment in the near term and details on this initiative are expected to be announced in the 2016 budget. Investment in efficient infrastructure has the benefit of not only supporting short-term demand, but also strengthening potential output.
But the government will need to start looking beyond its first budget in putting together a domestic based growth strategy. It will take time (and several budgets), careful planning and, most of all, political commitment by both the federal and provincial governments to put together a credible growth strategy.
An effective domestic led growth strategy will require actions across a wide range of policy areas. But there are two areas which if not addressed early could seriously weaken any growth strategy.
First, the federal and provincial governments need to start working immediately to create a free trade agreement among the provinces in Canada; an agreement that would allow greater mobility of capital, labor, and goods and services.
Such a provincial free trade agreement does not exist now. There has been lots of political“ support” from political leaders about the need to break down inter-provincial trade barriers. Some bilateral agreements have been negotiated but nothing significant on a Canada wide free trade agreement. The “support” has largely turned out to be empty political rhetoric. The federal government needs to devote just as much time negotiating an IPFTA (Inter Provincial Free Trade Agreement) as a TPP, or trade agreement with Europe, or even China.
The second area where work needs to begin immediately is the simplification and refocusing of the tax system. Canada needs a tax system (personal, corporate, and sales) that is efficient and promotes economic growth. The current tax system needs to be reformed and refocused.
The current personal and corporate tax systems have become overly complex and inefficient. The first income tax act, introduced in 1917 as the Income War Tax Act, had only 11 pages. Today, the Income Tax Act has 2800 pages including regulations and commentary. It needs to be simplified.
There have been few serious attempts at tax simplification and for good reason. They come with significant political risks, because it means eliminating special preferences for groups, individuals, industries, and sectors – preferences that can no longer be justified or were never justified in the first place.
A credible growth strategy will require comprehensive reform of the income tax system. The pay off of such a reform would be substantial in both financial and economic terms. A reasonable estimate would be annual savings of at least $5 billion. These “new” resources could be used to support tax changes that would strengthen economic growth and job creation.
The Liberal’s election platform promised to conduct a review of over $100 billion in tax expenditures. Details of this review are expected in the upcoming budget. This review would be a good start, but more needs to be done.
The current mix of taxes needs to be changed so that it better supports savings and investment. This means moving to a tax mix that depends less on income taxes and more on consumption taxes. A tax system that relies more on consumption taxes encourages savings since an individual will be taxed primarily on what is consumed not on what is earned. In that way, double taxation of income on savings is avoided.
In 2014-15 personal income taxes accounted for 48.1 percent of total revenues and corporate income taxes 14.0 percent. GST tax revenue accounted for 11.1 percent of total revenues. This mix needs to be changed.
Consider, for example, restoring the two-point cut in the GST implemented by the Conservative government in 2006 and 2007, against the advice of all economists. This would raise GST revenues by about $14 billion annually. This would increase total government revenues by less than 5 percent annually. This is not a large amount.
The government would then have several options on how to use this additional revenue. It could, for example, use the full amount to implement a major reduction in personal income (and corporate) taxes, thereby maintaining revenue neutrality. Or it could use some of the revenue to pay for government operating costs (not infrastructure investment), thereby reducing or even eliminating the “operating” deficit and the need for government borrowing.
The Prime Minister has said he would not rise the GST. This is truly unfortunate since this would seriously impede the implementation of an effective and credible growth strategy. The reality is that a tax mix that relies more on consumption taxes and less on income taxes would be more beneficial to low (with a higher GST rebate) and middle income Canadians, than the current tax mix, while strengthening savings, investment and economic growth. The size of the federal government would hardly increase at all.
The above policy areas will need to be part of any serious discussion of a credible domestic based growth strategy.